Inner City Banking - The pitch

The inner city bank is like an anti-big bank. It does have fees for everything you do, it doesn’t have sky high interest rates for loans, and it values its’ customers. The proposed bank is as interested in customers growing real wealth as it is in growing profits. As a hybrid for-profit and non-profit, the proposed bank is designed from the ground up to give back to the community.

Inner City Banking - The fun part

I like the idea of using A/B testing to determine which personal finance aid really works. As a bank that works with a non-profit, the bank could help choose which people are randomly chosen for different services. This would bear fruit when it came time to give someone a loan. Knowing that people have gone through financial training could mean increased probability of having the loan repaid. If a program didn’t work, it would show in the future finances of the individual. Any value would be fairly easy to quantify.

Inner City Banking - The growth potential

I think this could grow to be the primary bank for tens of millions of people. If the inner city bank grew to be one tenth as large as Bank of America it would get $8 billion in revenue. If NUB had a 10% profit after giving to the charity arm, then it would make $800 million in profit each year.

Inner City Banking - The monetization

As described so far, the bank is extremely lean by having no physical locations. Avoiding physical stores reduces costs in several ways. First, the bank doesn’t have to pay rent for the location. Second, they don’t need a vault, extra security, or the costs of armored trucks to transport money. Lastly, they don’t need to have retail representatives who may spend much of the day idle. These costs are significant enough to get McKinsey’s attention, in fact, the costs of branches account for 40%-60% of operating costs. If those costs could be avoided with being replaced by other costs, then this bank could make 25% more profit than other banks. Now, I don’t think that will be the case, as I expect this bank to have less revenue per customer than other banks. I think reducing fees, giving higher savings rates and lower loan rates would cut that 25% down to 15% or 10%. About 5% of the profit would get transferred to the non-profit arm (but that would also reduce the bank’s tax bill).

The in-store ATM equivalent would involve installing a low-end smartphone ($50) that uses only a small amount of data that is required to pass along withdrawal and deposit information. It would also serve as the verification for the transaction (through scanning the QR code and the acknowledgement of the cashier). The local business would take a 1% cut of the transactions. They get other benefits like additional foot traffic.

Inner City Banking - The idea

The normal banking model is broken for poor inner city residents. I aim to tackle each of the hurdles that these residents face. The main themes of this idea are reducing costs, increasing access, and fostering responsible behavior.

Smart phones have become very cheap. Low end smartphones cost less than $100 off-contract.  This is why 62 to 80% of young adults with cell phone plans have smartphones, and this number is only going to continue to rise. The primary way that customers will access their accounts will be through their phones. Depositing a check will be as easy as taking a photo from your phone, which at least 9 banks already do. All balance inquiries, transfers, and initial loan requests can be made using a smartphone, tablet, or laptop.

Deposits and withdrawals will be made using local businesses. It works like this, you request how much you’d like to withdraw and find out if you can take it out of a local business, for example the corner store. If they have enough money, then you get the go-ahead to pick up the money. You go into the store and scan a QR code, and the business verifies the withdrawal with the bank with another smartphone*. Roughly the same thing happens with deposits.

Customers will be able to open (and close) accounts online and apply for loans, which means that there won’t be any reason to have physical bank branches for practically all activities. The only thing that will involve a physical bank location is credit counseling.

The bank would also have non-profit functions to facilitate financial education. There are two ways to make this work, either using a non-profit for-profit hybrid, or creating a low-profit limited liability company (L3C). The goals would be to run workshops on personal finance, one-on-one guidance on financial decisions, and setting up personal finance mentorships in which responsible members of the community help others develop healthy personal finance practices.

The bank would give lower rates to those who have been through one or several workshops and have a personal finance mentor. Another thing that could lower the interest rate is if other members of the community are willing to put up a small amount of collateral (1%-5%) as sponsors of the loan. This collateral would show that people who know the individual believe that he or she will pay back the loan and provide an incentive for community members to help that person to do so.  The bank could facilitate provision of collateral by providing two savings accounts: a normal savings account and an account in which money will be set aside to be used as collateral for a particular loan.

By reducing loan generation costs (by eliminating physical branches), increasing healthy personal finance (from the the non-profit), and increasing community responsibility (using community members’ collateral) it’s possible to give loans out at reasonable rates, say 8%-12% and still get a return of 5%. About 1.5% would be paid out as a high savings rate, which further encourages healthy finances.

*I heard about this general idea from an NPR story. The company was targeting developing countries though.

Inner City Banking - The motivation

It’s surprisingly expensive to be poor. Being poor usually means living in areas that have significantly higher crime than upper middle class suburbs. That means that you’re at a higher risk of being robbed (which is expensive because you then have to replace what was stolen). Another expense of being poor is not having a bank. The first effect of not having a bank is that you need to use a check cashing store to get your money. Check cashing stores usually take a cut of about 3% of the amount of the check. The next problem with not having a bank is that the inability to use credit cards may lead people to turn to payday loans to make ends meet. These loans typically charge interest at an annual percentage rate (ARP) of around 400-600%. Payday loans make credit cards look like a great deal. Not having a bank account is a serious impediment to people trying to get out of poverty.