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The High Cost of Being Unbanked
Data from Mexico, Colombia and Brazil shows urban poor
pay large portions of income for basic financial services
By
Tova Solo, LCSFU
Micro-economists
and students of socio-economic data often refer to a “vicious
circle” of poverty, reflecting the way the poor tend to pay more
for basic services, (water, sanitation, etc.), for basic needs
(shopping piecemeal in poor neighborhoods is more costly than
buying in bulk supermarkets) and for transportation or in travel
time (low-income neighborhoods tend to be located far from the
work, schools and markets). New data is showing how the poor also
pay more for financial services. These costs can cut significantly
into already meager earnings, since the “unbanked” as a group
overlap with low-income groups, adding to the difficulties of
escaping from the vicious circle and moving towards upward
mobility.
Data gathered during the past four years in
Mexico, Colombia and Brazil suggests that in these countries
somewhere between 65 and 85% of urban households do not hold any
kind of deposit account in any formal financial institution.1
The
macro-economic implications of the large number of unbanked have
been analyzed in terms of overall financial sector development and
its links to economic growth, to income distribution and to
poverty alleviation.2 On a
micro-economic level, however, less work has been done. The data
from Mexico and Colombia begins to shed important light on the
flip side of the macro-economic studies, showing how the
underdeveloped financial sector – translated into a lack of
financial services at the household level – can limit economic
growth and poverty alleviation, by significantly increasing costs
to families who already tend to be in the lower income brackets.
The data show how the poor and unbanked pay more to get paid, to
make payments, to save, and to borrow, than their compatriots who
have bank accounts.
Costs of making payments.
Officials at the Central Bank of Mexico report that cash
transactions cost up to five times more than payments by check,
which, in turn, cost up to fifteen times more than electronic
payments. For urban families in Mexico City and Bogota who have no
bank accounts, paying monthly bills by cash– for water,
electricity, sanitation, telephone, and for schools – means a
trip downtown with a wad of bills. It’s worrisome (pickpockets
and muggers abound), costly in terms of transportation, and costly
in terms of time too. In Mexico City 70% of those surveyed
reported that there are no service payment offices within 20
blocks of their homes or places of work. Over half claimed
travel time of over two hours to make payments for water,
electricity, telephone, gas and urban services. That’s ten
hours each month, not counting the fact, relayed by focus group
participants, that the lines in each office are two to three hours
long.
Focus
group participants seem resigned. “If it’s not raining, I have
a good time in line. I catch up with friends from other parts of
the city.” And it beats the alternative, since paying directly
at a commercial bank costs US$3.50 for non-account holders. In
Colombia the commercial banks will receive payments from
non-account holders without charge, but they provide only one
teller for a limited number of hours per week.
In
the United States, check cashing outlets (“CCO’s”) and pawn
shops usually offer bill payment services. For a fee, they write
checks for families who have no bank accounts and cannot do so
themselves. John Caskey, of Swarthmore College, estimates that
unbanked families in the US pay an average of US$450 annually for
bill payment services.3
Costs of getting paid.
Even though fewer than 75% of those surveyed in Mexico City have
deposit accounts, a full 85% of the unbanked report getting
payments by check. Another 6.3% get paid through deposits to a
third party’s account. Turning a paycheck or deposit into usable
cash is costly for persons without bank accounts. Most of those
interviewed reported that they make the trip to the bank which
issued the check. (Financial institutions will not cash checks
drawn on other banks for non-account holders.) The bi-weekly trip
to the bank is costly again in terms of time and travel. Banking
hours and locations are not convenient to low-income earners. (The
trio of Bank studies also shows that banks tend to locate in
better-off neighborhoods.) About a third of the unbanked reported
changing checks in commercial stores (in return for purchases) or
at money changers (cajas de cambio) for a fee. As in the
United States, check cashing services charge between 5% and 10%,
which amounts to a direct tax on the income of many poor.
Costs of savings. Deposit accounts, even without interest, figured as
the “most wanted” financial product among the unbanked in
Colombia, Mexico and in Brazil. Although it may be that families
realize that a deposit account would also allow them to lower
greatly the costs of service payments and check cashing, deposit
accounts also help them to save, and about half of the unbanked
report holding liquid savings.4
But saving outside of a formal system can represent
opportunity costs, as well as insecurity. Savings options reported
by the unbanked were, in order of popularity: cash under the
proverbial mattress; informal savings clubs (“tandas” in
Mexico, “cadenas de ahorro” in Colombia);
savings clubs in commercial stores, like “lay- away
plans” linked to specific items; and loans, interest bearing or
interest-free, to relatives and friends. In Mexico and Colombia,
where the nominal interest rate on passive deposits is on the
order of 8% per annum, saving in any of these informal systems
represents a loss of value relative to formal deposits, and a
potential loss from robbery or non payment
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Costs
of sending and receiving money. About 5% of those surveyed in both Bogota and Mexico City
reported receiving income from remittances.
