Post Office Plan May Revolutionize the Financial Lives of the Unbanked

Female postal worker looking through mail
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"Oh, yes, wait a minute, Mr. Postman/Please Mr Postman, look and see/If there's a loan in your bag for me."

If the post office sounds like a strange place to be going for banking services -- it is (at least in this country). But expect more and more Americans to start doing just that in years to come.

Last week, Sen. Elizabeth Warren, (D-Mass.) published a letter on the Huffington Post endorsing a plan (based on a proposal from the Post Office's Office of the Inspector General) to allow the U.S. Postal Service to partner with banks to provide "bill paying, check cashing, [and] small loan" services to customers who lack traditional bank accounts.

As Warren explained in her letter, some 68 million Americans currently have no active checking accounts. That's a direct result of the fact that so few banks offer "free checking" as a standard option anymore, making a traditional account costly for people who can't maintain the fair-sized balance at which banks now forgo fees.

According to Warren, despite their best attempts to avoid the high cost of banking by eschewing bank accounts, many people still end up paying in the end:

"Collectively, these households spent about $89 billion in 2012 on interest and fees for non-bank financial services like payday loans and check cashing, which works out to an average of $2,412 per household. That means the average underserved household spends roughly 10 percent of its annual income on interest and fees -- about the same amount they spend on food."

Round Up the Usual Suspects

That hardly seems fair. Indeed, progressive website ThinkProgress describes the payday lending industry as downright "predatory" in its practices, charging "annual interest rates well north of 100 percent [that] suck billions of dollars out of poor communities every year."

The proposed solution is to partner the Post Office with America's traditional banks to offer loans, check cashing, bill paying, and similar day-to-day financial services at a lower cost to the consumer.

%VIRTUAL-WSSCourseInline-983%According to consumer financial advice website, most banks these days charge between 12 percent and 27 percent interest on credit card balances. Those are high rates, to be sure. But they're nowhere near the 300 percent to 700 percent annual rate that payday lenders like Cash America (CSH) or EZCORP (EZPW) charge.

By partnering with banks, the Post Office could generate up to $9 billion annually to plug the gap in its balance sheet. And because the Post Office would be sharing the banks' risk of loan default, banks should be more willing to offer loans at more affordable rates.

Bankers, Rejoice!
If this sounds like good news for borrowers, and for the Post Office, then it may be even better news for bankers who should be jumping at the chance to take advantage of Sen. Warren's offer.

While it's true that bankers on average charge interest rates in the teens and twenties to their customers, the actual percentage-point profits they earn from making unsecured credit card loans (similar to the sort that payday lenders make to people in the bad-credit demographic) can be counted on the fingers of one hand.

Losses from defaulting borrowers, you see, eat into the fat interest rates that banks charge on their cards. The result, as revealed in a recent report out of the Federal Reserve, is that on average, big banks like Citigroup (C), JPMorgan Chase (JPM), and Bank of America (BAC) earn profit margins of only 2 percent to 4 percent on their credit card portfolios. That's on par with the 3 percent profit margin that EZCORP brought in from its business last year, and significantly below the 8 percent profit margin earned by Cash America.

In 2012, 15 percent of EZCORP's customers failed to pay back their loans. The corresponding figure for Bank of America was 2.6 percent.

Sen. Warren's plan, though, promises to reduce losses from defaults by leveraging the power of the federal government to collect debts. In the event a borrower stops making payments on his or her loan, the Post Office can instruct the Treasury Department to garnish a borrower's tax refund to recover what's owed.

By reducing the risk of loss in this manner, the plan offers bankers a chance to widen their profit margins on unsecured loans, even while lowering rates for (current) payday loan-borrowers. This way, everybody wins. Everyone except the payday lenders.

Motley Fool contributor Rich Smith has no position in any stocks mentioned. The Motley Fool recommends Bank of America. The Motley Fool owns shares of Bank of America, Citigroup, and JPMorgan Chase.