Profitwise News and Views

Spring 2003 Issue

• High Profile Predatory Lending Cases
• Research Methodologies Identify Deal Flow Finding the Intersection Between Compliance and New Markets
• FLLIP's "Your Money & Your Life" Financial Education Program Reports High Marks after First Year
• CEDA Community Development Fund ATM Demonstration Project
• Financial Institutions and Participation in Individual Development Account Programs
• From the Editor
• Around the District
• Calendar of Events

Financial Institutions and Participation in Individual Development Account Programs
By Robin Newberger

This article considers the roles that banks and credit unions play as part of the delivery mechanism for Individual Development Accounts (IDAs) within the geographic district covered by the Federal Reserve Bank of Chicago.¹ IDAs began as a theory put forth by Michael Sherraden in the early 1990s to address the wealth-building component of anti-poverty strategies in the United States.² IDAs are savings accounts matched with outside contributions that are designed to help lower-income families accumulate money for homeownership, education, job training, and business development. In most cases, IDA programs operate through partnerships between nonprofits that recruit and counsel participants and financial institutions that hold the savings accounts. The participants attend classes on financial topics and make regular deposits of earned income. Appropriately earmarked deposits and interest are matched by government, foundations, the community and/or financial institutions.

The IDA field has grown from three programs in 1995 to over 350 programs in 2001 (Schreiner 2001). Programs are flourishing in each of the states within the Federal Reserve Bank of Chicago's district. The expansion is due, at least in part, to the fact that a savings strategy for low- and moderate-income individuals appeals to a range of constituencies. Community groups support IDAs because matched savings help their target populations reach goals like buying a house or attaining higher education. Federal and state governments have allocated funds for IDAs as they further the agenda of welfare reform to build the assets of lower-income families.

IDAs also offer a mechanism for drawing so-called "unbanked" households (people without bank accounts) into the financial mainstream. The impediments to having a bank account are a policy concern in so far as these households may pay more in fees, face a loss in personal security, forego an opportunity to build a credit rating, or accumulate less savings. In addition, IDA programs showcase the importance of financial education and related support services for clients who seek to maintain financial assets.

The Consumer and Community Affairs division (CCA) of the Federal Reserve Bank of Chicago has chosen to include greater economic literacy, the use of mainstream financial services, and asset-growth among low- and moderate-income households in its mission to promote sustainable community development. The CEDRIC Web site, founded and maintained by the CCA division, contains a repository of research and other documents on consumer education, alternative financial services and community development. The Federal Reserve Bank of Chicago has also launched its own projects for fostering mainstream financial access for the unbanked and improving the population's understanding of fundamental financial concepts.³ In addition, the Community Affairs staff is encouraging the study of community development programs at the level of implementation.⁴

The effectiveness of the IDA model is being measured in two national evaluations that look at impacts on individual participants, design features, and community effects. Financial institutions are also stakeholders in the IDA strategy. IDA programs, as currently structured, could not exist without depository institutions that hold the deposits and track account balances. It is therefore worthwhile to understand the contributions made and received by financial institutions from their own perspective.

Overview of Findings
A diverse group of financial institutions, most of which have no explicit community development mission, hold IDA accounts in the district. Banks tend to limit their IDA-related activities to conventional depository functions such as holding accounts and mailing statements. A larger proportion of credit unions dedicates resources to program operations, reflecting the prevalence of low-income credit unions in this study. The most frequently cited motivation for involvement by both banks and credit unions is their desire to help the communities in which they do business. Fewer banks list business-related interests as a reason for involvement. A higher proportion of credit unions cite opening new markets and cross-selling products as their motivation.

Data Collection
The findings are based on short interviews with financial institutions that participated in IDA programs in the first half of 2001. Sixty-three financial "partners" were identified through conversations with selected IDA program operators, publicly available lists of programs that were awarded Assets for Independence Act grants, and discussions with state personnel in Illinois, Iowa, Indiana and Michigan. (The state of Wisconsin does not fund IDAs.) The conversations focused on how the institutions became involved, the functions they perform for IDA account holders, their incentives to participate, and how they structured their savings product. Representatives from state agencies and selected community-based organizations supplemented some of the explanations obtained from financial institutions. A number of financial institutions may not have been included because their programs were just getting started. Personnel ranging in positions from account representatives to presidents participated in the interviews.⁵

Data on participating banks is also drawn from the most recent public Community Reinvestment Act (CRA) performance evaluations, from the Federal Deposit Insurance Corporation/Office of Thrift Supervision Summary of Deposits database, and from Home Mortgage Disclosure Act reports available through the Federal Financial Institutions Examination Council (FFIEC). Data on credit unions is taken from the National Credit Union Association and conversations with credit union officials. Census tract income information for the banks' assessment areas (the geographic market where financial institutions conduct business) and branch locations comes from the FFIEC census reports.

