THE SPEAKER was passionate. “You bankers need to understand our culture is not like your culture. In our community, we don’t expect bills to be paid on time. If you’re really interested in serving our community, you need to adjust your expectations and not be asking us to change our culture in order to qualify for your loans.”
Wow, did I get an education some years ago, when my bank attempted to reach out to the town’s minority community. We were prepared to discuss credit scores and the importance of a good track record of paying bills on time. Instead, we walked away thinking we may have done more damage than good. Clearly, the community’s view of our industry didn’t match our own view.
In our defense, our intention to serve every segment of our community, including low income areas, was honorable. But we ran into a wide cultural divide we were ill-equipped to handle.
But as a young community bank chief executive, I was idealistic and not easily discouraged. I was intent on finding a way to serve everyone. We had purchased a wealth management company to cater to our well-heeled customers. The bank itself was well-positioned to serve most of the financial needs of the middle class. But I wanted a way to reach the unbanked. That desire, however noble, set me up for an embarrassing failure.
Freedom Loans—not its real name—sat in the middle of our Midwestern town. The most remarkable feature was a big ugly green sign in front of the tiny store. The sign would come alive at night and blink its bright neon lights spelling out the word, “LOANS…LOANS…LOANS.” It wasn’t subtle marketing—and hardly the image a preeminent bank in town would want to project.
The owner of Freedom Loans—let’s call him Tex—wanted to sell the business. “Perfect,” I thought. We’ll buy Tex’s company and this will be our way to learn how to serve the unbanked in our community, plus I hoped to teach Freedom’s customers how to improve their credit standing and to encourage them to favor the lower-cost loans available from my community bank. And, boy, did I learn a lot. Here are the highlights:
1. The poor don’t pay on time and don’t care about late fees. One of my first conversations with Tex was on his need to bring down his “past due” ratios. My bank kept past dues below 1%, while Tex was around 20%. He just looked at me and shook his head, saying, “You don’t understand what we do at all, do you? We love past due loans. That’s how we build up our late fee income. And nobody ever complains.” As I found out, he was right.
2. The poor don’t care what interest rate they pay. Tex charged an average 28% interest on loans. Tex taught me the poor don’t care about the rate. Only the payment schedule mattered to them.
3. The poor will pay almost anything to maintain one reliable line of credit. Tex gave me an education into the mind of the unbanked. They don’t care about interest rates. They don’t care about late fees. They don’t care about any other debts they were running past due. But they did care about keeping Tex happy, because he was their emergency fund. Tex would always advance them a new loan when needed if they would continue to pay him something from time to time. You could say Tex was a friendly loan shark.
4. It’s hard to find ethical lenders who share Tex’s view of customers. After the sale of the business, Tex only wanted to stay on for a short transition period. We hired a young man to train under Tex, with the intention of making him the new president when Tex retired. This trainee, however, never bought into Tex’s exploitation philosophy. He quit and went to work for a church, where he found more compatible values.
5. The poor suffer from fear and shame. Freedom Loans had a hidden parking lot in the back, which allowed customers to enter without being seen. Tex explained to me that this private rear entrance was a key to business success. The poor will almost never enter a traditional bank lobby, because they don’t feel they belong there. But they also want to hide their poverty from others, which would be revealed if they were seen entering a high-interest loan shop.
The Freedom Loans experiment fairly quickly ended in failure. Our bank’s values were incompatible with the idea of charging exorbitant interest and fees, especially to the poorest among us. Freedom Loans never made any money. The lack of profitability was probably because no one in my company could buy into the Freedom Loans philosophy.
But the failure motivated me to look elsewhere for ideas on how to help the poor. Over time, I’ve found some answers that work much better than my poorly conceived idea to buy Freedom Loans.
Warren Buffett’s partner, Charlie Munger, has a saying: “Invert, always invert.” In other words, turn a problem upside down and look at it backwards. Here are two ideas that appear to be effective in raising the poor out of their mindset of poverty.
Investment clubs. Over time, I became friends with a number of pastors in the minority community. They had formed an investment club that regularly met to pool members’ money and make investment decisions. These wise pastors knew that one path out of poverty was to teach their members to think more like owners and less like debtors. I think the club was successful because the effort came from within the minority community.
Peer micro lending and savings groups. Similar to investment clubs, savings groups have proven successful in developing countries. These savings groups encourage capital formation, without the bureaucracy of bankers like me getting involved. Members can take loans from these savings groups, if approved by their peers, for purposes such as business expansion, home improvements, medical care or other needs—and without paying exorbitant interest rates.
There’s a reason for the biblical prohibition against moneylenders charging interest to the very poor, who are least able to pay it. As far as I know, Freedom Loans didn’t help anyone in my town escape poverty. It most likely kept them poor.
