The Federal Deposit Insurance Corporation estimates 10 million U.S. households do not have access to a checking account. In 2012, 8 percent of Americans used check-cashing services to access $52 billion from paper checks, and paid $1.8 billion in fees for the privilege — almost 4 percent, on average, of the checks themselves, according to the FINRA Investor Education Foundation. Professor Ryan McDevitt conducted the first research in this area based on transactions rather than surveys. He analyzed data from a community bank in New York to better understand how price, distance and check-clearing time affect this "underbanked" population.
McDevitt discusses this working paper, produced with Aaron Sojourner of the University of Minnesota, in this Fuqua Q&A.
Q: Why is this research important to the financial industry and the economy?
This is an understudied population in the United States. A lot of people aren't even aware that check-cashing is how a large chunk of the population accesses their money, and the fees add up over the course of a year. We were able to estimate people's annual income by summing up their checks over a year. We found that among people earning less than $20,000 per year — below the poverty level for a family of three — the rate of check cashing is almost twice as high as families with earnings above that benchmark. Low income families spend a much higher proportion of their income on financial transactions. We really wanted to know how check-cashing decisions are affected by cost, how far people have to travel and the time it takes for checks to clear a bank.
Q: Tell us more about how you were able to study this population. What make this sample unique?
We studied New York because it caps how much check cashers can charge, currently around 2 percent, and also regulates where they locate. You can't locate within 3/10 of a mile of another casher, so existing businesses establish mini-monopolies. Every year the state re-indexes the maximum rate, and the check cashers increase their rates to the new cap.
Because most checkers charge the same, it's hard to study how price differences affect demand. But Spring Bank in New York has a mission to serve this underbanked population and charges lower fees to check-cashing customers. While everyone else was charging 1.8 percent — the maximum allowable amount — Spring Bank charged $1 for checks up to $1,000, and 1 percent after that. As an economist this is a very appealing variation because now we can estimate how sensitive people are to price. And based on home addresses, we could see how far people traveled to go to the bank to save money. People in this population are very travel-sensitive. We could calibrate how much they're willing to pay in fees to save on travel. And because Spring Bank has customers with checking accounts who also use the bank's check-cashing services, we could also see how check-clearing times affected their decision to cash a check instead.
Q: What did you find is the most important factor for people using these services?
It turns out customers care more about the fees than the distance. We found check-cashing fees affect demand almost two-and-a-half times as much as travel costs. But the immediacy is what makes the difference. Because this population is so income-constrained and has this urgent need for cash to pay bills and meet other needs, they're often willing to pay $20 to get their cash sooner. If you deposit a check on a Friday, it won't be available until Monday at the earliest. We explored this variation to find out how sensitive people are to the waiting time for access to their cash. It turns out to be a big factor. Every day of extra hold time makes you 15 percent more likely to cash a check than deposit it. That's equivalent to a 274 percent annual interest rate to expedite access to cash, but people in this situation don't think in those terms. The percentage is meaningless to them, but it's the equivalent of 10 times the interest rates of even the highest credit cards.
Q: Does this research have policy implications?
In New York, the state could reduce the state cap on check cashing fees but give check cashers a larger protected area, such as half a mile rather than the current three-tenths of a mile. Customers would pay less but the businesses would have a larger customer base. As long as you change both, everyone is going to be better off.
The second part is to reduce check-clearing times, which is already up for debate. Unfortunately the most lucrative customers for a bank are the ones for whom this isn't a concern. There just hasn't been a focus on the needs of the low income population. The only way for banks to make money off them is to charge fees, so they're not motivated to reduce check-clearing times.