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The Underbanked Market: A New Frontier for Retail Bank Growth• Less than average usage of and access to traditional banking products and services

• 20 percent of U.S. households, 24 million households and 51 million adults

• Demographic and societal trends will fuel this market and present challenges and opportunities for financial service providers for years to come

1

For thousands of years people have engaged in trade and commerce that required innovative forms of financial exchange — ways to settle debts and receive payments, even ways to invest in gold, silver and other assets. In ancient Babylon, Greece and Rome loans were made, deposits were accepted and currency was exchanged. However, the term “banking” goes back only as far as 14th century Italy and the rise of the powerful Renaissance families who established the first banks. So while the term is only about 700 years old, people have been “banking” under different names, descriptions and methods for much longer.

In the United States a confluence of factors established “banking” as we came to know it for decades. The regulatory reforms brought about in the wake of the Great Depression provided much needed confidence and security in a financial system that had been rocked to its core. This, coupled with the rise of the post-World War II American middle class and its baby-boom children, kindled the need and desire for consumers to utilize a full array of “banking” services as we know them today. While it may seem like banking as we know it has been around for a very long time, it dates only to the mid-20th century. And it looks like the next wave of change may be on its way.

The Underbanked Market

What will the next generation of banking look like and will it resemble the cadre of products and

services we have come to know?

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If the combination of cataclysmic events and demography created modern banking in the second half of the 20th century, banking today and how consumers view banking has been greatly shaped by the aftermath of the financial crisis and Great Recession of 2007-2009. This and a new demographic reality are beginning to create new challenges to the status quo of consumer banking. The emergence of Generation Y — the children of Baby Boomers — are highly suspicious of banks and financial institutions, are coming out of college with higher debt and lower incomes than graduates from the prior decade, and are open to conducting their financial affairs with an array of products and services, some of which are not traditional “banking” products. They are not wedded to the status quo. They are more interested in finding products and services that provide value, convenience and functionality than they are fitting into the traditional products many banks offer. They present both a challenge and an opportunity for existing players seeking to grow into the next decade, as well as new players seeking to stake a claim on the future of consumer financial services.

Challenge: How to continue growing?In an increasingly competitive landscape with traditional financial institutions seeking to grow, the question is “where” will the growth come from? For nearly 25 years leading up to the financial crisis of 2007, much of the growth for many retail banks came from acquiring competitors. While some banks will continue to find opportunistic growth through acquisitions, much of the industry consolidation has already occurred.

As such, many banks are now more focused on growth through outbound marketing, cross-selling additional products and services to new and existing customers and retaining their best, most profitable customers. Many retail banks seek the highly coveted demographic segment of “mass affluent households,” but acquiring them is challenging, costly and difficult to retain, because so many banks are pursuing the same limited pool of customers.

Based on its sheer size and likelihood to continue growing, the underbanked market may be the nextfrontier for retail bank growth, but it will require a radical rethinking of how banks develop products and services and engage the consumer, as old business models and marketing methods will likely fail with this group. To date, alternative financial services (AFS) providers — not banks — have been most creative and aggressive in serving this market. That’s because of their ability to innovate and the advantage of being less regulated. Nonetheless, banks have inherent advantages of brand, distribution, data and delivery systems/networks. Will banks continue to pursue a finite number of similar-type customers or will they hedge their bet by finding a way to attract, satisfy and retain a whole new kind of customer?

A radical rethinking of how banks develop products and services will be required as old business models and marketing methods

will likely fail.

Opportunity: A large and emerging marketThe underbanked are consumers with a checking or savings account at bank or credit union but with less than average use/access to other basic banking products such as credit cards/loans and savings accounts. Underbanked consumers conduct some of their financial transactions outside of the mainstream banking system — defined as retail banks, savings and loans and credit unions. They use a combination of traditional bank products and alternative financial services. The FDIC defines them as those who have used alternative financial services (AFS) in the past 12 months.

