Financial services can be thought of as two distinct concepts: finance and service. Finance is the business of allocating capital, creating debt, and moving money. Service is how customers are treated in this experience. Although much energy has been spent looking at the evolution of finance, less attention has been paid to changes in how services are provided. In this article, I explore changes in the services component of financial services, analyzing how some of these changes have helped to democratize financial services. Changes in how services are provided in payments and consumer banking have provided substantial, often underappreciated gains to consumers. Furthermore, unlike many other benefits that have favored the wealthy, some of these services advancements have provided variety of benefits, especially to the middle class and traditionally underserved communities.
Financial technology (FinTech) is usually described as a new, growing field that may compete or cooperate with banks on any given day. However, the reality is that financial services have been undergoing a substantial technological evolution for several decades. Several major FinTech innovations on the services side of finance have changed how consumers interact with banks.
The growth in online and mobile banking has been stunning. Today, more than seven out of 10 bank customers access their accounts online.
Two significant advancements are the advent of online banking and remote check deposit. These are fundamentally changes in services, providing consumers the ability to access a series of financial options through additional easy and convenient service conduits. They aren’t really changes in finance – checks are still checks and bank accounts are still bank accounts. Yet, consumers can now access information regarding their funds; move funds between accounts; create, send, and deposit checks; initiative and automate electronic payments; and conduct other transactions from the comfort of their own homes at their convenience. And with the advent of smartphones, these transactions can be conducted anywhere and at any time.
The growth in online and mobile banking has been stunning. Today, more than seven out of 10 bank customers access their accounts online. Online banking surpassed interaction at branches as the main way that Americans access their accounts in 2013, and by 2015 it had expanded that lead even more (37% vs. 28%; the ATM is third, at 21%). For mobile banking, growth is rapid. Over the five-year period 2011–2015, the share of Americans who engage in mobile banking doubled, according to the Federal Reserve. Almost half (43% percent) of those who have bank accounts and mobile phones use mobile banking. And mobile banking almost doubled its share as the primary way in which customers access their accounts, growing from 5.7% in 2013 to 9.5% in 2015. The top three reasons why consumers started using mobile banking highlight its value to consumers. They are:
- Just purchased a smartphone
- My bank started offering the service
Mobile banking is part of the democratization of financial services by changing how services are offered. Mobile banking is reaching traditionally underserved communities. Consider that adoption rates of mobile banking are higher for African Americans (50%) and Latinos (56%) than for white Americans (37%).
Higher adoption or penetration rates among minorities for financial services are rare. Ownership of smartphones is also higher for minorities than white Americans, indicating that the prior digital divide debate has been flipped on its head, as it relates to smartphone and mobile-based access to bank accounts among those who use banks. This data indicated that banks adopting FinTech can transform how services are provided and help to democratize finance, while increasing its reach.
There is a common hypothesis that introducing these technologies to consumers will result in the elimination of the traditional bank branch. The CEO of Morgan Stanley wrote this in the Wall Street Journal in 2014: “Universal adoption of mobile devices puts a bank branch in everyone’s pocket and renders bricks and mortar obsolete. Of the 97,000 bank branches that exist across the U.S. today, all but about 10,000 will disappear.” This has yet to happen – in fact, the number of branches has grown.
Consider that in 1980 there were over 14,000 banks and a corresponding 38,738 number of branches in America. (Note: These numbers do not include thrifts, although incorporation of that data would not change the conclusion that we have yet to experience the dramatic decline in bank branching despite the dramatic decline in the number of banks.) Today, the number of banks has dropped substantially to around 5,000, but they support a network of more than 82,000 branches. Although the number of bank branches peaked in 2009, the rate of decline is hardly that of video stores. When bank customers with smartphones are asked how they interact with their banks, more than eight in 10 say they have visited a branch in the past year. Furthermore, among those with smartphones, online access is tied with branch access for the most common method that customers use to interact with their bank. While online and mobile are growing and will continue to do so, this isn’t necessarily a zero-sum game in which branches will disappear or lose value.
When bank customers with smartphones are asked how they interact with their banks, more than eight in 10 say they have visited a branch in the past year.
These technologies have changed how consumers use their time. In 2003, on any given day, 4% of Americans spent time engaging as customers in financial services, according to the American Time Use Survey. In 2015, the most recent data we have, that figure was down to 2.5%. There are over 37% fewer people who engage in financial services on any given day today compared with 2003. Put another way, a little over a decade ago, one in 25 Americans was visiting a bank or logging in online, and today that number is down to one in 40.
