Racism and the Economy: Focus on Financial Services - November 16, 2021

The tenth installment of our series focused on the impact of structural racism on our economy and advances ideas to improve economic outcomes for all Americans.


Barriers to Basic Financial Services Perpetuate Persistent Economic Gaps

By Charles Davidson

A discussion of fair access to financial services may, on the surface, seem less urgent than issues like housing discrimination and wealth inequality. Yet the ability to open a checking account, obtain a reasonable home mortgage or business loan, or quickly access money you've earned are critical steps in addressing historic racial disparities in economic outcomes.

"Being able to save and borrow money on fair and equitable terms is very much at the heart of financial security," Esther George, president of the Federal Reserve Bank of Kansas City, said in opening the 10th installment of the Federal Reserve's Racism and the Economy series.

The virtual event explored longstanding barriers that prevent disproportionate numbers of Black, Indigenous, and people of color (BIPOC) from accessing affordable financial services. These barriers perpetuate persistent gaps in wealth, income, home ownership, business growth, credit scores, and other economic measures between White Americans and communities of color. In the Racism and the Economy webinar, scholars, nonprofit leaders, bankers, and financial entrepreneurs who serve historically disadvantaged communities, along with a panel of three Federal Reserve Bank presidents, discussed the origins of those barriers and ideas to dismantle them.

Throughout the two-hour event, panelists discussed how traditional financial sector business approaches continue to thwart low-income and BIPOC communities' access to financial services. These exclusive approaches can involve unwitting cultural bias, predatory lending practices, ambiguous pricing and fee structures, and a reliance on credit scoring methods that are viewed in some quarters as outdated and sometimes discriminatory.

The pandemic-induced economic crisis highlighted the pernicious effects of many of those practices. For example, Black business owners nationwide struggled to secure Paycheck Protection Program (PPP) loans, according to research by Terri Friedline, an associate professor of social work at the University of Michigan and a panelist at Racism and the Economy: Focus on Financial Services.

Among other problems, Friedline discovered that in the rush to disburse PPP loans, banks relied on existing customer relationships, which more often involve White-owned businesses. Further, even among firms with good credit scores, Black-owned firms were about half as likely as White-owned companies to receive all the PPP financing they sought, according to the Federal Reserve's 2021 Report on Firms Owned by People of Color. Black- and Latinx-owned firms in many cases needed PPP assistance most, as they are concentrated in industries most affected by public health safety measures. Indeed, in the early months of restrictions meant to contain the pandemic, the number of Black and Latinx business owners in the United States fell by 41 percent and 32 percent, respectively, as the number of White owners declined 17 percent, according to an August 2020 report from the Federal Reserve Bank of New York.

The fallout continues, observed Bill Bynum, a webinar panelist and CEO of Hope Enterprise Corporation, a family of organizations that provides financial services and engages in advocacy based in Jackson, Mississippi. "Over the past 20 months, we've seen disastrous effects of relying on traditional banks to finance Black businesses," he said.

Privacy concerns different for people of color

In terms of cultural forces that hinder access to financial services, Friedline pointed out that people of color often must make different calculations from White people in deciding how much privacy to surrender to a financial institution or financial technology firm in exchange for convenient services.

"White people... may feel more comfortable sacrificing their privacy," Friedline said. "There's a whole different set of questions asking Black and Brown people to sacrifice more limited privacy and be subjected to surveillance in these other forms, particularly in our current moment."

Discomfort also can result from opaque pricing, panelists said. Lisa Servon, chair of the Department of City and Regional Planning at the University of Pennsylvania, spent a year working at payday lenders and check cashing storefronts to research why certain populations do not use traditional financial institutions. Customers use these alternative channels in part because bank branches generally don't display clear information about prices and penalties like overdraft fees. Payday lending and check cashing outlets, by contrast, have large signs detailing their services and prices.

Limitations for assessing credit scores undergird everything

Several speakers at the webinar suggested that the methods of compiling credit scores inherently work to the detriment of lower-income populations. A core assumption of credit scoring is that everyone starts adult life at the same point financially, and then some take actions that enhance their financial standing, like making mortgage payments on time, while others do not, said Camille Busette, senior fellow in economic studies and director of the Race, Prosperity, and Inclusion Initiative at the Brookings Institution. That core assumption, in her view, is a fundamental flaw at the heart of algorithms that generate credit scores.

"We need to reexamine some of the basic assumptions behind credit scoring," Busette said. "That undergirds everything."