In the U.S. 20.1 percent of households are underbanked. This represents 24 million actual households with 51 million adults. 29.3 percent of households do not have a savings account, while about 10 percent do not have a checking account.1 This is in contrast to about two-thirds of “banked” American households that have both checking and savings accounts. In the last year, one-quarter of households have used at least one AFS product, and almost one in 10 households has used two or more types of AFS products. The underbanked market is large and growing in the United States. Demographic and societal trends will continue to fuel this segment of the consumer financial service landscape and will present challenges and opportunities to financial service providers for years to come.

69%

20%

8%

3%

Fully-Banked Underbanked Unbanked Unknown

UNDERBANKED MARKET: LARGE AND GROWINGPercentages Based on 120 Million U.S. Households

Source: FDIC: National Survey of Unbanked and Underbanked Households, September 2012

DEFINITIONS:Unbanked: Consumers without a checking or savings account at a bank or credit union and are considered to be outside the mainstream financial system. They rely almost entirely on the use of cash and Alternative Financial Services.

Underbanked: Consumer with a checking or savings account at bank or credit union but with less than average use/access to other basic banking products such as credit cards/loans and savings accounts. The FDIC defines them as those who have used alternative financial services (AFS) in the past 12 months. They use a combination of traditional bank products and alternative financial services.

Fully-Banked: Consumer with all major types of banking products; deposit/checking, credit/debit cards, loans, savings. However — nearly a quarter of these consumer still use some AFS in the course of a year (23.6% FDIC Data).

Alternative Financial Services: Non-bank products and services such as fee-based check cashing, money orders, remittances, payday loans, auto title loans, rent-to-own agreements, tax refund anticipation loans, payroll-related reloadable cards2.

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Unbanked versus underbankedThe unbanked/underbanked market is not a monolithic group of consumers who look and act the same way, although the highest unbanked and underbanked rates are found among non-Asian minorities, lower-income households, younger households and unemployed households. However, when the unbanked and underbanked are broken out as separate groups and contrasted against each other their differences are starker. Statistics such as employment and income reveal that underbanked households are more similar to fully-banked households than to unbanked households. Therefore, because the underbanked are a better and more realistic opportunity (than the unbanked) for new growth at traditional financial institutions, they are the primary focus of this paper.

The underbanked market reinforces some stereotypes3

• Their net worth is lower than the U.S. average• A higher percentage rent their home vs. owning it• Their home values are lower

But it also offers a few surprises...4

• The majority of the market is addressable and reachable• The household composition mirrors U.S. averages• The market is older than you may think. Half of underbanked consumers are 45 or older• The majority of households have steady income• The market is nearly as educated as the traditional fully-banked household

California

New York

NewJersey

Illinois

FloridaVirginia

Louisiana

Alabama

Arizona

Georgia

Texas

Michigan

NorthCarolina

Ohio

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• The market is geographically distributed...

...but concentrated in about a dozen states5

Gen Y: A transformational demographic tidal waveToday, 51 percent of the market is older than 45 and only 28.7 percent is between the ages of 15 and 34.6 This is about to change quickly and dramatically. Generation Y — the largest generation in history (even larger than the Baby Boomer generation) is coming of age and entering the early-working life stage when initial experiences and preferences for financial products and services are forged. While many of these new consumers will likely be fully-banked or partially-banked at some point, the initial statistics for this group are striking. Acxiom’s Underbanked Index (UBI) shows a significantly greater proportion of Gen Y overall and across all age groups within Gen Y than other generation/age groups.7

Acxiom UBI data also shows significantly higher representation of Gen Y in the consumption of both a number of traditional bank products such as savings and checking and AFS offerings such as internet tax services, money wiring and cash advance services.8

While it is still too new and too early in Gen Y’s lifecycle and consumption patterns to clearly understand and accurately diagnose what is driving these behaviors, it raises a few questions and hypotheses.

• Are their preferences because they are young consumers early in their working lives with lower incomes — leading to the consumption of less traditional financial services?

