According to Margin Calls (2013, par. 2), a survey was conducted in December 2012 by the FDIC to establish the financial well being of Americans. The outcome of the study indicated that one in every 12 households in the U.S. lacked a current or a savings account, and the households were therefore unbanked. In addition, one in every 5 households in the U.S. was ‘underbanked’ based on the findings of the same survey. ‘Underbanking’ means that the households have a bank account that is not effectively utilized and the customers rely on other financial services such as payday loans and services of cheque-cashing. There is a direct link between the level of the unbanked households and the income gap in the U.S. This is because the unbanked households are three times the overall rate according to the FDIC survey. Using all other transactions other than a bank account means incurring a fee, which could have been saved if the account was used (Margin Calls 2013, par. 3).
The scenario is common in the U.S. as noted by Margin Calls (2013, par. 4), who argues that the unbanked households turn to payday lenders or obtain car title loans that are secured by their vehicles in order to obtain any credit that could have been obtained from banks had they used their accounts. Margin Calls (2013, par. 6) further notes that the ability of unbanked households to turn to payday lenders means that the firms are not making much money due to a large customer base, but it is because the borrowers are turning on other additional loans to cover their original debts that are very high. In another study conducted by the Financial Service Innovation, it was established that on average, payday clients take out an estimate of about 11 loans in a calendar year with an annual interest that is over 400%. This payday borrowing is not making the households rich but fleecing them since the rate of borrowing is too high.
Due to the high interest rates charged on borrowed funds, 18 states including the District of Columbia have outlawed payday lending that has high interest on repayment. This is only an indicator that the Federal government may soon begin regulating payday lending since it is worsening the income gap between the lower population decile and the upper income group (Margin Calls (2013, par. 9).
Income Gap in the U.S.
The gap in the income as defined by Winkler (2013, p. 8) is the difference exhibited in the incomes earned by the different participants in an economy. This means that not all participants get equal income since there are some that get high incomes while others low. The income gap is often presented as a percentage of the total population in a country. According to Winkler (2013, p. 6), the inequality of income as measured by the Gini coefficient in the U.S. has been on the increase over time and it is higher than any other developed country across the globe. He further argues that though simple to express the level of inequality in the U.S., its causes could be attributed to various factors. To begin with, globalization and advances in technology can simultaneously be used to explain the increasing inequality. While the skilled high class earn more based on technological change, the unskilled low class earn less and have lost membership to their unions.
The real after tax income in the U.S.s’ top 1% households has increased 275% since 1979 to 2007. The income for the remaining top quintile grew by 65% over the same period while the middle class’s income increased by only 37% over the same period. However, the bottom quintile experienced little growth that stood at 18% only and is shown in this figure below.
In addition to income, the top management represented by the CEOs earned 20 times more than the normal worker in 1965. However, they currently earn 383 times more than the normal employees. The level of income as a percent of the national income earned by the top 20% of the U.S. population rose from 42.6% to 50.2% in 2010. While the middle income saw its share decline from 53.2% to 46.5%, the Gini coefficient increased from 0.316 in the mid 1970s to 0.378 in the late 2000s.
In comparison to other countries, the U.S. has a higher income gap. For instance, France and Germany have a more equal level of income as compared to the U.S. with the two countries’ Gini coefficients being slightly over 30. For the case of the United Kingdom, though the Gini values are as high as 35, the level of inequality is less than that of the U.S (Kelly 2003, p. 35).
The economics of banking the poor is not as attractive as it was some years back. To begin with, the Dodd-Frank Act was amended by the Durbin Amendment thereby capping interchange fees. The Credit card and accountability bill had been enacted a year earlier and it had reduced the late fee that is charged on credit cards and the increases on the interest rates. The low interest rates have continuously reduced the income that banks earn on interest margins thereby making the industry unattractive for banks and leaving payday lenders to exploit the sector. According to Margin Calls (2013, par. 8), although every bank account used to earn some income for the banks, regulations after the crisis has left banking for the low class unprofitable for banks and thereby enabling the households to seek other means of meeting their bills but a higher cost than before. This only reduces their well being in the long run rather than helping them meet their obligations.
Due to regulations on banking that were imposed after the global financial crisis, it is evident that many people at the low end of the society do not have enough credit to obtain loans that can finance their obligations. Following this development, other sources have come up not only in the U.S., but other developing countries as well. While in the U.S. the payday lenders are common, paperless banking have been established in other developing countries to help the low income households that are not credit-worthy to banks. LL (2013, par. 5) argues that cashless transactions have increased in developing countries with a good example being the unveiling of M-PESA by Safaricom, a mobile phone company in Kenya, which is a developing country in sub-Saharan Africa. The firm offers loans to small time businesspersons that have no collateral to access large finances from banks. One of the benefits of cash-less transactions is that they are secure, can be easily traced and it is not easy to redirect them. However, the services offered increases costs of transactions for the low income households, especially when combined with brick and Mortar banks (LL, 2013, par. 3).
The services of lending to small groups are not isolated only to the U.S. and developing countries. Other developing and developed countries also have realized that small income businesses do not have collateral to borrow funds from banks are have established firms such as the payday lenders in the U.S. that offer loans to small businesses. For instance, Wonga, the loan ranger offers loans to small and medium enterprises in UK since the firms cannot access loans from banks. The market for such services is large since the number of households that cannot access bank loans is large and increasing. Despite the benefits of the households to access the loans from these payday lenders, the loans come at a higher cost than expected and the overall income is the widening gap between the upper class and the lower class. As noted by Middle Income Claptrap (2013, par. 10), this wide gap encompassed by the middle income trap is one reason for stagnation of economic development and sustainability for some countries such as North Korea and Brazil among others.
The income gap is a significant aspect in the U.S. economy since it is closely related to the economic growth and wellbeing of the country. The financial crisis left many businesses and families devastated with the federal government increasing restrictions on the creditworthiness of customers borrowing funds from banks. Due to restrictions, many people from the low income decile of the population lacked the collateral to borrow funds from banks. However, payday lenders emerged to offer financial services but at a higher cost thereby worsening the wellbeing of the income group and it could worsen the income gap in the long run. The situation is also common in other developing countries since small businesses obtain loans from microfinance and not banks. It is therefore important that banks target the low decile of the population to improve their well being and stop increasing the income gap, if not reducing it.
Kelly, M 2003, The Divine rights of Capital: Dethroning the Capital Aristocracy, Berrett-Koehler Publishers, Inc. San Francisco.
Margin Calls, 2013, ‘Life on the edges of America’s Financial Mainstream’, The Economist, Web.
Middle income Claptrap, 2013, ‘Do countries get trapped between poverty and prosperity?’ The Economist, Web.
Winkler, P 2013, Notes on Money Creation: Some Arresting Facts, Webster University, New York.
LL, 2013, ‘Bit Loans’, The Economist, Web.