In 2018, two professors and a Ph.D. candidate in economics from the University of Bonn designed a study to investigate long-term income and wealth inequality in the United States. They were specifically interested in how the financial crisis of 2008 had exacerbated existing inequalities and disproportionately affected middle- and lower-income Americans. One of the things they found, unsurprisingly, was that “race remains a major dividing line” in the financial situations of American households.
“Racial disparities in income today are as big as they were in the pre-civil rights era,” they wrote in the Harvard Business Review, noting that as of 2016, Black household income was still only half that of white households, and the wealth gap was even larger.
According to data from the U.S. Census Bureau, the median net worth of non-Hispanic white households in 2016 was $143,600; the median net worth of Black households was $12,920. Fast-forward four years to the pandemic and record unemployment, and the gap could become even wider.
Racial income and wealth inequality in the U.S. has roots in slavery and Jim Crow laws. The problem is perpetuated by things such as educational inequality, regressive tax policies and displacement, exclusion and segregation in the U.S. housing system that limit the economic mobility of many Black and Brown Americans.
This is a problem that, in my opinion, should be receiving much more national attention in the recent calls for social justice. It isn’t a problem that digital banks will be able to fix single-handedly. But our sector does have an important role to play.
How Digital Banks Can Help Close The Wealth Gap
According to the Fed, 22% of Americans are unbanked or underbanked, with 14% of Black Americans being unbanked. Below are three areas of focus along with corresponding tactics digital banks can use to help this segment get ahead.
1. Smoothing and stabilizing cash flow. Financially vulnerable people generally suffer from high volatility in income and expenses. Offering accounts free of overdraft, minimum balance, account maintenance and other opportunistic fees can help reduce the negative impacts of this volatility. Digital banks can also offer early payday and similar services to help stretch paychecks or give people access to their money more quickly, which is critical to people living on the financial edge. They could also integrate with gig platforms to help customers pick up extra work when money is tight.
2. Building and repairing credit. Credit plays a critical role in helping people achieve financial stability. A person’s ability to secure employment or housing for their family often hinges upon their credit score, not to mention larger lending products such as mortgages and small-business loans.
But the FICO-based system excludes many people from accessing affordable credit or any credit at all. According to FinRegLab, a nonprofit innovation center that hopes to move the financial sector toward inclusivity, this system is limited in three critical ways:
• It relies heavily on credit history, which makes it difficult to assess people who don’t already have mainstream credit access.
• It can reflect previous discrimination in employment, housing, wealth building and financial services, thus perpetuating it.
• It’s subject to reporting lags that make it difficult to assess borrowers accurately in rapidly changing economic conditions.
By using alternative data and machine learning innovations, digital banks can extend affordable credit to a much larger population of consumers, including “credit invisibles,” former felons and other people stigmatized by damaged credit.
3. Saving and building financial resiliency. The final rung of financial resilience is saving and investing. Offering high-yield savings accounts, automated savings features and robo- and microinvesting tools can help boost customers’ savings.
Even a modest amount of savings can help people better cope with unexpected expenses or begin thinking about longer-term goals. Perhaps they hope to own a home or start a business. These are the financial building blocks that can help them succeed.
The racial wealth gap is a complicated issue, and it will take a multifaceted, concerted effort to solve. But by using the tactics above, digital banks can help the most financially vulnerable Americans improve cash flow, build credit, save money and begin their climb up the wealth ladder.