• Could the financial turmoil of the past several years that has disproportionately impacted this group also contributed to this?

• Or is there a fundamental shift occurring where younger customers simply view financial services in a vastly different way than their parents and previous generations did?

While there are no simple answers to these questions, the present and trending data suggests all threeof these dynamics may be in play. The underbanked market is less homogeneous than many thought and is about to become even more diverse and complicated as Generation Y enters the market. A large percentage of these consumers may behave as underbanked in their early working years and evolve into fully-banked customers over time as their income increases. Some will move in/out of traditional banking and AFS products as their economic situation changes. Others will rely heavily on AFS products and services more permanently.

Due to the sheer size of Gen Y, if a historically consistent percentage of its members is underbanked asin previous generations, it will have a large impact on the demography of the market. However, if early Gen Y consumption of non-traditional financial services is based on actual preferences and not just present life stage, the fortunes and futures of traditional financial institutions and AFS providers will be greatly impacted — be it for better or for worse.

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The largest generation in history is coming of age and entering the early-working life stage

when preferences for financial products and services are formed. Many of these

people will be underbanked.

Challenge: Diverse customers with very different needsNotwithstanding the massive cohort of Gen Y consumers coming into the underbanked market, there is still a large portion of the underbanked market that is older and traditional in the way it views and uses financial products and services. In fact, these customers tend to use some traditional bank products, but not to the extent a fully-banked household does. For instance, it is much more likely for an older underbanked consumer to have a basic checking account and pay bills with checks, while also using a debit card or credit card — maybe both. However, among other consumers it’s a very different story.

Many younger customers with college degrees and good credit ratings are choosing to use a prepaiddebit card instead of initiating a more traditional bank relationship that might include a checking/debit account. They aren’t doing this because they can’t qualify for a credit card or a checking/debit account; they simply don’t see the need. They don’t look at financial services as specific products they must have. They understand they have a particular utilitarian need such as the ability to pay with a card, a place to “deposit” their funds and a way to pay bills. If a prepaid card can accomplish all of these things without the fees a low-balance checking account would likely generate — and without a credit card that might encourage them to overspend — they feel the prepaid card has met their needs. Being categorized as “underbanked” for not using other banking products is of little concern to them.

In retail banking, the marketing/product playbook has always been to sell some kind of deposit/checkingaccount as the introductory keystone product of the customer/bank relationship and then over time to cross-sell the customer other products and services. Could it be that for certain segments of the market, the prepaid card is the new foundational product? The answer may be yes. But either way it’s clear that for many underbanked consumers, traditional banking products don’t meet their needs, and many banks are failing to introduce more relevant products. Banks and AFS providers can succeed in this market if they focus on the customer’s needs and the utility they want and are open to innovating new products, marketing and delivery methods.

Opportunity: Mobile...the new common channel and platformBecause the demography of the underbanked market is no longer homogeneous there are challenges to finding cost-effective approaches to reach both older and younger customers who consume media very differently. While some older consumers use some digital media, in aggregate there are wide differences in the way the generations interact with and are impacted by certain media and combinations of media. As a result, finding efficient marketing and product delivery channels that are relevant and scalable is very challenging.

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Not surprisingly, the pre-Baby Boom generations are either not cell/internet users or are very light users (see chart below, Retirees 1-3). Due to the maturity of these segments and their ingrained habits, providers seeking to serve this market will likely need to continue utilizing offline channels for marketing, consumer communications and product delivery.

However, it’s a very different story for Gen X and Gen Y. The digital and mobile levels of adoption forthese groups is more than sufficient for mobile to become an important, if not predominant channel for marketing, consumer communications and product delivery.9

The Center for Financial Services Innovation (CFSI) has studied this issue and has concluded thatmobile financial services (MFS) has the potential to reach and serve the underbanked market in new ways. The CFSI outlines four attributes to mobile that make it highly appealing and viable in serving this market.10

• Portable Portability makes mobile phones ideal for delivering financial information to consumers and provides

greater convenience of consumption and service. Underbanked consumers have a time-sensitive element to their needs that lends itself to immediate communication for fraud alerts, low-balance warnings, overdraft warnings, etc.

