The Inequality of Fintech

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Scholars argue that regulators should act now to prevent fintech from exacerbating wealth inequality.

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In areas such as instant mobile payments and online car purchases, fintech is transforming the way we spend and think about money. But is this transformation coming at the cost of deepening existing inequalities?

Innovative uses of financial technology, such as instant payments or online lending make it easier to access money. But they also evade existing regulations designed to protect consumers, two scholars claim. New regulation is needed to prevent fintech from worsening wealth inequality, argue Pamela Foohey of the Cardozo School of Law and Nathalie Martin of the University of New Mexico School of Law in a forthcoming article.

Foohey and Martin point to several fintech innovations that sound beneficial but have the potential to trap consumers in a cycle of debt.

One innovation they highlight takes the form of payroll cards, which essentially function as paychecks in the form of prepaid debit cards. Payroll cards allow employers to transfer money to employees without bank accounts—predominantly lower-income workers.

Foohey and Martin acknowledge that payroll cards streamline access to paychecks for workers without bank accounts. But they also note that the fees associated with these cards eat up significant portions of workers’ paychecks. A 2014 study of New York workers paid with prepaid cards found workers paid an average of $20 a month in fees, equivalent to approximately three hours of work at minimum wage.

Foohey and Martin argue that prepaid cards’ ease of use paradoxically makes it harder for lower-income workers to build up savings by discouraging them from opening bank accounts. The result, Foohey and Martin contend, is that lower-income consumers end up paying hundreds of dollars in avoidable fees each year.

Foohey and Martin identify early wage access programs as another example of a fintech innovation that promises to benefit low-income workers but ultimately exacerbates inequality. These programs allow workers to access their monthly earnings in advance—with interest—via a few clicks on a website.

Data on early wage access programs show that they are overwhelmingly used by low-income workers. Even though the programs allow workers to obtain access to cash, Foohey and Martin argue that these benefits come with a hefty price. One analysis showed some users of these programs end up paying astronomical annual interest rates of up to 1,200 percent. Because providers claim that the programs are “money transmission” services rather than loans, borrowers lack any of the normal disclosure protections required for loans, according to Foohey and Martin.

Online auto lending platforms are yet another potentially exploitive fintech practice that Foohey and Martin highlight. These websites allow customers to shop for cars, obtain financing, and purchase vehicles—all without ever setting foot in a dealership. Like early wage access and prepaid cards, online auto lending makes it easy for consumers to make critical financial decisions in a matter of minutes.

Foohey and Martin point to a now-defunct program run by Uber to illustrate the pitfalls of online auto lending. To help new drivers purchase vehicles, Uber created an online platform to connect them with lenders. A Federal Trade Commission investigation into the program found that drivers paid far higher interest rates than typical for their credit scores. Drivers who fell behind had back payments withdrawn directly from their paychecks, a system Foohey and Martin compare to “indentured servitude.”

As new fintech innovations such as these continue to spring up, Foohey and Martin spotlight several steps regulators can take to respond.

First, the U.S. Congress could pass legislation capping interest rates for all borrowers. Congress already enacted legislation requiring lenders to charge military borrowers no higher than 36 percent interest rates. Foohey and Martin claim that extending this cap to all loans could prevent exorbitant interest rates that disproportionally affect low-income borrowers.

Second, regulators should push banks to increase their offerings to low-income individuals. Encouraging these individuals to create traditional bank accounts would give them an alternative to less regulated—and potentially more exploitative—options such as early wage access programs and payroll cards, Foohey and Martin claim.

Third, Foohey and Martin encourage regulators to address discrimination in new financial products. Even though federal law currently prohibits discrimination in lending based on factors such as race and sex, consumers face extreme difficulty in proving discrimination from new financial products because of the complexity and opacity of the algorithms they employ. Reforms to make it easier for consumers to pursue these claims could encourage fintech companies to address bias in their algorithms, Foohey and Martin argue.

Finally, the government could directly step in to provide a viable alternative to exploitive financial products. One option would be postal banking—which would allow Americans to set up accounts directly managed by the United States Postal Service. Other countries have proven the postal banking model works by creating a convenient and effective way to manage money for low-income individuals, according to Foohey and Martin.

With or without new regulation, fintech innovations will likely continue to shift the financial landscape. For Foohey and Martin, the central issue for regulators is whether this shift will throw low-income individuals a lifeline—or further cast them adrift.