How Fintechs Can Help Advance Financial Inclusion

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Last year, the coronavirus pandemic swiftly shut down the U.S. economy. Demand for manufactured goods stagnated while restaurant activity fell to zero. The number of unbanked and underbanked persons looked likely to increase, after years of decline. However, federal legislation has created incentives for community banks to help those struggling financially. Fintechs can also play an important role.

The Covid-19 pandemic has affected everyone — but not all equally. Although the number of American households with bank accounts grew to a record 95% in 2019 according to the Federal Deposit Insurance Corp.’s “How America Banks” survey, the crisis is still likely to contribute to an increase in unbanked as unemployment remains high. Why should banks take action now?

Financial inclusion is critical — not just for those individuals involved, but for the wider economy. The Financial Health Network estimates that 167 million America adults are not “financially healthy,” while the FDIC reports that 85 million Americans are either unbanked or “underbanked” and aren’t able to access the traditional services of a financial institution.

It can be expensive to be outside of the financial services space: up to 10% of the income of the unbanked and underbanked is spent on interest and fees. This makes it difficult to set aside money for future spending or an unforeseen contingency. Having an emergency fund is a cornerstone of financial health, and a way for individuals to avoid high fees and interest rates of payday loans.

Promoting financial inclusion allows a bank to cultivate a market that might ultimately need more advanced financial products, enhance its Community Reinvestment Act standing and stimulate the community. Financial inclusion is a worthy goal for all banks, one that the government is also incentivizing.

Recent Government Action Creates Opportunity
Recent federal legislation has created opportunities for banks to help individuals and small businesses in economically challenged areas. The Consolidated Appropriations Act includes $3 billion in funding directed to Community Development Financial Institutions. CDFIs are financial institutions that share a common goal of expanding economic access to financial products and services for resident and businesses.

Approximately $200 million of this funding is available to all financial institutions — institutions do need not to be currently designated as a CDFI to obtain this portion of the funding. These funds offer a way to promoting financial inclusion, with government backing of your institution’s assistance efforts.

Charting a Path Toward Inclusion
The path to building a financially inclusive world involves a concerted effort to address many historic and systemic issues. There’s no simple guidebook, but having the right technology is a good first step.

Banks and fintechs should revisit their product roadmaps and reassess their innovation strategies to ensure they use technologies that can empower all Americans with access to financial services. For example, providing financial advice and education can extend a bank’s role as a trusted advisor, while helping the underbanked improve their banking aptitude and proficiency.

At FIS, we plan to continue supporting standards that advance financial inclusion, provide relevant inclusion research and help educate our partners on inclusion opportunities. FIS actively supports the Bank On effort to ensure Americans have access to safe, affordable bank or credit union accounts. The Bank On program, Cities for Financial Empowerment Fund, certifies public-private partnership accounts that drive financial inclusion. Banks and fintechs should continue joining these efforts and help identify new features and capabilities that can provide affordable access to financial services.

Understanding the Needs of the Underbanked
Recent research we’ve conducted highlights the extent of the financial inclusion challenge. The key findings suggest that the underbanked population require a nuanced approach to address specific concerns:

  • Time: Customers would like to decrease time spent on, or increase efficiency of, engaging with their personal finances.
  • Trust: Consumers trust banks to secure their money, but are less inclined to trust them with their financial health.
  • Literacy: Respondents often use their institution’s digital tools and rarely use third-party finance apps, such as Intuit’s Mint and Acorns.
  • Guidance: The underbanked desire financial guidance to help them reach their goals.

Financial institutions must address both the transactional and emotional needs of the underbanked to accommodate the distinct characteristics of these consumers. Other potential banking product categories that can help to serve the underbanked include: financial services education programs, financial wellness services and apps and digital-only banking offerings.

FIS is committed to promoting financial inclusion. We will continue evaluating the role of technology in promoting financial inclusion and track government initiatives that drive financial inclusion to keep clients informed on any new developments.

Highlights From CECL Adoption

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On Jan. 1, 2020, approximately 100 SEC financial institutions with less than $50 billion in assets across the country adopted Accounting Standards Update 2016-13, Financial Instruments—Credit Losses (Topic 326) Measurement of Credit Losses on Financial Statements.

More commonly referred to as “CECL,” the standard requires banks to estimate the credit losses for the estimated life of its loans — essentially estimating lifetime losses for loans at origination. Not all banks adopted the standard, however. While calendar-year SEC filers that are not considered to be smaller reporting companies or emerging growth companies were set to implement the standard at the start of 2020, the Coronavirus Aid, Relief, and Economic Security Act and subsequent Consolidated Appropriations Act, 2021, allowed them to delay CECL implementation through the first day of the fiscal year following the termination of the Covid-19 national emergency or Jan. 1, 2022. Of the publicly traded institutions below $50 billion in assets that were previously required to adopt the standard, approximately 25% elected to delay.

Highlights from the banks that adopted the standard could prove very useful to other community banks, as many work toward their January 2023 effective date. A few of the relevant highlights include:

  • Unfunded commitments had significant effects. It is important that your institution understands the potential effect of unfunded commitments when it adopts CECL. The new standard has caused significant increases in reserves recorded for these commitments. At institutions that have already adopted the standard, approximately 20% had a more significant effect from unfunded commitments than they did from funded loans.
  • Certain loan types were correlated with higher reserves. When comparing the reserves to loan concentrations at CECL adopters with less than $50 billion in assets, institutions with high levels of commercial and commercial real estate/multifamily loans experienced larger increases in reserves as a percentage of total loans for the period ended March 31, 2020.
  • Certain models were more prevalent in banks with less than $50 billion in assets. Approximately 60% of the banks with less than $50 billion in assets indicated they used the probability of default/loss given default model in some way. Other commonly used models were the discounted cash flow model and loss rate models. Less than 10% of adopters so far have disclosed using the weighted-average remaining maturity (WARM) model.
  • One to 2 years were the most commonly used forecast periods. The new standard requires banks to use a reasonable and supportable economic forecast to guage loss potential, which demands a significant amount of judgment and estimation from management. Of the banks that adopted, more than half used 1 year, and approximately a quarter used 2 years.
  • Acquisitions impacted the additional reserves recorded at adoption. Of the 10 CECL adopters with the most significant increases in reserves as a percentage of loans, nine had completed an acquisition in the previous year. This is due to the significant changes in the accounting around acquisitions as a part of the CECL standard. The new standard requires reserves to be recorded on purchased loans at acquisition; the old standard largely did not.
  • Reserves increased. Focusing on banks that adopted CECL in the first quarter that have less than $5 billion in assets (21 institutions), all but one experienced an increase in reserves as a percentage of loans. Approximately 70% of those institutions had an increase of between 30% and 100%.

The CECL standard allows management teams to customize the calculation method they use, even among different types of loans within the portfolio. Because of that and because each bank’s asset pool will look a little different, there will be variations in the CECL effects at each institution. However, the general themes seen in these first adopters can provide useful insight to help community banks make strides toward implementation.

This article is for general information purposes only and is not to be considered as legal advice. This information was written by qualified, experienced BKD professionals, but applying this information to your particular situation requires careful consideration of your specific facts and circumstances. Consult your BKD advisor or legal counsel before acting on any matter covered in this update.