A few caveats about the responses deserve mention. At the time of the interviews, programs were relatively young, many financial institutions had opened only a small number of accounts, and these institutions were still forming their impressions about IDAs. About 80 percent of banks have been offering IDA accounts since 1998 and more than 70 percent of the credit unions began offering IDA accounts as of 2000. Information on banks from the CRA performance evaluations may be dated as the most recent reports for a number of institutions were published in 1996, 1997 and 1998. CRA performance evaluations were not found for this study for four banks.⁶ For the 44 banks with CRA reports, not all reports contain all the data analyzed in this study such as the percent of low- and moderate-income census tracts in their assessment areas. In addition, since a preponderance of institutions are in Indiana, the general perspective of the respondents, as summarized at various points in this paper, may be tilted towards issues specific to Indiana.

The remainder of the article is organized as follows. Section I compares the characteristics of participating institutions based on asset size, market share and mission. Section II lists the responsibilities of financial institutions in IDA programs. Section III presents the reasons financial institutions (among the sample) support IDAs. Section IV discusses the program design features that encourage participation.

I. Characteristics of Financial Institutions

Size and Market Coverage
Of the 63 financial institutions interviewed, 78 percent (49) are banks and 22 percent (14) are credit unions.⁷ The participating banks divide fairly evenly between larger institutions with more than $1 billion in assets, midsize institutions with assets between $250 million and $1 billion, and smaller institutions with less than $250 million in assets. Among credit unions, asset size ranges from less than $1 million to more than $380 million. The preponderance of institutions dominate their markets in terms of deposits held. Over half of the banks rank within the top five in deposit market share in their assessment areas.⁸ Eighty percent (35) rank within the top ten in their assessment areas.

An outside entity such as a local nonprofit or government agency approached over 80 percent (50 of 60) of the institutions with proposals to open IDA accounts. More than half of these institutions were contacted by nonprofits with which they had a previous relationship. The rest were approached because of their proximity to the target population, their known participation in IDA programs in other states, or their entry into a new market.

Institutional Mission
Most institutions qualify as "mainstream"-full service entities that provide a range of traditional banking services with no particular community development mandate. Ninety-three percent of banks (38 of 41) target assessment areas in which half or fewer of the census tracts are low- or moderate-income (Table 1 below). Sixty-three percent (27 of 43) show a lower or equal percentage of mortgage financing in low- and moderate-income census tracts than the average for all banks in the metropolitan area in which the institution is located (or is in close proximity). Most of the institutions assign a particular branch to serve IDA customers. Over 60 percent (26 of 42) of the banks and two thirds (6 of 9) of the credit unions that operate multiple locations offer IDA accounts at just one branch or office.

Institutions with a mission or business strategy to serve distressed communities and target low-income individuals are relatively well represented in the sample. Eighteen percent of banks and credit unions (11 of 62) have a designation as a community development financial institution (CDFI), a community development credit union (CDCU) or a low-income credit union (LICU). One bank drafted and plays the lead role in carrying out the area's plan as a Federal Enterprise Community, and yet another focuses its branch on an immigrant neighborhood. In comparison, among all 1,635 banks in the district (including the banks and thrifts overseen by other regulators), nine banks, less than one percent, have a CDFI designation. Among all 1,591 credit unions in the district, 3.7 percent (59) have a CDCU or LICU designation.

In addition, 62 percent of banks (28 of 45) reported that low- and moderate-income IDA account holders fall within the spectrum of their existing customer bases, although some indicated that IDA participants represent the lowest-income group in this spectrum. Many of the institutions offer various deposit products with low or no opening balances, and have a history of participation in housing and economic development projects with local community groups and city government. Eighty-six percent of credit unions (12) say they serve low- and moderate-income individuals as part of their existing customer bases. Many of the institutions that do not think IDA account holders fall within their customer base describe the IDA participants as "unbanked"-having no previous relationship with a financial institution.

