What Is Underbanked?

August 24, 2024 4 min read Banking Finance Underbanked Financial Services Banking Access Economic Inequality Financial Inclusion

A comprehensive exploration of the underbanked individuals and families who have bank accounts but frequently rely on alternative financial services to manage their finances.

Underbanked: Understanding the Financially Underserved Population

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The term Underbanked refers to individuals or families who possess a bank account but predominantly depend on non-traditional or alternative financial services to manage their finances. These services include payday loans, check-cashing services, and money orders. Despite having a relationship with a mainstream financial institution, underbanked individuals often resort to alternative services due to various barriers such as fees, availability, and strict banking requirements. This demographic often faces financial instability and limited access to credit.

Types of Alternative Financial Services

Payday Loans

Payday loans are short-term, high-interest loans intended to cover immediate expenses until the borrower’s next payday. Due to their high fees and interest rates, these loans can lead to a cycle of debt for borrowers.

Check-Cashing Services

Check-cashing services allow individuals to cash checks without having a bank account. These services are characterized by their convenience but often charge hefty fees for their use.

Money Orders

A money order is a payment order for a pre-specified amount of money, often used as a secure method to send payments through the mail. Money orders are generally safer than checks but can be inconvenient and costly over time.

Special Considerations

Financial Barriers

Underbanked individuals might face several financial barriers including low income, lack of credit history, or distrust of financial institutions. These barriers often lead them to seek alternative financial services which tend to have higher fees and interest rates.

Geographic Barriers

In some cases, underbanked individuals live in areas with limited access to traditional banking facilities, known as “banking deserts.” These areas may lack physical bank branches and ATMs, pushing residents towards alternative financial services.

Examples of Underbanked Situations

Low-Income Families: Frequently face challenges in meeting minimum balance requirements and are charged higher fees by traditional banks, leading them to use more accessible but expensive alternative services.
Immigrant Communities: May experience language barriers or a lack of necessary documentation to open traditional bank accounts, making alternative financial services more practical for their immediate needs.
Rural Residents: Living in areas without sufficient banking infrastructure, rural residents might find it more difficult to perform banking tasks without incurring significant travel costs.

Historical Context

The concept of the underbanked has evolved over time, paralleling the development of financial services. In the early 20th century, many Americans relied on community-based financial support systems. With the rise of modern banking, the accessibility gap widened, creating a subset of the population that either could not or chose not to fully engage with traditional banking systems. The advent of alternative financial services provided a much-needed solution, albeit at higher costs, for those left out by mainstream banking.

Applicability

Economic Impact

Studies have shown that underbanked individuals contribute to the economy by engaging in various financial activities. However, their reliance on costly alternatives often minimizes their disposable income, affecting their overall purchasing power and financial health.

Financial Inclusion Efforts

Efforts to bring the underbanked population into the traditional financial system—termed “financial inclusion”—are multifaceted. These include regulatory changes, financial literacy programs, and technological innovations like mobile banking, which aim to offer affordable banking solutions to underserved populations.

Unbanked

The Unbanked are individuals who do not have a bank account at all. This contrasts with the underbanked who have bank accounts but still rely on alternative services.

Fully Banked

Fully Banked individuals primarily use traditional banking services exclusively and have little to no reliance on alternative financial services. They generally have better access to financial products, lower fees, and better credit opportunities.

Financial Exclusion: The lack of access to useful and affordable financial products and services.
Banking Deserts: Areas with limited access to banking facilities.
Financial Inclusivity: Efforts to include more people in the mainstream financial system.

FAQs

Why do people become underbanked?

People may become underbanked due to factors such as high banking fees, lack of trust in financial institutions, limited access to banking facilities, low income, or previous negative banking experiences.

How can the situation of underbanked individuals be improved?

Improving the situation involves regulatory reforms, increasing financial literacy, expanding access to affordable banking options, and leveraging technology to offer innovative financial solutions.

Is being underbanked a choice or circumstance?

While some people may choose to use alternative financial services, many are underbanked due to circumstances beyond their control, such as financial barriers, geographic limitations, or systemic inequalities.

References

Summary

The concept of being underbanked highlights the financial challenges faced by those who, despite having bank accounts, rely heavily on alternative financial services due to various barriers. By understanding the factors contributing to this situation, efforts can be made to integrate underbanked individuals into the traditional banking system, thereby promoting greater financial inclusion and stability.