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Analysis of Alternative Financial Service Providers

Noah Sawyer, Kenneth Temkin
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Document date: February 19, 2004
Released online: February 19, 2004

Prepared for The Fannie Mae Foundation by the Urban Institute Metropolitan Housing and Communities Policy Center.

The nonpartisan Urban Institute publishes studies, reports, and books on timely topics worthy of public consideration. The views expressed are those of the authors and should not be attributed to the Urban Institute, its trustees, or its funders.

Note: This report is available in its entirety in the Portable Document Format (PDF).


Noah Sawyer is a research associate at the Urban Institute in the Center on Metropolitan Housing and Communities. Since joining the institute, Mr. Sawyer has worked on projects involving access to financial services, indicators of neighborhood health, and community development strategies. He is currently involved in analyzing neighborhood indicators in Washington, D.C., as part of the DC Data Warehouse.

Kenneth Temkin is a task manager at Kormendi\Gardner Partners, a Washington, D.C., investment banking firm. He is responsible for participating in the development and execution of a variety of structured transactions. Prior to joining Kormendi\Gardner Partners, Dr. Temkin was a senior research associate at the Urban Institute, responsible for leading housing finance research within the Center on Metropolitan Housing and Communities. In that position, Dr. Temkin participated in projects related to secondary markets for CRA affordable loan portfolios, analyzed the roles that Fannie Mae and Freddie Mac play in secondary markets for subprime and affordable mortgage loans, and assessed the effects of secondary market underwriting guidelines on credit availability.


Most Americans conduct their financial affairs using retail banks or similar mainstream financial institutions, giving them ready access to some of the most efficient and sophisticated financial services in the world. But alongside these consumers, millions of minority and low-income households conduct financial transactions without ever using mainstream financial services. Indeed, according to a recent estimate, as many as 56 million adults have no relationship to mainstream financial service providers. Many of these consumers often rely on alternative financial service providers—check-cashing outlets, payday lenders, pawnshops, rent-to-own stores, and auto title lenders.1 While these alternative, nonbank financial service providers offer convenient services and easy access to cash, their services often carry high costs, limiting low-income families' ability to accumulate assets and establish a credit history.

It is well established that minority and low-income families are more likely than other families to use the alternative financial service market. Less clear is how much of this use occurs simply because these businesses fill a void created by the absence of conventional services. Previous studies have found fewer conventional services and more alternative services per capita in low-income neighborhoods. But these studies tend to be marred by narrow geographic coverage and other methodological weaknesses. Previous studies, for example, have relied on the Standard Industrial Classification (SIC) code—which reflects an establishment's primary business—to identify alternative providers. This method misses liquor stores and other retail establishments that also provide financial services (mainly check cashing).

To address the limitations of previous studies and to examine more definitively the location of alternative providers, this report investigates the location of three types of alternative providers—check-cashing outlets, payday lenders, and pawnshops—in eight diverse demographic and regulatory environments: Cook County, Illinois (major city Chicago); Fulton County, Georgia (major city Atlanta); Harris County, Texas (major city Houston); Jackson County, Missouri (major city Kansas City); Los Angeles County, California (major city Los Angeles); Miami-Dade County, Florida (major city Miami); Shelby County, Tennessee (major city Memphis); and Washington, D.C.

For each of the eight sites, the study presents a demographic profile of alternative provider neighborhoods (census tracts with at least one alternative provider) and bank neighborhoods (census tracts with at least one retail bank). It then examines how the racial/ethnic composition and poverty rates of these neighborhoods differ from the site averages. It uses the same technique to compare the characteristics of areas that contain geographic "clusters" of alternative providers and banks (five or more providers located near each other). It also examines the mix of banks and alternative providers within neighborhoods and assesses whether the regulatory environment affects the number and location patterns of financial service providers.


Five major findings emerge from the study.

Alternative financial service providers are disproportionately located in minority, low-income neighborhoods. In seven of the eight sites, the typical alternative provider neighborhood has a greater share of minorities than the overall site or the typical bank neighborhood. Alternative provider neighborhoods also tend to have a higher poverty rate.

Alternative providers tend to cluster in neighborhoods with a higher share of minority and low-income residents. In seven of the eight sites, minorities account for a higher share of residents in the areas that contain alternative financial service clusters. The picture, however, differs slightly for specific minority groups. In all eight sites, alternative financial providers tend to cluster in neighborhoods that are disproportionately Hispanic. In only two sites are these providers clustered in neighborhoods that are disproportionately African American.

More alternative financial service providers per capita (and fewer banks) are found in census tracts that are disproportionately minority and/or poor. This holds true in all eight study sites. Interestingly, however, conventional banks outnumber alternative providers in all but the very highest minority neighborhoods (neighborhoods in which minorities constitute at least 75 percent of the population).

Neighborhoods often contain both banks and alternative providers, casting doubt on the "spatial void hypothesis," which contends that alternative providers fill a supply vacuum. In all eight sites, the majority of alternative providers are located in neighborhoods with at least one bank. Furthermore, many of these banks are located near the alternative providers. In each of the eight sites, the median distance between alternative providers and banks is no more than seven city blocks; in five sites, the distance is five blocks or less.

The regulatory environment makes little difference to the locations of alternative financial service providers. Many local jurisdictions and many states have enacted laws to limit the allowable types of alternative providers and the fees they charge. The analysis finds that the regulatory environment (weak, intermediate, or strong) makes little difference to the number and location of such providers across sites, although it may influence the mix of institutional types. During the study period, for example, Fulton County (Atlanta) and the District of Columbia prohibited payday lenders. Our data suggest that this restriction may simply have increased the per capita representation of pawnshops in Fulton County and of check cashers in Washington, D.C.


Our analysis provides definitive evidence that alternative financial service providers are disproportionately located in minority and poor neighborhoods. This finding holds regardless of a city's geographic location or socioeconomic composition. These conclusions are consistent with findings of other studies using less comprehensive data and methods. But we have three additional pieces of evidence that may move the debate to a new level.

First, alternative providers do not operate in geographic isolation from banks. Second, the regulatory environment makes little difference to the number or location of alternative providers or banks. Third, alternative provider clusters (i.e., groups of at least five in close proximity to each other) are more likely to be found in predominantly Hispanic neighborhoods than in predominantly African-American neighborhoods.

This combination of findings suggests that, contrary to popular perception, consumers do not choose alternative financial service providers because an area lacks mainstream providers. Rather, location is not the only factor affecting a customer's decision to use an alternative provider instead of a traditional bank. It appears that mainstream financial providers either are not offering lower-income, minority households the core products and services they need or providers are not effectively reaching out to these consumers. These possible shortcomings point to the need for further research into the financial service needs of low-income communities and the effectiveness of different outreach strategies.

Note: This report is available in its entirety in the Portable Document Format (PDF).

1 General Accounting Office. 2002. "Electronic Transfers." Report to the Subcommittee on Oversight and Investigations, House of Representatives, September.

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