Interestingly, the amount of time spent dealing with financial services has not changed. Those who engage in financial services activities spend an average of 15 minutes doing so, a figure that is not statistically any different today compared with 12 years ago. This indicates that the frequency in which people use financial services, but not the time spent once engaged, has decreased as result of FinTech adopted by banks. This is slightly counterintuitive. The hypothesis that depositing a check at home on your phone takes less time than going to the bank is accurate, as anyone who has done both can confirm. However, this data indicates that people are still grouping financial activities together, but they need to do so less frequently. Perhaps when they are depositing that check at home, they’re also logging in to send a few payments, check their balance, and transfer funds. The efficiency gains are shown as fewer engagements.
What does this mean for customers? To start: time is money. Therefore, saving time can be thought of as saving money. If people use financial services less frequently, that’s freeing up time. Using the relatively constant figure of 15 minutes per financial services session, the typical American spent 3.7 hours engaged in financial services in 2003. That figure would have fallen to 2.3 hours in 2015, resulting in savings of about an hour and a half of time for the typical consumer over a year.
The savings of 90 minutes doesn’t incorporate the potential additional value that more activity has been accomplished in less time. Because the data itself is time spent, advances in efficiency would necessarily be underincorporated in this calculation. The alternative question – how much more time would people have to spend if they still needed to use 2003 technology? – can’t be answered.
What we know is that the value of this time itself is distributed differently among different consumers. Although economists often think in terms of budgetary constraints, they sometimes fail to appreciate the equally constraining element of time. Just as people’s elasticity of demand for objects varies with their price, so too does it vary with the amount of time it takes to accomplish a task. Consumers’ elasticity of time – that is, how easily they can substitute activities for each other at any given time – may be very different, even if they have the same income. Think of a single working mother of young children compared with a single retiree living at the same annual income but with extremely different elasticity of time.
The United Kingdom, Poland, South Africa, and Mexico have all modernized their payments systems to allow for real-time payments.
It’s not difficult to argue that the value of time savings to middle- and lower-income consumers may be greater than to older, retired, and possibly wealthier individuals. That’s not to say that, from a purely economic standpoint, the value of time is greater for middle- or lower-income people. On the contrary, textbook economics solves the time-is-money calculation by looking at the marginal value of time, which is usually equated to the marginal income derived from an additional hour worked. By definition, that formulation would show a greater value of time for higher-income individuals.
However, when the elasticity of time is considered, this value should be thought of differently. Lower-income individuals often have less flexibility and control over their time. Their elasticity of time may be lower. The ability to conduct financial services at a time and location that works for the bank branch may not work for them. Thus, the value of time flexibility in conducting financial services may be greater. To the extent that this allows for access to financial services, or a change in activities that can be accessed, this could result in substantial savings because there is a high cost to being unbanked. In absolute terms, the dollar value is likely still lower than for substantially wealthier individuals, but in terms of a percentage gain on their existing income, it may be higher.
There are reasons not to be too optimistic about this argument. Despite the advances in mobile banking discussed above, 17% of those who are unbanked still cite inconvenient bank locations and hours as a reason why they are unbanked. Ultimately, the cost of maintaining a basic transactional account may not be lowered by technology as much as we have hoped. And cost is still the #1 reason why individuals remain unbanked. However, greater penetration of information regarding all that can be accomplished through online and mobile banking in terms of alleviating this time mismatch may still be a viable path to combating some of the challenges in moving those that are unbanked and underbanked into the financial mainstream.
The next big innovation in services will happen as a result of the adoption of real-time payments in the United States. Real-time payments are a service innovation; they are just changing the speed at which one set of financial transactions occurs. In a digital world, it’s disgraceful how long it takes to clear checks, both paper and digital. The United Kingdom, Poland, South Africa, and Mexico have all modernized their payments systems to allow for real-time payments. The technology is there; the issue is one of leadership, innovation, and coordination.
The inability of the United States to follow the lead of those countries harms consumers, particularly middle- and lower-income individuals and families. Millions of Americans are subject to liquidity constraints as their cash flows fail to match their expenses. Sixty-three percent of American families lack access to $500 in cash even when faced with an emergency, while one in three families report zero liquid savings.
