01I

I

I The Fed Reader Peyments and Foreign

Exchenge

r Caskey: Check-Cashing

Outlets in the U.S.

Financial System

© McGraw-HilI. Inc. 1994

Check-Cashing Outlets inI the U.S. Financial Systenl, John P. Caskey

John P. Caskey. "Check-Cashing Outlets in the U.S. Financial Sys-

tem." Federal Reserve Bank of Kansas City. Economic Review(November/December 19911. pp. 53-67.

John P. Caskey is a visiting scholar at the Federal Reserve Bank of

Kansas City. The Russell Sage Foundation provided funding for this

study. The views expressed in the article are solely those of theauthor and do not necessarily reflect the views of the Russell SageFoundation. the Federal Reserve Bank of Kansas City. or the FederalReserve System. The author would like to thank Jennifer Ekert and

Bart Yavorosky for excellent research assistance. The three of usare grateful to the commercial check-eashers and state regulators

who took the time to explain the business and its regulatory environ-

ment to us. The article also benefited from conversations about thisresearch with Gordon Sellon. Hyman Minsky. and my colleagues at

Swarthmore College. The author is also grateful to Kristin Lewis of

American Business Information for providing some of the data used

III this article.

On the current debate over bankingreform, some policymakers and con-sumer advocates have expressed con-

cern that many lower-income Americans haveI lost access to basic payment senTices providedI by banks. Reports of branch closings and in-I creased service charges have led to proposals

that banks be required to provide basic bank-ing services to all consumers.

Most discussions of this issue atOeincom-plete, however, because they overlook existing

, alternatives to banks for those who cannot or: choose not to use banks to meet their pay-I1 _

I

ments needs. This article exammes the roleof check-eashing outlets (eeOs), a principalalternative to banks for many low- and moder-ate-income consumers.! Despitc evidence of:rapid growth over the past decade, relatively Ilittle is known about the check-eashing indus-try. Understanding who uses eeos and whyprovides new insight into the costs of paymcntservices and adds a new dimension to the de-bate over basic banking services.

The first section of the article provides anoverview of the check-eashing industry, in-cluding its services, fees, structure, and recentgrowth. The second section examines whouses ecos and why, and offers possible expla-Inations for recent growth. The final section Iaddresses the regulation of ecos and theirpossible role in providing basic banking ser-vices to low-income consumers.

An Overview of the Check-CashingIndustry

The check-cashing industry began in the I930sas a response to banking problems during the

1. In Indiana. Illinois. Minnesota. and Wisconsin. firms that cash Icustom~rs' checks for a fee are said to be in the "curren~y-I

-The Fed Reader Payments end Foreign

ExchangeCeskey: Check-CashingOutlets in the U.S.Financial System

(el McGraw·Hill,Inc, 1994 '0

Depression and to changes in employer pay-ment practices. eeos originally specialized incashing payroll checks but over the years haveevolved to provide a variety of payments ser-

! vices. Largely unregulated, the check-cashingindustry has grown rapidly in the past decade,expanding beyond its traditional base in ur-ban areas.

I Services Provided by CCOs

Nonfinancial businesses have cashed COll-sUlIlers' checks for lJlany decades. TraditiolJ-ally, this role was /illed by bars, grocery stores,

i or other businesses that would cash third-part)'! checks for regular customers or for customersI making purchases. Such establishments rarely! charged an explicit fee for cashing checks.! The cost of the service was covered by theI additional sales it gencrated.2

It is difficult to establish exactly whenfinns began to specialize in check-eashing andto Icvy a fee for the service. Most evidence

I

I suggest" that ecos evoh'ed from other busi-I .i nesses th;lt cashed checks on the side. eeos: apparcnlly first appeared in Chicago and New

York in the 1930s and spread to other largeurban areas.

Ivlost accoullts cite widespread bankingproblems and changing employer paymentpractices as the principal factors motivatingthe early development of eeos. For example,in Chicago, specialized check-cashillg [inns

II arose to provide payments services duringI the ball king crisis of the 1930s (Illillois Depart-I ment of Financial Institutions 1980). In addi-! tion, ecos were stimulated by firms convert-: ing from cash pavrolls to payroll checks duringi the 1930s and 1940s (Wolf).! The core business of a contemporary eeoI

exchange" business. Themore widelyused term" check-cashing"business IS used to avoidconfusionwithforeignexchangetransac-tions.2. Forlackof data, the articledoes not attempt to examinerecent

. trends in check-cashingby these nonfinancialbusinesses. It alsoI excludesfrom the analysismobilepayrollservices.