• Ubiquitous Mobile phone usage is almost universal across the two Baby Boomer segments and Gen X and Gen Y.

Unlike internet usage at home, which varies even within these groups, mobile is more widely owned and used. Segments that are highly represented within the underbanked market such as Hispanics, African Americans, and youth (Gen Y) are heavy users of text messaging and data, so their use and adoption for MFS is highly likely.

INTERNET AND CELL PHONE ARE MOST POPULAR WITH YOUNGER GENERATIONS.

BOTH PRIMETIME AND DAYTIME TV ARE MOST POPULAR IN OLDER GENERATIONS.

BUYING CHANNEL PROPENSITY MEDIA USAGE PROPENSITY Cell Primetime Daytime Internet Mail Phone Internet Phone TV TV Outdoor Radio Newspaper A − GenY/Millennials 117 60 62 122 127 57 88 104 121 43

B − GenX 107 89 92 120 129 64 74 114 121 73

C − Boomers 2 100 103 105 109 108 92 71 109 113 105

D − Boomers 1 98 113 114 99 83 122 109 102 93 121

E − Seniors/Retirees 3 88 113 105 55 51 164 175 64 44 137

F − Seniors/Retirees 2 76 116 101 21 27 188 200 42 27 142

G − Seniors/Retirees 1 77 114 99 21 20 194 195 41 27 142

MEDIA USAGE BY GENERATIONS

Source: Acxiom Data

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• Personalized Phones as personal devices house a great deal of information about the people who use them —

their location and movement patterns, purchasing behavior and interests. While various cards in the wallet have traditionally been thought of as the place where this information is revealed, for many underbanked consumers mobile is the new wallet.

• Multi-Modal Because phones can perform many tasks (send email, manage appointments, access maps, provide

traffic information, read and edit documents, view photos) they provide opportunities for marketing and customer service. Activities such as check deposit, bill pay and bill pay alerts, ATM location, messaging/reminders are all functions that can be performed well and inexpensively.

While all mobile phones are not created equal, and smart phones offer more functionality than regularmobile devices, many within the younger segments of the underbanked market (Gen X and Gen Y) already have smart phones, and penetration is increasing across the underbanked market as smart phones become available via prepaid providers. Additionally, more than 90 percent of all phones in circulation provide internet access.11

Acxiom’s point of viewMost within the mainstream retail banking cards/payments industries are serving and outwardly seeking more customers who fit neatly with their own products, pricing, risk and business/service models. While this is understandable it is also problematic as these providers are all looking for the same type of customer, of which there is a finite number. The pre-Baby Boom generations are in the twilight of their consumption stage, and both segments of Baby Boomers have highly ingrained product and brand preferences in financial services that will be difficult to change. That being the case, financial services providers seeking to drive healthy growth over the next decade will need to begin focusing more intently on Gen X and Gen Y consumers who are younger and more open to new brands, products and delivery channels.

10M

8M

6M

4M

2M

0M

A: 18-2

8

B: 29-4

6

C: 47

-56

D: 57-

66

E: 67-7

7

F: 78

-88

G: 89-10

0

2M

9M

6M

5M

3M

2M

0.3M

-32%-9% +37%

+96%

+48%

2011

2014

2017

2020

CHALLENGES OF AN AGING CUSTOMER BASE

PROJECTED % CHANGE OF# OF CLIENTS IN GIVENGENERATION IN 9 YEARS

TODAY’SCLIENT COUNT

Source: Acxiom Data

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Because Gen Y (85 million) is significantly larger than Gen X (50 million) banks’ growth will be highlydependent on this youngest generational cohort, and it is this group that makes up a large and growing portion of the underbanked market.12 If one follows this logic stream, it leads one to recognize that even for financial institutions with no experience with the underbanked finding a way to attract and serve portions of this market may mean the difference between robust growth or achieving little to no growth. Our point of view is based on the generational and demographic realities that are rapidly transforming the marketplace and will only intensify as Baby Boomers retire and age and the consumer marketplace is dominated by Gen Y for decades to come.

