Why we’re wrong about lower income consumers, a three-part series
Products and services that help low- and moderate-income (LMI) consumers manage their day-to-day finances and improve their long-term financial health are a clear need that hasn’t yet been solved by mainstream or alternative financial providers. Why haven’t the needs of LMI consumers been met by the market? The latest research uncovers three pernicious myths that discourage innovation for the low- to moderate-income segment: that lower income consumers don’t want to save, are bad at managing their finances, and don’t have the money to pay for financial services.
In this series, a companion to our recent white paper, Reimagining Financial Inclusion, we’ll tackle each of these three myths in turn. If you haven’t read Parts 1 and 2 yet, you may want to begin there.
Throughout this series, we’ve discovered that many common assumptions about LMI consumers do not hold true. While lower-income consumers often want to save money and are much better at managing their finances than is commonly believed, nevertheless, LMI households struggle to accumulate savings and repay debt. At first glance, it may seem hopeless to expect these consumers to be able to pay for financial services on top of other obligations. Yet this assumption overlooks the fact that lower-income consumers are already spending a sizeable chunk of their income on financial products and services.
MYTH #3: Lower income consumers don’t have the money to pay for financial services.
FACT: LMI consumers actually spend a significant amount of money on financial services, often more than what an average consumer might spend.
Underserved consumers spend a lot on financial services—to the tune of $138B in fees and interest in the aggregate in 2014.
Our latest estimate is that underbanked consumers spend an average of $1,100 per year just to juggle their basic finances outside the financial mainstream, or what amounts to about 5% of a $20,000 annual income.
Part of the reason consumers spend so much on financial management is a mismatch between what consumers need and what financial institutions—both regulated and alternative—can provide, resulting in a patchwork of partial solutions that’s expensive to manage in fees, time, and mental energy. LMI consumers pay to access services like check-cashing and money transfers that many middle- and upper-income consumers can access for free, and volatile income and expense streams combined with low savings buffers increase the risk of overdraft fees, non-sufficient funds fees, late fees, etc.
However, financial institutions that design products and services that take into account the realities of the lower-income context — the spikes and dips in income, the sudden expenses, the low savings — can help these consumers manage their finances in an affordable way. A single integrated product that provides credit to meet obligations when cash flows are low, automatically sets aside savings when cash flows are high, sends smart alerts and reminders about bills and low balances to free up mental bandwidth, and simplifies and reduces fees could meet the financial needs of LMI consumers and build financial health in the long-term. According to our estimates, such a product could be offered at a significantly lower price than what consumers spend on these functions today, saving consumers as much as $500 per year.
From the provider perspective, a product that automatically accumulates savings and replenishes credit could generate a sustainable profit by increasing deposit revenue and lowering credit risk and expected losses. We estimate that such a product could increase profitability by $120 per LMI consumer per year, a $1B+ opportunity for a large bank.
Learn more about the myths surrounding LMI consumers and new ideas for a better financial solution in our report, Reimagining Financial Inclusion.