Making purchases with insufficient funds results in overdrafts. This cost consumers $11 billion in 2015. Consumers who overdraw their accounts are almost by definition those with fewer assets and lower income. However, given how widespread the practice is, and the large number of families who live paycheck to paycheck or close to that, it is also a middle-class problem.
Consider this example, which I witnessed one Saturday morning while at my bank branch making a deposit. A woman in front of me asked the teller when the funds from the check she was depositing would become available. The teller responded “Wednesday,” because the check took several days to clear and Monday was a federal holiday. The customer said that was a problem because she had multiple scheduled payments that had to be made before then (although she didn’t list them, it’s easy to imagine a car payment, tuition for child care or school, monthly bills, etc.). The teller said there was nothing she could do to expedite the funds.
The customer asked whether she would be charged one overdraft or multiple. The answer was multiple charges, one for each payment made with insufficient funds. This could quickly add up.
Another customer, overhearing the exchange – which was rather noticeable, as the woman was becoming more distraught – interjected: “Why don’t you go around the corner to the check casher? He’ll give you cash, and that will be there right away. He’ll charge you for it, but it will be less than your overdrafts.” The woman with the problem conferred with the teller, who acknowledged that the cash would be available immediately and that as long as she didn’t charge more than she’d deposited, there would be no overdraft.
I watched in complete amazement as the woman left the branch. The decision by this bank customer to use a check casher was rational and cost-minimizing for her situation. In this day and age, there is still a role for a non-bank intermediary to process payments by turning checks into cash, in effect providing a time arbitrage for the antiquated payment system.
Real-time payments should solve this problem. They will also allow individuals to better manage their funds to avoid overdraft fees. Undoubtedly, real-time payments will also lead to a host of auxiliary FinTech apps that help consumers track their funds and manage their purchases. Financial institutions that embrace those applications may succeed in attracting customers, but at the same time will reduce their own income, because overdrafts result in fees for financial institutions.
While the failure of the Federal Reserve to lead adoption of real-time payments is disappointing, the market demand for them will ensure that adoption will still take place. Currently, pilot programs operated by The Clearing House are already well ahead of the Federal Reserve in establishing and operating a real-time payments system. Non-bank FinTechs are also pursuing real-time payments, notably Ripple, which has partnered with a mix of bank and non-bank financial institutions in the U.S. and abroad. Financial institutions would be wise to embrace real-time payments, even though they will reduce overdraft fees. Consumers, particularly those with little or no savings, will be willing to pay modest amounts for real-time payments and corresponding services that allow them to better manage their funds.
Advancements in the services component of financial services have led to greater democratization and access to banking. Americans can conduct their financial transactions more efficiently and effectively, freeing up time for other pursuits. Time savings and, importantly, greater flexibility in when to conduct banking are likely to help time-constrained working families. Mobile and online banking has proven to be more effective at reaching minorities. The rate of unbanked households has fallen by 14% since 2011 or, put another way, one out of every seven unbanked households then now has a basic bank account. The advancement and successful incorporation of online and mobile banking has likely played some role in this positive development.
The adoption of real-time payments will continue this trend and provide substantial benefits to consumers, particularly middle- and lower-income individuals. Although real-time payments will reduce one area of income for financial services, they will open up other streams. Financial institutions are developing and implementing real-time payments and should continue to do so. This is particularly important because there hasn’t been a successful push by the government or bank regulators to create and adopt such a system. Implementing real-time payments would be a major move forward by banks in democratizing the financial system to provide enhanced benefits to ordinary Americans, who are likely to continue to benefit from existing bank-deployed FinTech, such as mobile and online banking.
About the Author:
Aaron Klein is a fellow in Economic Studies and serves as policy director of the Center on Regulation and Markets. He focuses on financial regulation and technology, macroeconomics, and infrastructure finance and policy. Previously, Klein directed the Bipartisan Policy Center’s Financial Regulatory Reform Initiative and served at the Treasury Department as deputy assistant secretary for economic policy. Prior to his appointment as deputy assistant secretary in 2009, he served as Chief Economist of the Senate Banking, Housing and Urban Affairs Committee for Chairmen Chris Dodd and Paul Sarbanes. Klein is a graduate of Dartmouth College and the Woodrow Wilson School for Public Affairs at Princeton University.