II. Responsibilities of Financial Institutions

IDA proponents have identified various ways for financial institutions to contribute to IDA programs, spanning from servicing accounts to contributing operating funds. In addition, federal banking regulators granted CRA credit for a range of IDA-related activities including making grants to IDA programs, providing staff to participate in the development of IDA programs, and making loans to IDA holders.

Table 2 (below)presents the list of responsibilities reported by banks and credit unions. All but one hold deposits and send account statements. (One of the banks contributes only match funds, held outside of the bank.) In fact, 62 percent of banks and 21 percent of credit unions limit their involvement to holding deposits, sending account statements and holding match funds. These are functions that fall within the normal activities of depository institutions, although roughly a quarter of the banks must also assist program sponsors in allocating match funds to individual accounts (as technical assistance to nonprofits or as a mandate from the funding sources).

Their services depart from convention in that participating institutions do not assess charges on the accounts. All waive fees on balances below pre-set thresholds and pay interest (usually a basic passbook rate) regardless of the balance, with the exception of one bank that pays interest on balances of $100 and over. One bank pays in excess of the rate on non-IDA accounts. The majority of institutions require no minimum balance for opening an account, although eight banks require opening deposits of $1 to $30, and seven credit unions require opening balances of $5 to $25. Some institutions offer savings bonds or certificates of deposit rather than savings accounts. Thirteen percent of banks (6 of 47) also cash payroll checks at no charge and offer free ATM cards. One institution relaxes certain requirements to enable some IDA participants to open checking accounts.

Compared with the credit unions in the sample, a smaller percentage of the banks participate in activities that fall outside of standard depository functions. Thirteen percent (6 of 47) contribute to match funds in addition to holding deposit accounts. A seventh bank contributes match funds without holding any deposits. Of these, one indicated direct compensation from the U.S. Treasury Bank Enterprise Award Program for its work with CDFIs was the motivation, and another institution waited to allocate money until it identified other sources with which to supplement its own contribution. Thirty percent of the banks (14 of 47) report participation in financial literacy programs, which ranges from overseeing a money management workshop to providing space for a course.

As Table 2 shows, credit unions tend to take a broader operational and administrative role, reflecting the prevalence of in-house IDA programs at these institutions. Half of the 14 credit unions sponsor their own IDA programs, while 98 percent of banks in the sample do not. Each of these credit unions has a mandate to serve traditionally under-served customers or markets. Over half of credit unions contribute operating funds or recruit and screen participants, over a third sponsor a VISTA volunteer,⁹ and 43 percent report involvement in the economic literacy component. In contrast to the banks, none of the credit unions in this study contributes matching funds.

III. Motives for Participation

The literature in support of IDAs notes the following reasons financial institutions might want to partner in IDA programs:

• Better serve the local community
• Tap new markets
• Cross-sell products like mortgages, business loans, or college loans
• Receive CRA credit
• Realize profit potential with the right mix of public, private, and nonprofit support (Boshara 2001)

Community Outreach
Community outreach is by far the most common motive for becoming involved in an IDA program according to the institutions in this sample. Seventy percent of banks and 79 percent of credit unions list "contribution to the community," "relationship-building with the local service provider," or "mission of institution" as at least one of their motives. Many credit unions consider the IDA program an extension of their mission. Many banks mention that they want to help individuals build wealth. Other banks indicate that there is no reason not to participate. The commitment is relatively "easy" inasmuch as the bank incurs little or no risk (if the accounts can be easily monitored), existing savings products can be adapted to IDAs, staff do not need intensive training, and the banks do not have to choose from a pool of potential grantees.

In conjunction with the benefits of contributing to the community, banks receive CRA credit for their participation. Fifty-five percent of banks (26 of 47) mention CRA as a reason for participation; however, many others are reluctant to explain their involvement in quid pro quo terms. For large banks, CRA service credit is awarded for holding the IDA accounts and investment credit is awarded for contributing match funds. Forty-nine percent of banks (23 of 47) participate exclusively for community outreach, CRA credit, or both (i.e., they indicate no business motivation).

