This week on Handful, I explored the role of financial exclusion in exacerbating poverty in the US– and how financial inclusion can play a role in alleviating poverty. Listen to this week’s episodes below or keep reading to learn about financial inclusion!
What is financial inclusion?
Most broadly, financial inclusion means access to and the ability to use financial services. While many of us take access to credit and having a bank account for granted, about 2.5 billion people around the world are “financial nomads,” meaning that they don’t have access to these basic financial services. These people are often also referred to as “unbanked” because they often aren’t served by traditional banks and other financial institutions.
This might be because there isn’t a bank near where they live. Beyond physical proximity to banks, many in the world are unbanked because they don’t have the proper identification, such as an ID card, to start a bank account and to access financial services. Banks have “Know Your Customer” or KYC policies requiring that they verify the identity of new customers. If a potential customer doesn’t have the proper identification, such as an ID card or birth certificate, they aren’t able to fulfill those KYC requirements, can’t get a bank account and ultimately remain outside the financial system. Without access to the financial system, one can’t get a loan or put money into a savings account.
The limits of cash
In the past decade, credit and debit card usage has grown significantly in the US, and it isn’t slowing down. Digital financial technology makes our lives a lot easier. But for those without access to digital financial services, the alternative comes with significant burdens.
Imagine paying your rent or receiving a paycheck if you don’t have a bank account. To pay rent, you would have to use cash. To receive a paycheck, you might have to go to a bank to cash your paycheck. Financial transactions such as paying rent or a phone bill are much more costly and time-consuming without access to credit and an insured financial institution. Extra fees and costs just to be able to use your money can amount to up to $500 for those who can’t afford mainstream financial services.
The pandemic has exacerbated these difficulties, with many banks offering fewer in-person services. While the economic impact of state-mandated shutdowns is likely hitting the unbanked, who have an average annual income of $18,203, most hard, the pandemic may also be further excluding these individuals from the economy. Without access to credit, the unbanked cannot purchase essentials through Amazon or have their groceries delivered. If their local grocer or pharmacist no longer accepts cash, these individuals must find another way to pay or shop elsewhere. This makes daily life outside the financial mainstream even more burdensome.
Cash is often the best option for the unbanked, but it presents a host of challenges and costs in an increasingly digital economy.
Why credit is so valuable
While cash is difficult if not impossible to use for many large purchases, credit can be incredibly convenient to use.
However, credit is out of reach for many people. According to the Consumer Financial Protection Bureau, 20% of Americans cannot have their credit score generated because of their limited credit history. These people are referred to as credit invisibles, because they are invisible to the credit reporting industry. Blacks and hispanics are more likely to be credit invisible in the US. Individuals from low and middle income neighborhoods are more likely to transition out of credit invisibility at later ages or to be unscorable, meaning that they have too short or outdated credit histories to receive credit.
Credit invisibility is a double-edged sword– individuals have difficulty accessing credit without a credit history, but they can’t build a credit history without credit.
Without a credit score and history, consumers have trouble getting a loan, a mortgage, or otherwise making large purchases. According to a report from the US Congressional Research Service, financial inclusion is important for financial well-being, and certain segments of the population face greater barriers to building credit. For example, immigrants may lack the proper identification to open a bank account or use other financial services, and credit history from another country will not transfer to the US.
How financial inclusion transforms the lives of the unbanked
Financial services, especially digital financial services, make everyday transactions and larger purchases incredibly easy to complete. Without a bank account, you can’t make direct deposits, which makes paying rent and receiving your paycheck difficult or impossible. Having a credit card and good credit allows you to make small, daily purchases in seconds
Access to financial services makes many of our lives easier. But for the 2.5 billion people in the world who live and operate outside of the financial system, the lack of access to financial services like a bank account makes escaping poverty much more difficult. Basic financial tools like a place to save money, insurance and access to credit make it more feasible for individuals and entrepreneurs to develop financial stability and ultimately escape poverty.
Financial services are an important tool for inclusive development.
The impact of financial inclusion isn’t always direct. Simply having a bank account or a credit card doesn’t mean that one has money in that account, or that they have credit to make larger purchases. But financial inclusion can have a multitude of indirect impacts.
For example, with access to financial services, those experiencing poverty are able to pay for services like electricity and energy. PAYGo is a micro-payment service that gives its users access to clean and affordable fuel. Households that use PAYGo use more light, which can increase safety and security. Using clean fuel could lead to fewer health problems. The secondary impacts of access to this financial service go on, and this service could be extended to other utilities and services. In this way, financial services are an important tool for inclusive development.
Steps towards financial inclusion in the US
Kiva is a nonprofit based in the US that crowdfunds microloans for entrepreneurs around the world. Microloans are just what you think they are– very small loans. Through Kiva, anyone can loan as little as $25 to a small business or entrepreneur. While Kiva has traditionally loaned to individuals and businesses in developing countries, you can also support entrepreneurs in the US through the platform.
Kiva is a great way for entrepreneurs and businesses to get the funds that they need without credit or traditional financial services. But how can individuals in the US who aren’t starting a business enter the financial system?
Innovations in financial technology, or fintech, provide one way forward. For example, mobile banking or financial services available via cell phones can make these services more accessible. These digital products can lower the cost to provide banking services to the unbanked. For individuals who don’t have a credit history, lenders might use alternative data to determine their default risk. For example, a lender or financial institution might assess a consumer’s education or employment, and can expand access to credit in that way. Fintech lending of this kind is a small part of the overall consumer financial market, but it’s rapidly expanding.
In a few weeks, I’ll be further exploring what financial inclusion can look like in the US and globally.
Learn more about financial inclusion.
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