Consider this shopping horror story: You go to the supermarket to buy groceries, selecting your usual items. But when you arrive at the checkout line, the clerk asks for your annual income. Though the question seems rather intrusive, you tell her. As she begins scanning your purchases, you notice that each item has two price tags on it, one white and one red. The white tags reflect the regular prices, but the red ones are about 50% higher. As you watch the tally rise on the cash register screen, you’re annoyed to see that you’re being charged the inflated price. You complain to the clerk, and she informs you that it’s store policy: due to your low income, they have to charge you more.

Not only does this sound cruel, it seems counterintuitive – why charge more to the people least equipped to pay? And it’s something nobody would tolerate when purchasing most products or services. Yet when the product is money itself, this pricing double standard is a universal practice that’s widely accepted by consumers. For instance, credit cards currently charge around 15% interest to the average customer – but almost 23% to those with bad credit. Borrowers with poor credit can pay up to $63,000 more in interest on a $200,000 mortgage than those with better scores.

What’s more, banks don’t just charge additional money to low-income customers with credit products. In 2013, the Consumer Financial Protection Bureau (CFPB) found that fees for over-drafts and insufficient funds make up 61% of the revenue banks generate with consumer checking accounts – amounts that could total up to $32 billion a year. These fees average around $34 per overdraft, and are usually triggered by small transactions that are often less than the fees themselves. To make matters worse, when a customer makes multiple transactions during the same day, many banks deduct the largest amounts first, depleting accounts faster and leading to multiple fees for subsequent deductions. And poor customers tend to bear the brunt of these charges.

The CFPB is contemplating new rules for overdraft fees and related issues later this year. But though it can rein in abusive practices, regulation can’t solve the underlying issue that leads so many financial services providers to overcharge the poor. Because while greed can be a factor behind the inflated prices they charge, most providers are motivated by a more benign reality: it’s very difficult to provide affordable financial services to the poor in a sustainable manner.

Take checking accounts for example. Servicing these accounts claims a significant percentage of banks’ staff time, infrastructure (like ATMs), and other overhead expenses. According to the American Bankers Association, maintaining a checking account costs banks between $250 and $400 per year. Even so, the accounts can often be profitable, because the expenses are counterbalanced by earnings from interest and fees, and the accounts bring in new customers that may later buy higher-margin products, like mortgage loans. But this isn’t typically the case for low-income customers, who generally don’t open additional accounts or take out loans, and who tend to maintain a low average balance on the one account they have. This makes them likely to number among the roughly 40% of checking accounts estimated to be unprofitable. Among these account holders, only 23% have a savings account, and just 3% have a loan product – their total annual revenue contribution to the bank amounts to just $92. So it’s not surprising that banks have turned to overdraft and other fees to try to even the balance – especially in light of regulations that have cut further into their checking account revenue.

Apply this dynamic to other financial services, and factor in the high costs of maintaining brick-and-mortar branch networks, and it’s easy to see why banks have virtually abandoned many low-income neighborhoods in the U.S. It’s also easy to understand why banks rarely attempt to serve poor, often rural communities in the developing world, leaving approximately 2 billion unbanked. And it’s even a bit easier to justify some of the eye-popping interest rates charged by financial institutions that do venture into low-income communities, which regularly exceed 50% for microcredit, and are often much higher for payday loans.

But though the challenges of serving the poor have vexed the financial industry for many years, the facts on the ground are changing. In the U.S., around 70% of unbanked people now have a cell phone, and mobile access has grown explosively in emerging economies. Though many low-income people still use simpler feature phones, smartphone access in the developing world is also skyrocketing. And with80% of the world’s adults predicted to own a smartphone by 2020, it’s likely that most of the world’s poor will soon have access to the devices.

This new reality is transforming the way financial services are delivered. Rather than requiring expensive branch infrastructure, it’s now possible for banks to reach billions of previously excluded customers with low-cost mobile products. In Kenya, for instance, almost 67% of the country’s residents now have access to formal financial services – even in rural areas – largely due to mobile platforms like M-Pesa. And innovative companies are utilizing this new technology and access to reduce other common banking costs as well.

For instance, Lenddo is delivering small loans to borrowers in developing countries using information from their social networks to prove their identity and trustworthiness, cutting the costs of due diligence. Person-to-person lenders like Prosper are connecting lenders and borrowers via smartphones, eliminating the need for a bank intermediary altogether. At Meed, we leverage the power of smartphone access to make it easier for banks and low-income customers to afford each other. Its member banks offer consumers a debit account, domestic and international money transfers and an interest-bearing savings account that acts as collateral for a line of credit – all through an intuitive mobile interface. In addition, through SocialBoost™, its member banks agree to return 50% of the interest the credit lines generate to customers themselves, who get a share that’s determined by the number of new Meed users they invite into the platform. This not only provides a valuable revenue stream for customers, it helps reduce the cost of customer acquisition for banks, which is estimated at $300 to $400 per customer. It also allows banks to focus on their products and services, rather than spending time and money running their own mobile banking platforms.

Serving low-income customers will likely always present unique challenges to banks, but mobile-based services can go a long way toward leveling the playing field. And banks have only begun to tap the potential of mobile tools. If these trends continue, pricing double standards may one day seem just as incongruous in banking as they do in other industries.

 

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