What is fringe banking?

Borrow. Accumulate interest. Repay. Repeat.

Users of fringe lending services often find themselves stuck in this cycle. You take out a small loan to cover an expense, and by the time you have enough to pay it back, the interest charges have stacked up so high that you now owe much more than what you initially borrowed. In fact, fringe lenders have admitted that most of their profits come from repeat users who take out more loans in order to pay off previous ones.

So, exactly why do people use fringe banking services? Let’s dive in and break it down together.

Financial exclusion in Canada

Financial exclusion is a social problem that refers to the lack of access lower income communities have to regulated, appropriate financial services. According to Dr. Laura Lamb, a professor of economics at Thompson Rivers University, the financially excluded fall under two categories: the unbanked and the underbanked.

The unbanked consist of those who do not have accounts at traditional, mainstream banks. Three percent of the nation, or around one million Canadians, are unbanked.

The underbanked, on the other hand, are those who typically have some sort of a relationship with banks but are still considered financially excluded due to a lack of access to all of the services that they require, particularly to credit. Almost five million Canadians, or 15 percent, are underbanked.

There are three important elements to financial exclusion: banking operations, citizen’s choice, and government policy. Banking operations are often led by profit-oriented goals — what can they do in order to make the most money possible? This method seems to be working for them; In 2015, the six largest banks in Canada (TD, BMO, RBC, Scotiabank, CIBC and National Bank) generated $35 billion in profits, up from $29 billion in 2013.

However, this profit-driven desire results in the exclusion of already vulnerable communities. People from these groups are often in need of credit or loan services, but are considered to be a “higher risk” by mainstream banking institutions that doubt their ability to pay back. With nowhere else to go, the financially excluded turn to fringe financial institutions.

"Financial exclusion is a social problem that refers to the lack of access lower income communities have to regulated, appropriate financial services."

Let’s talk about fringe banks

So, what is fringe banking? They’re payday loan shops, pawn shops, and installment loan companies. These institutions offer financial services that charge much higher interest rates compared to regulated financial institutions, like big banks or credit unions. Despite these rates, the demand for fringe services has been steadily rising over the years. The percentage of Canadians who have made use of payday loans — either by themselves or through a family member — jumped from 1.9 percent in 2009 to 4.3 percent in 2015.

In fact, the demand has increased so much that there are currently more payday loan shops in Canada than Shoppers Drug Marts. Let’s just take a second to let that sink in, because… wow.

Why are so many people using these services if they’re guaranteed to accumulate all of these additional fees and interest charges? The unfortunate reality is that many mainstream banks have shut down in low-income communities, leaving a void that fringe banking institutions quickly swooped in to fill. “They found a spot in the market that wasn’t being serviced,” says Lamb.  And while these services are not necessarily good, society would be worse off without them.  Individuals from lower income — and often racialized — backgrounds are in need of financial services just like anyone else, perhaps even more so, and they need somewhere to go.

Fringe banking is also sometimes associated with informal financial services that are offered by family, friends, and/or local retailers. An example of these are “Banker Ladies,” Toronto’s African Canadian Women who’ve established community-driven Rotating Savings and Credit Associations. These peer-focused banking groups stem from roots of racism and oppression that continue to grow in traditional banking institutions. After encountering exclusionary and hostile behaviour from banks whenever they would go to carry out any form of transaction, these “Banker Ladies” organized their own banking services instead.

How do mainstream banks contribute to the problem?

“Banker Ladies” are one of many examples across the country of how mainstream banks have pushed members of low-income communities away from regulated services and towards informal financial services.

Kenzie Hofauer, an esthetician student at Seneca College, experienced different issues surrounding inaccessibility and hostility from her bank in the past few months alone. Just recently, a mix-up with her workplace caused a cheque she deposited to bounce. She called her bank, hoping to clear up the issue and reverse the charges made to her account due to the bounced cheque, but was instead rushed through the phone call by the customer service representative.

“[The representative] wasn’t being cooperative at all and didn't really seem like she wanted to stay on the phone with me and help me figure it out,” says Hofauer. “So I ended up getting off the phone with her … she just wasn't very helpful in general.”

Hofauer expressed that she’s been met with hostile service both on the phone and when she goes in-person to the bank, often being put on hold or not taken seriously. “Maybe because I look young and I have a child, they judge me for that too. Maybe I just don't look like I have a lot of money, and they can see obviously how much money you have in your account when you come in, I don’t know.”

Lamb’s research in 2015 found that a disproportionately higher number of Indigenous people were using fringe financial institutions as compared to the general population. Here, low income was not the only reason why. An additional factor was the discrimination Indigenous people have to face when walking into banks. Another was the lack of access to banking institutions in Indigenous communities and reserves that have led to a culture of relying on fringe banks as an only means of financial services. This system of geographical oppression contributes to Indigenous users of fringe services having lower levels of financial capability.

"The unfortunate reality is that many mainstream banks have shut down in low-income communities, leaving a void that fringe banking institutions quickly swooped in to fill."

So basically everything sucks and money is a scam?

It’s hard not to feel that way sometimes, but no! We can see through the innovative solutions by the likes of Toronto’s “Banker Ladies” that where traditional banks and fringe lending services are taking advantage of vulnerable groups, efforts to rectify the situation are in place. Additionally, modern, customer-driven fintech companies are working hard to build better financial tools and capabilities for all Canadians. For example, KOHO’s digital-first approach eliminates any potential for geographical exclusion, so anyone can sign up for an account, wherever they are.

Still, it’s hard to see any light at the end of the tunnel when these larger institutions have long played a strong role in enforcing systemic oppression in marginalized communities.

“There’s a need for the development of viable services,” says Lamb. For this to happen, the government would need to be involved in some way by working with members of the banking community and credit unions to develop solutions-based services that can serve the marginalized sectors of our society.