!

is cashing checks for a fee. The rce is intended j'to provide the check-casher a profIt after cov- Iering expenses, which include the cost of:maintaining a storefrunt alld illSltrallCe alld ipcrsollnel costs. Moreover, heGl\Ise the check- icasher advances funds 011 chccks that must isubsequently be cleared through the banking Isystem, ecos incur in terest expenses 011 the ifllllds advallced. Alld, ecos run the risk that!

I

some cashed checks will he uncollectible be- icause of insuflicien t funds or fraud ..'

Because of the risks associated with ad- I

vancing money on checks, III,UIY outlets cash:ollly customers' payroll or govcnllllent entitle-ment checks. Some eeos also cash persollal :checks bltt typically charge a higher fce for I

I

this service to cover the higher risk that thecheck will boullce. Many CCOs cash persollal .checks onl}' after they have COli/inned withthe bank it is drawn 011 that there are sltl'ficiellt ;funds.

111 some states, ecos m;lke "payday" loans. ,They do this by cashing a custolJler's personal!

Icheck, which is sometimes posldated, and,agreeing to huld it until tIle customer's pay- !

day. Since this amounts to making all unse- !- I

cured loan, check-cashers generally charge Imltch higher fees for this service. I t is generally!offered only to customers with stable employ- Imellt records who have mailltailled bank ac-;coltnts in good standing for sevcral mOllths.4 ,

While most eeos derive most of their rev- I

enlle from check-cashing fces, almost all eeos :do more thalJ,just cash cherks ..~They typically I

,3. As is clearfromthis explanallon.allcheck-cashingoutlets must I

workcloselywith at least one bank.This IS because a CCOneeds ~a bankto clearthe largevolumeof checks the firmcashes. More- iover.most CCOsrelyon banklinesof crel1ltto meet theirperiodiC.:substantialneeds for cash.4. Inthe few states that regulate the check-cashingbusiness, it is 'Illegalfor check-cashersto make such loans. In some unregulated !states, paydayloansare effectivelyillegalbecause the fees violate istate usury laws. :5. Datafromthe DepartmentofFinancialInstitutionsinIllinoisshow !check-cashingfirms earn about 67 percfmtof their revenue fromcheck-cashingfees and about 11 percent from sales of moneyorders.

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Exchange Outlets in the U.S.Finencial System

offer a range of financial and nonfinancialservices-they may sell money orders, makewire .transfers of cash, and handle telephoneand utility bill payments. In some states, theysell lottery tickets and public tran~ponation~sses, offer income-tax---P-~.Rill"ation_~~Iyi<:es,and distriQ.!J,te_welf!!r_~_...Qm'!!1_entsand foodstamp~Jn addition, many sell cigarettes andcandy or buy and sell gold jewelry.

Fees Charged by CCOs

CCO fees for cashing checks are usually ex-pressed as a percentage of the face value of thecheck. In most states, check-e~1:I~!:§.~.!!-char.gewhatever the market will bear; however, sevenstates currently set ceilings on check-cashingfees (Table 1).6 Asshown in the table, the maxi-mum permissible fee sometimes varies, de-pending on whether the check is drawn on anin-state or an out-of-state bank or is a govern-ment entitlement, payroll, or personal check.The different ceilings on fees across categoriesreflect the different speeds with which checksclear, different default risks, and the desire tolimit the fees that public aid recipients pay for

. cashillg their entitlement chc::<:l5._~,Outside of these seven states, commercial

check-eashing fees vary widely. In 1989, theConsumer Federation of America (CFA) con-ducted a surveyof the fees levied at check-eash-ing outlets in 20 major cities across the UnitedStates (Table 2). This surveysuggests that CCOscharge roughly similar fees for payroll and gov-

6. Other states partially regulate the indusry or have legislationpending. For example, Wisconsin has long required check-eashersto be licensed but does not otherwise regulate check-eashers'activi-ties. Washington state recently established extensive regulationsof the check-eashing industry that will take effect in 1992. but theregulations do not set ceilings on check-eashing fees. At the timeof this writing, Ohio and Pennsylvania have regulatory legislationpending. Legislation to regulate the industry was also recently intro-duced in a few other states. but failed to pass. Illinois and NewYorkwere the first to establish such regulations, enacting legislationin 1943 and 1944. respectively. Delaware and New Jersey beganto regulate CCO fees in the 1950s, and in the past two years,Connecticut, Georgia. and Minnesota have also done so.