Abbey Wemimo runs a firm focused on reworking the mechanisms behind credit scores. The cofounder and co-CEO of Esusu Financial, Wemimo described a proposal to credit renters for on-time monthly rent payments just as timely mortgage payments figure into the credit scores of homeowners.

Right now, only about 10 percent of rent payment data is captured and reported to credit rating agencies, Wemimo said. This affects a lot of people. About 110 million Americans pay aggregate annual rent of $1.44 trillion. Wemimo said requiring landlords to report on-time rent payments to credit agencies would unlock some $4 trillion in credit and other financing for mostly low- to moderate-income renters because they would enjoy better credit scores and thus broader access to financial instruments that are mostly off limits to them today.

"Let's give credit where credit is due," Wemimo said. "This would be not only advantageous to bridging the racial wealth gap but [would] contribute toward taxpayers' dollars and really fulfill the true founding creed of these United States, which is to make it (a) more perfect" union.

Another way perhaps to improve access to credit would be a return to relationship lending. Two panelists, José Quiñonez, CEO of the Mission Asset Fund, and Lakota Vogel, executive director of the Four Bands Community Fund, discussed the value of designing financial products based on what is working among "unbanked" or "underbanked" populations. What is working are informal financing arrangements rooted in immigrant or Indigenous cultures, including "lending circles" through which ordinary people pool their money and make loans to one another, Quiñonez noted.

An analysis of the small business-loan portfolio of Four Bands, a community development financial institution based on the Cheyenne River Reservation in South Dakota, showed that borrowers' character and commitment to their business—factors discernible only through personal relationships—mattered more than some traditional risk factors such as collateral, Vogel said.

Finally, Lisa Rice, president and CEO of the National Fair Housing Alliance, proposed a special-purpose credit program for first-generation home buyers. Rice explained that White households are 71 percent more likely than Black households to own their home, a gap that has not improved much in decades and continues to feed a corresponding Black-White wealth divide.

Special-purpose credit programs, she said, create a way for organizations to meet special social needs and benefit economically disadvantaged groups. If designed correctly, the programs can allow underserved consumers to circumvent structural inequities such as living in a credit desert or in a neighborhood hurt by appraisal bias or having a low credit score to obtain good, affordable credit.

Her proposal would also blend special-purpose credit programs with down payment assistance for first-generation home buyers.

Buying a home has, in fact, become so expensive, particularly for first-generation buyers, that it is time to overhaul the basic mortgage financing mechanism, said Robert James II, president of the National Bankers Association. "I think we need to look at the 30-year mortgage as a construct," James said in discussing Rice's proposal, "and start thinking about how we reengineer that to make it more relevant for the current economic environment."

Presidents discuss fast payments

A core purpose of the Racism and the Economy series is to examine what the Fed can do to advance economic inclusion. To that end, three regional Fed presidents commented on the day's panel discussions.

The presidents addressed the idea—raised by several panelists—that many people closed out of the mainstream financial system may be "unbanked" or "underbanked" in part because banks may not offer immediate access to their paychecks. If the funds
"really could be available immediately, I'm intrigued with the possibility of how many people might find that barrier reduced," If the bank's not open or available to you, you go to a check cashing outlet," said Tom Barkin, president of the Federal Reserve Bank of Richmond.

The Fed is working on a real-time payments service, FedNow, that could address that very need. Scheduled to go live in 2023 or 2024, FedNow is designed to allow money to move from account to account instantly, thus making a customer's money available to them immediately.

Atlanta Fed President Raphael Bostic added that speeding access to funds could indeed help dismantle structural racism in financial services. That step, Bostic continued, would bring the Fed closer to offering tools that respond to the daily realities of lower-income people, the ways they need to access and use their resources. He noted that in the drive to serve everyone in the economy, the Atlanta Fed this year established a Special Committee on Payments Inclusion. Forming that group constitutes a major step in the Atlanta Fed's work to ensure that payments innovations do not lock out consumers who rely on cash.

All these measures are part of the underlying goal, as Bostic put it, "to make being poor less expensive."

In closing the session, Minneapolis Fed president Neel Kashkari remarked that the series has exceeded organizers' hopes in stirring interest in confronting racism that is embedded in the nation's economic systems. Racism and the Economy will conclude in February 2022 with an event exploring ways the Fed can incorporate knowledge from the 10 topic-focused sessions into its work to advance economic inclusion.

"We have to look at what role we can play to try to improve outcomes for all Americans because we work for all Americans," Kashkari said. "This is fundamentally grounded in the mandate that Congress has given us, which is maximum employment—not full employment but maximum employment. Maximum employment—as many Americans as possible participating in our economy, contributing to our economic growth."