December 01, 2015
How the Other Half Banks: More of the Regulatory Story
Posted by Christine Hurt

Rarely does a fellow law prof's well-researched, well-written nonfiction book deserve as much attention as Mehrsa's book does.  In a very readable manner, the book gives all readers a window into the underbelly of banking.  HTOHB provides several contributions:  a brief history of banking, a broad overview of fringe banking and the high cost of being poor, a survey of governmental, market and philanthropic responses to the problem, and a proposal to implement postal banking.  The title is a nod to the middle chapters; an alternate title might be "How the Post Office Could Save Retail Banking." 

As someone who teaches The Law of Microfinance and has spent a lot of time in the economic development literature on microfinance, I was fixated on the middle chapters.  Microcredit and microfinance are proposed fixes to the ills of the unbanked in developing countries, and not enough time is spent discussing the challenges of the unbanked in the U.S.  Though being unbanked is difficult in a developing economy, being unbanked is becoming nearly impossible in our own cashless, electronic economy.  As Mehrsa notes, turning a paycheck into cash and then back into money orders and transfers for everyday expenditures is extremely inefficient and expensive.  If the book was Chapter 5 alone, it is worth the price just to see the daily toll being unbanked extracts.  The problems of the unbanked can be divided at least into two categories:  access to payment systems (the ability to write checks, make ACH transfers, use debit cards/ATMs) and access to credit (for either income smoothing or longer-term finance).  I say this because the solutions to each category may be different.  A payday lender may also cash checks and sell money orders; a microlender may only make small loans; a community bank may take deposits, make loans and sell financial products.  I believe that Mehrsa envisions the postal banking solution to address at least the most basic needs in each category:  payment systems, deposit accounts, and small loans.

One might envision unmet banking needs to be addressed by the market, government regulation or philanthropy.  Chapter 6 runs down the pitfalls in each.  Though I understand that postal banking may be the best of these solutions, I would push back a little on the reasons why neither the market nor philanthropy have fixed these concerns.  The one tension that will always be present in any solution is the tension between profit and protection.  As Mehrsa points out, commercial banks don't chase small depositors or borrowers because the profit margin isn't there.  But when the fringe market steps in, those players have the same math that big banks do.  So, interest rates have to be higher and so do transaction fees.  That may be enough to dismiss a market solution.  However, P2P businesses have tried to fill this niche with a different, cheaper model than brick-and-mortar businesses.  They seem to be meeting a need, but of course that is the need of people with access to computers and the internet and a bank account for funds to be wired into -- Lending Club cannot reach out and put cash into your hand.  However, one reason that the profit margins aren't there is regulation.  In talking to founders of P2P banking ventures, state lending laws come up quite a bit (not depositary safety and soundness laws, just lending laws), and of course Prosper and Lending Club had to eventually deal with SEC regulation.  It is very hard to simultaneously democratize credit and pursue consumer protection.   Perhaps this is where postal banking has an advantage with preexisting infrastructure and perhaps relaxed regulation.  In addition, philanthropy suffers from the same regulatory costs.  Chapter 7 talks about the now-defunct Chicago Shorebank.  Chicago is also the headquarters of Opportunity International, a global microfinance organization.  In talking with managers about why microfinance does not work well in the U.S., regulation will also be mentioned.  The magic question is how to simultaneously provide credit and banking services to the poor at affordable rates, with a low default rate, at a profit, in a highly regulated environment.  I think Mehrsa is saying that the answer is postal banking, and I think a lot of people are intrigued enough to hear more details!

I'm looking forward to hearing that answer in "How the Post Office Could Save Retail Banking"!

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