Cross-Sell Products and Target New Customers
Fifty-one percent of bank respondents (24 of 47) list cross-selling products and/or targeting new customers as a motive for holding IDA accounts. Six percent list these business motives to the exclusion of community outreach or CRA credit. Eighty-six percent of credit unions (12 of 14) aim to cross-sell or target new customers, and 21 percent (3 of 14) list these as their only motives. IDA participants have actually used other financial products-most commonly a checking account-at 28 percent of banks (13 of 47) and 50 percent of credit unions, although some of these institutions did not list cross-selling as a motive for participating in an IDA program.

Among those institutions that cross-sell, one bank reports that it made a mortgage loan to an IDA graduate, and three credit unions have offered secured loans to build a credit history. Among those institutions that target new customers, many see IDA accounts as giving an inroad into untapped markets including growing Hispanic populations and immigrant groups. Some state targeting new customers as a secondary consideration or phrase it in indirect terms such as improving the quality of life of the IDA account holder by turning them into a "regular" bank customer. For the banks that hope to cross-sell in the future, they focus on credit cards, car loans and other consumer products in addition to home loans.

Institutions that do not cross-sell cite a handful of reasons. Among them, many programs are relatively new and account balances are still low. Some institutions observe that IDA participants have barely enough resources to save for the match, let alone use other bank services. Some institutions suggest that cross-selling goes against their civic-minded motivation for participating in the IDA program. These institutions make a clear distinction between contributing to the community and deriving any business benefits from involvement.

Financial Bottom Line
In keeping with these results, no institution in this study lists profit potential as a motive for participating in an IDA program. Some institutions face higher costs with respect to their management of IDA accounts, sending statements every month rather than every quarter, and at times to both the local service provider and the individual account holder. Some institutions are required to complete and submit paperwork for the match funds, modify account-processing systems, and monitor authorized and unauthorized withdrawals. Dedicating match funds from the institution itself adds to the total costs. The extent to which an institution's management information system is compatible with IDA tracking is another factor affecting costs. The institutions in the sample have tended towards using "off-the-shelf" savings products to set up IDAs, flagging the accounts with special codes, creating custodial accounts held jointly by the nonprofits and the individual, or designating the accounts for deposit only. Some institutions confine their IDA accounts to a single location precisely to avoid making system-wide changes to their MIS systems. One large bank chose not to hold accounts (but to contribute to operating and administrative expenses) in part because its centralized processing system could not easily track IDA accounts. None of the institutions had performed a break-even analysis of the IDA accounts at the time of the interviews. Accounts do not cover costs as currently designed at 34 percent (15 of 44) of banks. Another 34 percent of bank respondents steer away from cost measurements given their community development reasons for participation. Two others indicated the accounts probably do not lose money for the bank. Among 13 credit unions, 23 percent (3) report that accounts do not cover their costs and another 23 percent (3) indicate they do not consider breaking even [a priority] given their goals. Another three are waiting to judge costs based on future lending opportunities. In instances where financial institutions say costs are not covered, many acknowledge the possibility that a change in the design of the account could lead to more profitable results. These changes include greater automation and a larger number of accounts with higher balances. The higher the match rate, the shorter the time it takes for the accounts to break even. To paraphrase one respondent, a short-term deposit account is not a moneymaking product. Four credit unions also recognize that utilizing VISTA volunteers substantially reduces the costs of operations. At the time of the interviews, about half of the banks in the sample had opened 30 accounts or fewer, and over three-quarters of credit unions held fewer than 50 accounts each.

IV. Discussion of Major Findings and Conclusion

Variety of Institutional Partners
Looking at features such as size, branch location or organizational mission does not suggest a particular type of financial institution to partner in an IDA program. From the perspective of an account holder, institutional trustworthiness and the suspension of credit checks might be the most sought-after features of financial institutions-potentially outweighing the importance of geographical proximity or personalized attention. From the perspective of a local service provider, institutions with larger capital bases and mortgage departments with formal relationships with entities such as the Federal Home Loan Bank and Neighborhood Housing Services may be better equipped to offer the most competitive loans to IDA graduates. Institutions that reach widely dispersed populations through multiple branches may also work best for service providers that operate across several counties.

Local service providers, perhaps anticipating few other choices, have often approached the institutions with which they had a pre-existing relationship. Differences in state legislation and policy initiatives have also resulted in various types of institutions holding IDA accounts. For example, the Center for Urban Affairs program at Michigan State University recruits special-mission credit unions to administer IDA programs.¹⁰ The federal government's Assets for Independence Act demonstration, offering the single largest pool of money for IDA service providers, comes with its own set of specifications for involvement by financial institutions. The relatively few CDFI-designated banks and low-income credit unions in the district may also explain why more local service providers have not opened IDA accounts at institutions with economic development missions.

