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The Retske Report: Legless Frogs and Prepaid

Edition: December 15, 2009
Gene Retske

A recent survey released by the Federal Deposit Insurance Corporation found that more than one-quarter of U.S. households don’t regularly use a bank account.

The FDIC claimed that this was the most comprehensive study of the nation’s unbanked and underbanked population. It said that 25.6% of households, representing nearly 30 million people, either don’t have a bank account or have one but regularly use alternative financial services, such as payday loans, instead. The FDIC said that it based its findings on a U.S. Census Bureau study of 54,000 households.

The study revealed that minorities are disproportionately represented in the unbanked and underbanked households, no surprise to anyone who has been following the prepaid industry. Consistent with what we have been reporting in TPP, the study found that 54% of black households, 45% of American Indian and Alaskan households and 43% of Hispanic households either don’t have a bank account or don’t regularly use one that they do have.

The eye popping conclusion of FDIC officials was that this proves that the government must do something to make banking available to a wider array of people.

FDIC Chairwoman Sheila Bair said, in a statement,  “Access to an account at a federally insured institution provides households with an important first step toward achieving financial security.”

Have you heard the one about the Bell Labs scientist who was doing an experiment on frogs? He put a frog down and said, “Jump, frog.” The frog jumped four feet, and the scientist noted in his journal that a frog with four legs can jump four feet.

He then cut off one of the frog’s legs and again told the poor creature to jump. The three legged frog managed to hop three feet, and the scientist noted this in his journal. As the experiment progressed, the scientist noted in his journal that a two legged frog commanded to jump hobbled two feet, and a one legged frog likewise ordered to jump, flopped a foot.

Finally, the scientist cut off the last leg and commanded the frog to jump. Nothing. He ordered again, more loudly this time, “Jump, frog.” But, the poor legless frog just laid there. After a few more attempts, the Bell Labs scientist made his final conclusion in his journal, “A frog with no legs can’t hear.”

Know where this scientist is today? Writing research conclusions for the FDIC.

The FDIC asked the unbanked in the study why they don’t have a bank account. The most common answer was that they felt they did not have enough money to need an account. Half of the unbanked respondents had never had an account, and half had previously had one, but did not at the time of the survey.

What would have been more interesting would have been to ask the unbanked who previously had a bank account why they no longer had it. If they asked this question, it was not indicated in the FDIC report.  The reason an unbanked family dropped a conventional bank account after trying it, might have more significance than the reason why someone never tried a bank in the first place.

This is the equivalent of concluding that a frog with no legs cannot hear, ignoring the obvious by getting lost in the process.

The answer may lie in one of the other significant findings of the study. The FDIC noted the extensive use of prepaid cards by the unbanked. It found that 12% of the unbanked and 16% of the underbanked households used general-spending prepaid cards.

This demonstrates that the unbanked largely understand the need for some form of payment account. The days when you could pay utility bills with cash at the local supermarket are over or ending. The process is just too labor intensive to make it viable much longer.  It is also damned inconvenient for the consumer, which is obvious by the increasing use of alternative payment systems by the unbanked.

Why does the FDIC study and its conclusions matter to the prepaid industry?

The scientist who reached the wrong conclusion about legless frogs could have been influenced by an interest in a Bell Labs product for hard of hearing frogs. Artificial reptile limbs are beyond the scope of Bell Labs. The FDIC conclusion could have a similar prejudice. According to the Wall Street Journal, FDIC officials said the results “create a government imperative to improve banking accessibility to a wider array of people.”

In other words, the FDIC is going to push to move unbanked customers to traditional banking accounts. This means that the government is going to compete for your customers. Not a pleasant thought, no matter what their motivation for doing so.

But, the smart money may be on the fleet of foot entrepreneurs of the prepaid industry, who have shown a knack for getting, and staying, ahead of the curve. For starters, they don’t make assumptions about legless frogs.

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