Many of us take for granted that we can open a bank account or a credit card, but not everyone has that luxury.

In 2020, 5 percent of U.S. households were unbanked, meaning they do not use or have access to any banks or traditional financial services like savings accounts, credit cards and personal checks, according to a 2021 Federal Reserve report. The same report found that 13 percent of U.S. adults were underbanked, meaning they have a bank account, but are more likely to rely on alternative financial services like money orders, check-cashing services and payday loans.

Tens of millions of U.S. residents are living in the financial shadows, with little opportunity to save money, conduct basic financial transactions or build a credit history. And it’s an issue that disproportionately affects young people and people of color.

What Does It Mean to Be Unbanked and Underbanked?

  • Unbanked: Individuals or families who do not use or have access to any banks or traditional financial services, including savings accounts, credit cards or personal checks. Although it is often an issue in developing countries, there is also a subset of unbanked adults in developed countries like the United States — a phenomenon often attributed to lack of money, lack of trust and privacy concerns.
  • Underbanked: Individuals or families who have a bank account, but are more likely to rely on alternative financial services like money orders, check-cashing services and payday loans as opposed to more traditional methods like credit cards and checking accounts. This is often due to a lack of access to convenient, affordable banking services, or a general preference for the alternative options.

In the United States, there is some legislation on the books that is meant to encourage financial institutions to meet the needs of low-income communities and underbanked people — an attempt to reverse the effects of redlining and other discriminatory lending practices. But traditional banks are still rife with barriers that keep the unbanked and underbanked out of the system, including minimum balance requirements and an overreliance on credit histories, fostering this separate and unequal financial reality.

“Traditional banks haven’t done this [community] a service,” Mia Alexander, a VP of customer success at fintech Dave, told Built In. “It really has become just doing the bare minimum — doing the least amount possible to serve.”

Dave is one of the many neobanks out there looking to remove some of these barriers. They exist solely online, offering a suite of services including checking and savings accounts with no minimum balance requirements, prepaid cards, peer-to-peer payments, interest-free paycheck advances and mobile investing. Other leaders in the space include Chime, Varo and Current.  

These apps have become a popular alternative to the brick-and-mortar banks of yesteryear, particularly in the wake of pandemic-related economic uncertainty. Buoyed by a combination of new technology, mass digital payment adoption and a favorable regulatory environment, these newcomers are taking a massive bite out of a $60 billion industry. And they are changing the game for the United States’ unbanked and underbanked population.

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Filling a Void for Unbanked and Underbanked Communities

When Dave first came on the scene in 2017, it was positioned as the little guy in this David and Goliath saga between consumers and banks — the inspiration for its name. It was out to disrupt the multi-billion dollar world of overdraft fees levied by traditional financial institutions.

Now, with a valuation of more than $4 billion and a reported 11 million users, Dave is on a mission to “level the financial playing field” for people who have been left behind by legacy banks, Alexander said.

In practice, that means providing not just a safe place for people to put their money, but also offering educational services, job and credit-building opportunities, and even extra cash when needed. Users can connect with Dave through their existing bank, start a new bank account with Dave or come to Dave for work opportunities.

“Our logic is that we need to fill the void,” Alexander said. “Our goal is really to say, ‘Let’s find those spaces where we can add value, and then it’s up to you to choose those paths that you want to take.’” 

Neobanks like Dave aren’t the only fintech companies looking to bridge the gap between unbanked and underbanked communities and financial stability, with companies focused on everything from medical care to solar energy

Take online mortgage lender Better, for example, which aims to break down some of the barriers to homeownership by removing commissions and lender fees, as well as offering services like instant loan estimates. And its in-house Appraisal University trains appraisers to better understand and address racial bias in the mortgage process. In 2021, Better originated about $11 billion in loans for families of color, a company representative told Built In.

 

‘Buy Now, Pay Later’ in the E-Commerce Era

But perhaps the most popular segment right now is the digitization of “buy now, pay later,” or BNPL, for consumer goods. According to a recent report put out by credit reporting agency Experian, about four in five U.S. consumers use installment payments through BNPL, helping shoppers purchase anything from clothes and cosmetics to Chipotle burritos to even guns online. These days, seemingly everything can be bought now and paid for later, with no credit history required and no interest later.

