A Fundamental Mismatch

On Tuesday I learned that traipsing across the city was not the only way to learn about microfinance in NYC – another way to gain insight was to simply sit back in my desk chair and listen to the phone at my ear.

That morning I participated in a conference call hosted by the NYC Office of Financial Empowerment (OFE) that presented the results of a “Neighborhood Financial Services Study.” The study, launched by Mayor Bloomberg in December 2006, was the first local government initiative in the nation exclusively dedicated to the financial empowerment of low-income residents. The study explored the supply and demand of financial products and services in low-income communities. It specifically looked at banking, savings, credit, and financial education in Jamaica, Queens and Melrose, the Bronx.

To collect data, OFE partnered with two community-based organizations that administered 640 in-person surveys in English and Spanish to residents. It also worked with other organizations to conduct an initial supply-side analysis and to gather relevant community and city data. The two communities of Jamaica and Melrose were selected because of their statuses as low-income target communities – more than one-third of Jamaica residents and more than one-half of Melrose residents have incomes of less than $20,000 per year.

The findings of the study showed that:

• A fundamental mismatch exists between current financial product and service offerings and the needs of households in low-income communities.
• This mismatch plays a more prominent role than bank branch proximity in determining why residents remain “unbanked” and why fringe financial services are so widely used in these neighborhoods.

The following graph displays the responses that polled individuals gave as to why they were unbanked:

This chart displays another example of the imbalance that exists between products offered and the needs of residents of low-income communities.

As a result of the disparity between supply and demand in the formal financial sector, many Jamaica and Melrose residents have turned to fringe financial services. Forty-six percent of the respondents polled reported use of fringe credit sources – of this portion, 26% used refund anticipation loans, 21% frequented pawn shops, 14% took advantage of rent-to-own schemes, and 9% sought short-term loans. All of these services were used either in addition to, or instead of, formal financial services.

The use of fringe financial services is closely linked to financial instability. Respondents with fringe debt have more than twice the odds of experiencing financial instability – 40% of them could not pay rent in the last year.

So what’s to be done? What can policymakers and members of the formal and informal financial sectors do to rectify this fundamental mismatch between products and needs? What measures can be taken to improve the overall financial well-being of low-income individuals?

Well, one answer seems to be to render financial services more amenable to the wants and needs of low-income communities. The OFE study names several target groups and proposes corresponding products that could attract target members to mainstream banking. Among other things, these new products would include: starter accounts, enhanced checking, short-term loans and automated savings mechanisms.

The OFE study also reveals that financial education is strongly associated with positive financial behavior. While many (71%) of Jamaica and Melrose respondents had never received formal financial education, those who had attended workshops or classes about money demonstrated improved financial behavior. A higher percentage of financially educated individuals possessed a bank account, formal savings, and debt in the mainstream sector only, as compared to their financially uneducated neighbors. What I found to be most interesting, though, was that 68% of respondents who belonged to this first category had checked their credit score within the last month, as compared with 46% in the second category. Increased financial education leads to increased awareness and knowledge of financial matters, which in turn results in improved financial behavior.

Simply increasing the number of bank branches in a given area will not improve the financial lives of the unbanked and the partially banked. More fundamental measures that truly get at the heart of the problem must be taken. The gap between formal financial products and the needs of low-income individuals must be closed. Residents of low-income communities must be given the opportunity to learn correct financial behaviors through the availability of financial education. Only once these basic measures have been taken will the unbanked and partially banked residents of Jamaica, Melrose, and elsewhere be able to participate in the formal banking sector and hence achieve financial stability.