My confession in this article may not have the same impact as the 13 books St. Augustine wrote discussing his confessions. Still, this was an important lesson for this banker to learn. Not every market segment is a profitable niche, nor is it ethical to try to make a profit to the detriment of the poorest among us. But that doesn’t mean there are no alternative ways to bring human flourishing to those who struggle the most.
Joe Kesler is the author of Smart Money with Purpose and the founder of a website with the same name, which is where a version of this article first appeared. He spent 40 years in community banking, assisting small businesses and consumers. Joe served as chief executive of banks in Illinois and Montana. He currently lives with his wife in Missoula, Montana, spending his time writing on personal finance, serving on two bank boards and hiking in the Rocky Mountains.
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Great article with a unique perspective. Banks will never be able to serve this market segment. They simply are not equipped operationally or philosophically. There are members of Congress who believe the USPS would be able to do it. Well, that’s just a horrible idea.
Great comment Bart. Banks are in a bit of a bind. We want to serve all segments of our communities, but its really hard to make a profit on very small loans made in a finance company without the high interest. However, most bankers recoil like I did at the practices employed which never raise anyone out of poverty. I agree with you that “They simply are not equipped operationally or philosophically.”
Very enlightening and thought provoking. Sure makes the case for financially education and literacy.
I wonder whether financial education would really make a difference. I would like to think so, but when I consider how all of my knowledge of nutrition and exercise doesn’t make it any easier for me to avoid junk food or get off the couch for a run, I’m skeptical. I think the core problem here is not just lack of knowledge about money, but also a lack of knowledge of how to manage one’s own psychology so that sound financial decisions are made. For me, the hard part of finance has always been the psychological aspect rather than the analytical part.
Joe, really interesting article about a challenging topic. I’ve seen similar attitudes in my volunteer tax preparation assistance work with AARP. I’ve seen many a previous year return done by the “big box” tax prep firms, at a cost of hundreds, that were wrong or too simple to justify the cost. Although the free tax prep is a big help to many, there are also many who need help in making decision before they get to tax time.
Thanks Rick. It’s way to easy for us to objectify people and see them as another sale instead of treating them the way we’d want to be treated. Good insight into the problems within the tax prep industry.
Great comment. Many Tax prep places on the lower end of the price scale operate under the idea that accuracy is less important than speed. The additional revenue justifies the penalties they may pay. That they thrive proves them right, from a business perspective anyways.
Volunteer work like you perform is a great service to the community, thank you!
This is a great article that addresses challenging problems that many people never encounter. However, I think technology is starting to play an important roll and provides new options not mentioned in the article. There are many “app-based” financial service companies (often called “fintechs”) that are developing new products and services. For example, there are several companies that issue you a debit card and allow you to spend your accrued wages without having to wait 2 weeks for your paycheck (and without having to take out an expensive payday loan). Many of them have very low fees (or none) including withdrawals at ATMs. Some also extend small personal loans too. All of this is done in an app on your phone which addresses the “shame issue” too. I realize that someone who has spent their adult life going to their neighborhood “Freedom Loans” won’t likely make the shift to an app, but I think this will be a big part of the solution for the next generation of people living paycheck-to-paycheck. Some of the better apps also offer some basic financial education, spend tracking, savings “buckets” (with decent interest rates), etc.
Great thoughts Jamie. My experience with Freedom Loans was before the fintechs existed. There are some great new options today that didn’t exist just a few years ago.
Are you saying that those who are un-banked or under-banked have less than optimal money handling habits? According to the FDIC most people who are un- or under-banked are so because they cannot maintain the minimum amounts and fees required by the banks where they live. Also, many banks are reducing the number of branches for cost cutting reasons. Isn’t some type of Postal Bank system more appropriate and would be more accessible in terms of location and the ability to regulate fees and interest rates? The US used to have a Postal Bank but it was abolished because of pressure from payday lender lobby in the late 60’s. In 2017, according to the FDIC about 24 million households were underbanked. Do you think the solutions you offer would be of much assistance in a state like Mississippi where the unbanked rate is in double digits?
Thanks for the comment Peter. I know the Postal Bank idea is getting talked about these days. I haven’t studied it, but my first reaction is that the Fintech solutions being developed may be a better solution. See Jamie comments below. There are a lot more options for the un-banked today than were available in the Freedom Loans era.
These fintech solutions are not always appropriate for underbanked households who often do not have access to sufficient broadband access. Probably about 10% of people in the US do not have broadband access. We have a country with food deserts and with banking deserts. Banks are moving away from so called bricks and mortar. Access to financial services for underbanked households is being limited more and more. If someone is not able to deposit a few hundred $ in a checking account do you think they can afford the monthly fee on a smartphone?