Another way to account for institutional diversity is in the risks and rewards to participation. When start-up costs are relatively low and financial institutions can contribute by carrying out traditional bank functions, IDA programs offer an opportunity for all types of financial organizations to support community development. Any number of depository institutions could have a basic affinity to the IDA concept when the scale of programs is kept relatively small.

Reducing Costs and Institutional Participation
From what financial institutions report as their responsibilities and motives, fewer institutions might show an interest in IDAs if they were charged with helping bring the IDA concept to scale. Many activists in the IDA field recognize that cost-cutting measures and direct subsidies are useful incentives to encourage institutions to open larger numbers of accounts or contribute match funds. One group of researchers is already promoting efficient account processing as the way to increase the impact of the IDA strategy. This approach removes IDAs from the domain of retail depository institutions and experiments with accounts based on 401(k) processing systems (Tufano 2001). Another broad coalition of IDA activists supports federal tax credits to for-profit depository institutions to mitigate the costs of contributing match funds. The "Savings for Working Families Act" would cover 100 percent of matching funds (up to $500 per account holder per year), and provide $100 for each new account opened and $30 for each account maintained.

Business Opportunities and Institutional Participation
Cross-selling financial products tailored to the needs of IDA participants could create additional incentives for institutions to partner in IDA programs. A number of financial institutions in this sample have not begun to link IDA participation with appropriate financial products, in part because programs are relatively young and many financial institutions have opened only a small number of accounts. Another impediment may be intermediation by local service providers, whom many financial institutions see as their clients rather than the IDA-savers themselves. This perception can be reinforced in situations where depositors themselves rarely, if ever, visit the financial institution. (Bank personnel pick up deposits and open accounts directly at the local service provider's office, or depositors send their money by mail.)

The business potential of IDA accounts might be best appreciated in the context of how people with savings accounts but no checking accounts, and the "unbanked" population in general, conducts their financial transactions. A survey of banked and unbanked households in New York and Los Angeles revealed that only 12 percent of savings accounts holders used personal checks to pay their bills (perhaps using other household members' checking accounts). The remainder rely on money orders and cash, much like the unbanked (Dunham 2001). The profit potential of IDA participants depends in part on the availability and cost of products that this population accesses elsewhere- convenient check cashing, purchasing of money orders or wire transfers, non-English speakers for recent immigrants and bill paying services, among others (Rhine et al, 2001). A financial institution's involvement in an IDA program can offer an inroad into this client base by improving their qualifications for having a checking as well as a savings account, and potentially changing their attitudes toward services offered by banks and credit unions.

Notes
¹The district includes Iowa and portions of Michigan, Illinois, Indiana and Wisconsin.

²See Assets and the Poor: A New American Welfare Policy.

³Please visit the Federal Reserve Bank of Chicago's website for more information on the unbanked and Project MoneySmart.

⁴The Community Affairs officers of the Federal Reserve System have jointly sponsored their third biennial research conference in March 2003 to address these and related issues. Visit CEDRIC on the Federal Reserve Bank of Chicago's website for more information.

⁵Some financial institutions had terminated their involvement in IDAs. Although beyond the scope of this paper, conversations with these institutions could provide a fuller understanding of the incentives and disincentives for participation.

⁶CRA information for those institutions was not located through their regulators' Web sites.

⁷The remainder of the analysis does not include one of the banks that provided money indirectly to a coalition of IDA programs. Also, the total does not count branches of banks that partner independently with nonprofits in their areas.

⁸Based on information from the FDIC/OTS database for 44 banks where the CRA performance evaluation gives information on the bank's assessment area.

⁹The Volunteers In Service To America (VISTA) program is a national program placing individuals with community-based agencies to address urban and rural poverty issues.

¹⁰A complete description of state IDA policies is available through the Center for Social Development at Washington University.

Robin Newberger is a research analyst in the Consumer and Community Affairs Division at the Federal Reserve Bank of Chicago. Ms. Newberger conducts research and writes on matters related to the savings behavior of low- and moderate-income people in Chicago. She holds a B.A. from Columbia University and a Masters in Public Policy from the John F. Kennedy School of Government at Harvard University. She received a Chartered Financial Analyst designation in 2001.