Slightly more than half of the
remittances were national, while the remainder were international.
While the number and percentage of persons affected is low, costs
of a remittance for an unbanked person are significant.
Information from the focus groups in Mexico and tests by the
authors of the Bank’s study found that sending US$100 by wire
through a bank costs US$19 for the transfer if the recipient does
not have a bank account. If the sender and recipient both have
accounts in the same bank, however, the transfer may only cost as
much as the recipient must pay in ATM fees to withdraw it.
Costs of borrowing.
About a third of those surveyed in both countries reported
taking out a loan of some kind in the past three years. But costs
differ enormously depending on the source of the loan. Currently
the interest rates on bank loans are capped at around 17% in
Mexico and Colombia, but credit card charges can reach 36% and 40%
per year. On the other hand, loans from commercial stores, money
lenders and pawn shops, where the unbanked commonly borrow, start
at 10% per month and reportedly reach up to 35% per month (150% to
over 400% per year). It should not be surprising that respondents
from both Mexico City and Bogota report their preferred source of
loans to be friends and relatives, the actual source in about a
third of cases.
Summing
up, it’s expensive not to have a bank account. For those who are
starting up or managing informal businesses, having to rely on
informal financial systems can cost up to 15% of their income for
families in Mexico City and up to 20% in Bogota, Colombia.
Granted, this group represents only about a quarter of the
unbanked population, but that’s close to 20% of the overall
population. For the
have
to spend up to 10% of their income merely to cash in their
paychecks. Ironically, for the families who take steps to break
out of poverty by starting up a business, investing in education
or in a home, or attempting to develop liquid savings, reliance on
financial services increases. But if unbanked, they must pay a
higher cost for savings, credit and payments services.
Thus costs of financial services can cut deeper into the
incomes of families trying to get on the path to upward economic
mobility.
The difficulties of breaking out of
the “poverty cycle” have been widely studied along with the
high costs of being poor. With new data on the unbanked we can now
begin to understand how financial services figure among those
costs, and how the poor can benefit from access to formal
financial institutions.
1 Information from Colombia and Mexico is based on statistically
representative surveys of the capital cities (Bogota and Mexico
D.F.). Percentages of unbanked would probably increase if the
survey included other cities, where the ratio of banks to
population is markedly lower, and would increase still more if
extended to rural areas. The results of these surveys are
presented in: Brazil: Access to Financial Services, Report
No. 27773-BR, The World Bank, Washington, 2004; and Caskey, Ruiz
and Solo, “The Unbanked
in Mexico and the United States”, World Bank Savings
Institution, Brussels, 2004; and Broadening Access to Financial
Services Among Mexico City’s Unbanked and
Access to Financial Services in Colombia,
forthcoming, The World Bank.
2
Beck, Demirguc-Kunt and Levine, “Finance,
Inequality and Poverty: Cross-Country Evidence"
Oct. 2004. http://www.worldbank.org/research/bios/TBeck.htm
3
Selected readings on the unbanked by John P. Caskey include
“Reaching Out to the Unbanked”
(chapter in book, Inclusion
in Asset Building: Research and Policy, edited by Lisa Morris
and Michael Sherraden); Lower Income American, Higher Cost Financial Services (Madison, WI:
Filene Research Institute) 1997; “Beyond Cash and Carry:
Financial Savings, Financial Services, and Low-Income Households
in Two Communities”, a report for the Consumer Federation of
America, December, 1997; “Who Has a Bank Account and Who Doesn’t; 1977 and 1989”,
Research Working Paper, Research Division Federal Reserve Bank of
Kansas City, 1993; “Bank Representation in Low-Income and
Minority Urban Communities”, Research Working Paper, Research
Division Federal Reserve Bank of Kansas City, Kansas City, 1992;
and, Fringe Banking, The Russell Sage Foundation,
New York, 1994
4
65% own
their homes, revealing a capacity and habit of savings in
non-liquid form.
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