ernment support checks.7 For both types ofchecks, fees range from about 1.0 percent to3.0 percent of the face value of the check, withan average rate of about 1.75 percent.8

About a third of the check-eashing outletscontacted by the CFAwere willing to cash per-sonal checks. Not surprisingly, given the de-fault risk, they charge far more for this service.In the survey group, fees ranged from 1.66percent to 20 percent of the face value of thecheck and averaged 7.7 percent.9

CCOs also levyfees for the other financialservices they provide, such as selling moneyorders or making wire transfers. These servicesare largely used to pay bills by customers whodo not have checkable bank deposits. The datasuggest that many CCOs set low prices onthese services. For example, the CFA surveyfound that the average charge for a $50 moneyorder was $0.55, and many CCOs charged aflat fee independently of the sizeof the moneyorder. This compares favorably to the $0.75charged by the U.S. postal system for moneyorders up to $700.10

Structure of the Industry

An examination of the structure of the check-cashing industry indicates commercial check-cashing is a relatively large industry, domi-

7. It is also common for check--eashingfirms to levy additionalcharges for first-time customers. Check-easherssay these chargesare to cover the costs of issuing the customer an identification cardor registering the customer.8. The CFA survey suggests that CCOs charge slightly more forcashing AFDC (welfare) checks than for social security checks.9. A 1991 telephone survey. by the author, of 42 check-eashingfirms in several states found fees broadly agreeing with those foundby the Consumer Federation of America. In the unregulated states,most firms charged between 1.5 and 3.0 percent to cash govern-ment and local payroll checks. Three outlets charged rates as highas 5 to 6 percent. Those that accepted personal checks chargedfrom 4 to 15 percent. A small number of the firms permitted acustomer to cash a post-dated personal check. For a check that wasto be held up to one month, the customer typically was charged 20to 35 percent of the amount advanced.10. Check--easherswant to promote money order sales because acheck-easher selling numerous money orders will not need to useas much of his own capital or tap a relatively expensive bank credit

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FinancialSystem

TABLE 1Maximum Check-Cashing Fees in Regulated States(Rates are a percentage of the face value of the check)

State legal ceiling rate

Connecticut

Delaware

Georgia

Illinois

Minnesota

New Jersey

New York

2% for non-public aid checks and 1.0% for state public aid checks. (Ceiling fees set in1990.)

1% or $4.00. whichever is greater. (Ceiling fee set in 1989. The previous ceiling rate was0.5% or $0.25.)

The larger of $5.00 or 3% for public aid checks. 10% for personal checks. and 5% for allother checks (payroll). (Ceiling fees set in 1990.)

1.2% plus $0.90. (Ceiling fee set in 1986. The previous ceiling rate was 1.1 % plus $0.75.)

2.5% for public aid checks above $500 (5% for a first-time customer). no limit on personalchecks but the rate must be filed with the state Commerce Department and be•.reasonable." 3.0% on all other checks (6% for a first-time customer). (Ceiling fees set in1991.)

1% for in-state checks and 1.5% for out-of-state checks or $0.50. whichever is greater.(Ceiling fees set in 1979. The previous ceiling rates were 0.75% on in-state checks and1.0% on out-of-state checks. or $0.35.)0.9% or $0.50. whichever is greater. (Ceiling fee set in 1988. The previous ceiling rate was0.75%.)

Source: State regulatory agencies.

TABLE 2National Check-Cashing Fees

Service

Payroll checksGovernment checksPersonal checksMoney orders ($50)

Minimum charge

.9%

.9%1.66%$.19

Maximum charge

3.0%3.25%

20%$.99

Average

1.74%1.73%7.7%$.55

Source: Consumer Federation of America (19891.

nated mainly by local owner-operators. Histor-ically, eeos have been regulated extensivelyin only a few states. However, this picture ischanging as national chains begin to developand as more states consider regulating eeos.

