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The underbanked are physical and legal persons who do not have appropriate access to mainstream (retail) banking/financial services and hence are exposed to providers of nonmainstream financial services (loan sharks, car title lenders, payday loan stores, rent-to-own stores, financial predators, etc.). The term underbanked and the associated term unbanked are predominantly used in the United States and are rarely found in finance and banking literature outside the United States. In the U.S. context, the banking and financial services offered by nonmainstream providers are referred to as alternative financial services (AFS). In the United States, the market for AFS amounted to $320 billion in 2009.
Although underbanking is usually associated with what is traditionally called economically nonviable individual customers, the underbanked can include small and medium enterprises, especially microenterprises that do not have a long and credible financial history and consequently may be categorized as being “too risky” and denied access to finance. Although the phenomenon was initially associated with developing countries, and especially with the least developed countries, the underbanked population can be found in both developing and developed countries. For instance, more than 15 percent of the population in the United Kingdom is considered to be underbanked or unbanked, while in the United States, one-third of the entire population is either unbanked or underbanked (more than 10 million households). The underbanked population are subjected to (partial) financial exclusion; however, in contrast to the nonbanked (who are not offered any banking or financial services), the underbanked are offered some banking and/or financial services. Underbanked (and underbanking) as a term appeared more frequently in the literature in the 1990s, when the broader term financial exclusion was coined. Underbanking as a phenomenon is, however, older, as access to finance and the lack of it were studied in the 1960s and especially in the 1970s.
Microfinance and microcredit organizations, community development banks and institutions, and mutual credit cooperatives have been, to a greater or lesser extent, community-driven responses to the challenges of underbanked and unbanked populations (both individuals and businesses). The reasons why someone is underbanked can be economic, political, geographical, cultural, social/societal, and/or gender induced. In the case of developed countries, economic criteria will quite often be predominant, with some influence of geographical barriers, while in the case of developing countries, cultural, gender, and political factors may contribute more to underbanking. Financial exclusion may affect individuals, households (families), entire communities, individual entrepreneurs, businesses, and, in some cases, regions.
The underbanked do have limited access to services, but they do not use them on a regular basis. For instance, an individual may have an open bank account, but he or she may, in fact, be using predominantly cash; hence, the account is seldom used or is dormant. Also, the person may be using nontraditional providers of financial services— check-cashing agents, pawnbrokers, and/or loan sharks (nonlicensed providers of financial services). As these providers do not report their activities, it is very difficult to assess the volume of operations and the size of that parallel industry. However, thanks to the phenomena of the unbanked and underbanked populations, primarily in the developing countries, the microfinance industry was born. With the establishment of the Grameen Bank in Bangladesh to support the economic enterprise of the disfranchised strata of the society, the international trend of microfinance organizations began. Microfinance organizations offer some banking and/or financial services to those who do not have access to mainstream banking services; they also provide, as a rule, technical assistance and better loan-monitoring programs, assisting the customer to deliver the projected results.
The underbanked can also be defined by the type of services they use occasionally, despite having access to it arranged. The underbanked do not have the right to access money transmission services (including, but not limited to, payment, cash, or debit and credit cards), insurance (especially home—building and contents—insurance), short-term credit, and long-term savings facilities. Quite often, access to short-term credit is crucial for the unbanked and underbanked populations. In the case of the poorer people in a society, short-term credit is needed for maintaining financial liquidity and is increasingly seen as part of societal/financial participation.
Financial exclusion can also be initiated as a result of access exclusion, condition exclusion, price exclusion, marketing exclusion, and self-exclusion. In the case of access exclusion, the potential customer may be prevented from enjoying the full range of banking/financial services due to the strict application of risk management policies of a financial services provider. Condition exclusion happens when some characteristics of a financial product make them inappropriate for some sections of society (e.g., offering classical financial products to the highly religious Muslim population, without even considering offering any Islamic banking alternative). In the case of price exclusion, the financial products are priced in a manner that, from the very outset, makes it clear that the potential target population cannot afford them. Marketing exclusion is triggered by an inappropriate marketing approach that alienates the target population. Self-exclusion is the most difficult to battle, as the potential customer self-limits himself or herself and refrains from using some financial products and services.
The underbanked population is usually represented by the unemployed, those unable to work due to ill health or disability, single parents, single retirees, and members of various minority groups (ethnic, gender, etc.). These groups are quite often described as vulnerable and/or marginalized. Financial education, specially targeted to reach them, can, in the medium to long run, improve the “bankability” of these groups and ensure that they participate in mainstream economic life. In the case of ethnic groups, in many countries, these communities are closed and very inward looking— hence the resistance to the use of mainstream banking and financial services. Ethnic minority communities are well known for developing alternative social support networks, which may also provide some kind of mutual economic support to their members. Research has suggested that growing up in an environment where banking/financial services have been used significantly increases the probability that as an adult the person will be using the banking/financial services offered by a mainstream banking/financial services provider. Financial education, as suggested, may contribute to better financial inclusion and the increased use of mainstream financial services by the marginalized population. AFS, in developed countries (most notably the United States), and microfinance, in developing countries, may alleviate the situation in the short run but would not necessarily address the major issues of financial exclusion.
The term underbanked can also be understood to refer to the situation in which an underwriter is unable to sell securities, usually due to the chronic lack of interested investors, and consequently the placement of securities fails. However, the main use of the term is the one described above.
- Beal, Diana and Deborah Ralston. Economic and Social Impacts of the Closure of the Only Bank Branch in Rural Communities. Toowoomba, Queensland, Australia: University of Southern Queensland, Centre for Australian Financial Institutions, 1997.
- Bradley, Christine, Susan Burhouse, Heather Gratton, and Rae Ann Miller. “Alternative Financial Services: A Primer.” FDIC Quarterly, v.3/1 (2009).
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