Chairman Leach, Mr. LaFalce, and Members of the Committee, my name is Michael Stegman, and I am pleased to be here today to testify on H.R. 4490, the First Accounts Act of 2000, and related issues associated with bringing more Americans into the mainstream banking system. I am professor of public policy and business, chairman of Public Policy, and director of the Center for Community Capitalism at the University of North Carolina at Chapel Hill. I have been on the UNC faculty for 35 years, teaching and conducting research in affordable housing, and community and economic development finance. From May 1993 to June 1997, I was on leave from UNC to serve as Assistant Secretary for Policy Development and Research at the Department of Housing and Urban Development under Secretary Henry Cisneros.

The Center for Community Capitalism seeks to create public policies that foster innovative community development partnerships with the business community to reinvigorate markets, and grow jobs, incomes and wealth in America’s under-invested communities. Since returning to the university three years ago, a major portion of my work has involved EFT’99--the government’s move to deliver federal benefits electronically--and how electronic benefits transfer can bring millions of families into the mainstream banking system, helping them save for their futures. My book, Savings for the Poor: The Hidden Benefits of Electronic Banking, published by Brookings Institution Press in September 1999, chronicles the challenges and opportunities of EFT’99.

I mention my work in electronic benefits transfer because the activities authorized by the proposed First Accounts Act of 2000 (H.R. 4490) would complement and leverage the programs and resources associated with EFT’99. Among other things, EFT encourages unbanked federal check recipients to open a bank account so that they can receive their benefits by direct deposit, and provides incentives to mainstream financial institutions to create low-cost electronic transfer accounts (ETA’s) to serve this population.

H.R. 4490 would authorize an appropriation of $30 million to the Secretary of Treasury in fiscal year 2001 to support the financial education of unbanked persons, improve their access to financial services, and encourage the development of new financial products and services by mainstream financial institutions to serve their needs. This measure recognizes that EFT’99 targets only about half of the unbanked population, and that for the unbanked to become a commercially viable market, mainstream financial institutions must create accounts, marketing strategies, education campaigns, and delivery systems that target all 10 million unbanked American families.

As you know, EFT’99 led to the development of an inexpensive electronic transfer account that is now being offered by more than 600 financial institutions across the country and in Puerto Rico. The specifications of the ETA account and associated EFT’99 communications and marketing strategies were informed by important Treasury-sponsored market and product-development research. Among other things, the First Accounts initiative should support additional market research that targets those who are not eligible to open an ETA because they differ in significant ways from the EFT’99 population, especially in their age distribution. For example, while about 70 percent of federal benefit recipients receive Social Security payments, we estimate that just 4 percent of non-EFT’99 unbanked household heads are 62 years or older. It stands to reason, therefore, that the banking needs and tastes of these two populations might also differ in significant ways.

H.R. 4490 also has the potential to address the two critical dimensions of the problem of inadequate access to financial services that confront millions of low- and moderate-income persons. One dimension—reflected in Treasury’s on-going efforts to work with financial institutions to expand access to ATMs in safe, secure, and convenient locations, like post offices—focuses on improving physical access to mainstream services. The First Accounts initiative would, presumably, increase and accelerate these and similar partnerships. Initiatives like these have become necessary because of the recent spate of bank failures, mergers, acquisitions, and resulting branch closings. According to Federal Reserve data, the number of bank branch offices in low-income neighborhoods has declined by 21 percent over the past twenty years. Between 1978 and 1995, for example, Brooklyn lost around 14 percent of its bank branches and the Bronx, about 20 percent; a disproportionate share of closings occurred in the poorest neighborhoods.

But proximity and convenience is much less important in determining whether a family is banked or not, than it is in a family’s choice of bank to do business with, once it decides to have an account. Federal Reserve data indicate that just 1 percent of all unbanked families cite inconvenient hours or location as the most important reason for being unbanked, while 59 percent of all banked families cite location and convenience as the most important reasons why they chose the bank that they did. In contrast, 18 percent of the unbanked don’t have an account because they simply don’t like dealing with banks. It is important that the First Accounts initiative explore more carefully the cultural and psychological dimensions of the inadequate access issue.

Perhaps, more market research could also help us understand why so many previously banked families have decided to leave the mainstream banking system. Forty-six percent of all unbanked families have previously owned a transaction account, which is down from 48 percent in 1995. That the unbanked population consists of a growing core of families who have never been part of the financial mainstream is another reason why it makes sense for the federal government to forge alliances with financial institutions and community partners in an effort to reach a greater share of this more estranged population.

Because families are unbanked for different reasons, in all likelihood, it will take different products and marketing strategies to attract the never banked as customers compared with the previously banked. For instance, never-banked families are more than twice as likely to say they don’t write enough checks to make it worthwhile to have an account (35% vs. 16% of previously banked), and they are nearly twice as likely to have a strong dislike of banks (27% vs. 16% of previously banked). Unbanked families who were previously banked are more likely to have closed their accounts because of what they deem to be excessive fees--they are about four times more likely to be unbanked because of high service charges than those who have never had an account (15% vs. 4%).

H.R. 4490 comes at a good time because it should enable government and industry working together to leverage the positive impacts of the strong economy. According to the Federal Reserve, between 1995 and 1998, the number of unbanked declined by about 25 percent, from about 13% to 10% of all families. The good news is that minorities made the greatest gains—with unbanked rates falling by almost 30 percent among African Americans (36%-26%), and by about 17% among Hispanics (30%-25%). Smaller shares of all age groups were unbanked in 1998 compared with three years earlier, save for those 65 years or older, whose rate was unchanged.

