The Association of Alternative Financial Services Usage and Financial Inclusion: Evidence from the National Financial Capability Study

Background and Purpose

The 9.7 million unbanked U.S. households lack access to affordable savings and credit options from formal financial services providers. This population meets their financial transaction and credit needs using cash, or the nonbank financial services providers (i.e., Alternative Financial Services (AFS)).  Thus, the unbanked miss opportunities to access lower-cost financial products and services, build credit and wealth, and gain a financial foothold toward a better financial status. The unbanked population is increasingly a focus of policy and program efforts to encourage and facilitate being banked through financial literacy efforts and policy work. Few studies have used a full compliment of AFS indicators with a nationally representative sample to provide a robust indication of the strength and direction of the relationship between AFS use and financial access. This study sought to fill this knowledge gap.

Methods

This study examined the association of financial inclusion and AFS using a nationally representative sample from the 2012 National Financial Capability Study (N=25,509). Structural equation modeling was used to examine the relationship between financial access and AFS usage. Specifically, the overall AFS usage was measured based on payday loan, refund anticipation loan, pawnshop, auto title loans, and rent-to-own, check cashing, prepaid cards, and money orders, and modeled using confirmatory factor analysis. Ordinary least squares regression was used to estimate the relationship between banked status and the overall AFS usage as a latent variable while controlling for sociodemographic variables, financial education, financial knowledge, and home ownership.

Results

All specific AFS services could be described using a higher order AFS usage term, meaning that overall AFS usage is a one-dimension concept. Findings suggest that credit AFS has a greater influence on the overall AFS usage than transaction AFS. Further, being unbanked predicts AFS usage independent of financial education or knowledge. Exposure to financial education, and possessing financial knowledge are both significantly associated with AFS usage. In sum, those with lower income, lower education, lower financial education and knowledge, and those who are male, younger (18-34 yrs.), racial minorities, living with a partner, and renters are more likely to use AFS.

 Implications and Conclusion

Findings provide information about the role of financial education and financial knowledge in AFS usage as a whole, unbanked status and AFS usage as a whole, as well as the contribution of an array of specific types of AFS usage. Regarding policy, our findings indicate an overall expression by the unbanked of need for banking services, rather than a reliance on a cash economy. Thus, monitoring the use of AFS and developing policy to make these products safe and affordable is important. Social service organizations can consider creating partnerships with formal financial institutions to facilitate access to appropriate products. Human service providers may expand opportunities for formal or informal financial education efforts about the benefits and value of being banked for transaction, credit, savings, and wealth goals.