eeos are currently regulated in only eightstates. Seven states set ceilings on check-eash-ing fees and require that eeos be licensedand abide by other regulations. These regula-tions generally require check-cashers to posttheir fees in a prominen t location in the outlet

line to obtain cash for check-eashingcustomers. The check-cashersimply hands out the cash he receives from selling the moneyorders. In addition. check-eashers can earn float (i.e.. interest onmoney being transferred to someone elsel from money order sales.for the check-eashernormally pays the money order company witha slight delay (Gagerman).

and to provide customers with receipts. Often,the regulations require the eeo owner tomeet a minimum bonding or capital require-ment. Some states prohibit newlyopened out-lets from locating within a specified distanceof existing eeos. All states specify record-keeping requirements for the firms, andseveral of the states require check-eashers toreport large sales of money orders or largewire transfers. This is to prevent check-cashingfirms from being used in a money launderingprocess. Typically, the state banking depart-ment is responsible for issuing licenses andenforcing the regulations.

Because only a fewstates regulate the .com-mercial check-cashing business, it is impossi-

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Exchange Outlets in the U.S.Financial Systam

ble to know exactly how many check-eashingfirms are currently operating. However, acrossthe United States there were 4,289 yellow-page listings of check-eashing firms in early1991. This count is a lower-bound estimateof the total number of commercial check-cashing outlets nationally. In six of the eightstates that require CCOs to be licensed, forexample, the yellow-page count closely ap-proximates the number of licenses outstand-ing. However, the yellow-page count under-states the number of licensed outlets in NewYork by about 20 percent and by almost 50percent in Georgia.

Given the sparse information on the in-dustry, any estimate of the size of the industryin dollar terms is subject to a large margin oferror. However, a conseIvative estimate indi-cates that the industry cashed about 150 mil-lion checks in 1990with a combined face valueof $45 billion. From this activity, the check-cashing industry earned approximately $790million in fees."

The vast majority of CCOs across thecountry appear to be owned by local inde-,Eendent oper~~or~_IE~!~yofwb5~m own three

. tQ t~.n.Q!!!Le~j!Lg._giyeD.area. There is evi-dence, however, that large national chainsare developing. For example, one check-cash-ing company owns over 100 stores in the

11. In arriving at these estimates. it is assumed that there were4,250 check-eashing outlets operating in 1990, each cashing an

average of 35,000 checks. This estimate of the average number of

checks cashed is below the scale of operation of most check-eashingoutlets in Illinois, New Jersey. and New York, as reported by the

regulatory agencies in those states. However. outlets in these three

states must do a greater volume of business than the national

average to survive because these states have regulated fees lowerthan those charged elsewhere. Interviews with check-eashers in

the unregulated states suggest most outlets handle between 25,000and 40.000 checks annually.

These estimates also assume that the average check has a

face value of $300 and the average cashing fee is 1.75 percent. The

$300 estimate is consistent with the data for Illinois. New Jersey.and New York and was thought reasonable by check-eashers in the

unregulated states. The 1.75 percent fee agrees with the national

average reported by the Consumer Federation of America 11989).

Northeast and is publicly traded on the over-the-eounter stock market. And some check-cashing franchise operations have grown rap-idly in the past few years. Recently, WesternUnion, which has provided money-wiring ser-vices to many check-eashers, announcedplans to develop a national network of check-cashing outlets (Wall Street journal).

The Growth and Location of the

Check-Cashing Industry.•.,. •..•J 'i •••.,

Data on the check-eashing i:1dustry are sparsebut nevertheless indicate that the industry isgrowing rapidly. Moreover, the evidence sug-gests that the industry is beginning to expandbeyond its traditional concentration in lower-income urban areas.

In interviews, check-eashers who havebeen in the business many years said that theindustry grew slowly until the early or mid-1980s and then expanded rapidly. Unfortu-nately, there is not sufficient data to confirmthis view.'2 However, American Business Infor-mation (ABI), a firm that tracks yellow-pagelistings of businesses, reported 4,289 listings ofcheck-eashing (or currency exchange) outletsnationally inJuly of 1991. In 1987, the earliestyear it provided data, ABI reported just 2,151

12. Data are available for Illinois, New Jersey, and New York, but

the trends in these states may well have been affected by uniquefactors. For example. in both Illinois and New York there was asharp increase in the average annual growth rate in the number of

licensed check-eashing outlets in the second half of the 1980s as

compared to the first half of the decade. However, both of thesestates in the second half of the 1980s raised the ceiling on the fees

check-eashers were allowed to charge. Moreover, New York, atthe end of 1985, stopped considering distance between competing

check-eashing locations as a factor in approving applications for

licenses (Renshaw, p. 8). In New Jersey. the number of licensed

check-eashing outlets grew strongly throughout the 1980s, rising

from 69 in 1980 to 88 in 1989. However, the growth in the early

part of the decade may have been aided by a 1979 increase in thefee check-eashers in New Jersey could charge. Finally, the trends

in these states are unlikely to be nationally representative becauseIllinois, New Jersey, and New York. unlike almost all other states.

have had well-developed check-eashing industries for over 40 years.