The space is currently dominated by tech giants like Klarna, Affirm and, more recently, Apple, but this is certainly not a new concept. Layaway plans, which allow consumers to place a deposit on an item and pick it up later when they’ve paid the balance, have been around since the Great Depression and remained a popular option until they were supplanted by credit cards in the 1980s. But Marshall Lux, a research fellow at the Mozzavar-Rahmani Center for Business and Government at the Harvard Kennedy School, said the digitization of shopping has made the whole process a lot simpler, providing the instant gratification that comes with purchasing something online with the illusion that it’s free.

“I’m not a psychologist, but it probably feels better to put $200 down rather than $1,000,” he told Built In. “It’s incredibly attractive. … And, for a lot of people, it provides an outlet to buy things that they wouldn’t normally be able to buy.”

“I’m not a psychologist, but it probably feels better to put $200 down rather than $1,000.”

Although it’s been around for a while, Lux, who recently co-authored a paper on this subject, said that the BNPL model really took off amid the pandemic — particularly for high-end items like Peloton bikes. In fact, in response to the mass-closing of gyms in the early days of the pandemic, Peloton actually allowed customers to finance their purchases through Affirm, covering the interest for up to 39 months in an effort to attract lower-income households. At the time, this was quite a useful customer acquisition strategy even for higher-income customers, since it, in effect, subsidized the purchase.

 

The Unintended Consequences of ‘Buy Now, Pay Later’

Since then, the kinds of products offered with BNPL have changed, along with the demographics of the people who use it. Two-thirds of BNPL borrowers are considered subprime, or as having poor credit, according to Lux. This makes them especially vulnerable to economic downturns. “The people who can least afford for things to go wrong in their lives, particularly in a bad economy, are the people who are using this,” Lux said.

“This could have been a way for subprime consumers, young people, to build credit and learn how to budget. But instead, I think increasingly it’s the reverse,” he continued. “Some people have ten of these, or they can’t keep track, or they’re from three different companies. Then, all of a sudden, interest piles up, fees pile up. Something that looked free, isn’t.”

To be fair, Lux doesn’t think BNPL was intended to be predatory or bad. Instead, he likens it to the pharmaceutical industry.

“Pharmaceuticals have great benefits, right? But, if used improperly, [they] can be very dangerous,” Lux said. “There’s nothing wrong with subsidizing people, but if the price is you’re going to destroy your credit forever, that’s a bad thing. … This is not going to destroy the economy or anything, but it’s going to destroy a lot of lives.”

Therefore, Lux encourages everyone who uses BNPL services to read the fine print and keep close track of their payments. But his biggest piece of advice is to simply not use them at all, especially if money is already tight.

“If it’s an important purchase, and you really think you can afford it, and you’ve saved up for it, and someone’s willing to cross-subsidize you from a merchant — go ahead,” Lux said. “But if you’re using it to buy a pair of jeans because it’s convenient, you’re going to forget. So just don’t do it.”

 

Could ‘Buy Now, Pay Later’ Be A Viable Option for the Unbanked and Underbanked?

“Buy now, pay later” transactions are currently estimated to be at about $100 billion annually, and some analysts say that number could skyrocket to $4 trillion within the next decade. 

And yet, there is little to no transparency or regulatory oversight of the space. While other household debt like credit card spending and auto loans are gathered and tracked by the Federal Reserve, there is no comprehensive way for BNPL to report customers’ information to credit bureaus, which could have huge implications on their credit scores and ability to be financially stable in the future.

“I’ve talked to credit bureaus, and they’re figuring it out. But it’s not an easy problem,” Lux said. “I personally believe that regulation needs to play a part.”

Lux is not alone. Last year, the Consumer Financial Protection Bureau, a U.S. government agency responsible for protecting consumers in the financial sector, began an inquiry into the business models of some of the largest BNPL providers amid growing concerns about subprime borrowers using the service and loading up on debt they cannot afford to actually pay back. 

In the ongoing probe, the bureau is addressing several concerns about BNPL offerings, including whether its ease is allowing consumers to take on more debt than they can handle, if lenders are appropriately considering consumer protection laws in the creation of their products, as well as how these companies are collecting, managing and using consumer data.

Meanwhile, other fintech companies are coming up with solutions to the problems created by this model on their own. Accrue, which rewards consumers for saving up before they buy, got $25 million from VC heavyweight Tiger Global and others earlier this year. And Kafene, a company that just last year was pulling in eight-figure funding rounds for its BNPL services, is leaning more heavily into a lease-to-own model. 

