BNA INSIGHTS: How Going Postal Could Help the Underbanked

By Mehrsa Baradaran

 

Mehrsa Baradaran is Associate Professor at the University of Georgia School of Law. She is author of How the Other Half Banks, published 2015 by Harvard University Press, from which this Insight is excerpted.

All credit worthy Americans deserve equal access to credit, especially because reasonable and safe credit can provide a path out of poverty. If banks are not providing credit to the poor, the state should provide it directly. The existing post office framework represents the most promising path toward effectuating such a public option.

There have never been barriers to entry at post offices, and their services have been available to all, regardless of income. And so, it is not unreasonable to suggest that as America's oldest instrument of democracy in action, the post office can once again level the playing field, and in the process, save itself from imminent demise.

In fact the post office inspector general's office, a small regulatory branch of the post office, issued a White Paper report in January 2014 proposing just such a move. As of this writing, the postmaster general has not publicly supported the proposal and no congressional committee has seriously considered postal banking.

The basic idea of modern postal banking is a public bank offering a wide range of transaction services, including deposit-taking and small lending. The post offices could offer these services at a much lower cost than banks and the fringe industry because (1) they can use natural economies of scale and scope to lower the costs of the products, (2) their existing infrastructure significantly reduces overhead costs, and (3) they do not have profit-demanding shareholders and would be able to offer products at cost.

Postal banking may seem radical to many in the United States who remain convinced that banking should be a 'private market’ free from 'government intervention,’ but it is a mundane part of life for the rest of the world. Postal banking has operated in many Western countries since the 1800s, and currently, 51 countries use postal banking as their primary method of financial inclusion - only 6 percent of postal

Postal lending will likely be controversial, but it has the potential to radically advance the lives of the American public while balancing the skewed credit markets. Lending even small loans of less than $500 at a reasonable interest rate can help a significant portion of the American public withstand a short-term credit crunch. Much like central bank liquidity for struggling large banks, the post office would provide liquidity for struggling individuals.

Structured Loans

These loans would need to be structured such that they provide borrowers with a reasonable path toward repayment. As “unsecured” loans, or loans without an asset given as a security, these loans can take a few forms. They can be designed as low-cost installment loans, like those created by Arthur Morris.1 These loans are repaid over time with a set number of scheduled payments for a set term (anywhere from one month to several years). Much like a mortgage, which is a “secured” installment loan, each payment goes toward both principal and interest. Payments can be made in person or electronically deducted from the borrower's bank account, and a cosigner can even be used to guarantee the loan and reduce the risk of default.

The post office can also offer a lower-cost short-term loan. The loan would carry a fee or an interest rate for an up-front loan and a term of a few weeks or months. The borrower could pay down the principal without accruing additional fees and if the borrower needed more time to pay, he or she would take out another loan and pay another fee. There would need to be a limit on how many times the loan was “rolled over” so as to avoid accumulating debt.

These funds would come from the same sources from which banks lend: deposits, other business revenues, and central bank lending. How- ever, the scale would be much smaller. Even if the post office were to lend half the American public (about 150 million people) $500 each, that would equal $75 billion, which is just 1 percent of the $7.7 trillion the Federal Reserve pledged to the largest banks in 2009.7 Just as the federal government has enabled other markets for credit, so too can it enable this one. It would operate as any other bank, with a central-bank cushion and liquidity support. In other words, little to no taxpayer money need be used in postal lending. However, banking is already a heavily

subsidized sector, so any required startup or ongoing capital infusion would just bring credit services to the low-income on par with the rest of the population.

Reducing Risk

Still, all lending is risky. Postal savings accounts and financial trans- action products bear little to no risk of loss, but lending money some- times means losing money, especially when it comes to lending to average people with little financial cushion. Although the case can be made that these households need the credit more than any others, it would be unwise for the post office to lend if it meant losing money.

In order to reduce the risks inherent to lending, the post office would need to create a system of strong collection and underwriting standards. It can mitigate collection risks in the same way as other lenders by requiring a cosigner, securing an interest on future wages, or employing other legal mechanisms. Debt collection costs are one of the primary causes of the high fees attached to small loans. They are also a way in which the post office can use its unique position in the federal government to lower the cost and risk of lending small loans.

Though details would need to be hammered out, the post office inspector general's White Paper suggests that the post office can collect debts using a Treasury Department program only available to federal agencies that allows the garnishment of tax refunds. By using a low-cost and effective collection mechanism unavailable to any other lender, the post office can significantly alter the market forces in small lending.

Precautions would need to be taken to maintain the confidentiality of borrowers and provide indebted borrowers with appropriate recourse in the event of error or undue hardship. In this, the government is also uniquely capable. Government agencies can offer much more privacy and process to customers than any fringe lender or bank. The govern- ment has developed a set of norms and laws that direct the behavior of its agency actors and ensure that all citizens have the right to contest unfair or arbitrary government action.8

In contrast, fringe lenders often collect and share customer data and sell defaulting loans to other private buyers--transactions that are often kept secret. Once you have entered into a contract for a loan with one of these lenders, the right to collect on that loan can be sold to any third party. The post office's collection process, on the other hand, would have to be made public and submitted to agency and legislative review, which would offer more transparency than any other current lending and collecting mechanisms. The individuals involved would maintain the same, if not higher, privacy protections granted to all other customers of regulated banks.9

Underwriting Procedures

A system of strong and accurate underwriting procedures that can adequately separate the insolvent from the merely illiquid will also need developing. Of course, this is easier said than done. Creating a foolproof formula to accomplish such a thing would require the ability to accurately predict the future. There will always be loans that default as long as human beings are responsible for repaying them. Those with low to moderate income are no less responsible or capable of paying back a small low-cost loan than a large corporation is of paying back a large one. Any individual or company, wealthy or poor, can take out too much loan at too high a cost and be crushed by it. Formulas such as credit scores that track an individual's history of previous repayments can eliminate some of the guesswork.

