On October 12, Vanessa Tackett, a 28-year-old living in Lexington, North Carolina, tried to make a purchase with her RushCard. Tackett's card was declined, which she at the time attributed to a systems upgrade that RushCard—a pre-paid debit card that can be used to make payments, withdraw cash, and receive direct deposits, but isn't linked to a traditional bank account, and doesn't require a credit check or credit history—had notified its users it would be completing.
"They had sent out an email, maybe a week-and-a-half before, saying the cards wouldn't be working between midnight and 8 a.m. And then they sent a text message that morning, saying the outage would last until noon," Tackett says. "I tried to use the card later that day, and it didn't work. But they didn't say anything about the cards still being messed up."
Two days later, Tackett, who works full time at Dollar General, realized that her paycheck, which is direct-deposited onto her RushCard biweekly, had never appeared. After logging onto Facebook, Tackett realized she wasn't alone—hundreds of thousands of RushCard users were locked out of their accounts, unable to access any of their money. While RushCard claims the problem is mostly resolved, Tackett still has no access to her finances, making her one of a "handful of people" who RushCard admits are still experiencing faulty accounts.
The unbanked and underbanked are disproportionately low-income, young minorities.
The issues with RushCard, which was founded by hip-hop mogul Russell Simmons in 2003, have brought into the limelight the 25.4 million Americans described by the Federal Deposit Insurance Corporation as "unbanked" (7.7 percent of households in the United States)—that is, lacking a checking or savings account. In addition, 67.5 million Americans are "underbanked" (20 percent of U.S. households), meaning they have a back account but also utilize "alternative financial services," an amorphous category that includes payday lenders, pawnshop lenders, and check-cashing services. In low-income neighborhoods, those percentages can be much higher; over 50 percent of residents in some low-income neighborhoods have no bank account. The unbanked and underbanked are disproportionately low-income, young minorities.
Recent years have brought a proliferation of industries catering to these unbanked and underbanked. The total pre-paid debit card market grew from $124 billion in 2003, to $500 billion in 2012. The Center for Responsible Lending estimates that there were 22,000 payday locations in 2010, up from approximately 10,000 locations in 2000. The check-cashing industry has displayed similar growth. RushCard's large customer base—it now has hundreds of thousands of users, according to the company—thus reflects a larger trend: As banks have increasingly failed to provide products and services tailored to low-income customers, many have flocked to alternative financial service providers.
There are a variety of reasons for individuals to opt for an alternative financial service. Some people are simply barred from opening basic bank accounts or credit cards, either because of a poor credit score, a history of bouncing checks, or insufficient funds to maintain a minimum balance. To be sure, in the FDIC survey on the unbanked, 57.8 percent of unbanked households said they didn't "have enough money to keep in an account or meet a minimum balance."
But contrary to the popular narrative surrounding the RushCard fiasco, a surprising number of people who utilize pre-paid debit cards or other alternative services actually do have access to traditional banking. A 2014 Pew Trust report on the pre-paid debit card market found that 59 percent of pre-paid debit card users currently also have a checking account, and an additional 29 percent had had one in the past.
Indeed, Tackett used a traditional bank account before switching to RushCard. "I liked RushCard better," she says. "You get early deposit [of paychecks], no overdraft fees. It seemed like it would be cheaper and easier."
"A lot of low-income people are going to draw down their accounts to near zero at the end of the month or pay period."
Lisa Servon, a professor of urban policy at the New School, spent four months working as a teller at RiteCheck, a check-cashing store in the Bronx, and interviewing RiteCheck customers. In a 2013 article for the New Yorker, Servon came to a similar conclusion as to why low-income people often choose to avoid banks, namely that "banks are often costlier for the poor than check cashers and other alternative services."
"For somebody who has a low balance and doesn't actively manage their bank account, having a traditional bank account can be pretty costly," explains Michael Collins, a financial literacy expert at the director of the Center for Financial Security at the University of Wisconsin. "If you're only trying to save $300 [over the long term] and you're paying $10 a month in fees, it becomes really hard to justify having a bank account."
