Can digital currencies and blockchain technology pave the way for more low-income people to join the banking system?
Before we can start to answer that question, an analysis of the costs that banks incur in maintaining low-income accounts is needed.
Bank accounts are expensive to maintain, costing banks on average $349 a year per account, according to the American Bankers Association. Banks make up for these costs by 1) charging cardholders fees for activities such as ATM access, wire transfers, insufficient funds, etc. 2) charging merchants whenever account holders use their debit cards to buy things 3) lending out the float of funds that accumulate in customers’ checking accounts 4) selling other products to checking-account holders, such as credit cards, mortgages, retirement accounts,etc. On their own, checking accounts are a loss-making venture, but they end up subsidizing other, more profitable ventures. Checking accounts are the foundation on which banking relationships are built. The problem is the lower a customer’s income, the less opportunities there are for banks to derive additional income from the relationship. Even as it is now, according to the ABA, banks lose money from nearly half of all accounts they maintain — when measured solely on revenue earned directly from account servicing fees and debit card transactions. Lower-income account holders, make up the bulk of the loss-making customers, because they don’t spend enough money for banks to break even on stand alone checking accounts, and because they do not buy other banking products.
This analysis highlights a powerful factor behind the widespread problem of financial exclusion: banks lose too much money servicing low-income people’s accounts to make them worthwhile as a market. In fact, an argument could be made that banks are pricing their products deliberately to keep these customers out. For example, as of June 2017, Chase charges a $12 monthly maintenance fee, (in additional to numerous other transactional fees) and offers to waive the fee for customers meeting certain criteria that are difficult to meet by low-income customers. The challenge: how to get the cost of servicing the poor down so that they offer a more profitable opportunity.
Prepaid card providers have stepped in to fill the void left by banks at the low end of the income spectrum. Yes, prepaid cards are not perfect, and are a bit pricey, yet the largest prepaid card providers such as Green Dot were able to create a successful business by offering cards to folks living on minimum wage (Green Dot’s customers load on average less than $500/month). The solution was to avoid physical dedicated bank branches, to deploy new technologies, and overall to be very lean from an operational perspective. This got their costs down to $149 a year, according to my calculations — low by comparison to banks, but still too high to make a meaningful dent into the number of underbanked. And if we drill down further into this number, we find that about $37 a year is spent on distribution and advertising (getting people to use the cards) while $112 a year goes on actually servicing the accounts.
So where would blockchain technology help? Well, there are two interesting avenues:
- The first is a back-office solution. By adopting blockchains — or even just the more basic distributed-ledger models now being explored by financial institutions — to handle existing operations, banks could significantly reduce account-servicing costs. The transparency and traceability advantages of this technology could lower costs in various ways. It could reduce costs of compliance, given that currently banks employ armies of compliance officers and are forced to answer to audits from dozens of regulatory agencies. It offers the prospect of instant movement and settlement of funds, which is a material working capital improvement for merchants who currently face two-day waiting periods for every payment. In the realm of customer service costs, reducing fraud lowers the number of incoming calls, and improved auditability make it easier for banks to answer customers’ questions faster. Combining these savings with others they would generate by adopting the lean models proposed by prepaid providers, I believe banks could reduce their operating costs to less than $100 a year.
- A more radical but potentially more effective way to boost financial inclusion would be to build an entirely blockchain-centric bank. This would require banks to go beyond just back-office solutions and incorporate this technology as well into its customer-facing operations. A bank could, for example, facilitate cryptocurrency transactions, by acting as an intermediary within bitcoin transactions to reduce volatility. This bank, (think of a it as a more evolved version of the wallet and payment processor Coinbase that happens to have a banking license) could propose a more seamless movement between fiat currency and any cryptocurrency. Specifically by tapping the efficient payments functionality proposed by the Lightning Network, a blockchain-centric bank could facilitate instantaneous movements of funds to merchants. Additionally, by eliminating plastic and letting their customers transact exclusively through mobile phones, banks could vastly reduce distribution costs, fraud and customer-service costs. On that basis, it’s quite possible that an account could be maintained for less than $50 a year. This would make it much easier for banks to recoup costs on checking accounts via revenue sources other than cardholder fees. To be sure, this would be a dramatic shift for banks. In effect, they’d have to make peace with cryptocurrencies such as bitcoin, which is currently seen as antithetical to the banking model. Unless regulations were to change, pseudonymous transaction model proposed by Bitcoin would have to be supplemented by KYC/AML procedures that banks know all too well, but all of this is possible.
Until recently, banks were viewed as the only answer to getting the 2 billion “unbanked” individuals into the world’s financial system. To engage in non-cash transactions, you needed a bank account. Period. In a world where the commerce is getting away from face-to-face transactions and increasingly happens in an online setting, the failure to achieve that has had greater impact. Consumers increasingly need a way to transact electronically. Meanwhile, the advent of bitcoin proposed an alternative solution: it raised the prospect of electronic transactions without a bank, such that many now see banks more as the problem than the solution. At the same time, as electronic payment methods develop, Internet giants such as Amazon, Alibaba and Google will look to provide services that will either complement, or outright compete with banks. The low-income, financially excluded customers stand to benefit from this competition. They may finally become a sought-after market, so much so that banks themselves may need to go after them as well. In doing so, banks may find that bitcoin and its core blockchain technology functioning as much as a solution for them as for the low-income customers they have long shunned.