Central Banking for the Unbanked?

What if you and I could bank at the Federal Reserve? This is the premise behind a new paper by Morgan Ricks, John Crawford, and Lev Menand titled “A Public Option for Bank Accounts (or Central Banking for All).” Under the authors’ plan, the Fed would provide the public with FedAccounts, interest-paying no-fee accounts that could use the Fed’s underlying payments platform to effect free transfers to other accounts and enable point-of-sale purchases via a Fed-provided debit card. The Fed would not provide account holders with loans. 

While the authors provide a number of motivations for providing FedAccounts, a key one is financial inclusion. Around 7 percent of American households, or 9 million households, are currently unbanked, which means no individual in the household has bank-account access. Not only would the welfare of each individual who gains financial access improve, according to the authors, but society would enjoy significant positive externalities as those on the other side of the equation, say employers or businesses, could use a more efficient payments option.

The authors present central banking for all as a plan targeted at the United States rather than a universal one, and for good reason. Bank penetration is at 99 percent in the United States’ northern neighbor Canada, illustrating that banking is quite capable of filtering into most of society’s nooks and crannies. Canada provides a natural foil for the United States because it shares many characteristics including geography, culture, and history. Why would bank penetration rates suddenly rise dramatically just a few meters north of the 49th parallel? If we can answer this question, the United States might simply copy whatever Canada is doing rather than experimenting. 

How did Canada get to 99 percent? To begin with, no Canadian is allowed to bank at the Bank of Canada, Canada’s central bank, so we can’t attribute it to a Canadian version of FedAccounts. The authors point out that Canadian banks are required by law to open accounts for all applicants unless the applicants have a history of fraud or do not have sufficient identification. These changes came courtesy of the Access to Basic Banking Services Regulation of 2003. Furthermore, in 2014 eight of the largest banks entered into a voluntary agreement with the government to offer low-fee accounts to Canadians. For a monthly price of $4 (free for seniors and students), these accounts include a number of services including processing 8 to 15 transactions per month and providing unlimited deposits, check writing, and a debit card.

While these regulatory changes may have marginally increased Canada’s financial inclusivity, keep in mind that Canada already had a bank-penetration rate of 99 percent as far back as 2001, before these new rules came into effect. Even without a nudge from the government, Canada’s banks were already quite effective at reaching the unbanked. It is not the institution of banking per-se that is coming up short. There is something unique to the American experience. 

One driver may be cultural differences between the two nations. Americans seem to generally lack trust when it comes to banks. Ricks and coauthors bring this up, pointing to an FDIC survey that finds that 11 percent of unbanked American households cite “Don’t trust banks” as their main reason for not having an account, the second-most cited main reason after “Do not have enough money to keep in account.” According to the World Bank, unbanked Americans are more likely than unbanked adults in any other high-income economy to claim a lack of trust as a central reason for not having an account. 

The United States’ bank-penetration rate might also be lower than Canada’s because of higher rates of poverty. When households operate in the cash economy and only make enough to pay their weekly expenses, a bank account isn’t necessary. 

There could be differences on the supply side of the equation too. The United States had a long history of restricting the ability of banks to set up branches across state lines. From the initial debut of Canadian banking in the early 1800s, authorities allowed nationwide branch banking. The historical inability of U.S. banks to set up extensive branch-banking networks may have led to a large population of underserved people. 

Understanding what exactly causes low bank penetration in the United States relative to Canada is important. After all, if it is lack of trust that prevents Americans from making use of financial institutions, how can we know this lack of trust wouldn’t carry over to a government-provided financial solution? Perhaps it would be simpler to devote resources to building trust in American banks than to introduce FedAccounts. Alternatively, if there is some set of regulations (or historical regulations such as the limitation on branch banking) that set the United States on a separate course from Canada, perhaps the loosening of those regulations might spur increased U.S. banking penetration.

I wish I had a definitive answer for why the two nations have diverged so much, but I don’t. But by figuring out what drives the difference, a simple solution might present itself. Instituting FedAccounts is a major step to take, but it might not be the lowest-hanging fruit.

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J.P. Koning

J.P. Koning is a financial writer and blogger with interests in monetary economics, economic history, finance, and fintech. He has worked as an equity researcher at a Canadian brokerage firm and a financial writer and publisher at a large Canadian bank. More recently, he has written several papers for R3, a distributed ledger company, on the topics of central bank cryptocurrency and cross border payments. He founded the popular blog Moneyness in 2012. He designs economics and financial wallcharts at Financial Graph & Art.

Koning earned his B.A. in Economics from McGill University.