By Karen Petrou
- Economic inequality and ultra-low interest rates create a vicious cycle in which rates drive down savings, financial intermediation becomes less profitable, unequal households have still more difficulty preserving income and accumulating wealth, banks drop equality-essential services, consumers are made still more unequal, and it all starts all over again.
- Breaking this cycle requires hard decisions about which retail-banking services genuinely enhance economic equality and quickly developing effective, measurable delivery channels to promote widespread adoption.
- There is no shortage of commitments from high-level federal officials supporting equitable finance; what’s missing are specific, near-term action steps.
- This post thus provides a step-by-step roadmap for quick public- and private-sector innovation, regulation, and inclusion.
Almost a decade to the day after the “Occupy Wall Street” movement crystalized the populist politics that now characterizes U.S. debate, the Acting Comptroller of the Currency announced that his agency’s top priority is reducing inequality. This echoes the Biden Administration’s emphasis on equality and racial equity, but all of these high-minded goals are more hortatory than clear directives. They are thus unlikely to advance equitable banking, exacerbating not just economic inequality, but also America’s discontent and resulting disfunction. Reducing economic inequality is clearly essential, with banks and other financial companies sure to face mandates or even public-finance competitors if vital needs are not quickly and equitably met.
Importantly, ultra-low rates and income inequality are each other’s cause and effect, ensuring that market evolution in the absence of meaningful, equality-focused policy will accelerate disintermediation and transform retail finance at still greater risk to low-and-moderate income Americans unless government agencies step in. Indeed, demands increasingly call for federal intervention in areas such as a consumer-facing central-bank digital currency, public banks, and new mandates.
A Clear Destination
The first criterion of a successful roadmap is a clearly-marked destination. Metrics-based objectives that define economic-equality and racial-equity achievements include:
- identification of key income/wealth-enhancing must-have financial products (see below) that attract and maintain consumers disproportionately comprised of low-and-moderate income households and of minorities when compared to untargeted offerings in like-kind products;
- customer bases that represent women, minorities, LGBTQ, and disabled customers in proportions at least comparable to the demographics in each targeted community in which the firm providing the product does general as well as targeted business;
- interest rates, terms, and/or total cost equal to or less than like-kind offerings. Where there are few like-kind offerings for untargeted markets, pricing should be demonstrably no greater than that appropriate to enable repayment on specified terms and conditions, ensure deep market access, and provide a reasonable return;
- accessibility judged not by availability in terms of potential access (i.e., via digital media), but by actual accessibility for low-mod households, the elderly, persons with disabilities, and under-served urban and rural communities; and
- soundness judged by transparent, enforceable metrics and factors such as protection of principal, operational capability, service-remediation capacity, transparency (e.g., re underwriting models, embedded pricing/offerings), through-the-cycle return, and product integrity (e.g., no conflicts of interest by service providers related to retail-product offerings, other cross-selling/tying opportunities).
Meaningful metrics are only possible if regulatory change encourages them. For example, current disclosure requirements are ill-adapted to equality banking, omitting many risks to product integrity and often giving unscrupulous providers the edge due to continuing complexity and resulting “information asymmetry.” Regulators cannot change law, but they or the industry can and should devise disclosures, best-practice standards, and other consumer-facing and risk-measurement tools focused on financial services provided to low-and-moderate income consumers. Developing standardized products and measurement criteria will speed equality-enhancing innovation. Case history here is the low-cost, low-risk FDIC-insured Bank On accounts now being offered by more and more banks.
It should be noted that these performance metrics do not focus exclusively on the consumer; key criteria also govern the provider. Although some financial products may seem to be wholly in a consumer’s best interest, those a provider cannot offer without threat to its risk tolerance and long-term return objectives put the consumer, the provider, and even the financial system at risk.
Further, products that protect the provider but do so by transferring risk to others do not advance equality and equity unless the third party has the capacity to bear the transferred risk, continuing service-remediation capability, and a business model ensuring sustained product integrity.
Stops Along the Way
True inclusion requires going beyond the “cool” factor. Regulatory and industry goals can and should be focused on financial products likely to prove most critical to income preservation and wealth accumulation. These are:
- those enhancing transaction and savings account value, functionality, and access;
- investment offerings expressly suitable for low/mod households that preserve through-the-cycle wealth and achieve life-cycle objectives (e.g., mortgage-downpayment accrual, retirement security, rainy-day funds);
- payment products ensuring certainty, speed, and integrity (i.e., no cross-subsidization with retail sales or other corporate activities); and
- small-dollar loans enhancing payment liquidity (e.g., wage advances), wealth accumulation (e.g., low-balance mortgages, expedited refis), and inter-generational mobility (e.g., education savings accounts). Targeted offerings should not rely on those for which tax advantages are afforded since most low-mod households pay only payroll taxes.
Importantly, wholesale product offerings can have meaningful equality benefit. These include securitization channels for small-business loans; ESG funds focused on pools of small-dollar mortgages or start-up business loans; and new bond structures appropriate for social welfare (e.g., BioBonds), environmental-justice infrastructure improvements, and similar objectives.
Knowing Where You Are
Accountability is essential for equality banking. In the absence of accountability, many more companies may proffer the “illusion of inclusion” all too evident in all too many past and present entities. Federal law intends to enshrine equality accountability in standards such as those governing product suitability, consumer protections, conflict-of-interest prohibitions and transparency. Accountability is also mandated for banks under the Community Reinvestment Act and via standards imposed by government guarantors and loan-purchasers. However, mandated mission obligations are inappropriate for private-sector companies where government-afforded benefits do not directly or indirectly apply to the equality-focused financial product or to the provider.
Given the limited scope of mandated equality standards, targeted charters and delivery channels are vital vehicles on the road to equality finance. Regulators should thus consider furthering “Equality Banks” with distinct charters focused solely on equality-enhancing financial services such as those iterated above. More on Equality Banks may be found here, and in my book here, which detail the rules regulators can and should revise for such dedicated entities. Broader adoption of public-benefit corporate charters for entities within financial institutions can also ensure accountability via state tax law and permit larger and/or specialized financial companies to enhance economic equality via key financial products with more limited regulatory exemptions or other benefits from local, state, and federal government entities.
Danger Ahead
Equality banking is essential not only for the unequal, but also for the future of regulated financial intermediation. Prolonged ultra-low interest rates have long-term, adverse, and structural impact on the traditional bank business model of financial intermediation. Shrinking net interest margins unbundle the business of transforming deposits into loans, exacerbating the profit hit resulting from post-2008 standards and speeding the exodus of regulated providers to new, wealth-management-focused strategies. Many innovative providers have sprung up to replace banks by offering selected equality-essential products banks once monopolized, offering the promise of heightened competition and increased financial inclusion. However, these unbundled retail-finance activities often lack key consumer safeguards and, especially when combined with artificial intelligence and/or cryptography, present an array of additional risks.
Pro-equality finance thus requires not only a mat to where we want to go, but also clear warnings of the hazards along the way.