Fringe Banking: Check-Cashing Outlets, Pawnshops, and the Poor

Why Study Fringe Banks?

Why Study Fringe Banks? The United States financial system is undergoing a transformation . Many of the changes-the erosion of regulatory barriers between banks and securities firms or the rise in interstate banking -have been widely noted and discussed. But one important development has crept in, almost completely unobserved-a rapid, nationwide expansion in the number of pawnshops and commercial check-cashing outlets. These so-called fringe banks provide credit and payment services primarily to low- and moderate-income households, many of which rarely interact with the formal banking system. Despite the sparse attention that fringe banks receive, they are a significant part of the financial system, providing financial services to millions of households. In fact, although the popular notion is that pawnshops are a relic of the nineteenth century, pawnbroking has grown rapidly over the 1980s. There are more pawnshops today, both in absolute numbers and on a per capita basis, than at any time in United States history. Similarly, checkcashing outlets (CCOs), which charge a fee to cash customers' checks (mainly paychecks or government support checks), sell money orders, and make wire transfers, existed in only a handful 1 2 Fi inge Banking of urban areas prior to the mid-1970s. Over the 1980s, however, the industry expanded rapidly, and now there are large numbers of CCOs in cities throughout the country. In addition to its booming growth in the past decade, the fringe banking industry has become increasingly sophisticated as large national chains have replaced independently owned and operated stores. Pawnshops and CCOs have also spread beyond their traditional concentration in low-income urban areas into lower-middleclass suburban communities. This rapid expansion in pawnshops and check-cashing outlets is particularly striking in view of their relatively high fees. Pawnshops commonly charge annualized interest rates of 200-250 percent for small, secured loans. And CCOs generally charge l.5-2.5 percent of the face value of the customer's paycheck. A worker with an annual take-home pay of $12,000 can spend $250 a year just to convert his paychecks into cash. Given these comparatively high fees, fringe banks thrive by serving customers who are excluded from mainstream financial institutions and by differentiating their services from those of banks.1 Pawnshops provide small, fast loans primarily to customers with bad credit histories, low incomes, high debt-to-income ratios, or unstable employment patterns -characteristics that exclude them from unsecured loans. Check-cashing outlets mainly serve customers who value their convenient locations, hours, and speed; who do not have bank accounts; or who have insufficient funds in their accounts to permit them to cash their paychecks. This book is the first extended study of the roles that fringe banks play in the financial system. The motivations for the study are threefold. First, since pawnshops and check-cashing outlets are the primary financial institutions for millions of households, a knowledge of their operations is essential to a comprehensive understanding of the financial system. Second, fringe banks are a rapidly growing component of the financial system, which raises intriguing questions about the factors driving this growth. Third, pawnshops and CCOs deliver financial services primarily to lowand moderate-income households. Consequently, social concerns IThe term "bank" is generically used to include commercial banks, savings banks, and savings and loans. When it does not have this meaning, I explicitly indicate that it is to be understood in a more restricted sense. Why Study Fringe Banks? 3 about the economic situation and constraints facing these households make fringe banks a natural focus of study. Because of my background in financial economics, this study of fringe banks emphasizes the economics of the institutions themselves, rather than that of their customers. Nevertheless, it is impossible to consider fringe banking without inquiring into consumer behavior and crossing numerous boundaries in academic disCiplines. One is forced, for example, to address issues in financial economics, regulation and industrial organization, the economics of poverty, sociology, and psychology. This should be evident from the topics that are the primary focus of the study: explaining the services that pawnshops and check-cashing outlets provide and the fees they charge for these services; describing who uses pawnshops and check-cashing outlets and why they choose to do so; examining the factors responsible for the fringe banking boom of the 1980s; and investigating how fringe banks are, and should be, regulated. In studying pawnshops and check-cashing outlets, this...