How a state bank could challenge payday lenders

Earlier in the pandemic, West Coast states led the way in providing financial assistance to marginalized populations excluded from federal stimulus and relief packages. In Washington, Governor Jay Inslee has directed $40 million in aid for undocumented families. Oregon created the Oregon Worker Relief Fund to ease the financial burden of the unemployed and undocumented. And the California state government has cooperated with private philanthropists to channel hundreds of millions of dollars in aid for people without legal status. Cities like Los Angeles have also set up their own programs to provide cash to people left destitute by the pandemic.

Today, California has also taken small steps to reinvent the banking system, with the goal of providing access to basic financial resources to poor residents who historically operated in an underground economy without access to legitimate services.

This week, Governor Gavin Newsom signed AB 1177, which sets up a commission to study the state’s ability to create “CalAccounts.” These would function as a fee-free, federally insured banking system for low-income residents who might otherwise have to fall back on payday loans, check cashing, and other usurious practices.

If the commission finds the project feasible, California will establish a state bank to serve the needs of more than 7% of its residents who do not have bank accounts. The vast majority of these people are low income; indeed, in 2017, the FDIC reported that 27.3% of households in the state with incomes below $15,000 per year lived without access to bank accounts. In contrast, only one in 200 high-income households did not use banks.

It is important. Historically, payday lenders have exploited poor residents by charging monthly fees that, in practice, can quickly add up to the equivalent of an annual interest rate of several hundred percent. In California, these loans are limited to one month, but the maximum fees allowed are capped at the equivalent of 460% interest per year if the loan was for a full year. A person with good credit, on the other hand, can currently benefit from mortgage rates of 2.7%, fixed for 30 years.

Obviously, the creation of a state bank will not in itself prevent poor Californians from turning to payday lenders when they need a cash injection. After all, the state bank, while providing checking and savings services, will not necessarily lend small amounts of money for short periods. That said, once a person is in the banking system, it becomes easier for them to manage money, perhaps save it, or even negotiate overdraft terms with the bank that don’t include not levels of interest that equate to highway robbery. Over time, the presence of a state bank should at least reduce the stranglehold that payday lenders have on many poor communities.

Moreover, simply removing the need for poor residents to go to check cashing establishments will save them large sums of money throughout their lives. In California, these services typically charge 3-3.5% of the value of a paycheck to cash it, and 12% on personal checks. For all intents and purposes, this is a huge tax on poverty.

In 2012, the Stanford Social Innovation Review reported that 60% of low-income neighborhoods in California did not have a bank nearby. Surprisingly, according to data generated by the Center for Responsible Lending after the 2008 financial crisis, low-income families sometimes paid as much as $2,000 a year for check cashing services, and Californians spent nearly half a billion dollars a year to pay the fees on payday loans. Since then, data suggests that the payday loan and check cashing industries have only grown.

If California does, in fact, create a state bank after the commission’s report, it has the potential to fundamentally shift the balance of power between consumers and predatory lenders in the state. For too long, being poor in America has meant you pay much, much more to borrow money and cash checks than your wealthier peers. It is a poverty trap that makes it increasingly difficult for the poor to find a way out of poverty. It is high time for legislators to explore ways to provide reliable and affordable banking services to the poor. California is finally about to do just that.