However, when it comes to distinguishing creditworthy borrowers among the low income, credit scores are often too blunt a tool. Innovative private lenders have already realized this and are working to develop fine-tuned underwriting formulas based on publicly available borrower data to predict loan default with better results than credit scores.10Pioneering peer-to- peer Internet lenders have begun to boast of their success deploying these emerging mathematical models for small lending. The post office can rely on this developed expertise in designing its own underwriting system.

Distinguishing the merely illiquid from the insolvent is no easy task but is at the crux of any successful effort to provide credit to the poor. The credit unions, Morris banks, and savings and loans thrived because they succeeded in doing just that. They used the tools available to them at the time: community ties, close relationships, and character. Relational lending is difficult today, even though postal employees would probably be well suited to the task. After all, in many rural communities across the country, postal workers glean more information about the town's population than any other citizen. However, this is not the case with every community, and it is unclear whether such knowledge could be parlayed into accurate loan underwriting without significant training.

The post office need not rely on relational lending for good under- writing today but must learn to adopt existing modern technology to offer fair, useful, and self-sustaining products to those neglected by main- stream banks. The post office must also account for loan losses through accurate pricing, capital buffers, reserves, and other rules of sound banking so that it does not face a persistent shortfall. However, in the event that it does suffer a liquidity shortage, any government help to restore its balance sheets would only level the lending playing field.

Lower costs

There are several reasons to believe that the post office is uniquely capable of lending responsibly while reducing the costs of small loans. Most importantly, the post office is not an institution motivated by profit- making and therefore, will charge borrowers the actual cost of the loan. This has been the necessary premise behind every successful movement to foster financial inclusion.

The savings and loans, the credit unions, and the postal savings banks successfully achieved their goal of financial inclusion as long as they refused to let profits supplant their public duties. The post office is an independent agency connected to the federal government, which means that all excess profits are forfeited to the Treasury. Because the post office has no shareholders demanding a re- turn on investment, it is unlikely to be motivated to take advantage of its customers for private gain. All gains will be public, as will losses. A board of directors, presumably public representatives chosen by a democratically elected president, would be tasked to oversee its activities.

In addition, the post office can naturally reduce the high costs of lending to the poor because of its already large network of existing branches. Compared to payday lenders, the post office can use its present infrastructure and staff, thus saving money otherwise spent on advertising, marketing, personnel, and stores. It can add revenue on day one without the expense of starting from scratch.

One of the important lessons of banking history is that large and national banks won out against small unit banks, in part, because of natural efficiencies. The size and reach of the post office can lead to lower costs of credit. This ability to offer more at a lower cost is why large banks now dominate the market.

Economies  of  scale, or the control of a large market for a single product, could bring down the costs for financial services and even loans if the post office has enough customers. Economies of scope, the costs saved when an institution can sell a variety of products, could result in, for example, lower loan costs because the post office attracts more deposits, cashes more checks, or wires more funds.

Finally, because the post office never left the regions forsaken by the banks and other businesses, it has developed an ongoing relationship of trust with these communities. Many unbanked individuals already buy money orders at their local post office. This means that the post office has access to a customer base that is not comfortable in banks. Surveys of the unbanked show that minority groups are significantly more likely to be unbanked than other groups.13 This is especially true in certain regions of the country, such as the South for blacks, regardless of in- come or financial status. Certain groups simply do not patronize banks because they do not trust them. But the cultural and class barriers that keep many people away from mainstream banks do not exist at the local post office.

Even those who never go to their local post office branch are familiar with the mail carrier who visits their home daily. And following history's cue, the postal network can offer information in more languages than do banks and appeal to the large population of immigrants, or even the undocumented, who have money to save, but no access to banks. Many of these workers currently send their money abroad-- money that can be induced to stay within America's borders. As it was in the 1900s, this can be a surprising source of revenue for the postal banks.

Trust, especially in banking, consists of more than jus a “nice feeling.” It is a way to lower costs and reduce barriers of entry. This was the point of government deposit insurance. Banks cannot survive if their customers do not trust them to hold and lend their money. It is hard to predict whether the public will warm to postal banking, but in light of historical and international experience and the significant modern distrust of fringe banks, the public may view the post office as a safer and more trustworthy place to store funds.

If this is the case, the post office may even decide to forego the added costs and regulatory burdens of FDIC deposit insurance because the post office's position as a federal agency and its access to the Treasury's deep pockets can fulfill essentially the same function as FDIC insurance. If the goal of federally funded de- posit insurance has been to stop bank runs, it would be redundant for a deposit account linked to the federal government to also be insured by it. In fact, in the 1900s postal banking was considered a safer and more complete substitute to quell banking panic than federal deposit insurance.

The public already trusts the U.S. Postal Service and this trust is not undeserved. The post office enjoys a history of service to the American people unrivaled by any other institution or government entity. If our banks with a soul no longer serve the poor, perhaps a government institution with a soul can replace them--an institution that has, at its core, a public-serving function.

1 Morris was a Virginia lawyer who, beginning in 1910, offered loans to low-wage workers who were denied bank loans and would otherwise be forced to seek credit from high-interest loan sharks. Morris' loans were repaid over time.