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

1. Four Themes

1 Four Themes The following chapters investigate in depth how pawnshops and CCOs function, who uses these institutions, and for what reasons. They also discuss the factors behind the recent rapid growth in fringe banking and examine the case for regulating pawnshops and CCOs. This initial chapter, however, steps back from the details and sets out the four major themes that emerge in the book. The first theme is that households without financial savings must often pay more than other households for basic financial services. This observation includes financial markets in a pattern that has long been recognized in markets for nonfinancial goods and services (see Caplovitz 1963). For example, people living in areas with high concentrations of low-income households must often patronize a small number of local retail outlets that charge more for their products and offer a more limited selection of products than do retail stores in middle- and upper-income areas (Andreasen 1975). Stores in low-income urban areas that sell consumer durables commonly offer less favorable credit terms or market their products through rental-purchase agreements that greatly increase the effective price of the goods. While there is 5 6 Fringe Banking little disagreement that retail prices are higher in low-income urban areas, there is much disagreement over why this is so. Community activists often charge that the retailers in low-income areas use local monopoly power to exploit their customers. The retailers respond that their costs are significantly higher than those of retailers in more affluent areas. Financial markets are no exception to the rule that the poor pay more. But the relevant measure of poverty in financial markets is not household income; rather, it is the household's ability to maintain financial savings.1 Although these two measures are closely related, they are not perfectly correlated. A family's ability to maintain savings depends on its income level as well as its structure , stability of income, special needs, and lifestyle choices. Families that do not maintain financial savings often have bad credit records or debt to income ratios that exclude them from mainstream sources of consumer credit. This is true for several reasons. Such families have no financial margin of safety; even temporary disruptions in family earnings or unforeseen expenditure needs can interfere with their ability to service outstanding debts. Families without financial savings are often headed by individuals with low incomes and low education levels who may experience periods of unemployment and drastic earnings fluctuations . Other families cannot maintain savings because of expensive special needs, such as major medical bills, and may be forced to accumulate substantial debts. Paying for necessary medical care can understandably claim a higher priority than servicing accumulated debts. Finally, households that do not maintain savings because of lifestyles that are expensive relative to their incomes are likely to be near the limit of their debt service capacity and may not have had the financial discipline or foresight to meet past debt service obligations. In addition to being cut off from major consumer credit sources, households without financial savings are often excluded from mainstream payment services. One must maintain a deposit account at a bank or similar institution to write a check. Similarly, banks generally cash checks drawn on other banks only for their 1In another context, Michael Sherraden (1991) discusses this distinction in detail in Assets and the Poor: A New American Welfare Policy. Four Themes 7 own depositors. Even those with deposit accounts must commonly wait for a check to clear through the banking system before withdrawing the cash if they do not maintain a sufficient balance in their account to cover the check. Since households without financial savings are often excluded from the credit and payment services of mainstream financial institutions , many must turn to pawnshops and CCOs to meet these needs. Fringe banks, however, are a costly alternative. Pawnshop credit is commonly ten to fifteen times more expensive than consumer loans from banks. The payment services of CCOs are four to six times as expensive as those of banks. Although local monopoly power may account for a part of these fees, this is not the major factor. Rather, fringe banking fees are high because the cost of providing the credit or payment service is high relative to the size of the transaction. The second theme that emerges in this study is that the 1980s boom in fringe banking and the increasing...