By Nik MIlanovic, Forbes | November 3, 2020
The public banking model proposed in this article is not the same as the one proposed for NM, which is one that supports local revenues staying in the community for local benefits.
Banking in the United States has become – like many other critical services – stratified along class lines. Consumers with more assets and higher spending are rewarded for being customers with benefits like high APYs and robust credit card points. Poor consumers, meanwhile, are taxed for using financial services through fees and high APRs.
It is time for regional municipalities to create public, state-owned local banks focused on driving 100% financial inclusion.
For a sustainable retail banking system, it is a good thing that financial services are profitable. Banks are willing to broaden their risk apertures enough to serve lower-income consumers. As announced a week ago, has led the percentage of unbanked households in the US to drop from 7.7% to 5% (since 2009, the first year FDIC household data were available). Risk-based pricing is a feature, not a bug, of an industry that needs to profitably acquire and serve customers.
But ‘banked’ does not mean ‘fully addressed.’ An estimated 25% of Americans still turn to alternative financial institutions, not banks, for loans and savings. This status quo has led savvy entrepreneurs to create mission-oriented banks (like the recently-announced Greenwood) just to focus on underserved communities and compensate for an expensive consumer financial services standard.
We need to categorize access to basic financial services as a citizenship right (like healthcare and education), treat anything less than 100% provision as a market failure, and evaluate which public options can help consumers on the margins affordably access mainstream financial services.
A correctly-implemented public banking system should create a powerful ‘financial on-ramp’ from which consumers can graduate into banks. The devil is in the details, though: how can a federal government that has struggled to provide basic public services do this correctly?
One option: local state-owned public banks
Since the 2008 financial crisis erased the retirement savings and home ownership of countless Americans, advocates have been calling for a more conservative and inclusive consumer banking system to counterbalance the current system’s failures. Luckily, one fascinating recently-published feasibility study by Andrea Batista Schlesinger of HR&A Advisors outlines what this could look like.
The study defines a public bank as a, “financial institution that serves as a depository for municipal funds and operates with a mission to serve the public interest.” Their proposal is for the city of Philadelphia to establish and operate a public bank, focused on supporting local small businesses (one of many financial inclusion needs).
In addition to blanket-underbankedness in the US, the Philadelphia study highlights a few other shortcomings: racial disparities in banking, regional and local ‘banking deserts,’ and a lack of access to capital for small businesses (and diminished economic activity as a result).
The study recommends a few discrete steps for creating a local public bank, including establishing a regional bank authority, serving as a city depository, changing the collateralization requirement to accept deposits from non-public entities, allowing a city entity to invest in small businesses, and building internal banking capacity.
Notably, the study finds that if a municipality creates a public bank, and, “the public bank does not lend money […], then the bank runs at a loss and costs the City money.” However, A public bank that lends money […] could be an attractive proposition for the City,” achieving an ROAA (return on average assets) of 1.42% to 1.46%. Implication: a local or regional public bank could be a profitable enterprise for a municipality, rather than a tax or cost-center.
Though the Philadelphia study is focused on small business access to capital, its recommendations apply more broadly to consumer banking:
- Deliver market-rate and below market-rate loans to small businesses that achieve City priorities;
- Deploy patient capital with less pressure to foreclose on delinquent loans;
- Leverage stable capital to be a trusted guarantor and attract private investment; and
- Incentivize private capital to participate in small businesses loans.
That such a bank could be run with a positive ROAA provides strong support for the thesis that a public bank could be a powerful and sustainable on-ramp to drive financial success for consumers and small businesses.
A few recommendations I would add for a hypothetical local public bank:
- Partner with consumer groups like the Financial Health Network and Change Machine (formerly known as the Financial Clinic) to understand regional consumer financial needs and how to appropriately address them.
- Facilitate loans through entities like the Minority Business Development Agency.
- Leverage existing infrastructure like postal offices (a proposal that has been in vogue with some states recently) to radically lower costs while increasing banking footprint (especially offline, where it is needed).
- Explore feature-phone mobile wallets and digital financial services, similar to M-Pesa’s in Kenya, to increase real-time funds access for low-income consumers (who use phones as their primary point of internet access).
- Conduct an RFP for current retail banking partners to participate in the system (possibly as senior-secured lenders) and hold a comment period for input from private banks.
- Create institutional goals and measures built around consumer financial health.
Fortunately for these recommendations, we’re not limited to hypothetical examples: the Bank of North Dakota, founded over 100 years ago, validates the Philadelphia study thesis on the viability of regional public banking. As the study notes, “BND has achieved record returns in recent years, and it principally serves the state and does not require local governments to deposit their funds.”
The BND was originally founded to protect North Dakota farmers, who had little in the way of financial options, from predatory terms levied on them by coastal banks. Today, the bank makes business and student loans deemed too risky by other banks. As David Flynn, economics department chair at the University of North Dakota, notes, BND can “point to [their] mission and say, ‘We’re helping growth, the growth helps the state.’”
The BND is not alone, even in the US; the Puerto Rico Government Development Bank and the Territorial Bank of American Samoa are both publicly-operated banks for the benefit of their territories.
Let’s move beyond abstract proposals to concrete implementations of the local state-run banking model. Americans deserve a better, healthier, and more inclusive financial system.