Interestingly, some of the latest excursions into the underbanked space are by non-traditional players.Walmart has developed a full array of banking services for its customers, whose demography closely overlaps with much of the underbanked — millions of who walk into a Walmart every day. They have done this through partnerships with established financial services players like American Express, whose Bluebird prepaid card mirrors most of the functionality (not the features) with much lower fees than a traditional checking account. After years of bank industry lobbying that kept Walmart from obtaininga full-fledged banking charter, the chain has set up a virtual bank with products and services closely designed with their customers in mind.

Some traditional banks are tiptoeing into the market. JP Morgan Chase offers its Liquid prepaid cardlargely to serve its 8.7 million customer households with lower annual income. About half of the Liquid customers previously used few or no banking services — so they appear to have found a way to tap the underbanked market and pull those consumers into their brand.

While these are just two examples of many where traditional and new entrants are serving thismarket, the sheer numbers will continue to attract attention to organizations in need of a post-BabyBoom strategy.

ConclusionWhile they share some common characteristics, the unbanked and underbanked markets are quite different, and underbanked consumers are easier to reach and have greater resources to buy. Over the next decade the underbanked market — one in five households and 51 million adults overall — will represent a large and growing segment of the total market for consumer financial services. While diverse by age/generation, the new-market entrants into Gen Y will quickly make up a large portion of this market. Determining how to reach and serve the underbanked market, which spans several generations, and finding efficient and scalable ways to attract and serve them will be of utmost importance. Developments in technology and consumer adoption and behavior will require companies serving these markets to be proficient and creative in the use of digital and mobile channels for marketing and product/service delivery.

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10

While it is unclear who will win the land grab for this market and the next generation of consumers, whatis clear is that the rules are changing. Traditional retail banks do have brand, product and delivery assets that can be creatively deployed (i.e., JP Morgan Chase). But non-traditional entrants partnering with established product providers can also create offerings that can be distributed through massive non-bank channels in ways that are appealing to this market (i.e., Walmart/American Express).

Customer needs and expectations, in general, are rapidly changing — particularly among the underbanked. Companies that recognize this and see it as a big opportunity to rethink what modern banking means to one in five households will likely be the winners in the future. In this new era of financial services, the word “banking” means lots of things to lots of people, but “banking” is no longer the sole dominion of traditional financial institutions.

About the authorStephen DreesStephen Drees is Managing Principal, Industry Strategy Group, where he consults on advertising, marketing, branding, strategic alliances, media/channel optimization, customer loyalty/experience, consumer analytics, decision sciences, new product/service development and marketing technology. He has client-side experience in all aspects of financial services and consulting/agency-side experience in retail, consumer package goods and consumer services. During his career he has held marketing, product, strategy and executive management roles.

A frequent speaker, Stephen holds a B.A. in Marketing Communication from Bloomsburg University and M.S. in Management/Strategy from the University of Pennsylvania. He is a graduate of the Advanced Management College of the Stanford University Graduate School of Business.

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(1) FDIC National Survey of Unbanked and Underbanked Households, September 2012 (2) FDIC National Survey of Unbanked and Underbanked Households – Use of Alternative Financial Services, June 2013 (3) Acxiom Data (4) FDIC National Survey of Unbanked and Underbanked Households, September 2012 (5) Acxiom Data (6) U.S. Census Bureau: Census Data (7) Acxiom Data (8) Ibid (9) Center for Financial Services Innovation (CFSI) Reaching Underbanked Consumers Through Mobile Services Study, August 2011 (10) Ibid (11) Ibid (12) Center for Financial Services Innovation (CFSI) Underbanked Market Sizing Study, November 2012