 

‘A Significantly Better Alternative’

Harkening back to the Rent-a-Centers that gained popularity in the 1970s and 1980s, Kafene partners with retailers that supply pricey items like home appliances, furniture and electronics, and allows consumers to pay for those items in weekly installments until they’ve paid for it in full, at which point they own it. Consumers can sign up and get approved on Kafene’s website in minutes with no credit score required.

Technically, it’s a rental, which means consumers can return the products and cancel their payments anytime. So, rather than taking a loan to buy the product and taking on debt in the process, they’re getting financing that “meets them where they are,” co-founder and CEO Neal Desai said.

“I personally believe it’s a significantly better alternative to ‘buy now, pay later,’ while still sort of serving that need,” he told Built In. In Desai’s view, BNPL is just another way for consumers to put themselves into debt on items they don’t need. But the purchases people make with Kafene, Desai contends, are necessary — people need dryers and dishwashers if they break. If they have kids, they need to be able to buy beds and cribs for them. And they need a responsible and fair way to get these things if they cannot afford them outright, which is what Kafene is positioning itself to be.

To do this, Kafene collects a fair bit of information — utility bill payments, how often you move residences, how often you change cell phone providers. All told, Desai said the company collects more than 20,000 data points on every single user, and winds up approving about 70 to 80 percent of the consumers that get declined by traditional credit bureaus.

We really are serving a demographic that is being left behind, and we need a lot of data to do it.

“We really are serving a demographic that is being left behind, and we need a lot of data to do it,” he said, adding that the company doesn’t share any of this data with third parties. “We want to make sure that they can afford it. And so we really try to make sure that the consumer is in the best possible situation.”

In the event that a user does fall behind on Kafene payments, Desai said the company works with the customer to make sure that their payment plan works for them, and ensure that “one miss on their payment history isn’t going to put them in a bad spot.”

Kafene will only report a user to a credit bureau if the company has something good to report — “if you’re making your payments, we’re going to report that” — or if they miss a significant amount of payments in a row and don’t work with Kafene to try to figure out a solution, Desai said. “In order for us to negatively impact their credit, they would have to be trying pretty hard.”

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What the Future Holds

While the specific findings of the CFPB probe have not yet been made public, the federal agency came out with a news release last month outlining what it would like to have happen as far as regulations are concerned.

First and foremost, it is in support of BNPL providers furnishing nationwide consumer reporting companies with information about users, so long as it provides both positive and negative data. The bureau would also like to see the industry adopt “standardized furnishing codes and formats” that are specific to its unique product in the hopes that it will facilitate consistent and accurate reporting. Plus, the CFPB said consumer reporting companies should incorporate BNPL data into its core credit files and ensure that data is accurately reflected on consumer reports.

In recent announcements, three of the nation’s largest credit bureaus — TransUnion, Equifax and Experian — have said they’ll start accepting BNPL payment data. But the plans vary, and the CFPB has expressed concern that inconsistencies will limit the potential credit-building benefits of BNPL.

How the large BNPL providers named in the probe feel about added oversight is anyone’s guess, although Klarna has publicly come out in strong support of regulation. It and Affirm were the only two out of the five companies named in the CFPB inquiry to publicly come out and say they were going to cooperate and hand over the necessary data. Meanwhile, Kafene is in complete support of the added regulation to BNPL. 

“Consumers are getting taken advantage of, and I think stricter regulations are the right way to go.”

“Given that ‘buy now, pay later’ is debt, it should be regulated as debt. I don’t think it’s reasonable that it would enjoy a different regulatory structure that’s more lax,” Desai said. “Consumers are getting taken advantage of, and I think stricter regulations are the right way to go.”

This will grow even more important as the cost of living continues to skyrocket. With inflation hovering around near 40-year highs, about two-thirds of people in the United States are living paycheck to paycheck, according to a report released by neobank and peer-to-peer payment company LendingClub. And many are turning to BNPL and other financing alternatives to cover everyday expenses, considering it to be a safer option to taking out a loan or running up a tab on a credit card since many of these services don’t technically charge interest.

“The reality is that the next few years might be tough,” Desai said. “I think a lot of consumers are going to have to look very seriously at alternate forms of financing [and] a lot of retailers are going to have to start to be thoughtful about what types of financing they offer.”

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