Plus, banks can have especially tough overdraft fees. "You hear people complain about 'high fees' and 'uncertain fees' at banks," says John Caskey, an economics professor at Swarthmore who has studied pawnshops, payday lenders, and check-cashing operations. "High-income people often leave a buffer in their accounts, but for a lot of low-income people, they're going to draw down their accounts to near zero at the end of the month or pay period, and they don't know if they'll overdraw. So they'll periodically get fees that they can't predict."
The RiteCheck customers that Servon interviewed cited similar concerns about bank fees and transparency. "[M]any of the customers we interviewed told us that a lack of transparency at banks contributed to the costs they incurred; they found it difficult to predict when and what they would be charged," she wrote. "At RiteCheck and most other check cashers, in contrast, the fees for each transaction are typically displayed on large illuminated signs that span the row of teller windows, like the menu sign at a fast-food restaurant."
Even payday loans—the big, bad bogeyman of the alternative financial services industry—make a certain kind of economic sense. Low-income people rarely qualify for small, emergency loans from banks, so they're often faced with two options: a payday loan, or overdrawing their account. A 2009 report from the Federal Reserve Bank of New York comparing these two forms of credit concluded that (particularly for small amounts): "Although much maligned for its high prices, payday credit can be cheaper than overdraft credit."
RushCard's recent woes have prompted calls for financial literacy education and stricter regulations on pre-paid debit cards, which often charge high fees and aren't subject to the same regulations as traditional bank accounts. But it's not at all clear that pre-paid debit card users lack financial savvy when it comes to evaluating the costs of their banking options.
While behavioral scientists have demonstrated the very real mental toll of poverty—it can produce a kind of "tunnel vision" that makes it difficult to concentrate on anything other than the financial situation at hand—research also indicates that low-income individuals are actually pretty good at evaluating the opportunity costs associated with everyday expenses. Better than the wealthy, in fact. That same tunnel vision likely makes low-income consumers quite adept at comparing the costs of alternative financial services to those of traditional bank accounts.
Earlier this year, Anuj Shah, Eldar Shafir, and Sendhil Mullainathan published a paper in Psychological Science comparing the financial decision-making processes of people across the income spectrum. The researchers presented participants with a variety of scenarios designed to test how they thought about the opportunity costs of various purchases and time investments. The lower-income participants in the study were consistently more likely to correctly consider those opportunity costs.
The traditional banking system simply isn't designed to meet the needs of low-income Americans.
For a low-income person, it's easy to accurately assess the cost of a beer—they compare it to the cost of bus fare, or the next day's lunch. "People don't know how to look for the value of things, so we look for a clue," Shah tells me. "For people who are living comfortably, they lack a clear sense for what things are worth. Things are different for a low-income person." In other words, the rise of RushCard can't just be chalked up to consumer ignorance.
In the wake of her issues with RushCard, Vanessa Tackett recently opened a traditional bank account. The account has a monthly fee and a $50 minimum balance, expenses she can ill-afford at the moment. And while Tackett admits she's not sure how she'll ever pay back the money she's borrowed from her family and friends over the last few weeks to pay her power bill, medical bills, and bus fare, she knows she can't afford another "technical glitch."
While financial literacy education and regulatory changes to the alternative financial services market—say, curbing predatory payday lenders, and increasing protections on pre-paid debit cards—might help low-income families, they won't solve the fundamental reason the unbanked and underbanked prefer to use alternative financial services: The traditional banking system simply isn't designed to meet the needs of low-income Americans.
Federal regulation might help prevent another RushCard disaster, and financial literacy education might help Tackett compare financial products the next time she's in the market. But what Tackett really needs is an easy, low-cost bank account that won't drown her in fees if her account drops below the minimum balance the day before her paycheck hits. If those kinds of products existed, the ranks of the underbanked might actually start to decrease.