While we do not know for sure what accounts for this broad-based decline, the strong economy may have something to do with it. This is suggested by the 35 percent decline in the number of families who cited as the number one reason why they were unbanked that they do not have enough money to make it worthwhile (from 20% in 1995 to 13% in 1998). Federal Reserve data also suggest that banks might be doing a better job of marketing their products to low- and moderate-income populations. As indicated above, while a sizable percentage of unbanked families continue to say that they are unbanked because they just don’t like dealing with banks, their numbers have also sharply declined. In 1995, 23 percent of all unbanked families cited this reason, compared with just 18 percent in 1998.

Despite this good news, far too many Americans remain outside the financial mainstream. In 1998, 9.5 million families containing more than 25 million persons were without a bank account of any kind. And, just as in the mortgage market, there continues to be pronounced racial differences in the use of banks. Nationally, about one-quarter of African American and Hispanic families are unbanked, compared with just 5 percent of non-Hispanic white households. Just fewer than twenty percent of all families with incomes under $30,000 are unbanked, and between 13-14 percent of unmarried men and women are unbanked, compared with just 5 percent of married couples.

While lower income families are still much more likely to be unbanked, the good news is that incidence falls very rapidly as income rises. While more than one-quarter of all families with incomes under $20,000 are unbanked, just 7 percent of families with incomes between $20,000-$30,000 are without an account, while the unbanked rate plummets to just 3 percent for families with incomes between $30,000-$50,000.

A successful First Accounts initiative (as well as EFT’99) will not only give unbanked persons a more efficient way to cash checks and access other financial services, it also has the potential to help millions of unbanked, low- and moderate-income families begin to make financial plans and save for their futures. This is important because unbanked families are much less likely than similarly situated families with bank accounts to accumulate savings, to have a cushion against unforeseen family emergencies or even a brief spell of unemployment. According to the Federal Reserve, unbanked families with incomes of less than $30,000 has median assets of just $2,000 compared with more than $51,00 for similarly situated banked families. And the median value of assets held by all unbanked families in 1998 was just $2,300, and for more than half of them (54%), their only asset, if they held any, was their car.

Without bank accounts, unbanked families are not able to take full advantage of savings incentives like those contained in the more than 350 local individual development account (IDAs) programs across the country that match savings deposits of working families on a dollar-for-dollar basis, and are less likely to take advantage of national savings incentives that Congress may enact as part of, or in conjunction with, Social Security reform.

Another reason why targeted savings incentives may be important to the ultimate success of EFT and First Accounts, has to do with the economics of low-cost, low-balance, high turnover bank accounts. Treasury-sponsored research suggests that banks can expect to earn little float on electronic accounts that are limited to the receipt of federal benefits by direct deposit. The Texas pilot conducted by Citibank in 1996 found that because accountholders needed their Social Security and Supplemental Security Income (SSI) benefits to live on, they emptied their accounts in a matter of days, with the result that a financial institution might see earnings of only $0.19 per account per month.

Individual Development Accounts (IDAs), or other program to encourage working families to save a little each month over a sustained period, would not only help address a critical savings deficit, but by providing banks a source of cheap, longer-term deposits, would also improve the economics of basic bank accounts by increasing the float.

I believe that if all the pieces fall into place, EFT’99 and First Accounts can do for the provision of affordable financial services what the Community Reinvestment Act has done to increase the supply of affordable mortgage credit in under-served communities— and that is, to prove the commercial viability of the low- and moderate-income market for retail banking services by mainstream financial institutions. The other pieces of the national strategy for financial inclusion include a national financial education campaign and new savings incentives for working families who do not now benefit from existing tax-preferred savings incentives such as 401(k) s or Roth IRAs.

Mr. LaFalce, your letter inviting me to testify this morning also asked me to comment on H.R. 4584, which would require insured depository institutions to make available to consumers a low-cost basic transaction account.

I applaud the purposes of this legislation. In this era of mega-mergers, branch closings in lower income neighborhoods, uncertainty over whether the poor will have access to the new banking technology, and the increasing use of EFT, I believe that federal government should pay more attention to just how effective a financial institution’s retail delivery system is in low- and moderate-income neighborhoods. One way of doing this is by strengthening the community development services test under the Community Reinvestment Act (CRA).

As you know, there are three performance-based measures of CRA compliance: community development lending, investment and service. The service test, which focuses on the availability and effectiveness of an institution’s retail banking delivery system, is the compliance measure that is most relevant to EFT, First Accounts, and Basic Banking initiatives. Current CRA regulations assign twice as many points to a for achieving an outstanding rating under the community development lending test, than for achieving an outstanding rating under the community development services tests, which includes the quality of the bank’s retail banking system. Because CRA was enacted to combat credit redlining, it is understandable why the rating system was set up to favor the provision of affordable credit. However, to support First Accounts and its broader vision of financial inclusion and wealth-accumulation, it may be time to increase the weight assigned to the service test.

Giving more weight to the service component of the CRA compliance test would be strong incentive for banks to reexamine the way they provide and market basic retail banking services. At the same time, rewarding institutions for more aggressively providing affordable banking services in low- and moderate-income communities should not reduce affordable lending activities. As Federal Reserve economists recently reported, community development finance has proved to be a profitable business line for many financial institutions. According to Glenn Canner and Wayne Passmore "Lenders active in lower-income neighborhoods with lower-income borrowers appear to be as profitable as other mortgage-oriented commercial banks." Thus, lenders now have a strong incentive to maintain active lending programs even without the double weight given such activities under the current CRA regulations.

Mr. Chairman, that completes my prepared testimony. I will be pleased to answer any questions that the Committee might have.