In fact. the study by Reeb and others concludes that check-eashingin New York City is a mature industry with limited future growthpossibilities for its core services.

Ipayments and FOreign~key: Check-Cashing I © McGraw-Hili, Inc., 1994Exchange Outlets in the U.S.

Financial System

I The Fed Reader

national listings. Thus, in four years, the indus-try appears to have doubled, a phenomenalgrowth rate.

Existing CCOs are disproportionately lo-cated in major urban areas, generally in low-and moderate-income neighborhods. For ex-ample, in eight states fewer than 10 percentof the CCOs are located in cities of less than100,000.n The Illinois Department of Finan-cial Institutions (1980, p. 107) reported thatof 624 licensed check-cashers in the state in1985,90 percent were located in the Chicagoarea. And, a study for the NewYorkState Bank-ing Department found that 69 percent of allcheck-cashing outlets in NewYork Cityin 1990were located in low-income census tracts(Kemlage and Renshaw).

The evidence suggests that the recentgrowth in CCOs has been uneven, with espe-cially rapid growth outside of the few majorurban areas where check-cashing establish-ments have long existed. For example, yellow-page listings from late 1988 to early 1991show growth rates for Illinois, New Jersey,and New York of below 20 percent. Overthat same period of time, the number oflisted check-eashers grew by 85 percent inFlorida, 195 percent in Georgia, 96 percentin Missouri, 293 percent in North Carolina,80 percent in Texas, and 87 percent in Wash-ington.

In states with early and well-developedcheck-cashing industries, recent growth hasoccurred mainly outside of the traditionalinner-city areas. For example, the Illinois De-partment of Financial Institutions (1989, p.5) reported that from 1985 to 1989, 108 newcheck-cashing licenses were granted but only13 of these were for locations in Chicago; 75were for locations in the Chicago suburbs andthe remaining 20 were for downstate loca-tions.

13. This result is based on the author's survey of eeos in eightstates.

Explaining the Use and Growthof CCOs

Understanding the reasons behind the recentgrowth of check-eashing firms requires knowl-edge of who uses them and why. This sectioncompares the cost and typesof servicesofferedby banks and CCOs, presents recent surveyevidence on usage of CCOs, and examinesfactors behind their recen t growth.

Comparing Banks and CCOs

Since both banks and CCOs provide basic pay-ments services, a key question is why con-sumers use CCOs rather than banks. Onepossible explanation is that CCOs are cheaperthan...b.a..ILks•.Or, perhaps CCOs are more con-venien t than banks or p-rovidea typ-eof servicethat banks are unable or unwillin~oprovide.~4

The information on fees presented earliercan help provide an estimate of tlle cost toa household of meeting its payment needsthrough a CCO. For example, assume a familycashes its paychecks or government entitle-ment checks at a check-cashing firm charginga 1.5 percent fee and buys six money orders amonth at an average price of$0.50 per moneyorder. In this situation, a familywith a $10,000yearly income (about 75 percent of the 1990official poverty level for a familyof four) wouldspend $186annually on basic financial transac-tions. Since check-cashing fees are a fixed per-centage of the value of a check, a family Witllhigher income would pay more. Thus, in thisexample a family with $24,000 annual incomewould spend $396 annually for financial ser-vices.ls

14. eeos might also be used by those who do not want to create

deposit-account records because of tax reasons, immigration status,

etc.15. This example assumes no taxes or withholding. The low-incomefamily pays $150 ($10,000 x .015) for check-cashing and an addi·tional $36 for money orders. The moderate-income family pays $360for check-eashing and $36 for money orders.

