The proper use – and maintenance – of a checking account is one of the milestones of adult financial prowess. Checking accounts allow consumers to maintain an account and cash in and out for free, often with low minimums. Cash is available at your fingertips... and sometimes even with a little bit of interest.
For most of the population, there's not much to say about checking accounts. They earn low interest rates, but it's a $0 cost method to organize all your financial life.
How do checking accounts earn money?
When you read the fine print, you can see how banks earn their money off checking: fees.
Most banks maintain a minimum balance for their checking accounts: below the set amount will accrue a fee. Going over the limit incurs an overdraft fee.
Some banks even offer "overdraft protection" which is really a way to dupe you into a high interest credit account if you consistently overdraw. The rules and regulations for each checking account are usually surrounded by jargon and confusing terminology that only confuses most customers.
Who are The Underbanked? An Uninformed or Parallel Market
According to the FDIC, around 7.0% of American households are considered unbanked. Unbanked households do not maintain any money or accounts at an insured institution such as a bank.
An additional 19.9% of households maintain an account or obtain products outside of insured financial institutions. Perhaps they have a checking account, but they also obtain payday lending.
That's 26.9% of the population which deals with financial services outside traditional financial institutions!
Why do people do this when there are services that provide the exact same benefit for free? Are some people simply uninformed?
Non-Traditional Institutions can be a Better Deal
Very often, perception of the unbanked centers on financial literacy.
That's a naive approach, though: very often non-traditional financial services provide a better ROI than checking accounts for the very poor!
Here's how the argument goes (and the feeling is very, very different by socioeconomic status):
- Most fees (particularly account minimums, ATM and overdraft fees) disproportionately impact smaller balances.
- When you go to a check cashing service, the payment is often up-front, in cash and predictable.
- For the speed and service that these institutions provide for the very poor, it's understandable that there is a huge fee.
A caveat here: payday lending, however, is the absolute last resort. With exorbitant fees, confusing payback schedules, and a lack of collection standards everyone should avoid payday advances.
Strangely, though, these can be considered the best option when there are absolutely no other options. To wit: it's better to borrow from a payday lender than a loan shark.
Online Banking and the Demise of the Brick-And-Mortar Bank
Recent years have seen the amazing rise of the low or no cost online bank:
- No minimums
- No annual fee
- Free checking
- No (or even refundable!) ATM fees
These banks have about everything you'd want. For all intents and purposes, I consider them free - although there are of course fees for some services like wiring money. Most relevantly, these products are only serviced online.
Sometimes small accounts simply cost too much to service at a brick-and-mortar bank.
The bank needs huge amounts of capital to be able to lend (and increase their T1 capital ratio) and thus incentivizes their customers to maintain large balances (often with certain features unlocked with larger balances, or higher interest rates).
With online banks, there's nearly no marginal cost for an account to sign up. With this barrier broken, it appears almost everybody can have access to fantastic checking accounts.
Long story short: traditional checking services sometimes can't with check cashing services. Online checking accounts, however, appear to avoid the downsides of either, while maintaining the benefits of each.
Hopefully we see fewer bank fees and fewer check cashing activity in the coming years.