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Exchange Outlets in the U.S.Financial System

The cost of obtaining similar services froma bank would be somewhat less, according to

'-a 1990 national survey of bank fees by theConsumer Federation of America (1990). In

I estimating the cost of a checking accountbased on its survey data, the CFA assumedthat a family maintains an average balance ofunder $400 in the account and that the ac-count balance falls below $200 only once amonth. In addition, the CFAassumed the fam-ily writes ten checks, makes four ATM with-drawals, and two deposits monthly and, overthe year, the family bounces two checks anddeposits one check that fails to clear. Basedon this behavioral pattern, the CFA estimatedthat a familywould pay $107.96 a year to main-tain a non interest-bearing checking accountand would pay $111.39 a year to maintain aninterest-bearing NOW account.

Regardless of the type of account main-tained, it appears a family would save signifi-cant out-of-pocket costs by conducting it,,<;-fi:-nancial transactions through a_Qan~Jatherthan a CCO.I~ Because the fees for cashingchecks at a CCO are assessed as a percentageof the face value of the check, the differencecan be small for very low-income households.For example, a family earning $10,000 a yearwould save only about $80 annually by usinga checking account rather than a CCO, whilea family earning $24,000 a year would savealmost $300. However, the very poorest house-holds may be least able to afford the additionalcost.

Two explanations account for the successof the check-eashing industry in the face ofthis cost disadvantage. One explanation is thatout-of-pocket expenses do not measure thefull cost of using a financial institution.

16. While this example appears to be based on reasonable assump-tions, other assumptions could change relative costs. For example,

since the CFA study found that banks charged $15.11 per bounced

check, the cost of using a bank would increase if the family's accountwere overdrawn more frequently.

g.9J}Yt':nie.n!=~,_quality,and type of service alsomatter. In these aspects, CCOs may have anadvantage for many consumers since mostCCOs have IIllJ.Chlonger opening hours thando banks and are located more conv~nientlyfor some consumers. Also, CCOs may be fasterwith the range of simpie financial transactionsin which they specialize.

Another explanation for the success ofCCOs is that bank services do not fully substi-tute for CCO services. Most important, whileCCOs are willing to assume the risk that acheck they cash will bounce, banks generallywill not. Most banks require a consumer tomaintain a deposit account in order to cashchecks, even government checks with a negli-gible default risk.17 For depositors, most banksrequire the customer either maintain suffi-cient funds in an account to cover the checkor wait a few days for the check to clear. Ifthe check fails to clear and the bank hascashed the check for a customer with sufficientfunds to cover it, the customer's account isdocked for the amount of the check. More-over, many banks charge the customer for thebank's cost of handling a "returned" deposit.

Because of these differences in check-eash-ing policy, consumers without bank accountsmay be forced to take their business to CCOs.Moreover, even if they maintain a bank ac-count, consumers may not be able to cash a

17. In 1988, the Consumer Federation of America (1988) surveyed

110 banks and 84 thrifts located primarily in the urban areas of 15

states and the District of Columbia. It found that of the 191 financial

institutions responding to the survey, 71 percent would not cash

government checks for nondepositors at any price. Fourteen percent

would cash nondepositors' government cheCKS for free, and 15

percent would do so for a fee, averaging $3.88 for a $300 check.

Outside of urban areas, banks are apparently more willing to cashgovernment checks for nondepositors (U.S. GAO 1988, pp. 13-14).

The study IGAO 1988, pp. 16-17) suggests that banks thatrefuse to cash government cheCKS for free for nondepositors do so

because banks incur costs in handling cheCKS, they do not want tocrowd their lobbies with government aid recipients who only want

to cash their entitlement cheCKS, and they fear that some fraudulent

checks might be cashed for which the government would not reim-burse them.

The Fed Reader Payments and Foreign

ExchangeCaskey: Check-Cashing

Oullets in the U.S.

Financial System

@ McGraw·Hill. Inc., 1994 o

paycheck or government assistance check be-cause the amount exceeds their account bal-ance. Although these consumers could savemoney by depositing their check in a bank andwaiting for it to clear, they may prefer to pay afee to have the cash immediately.

Evidence on ceo Use

Surveys of who uses commercial check-cashingfirms and why they choose to do so suggest that

1..Q}Qg custQJILel~~[eJj thf:,flow-income to lower-ll!1id9le illC_orneworkers cashing,p.':lyroU chec~sII c~,:"r~cipientsofgovernmen~tr~nsfer payments.

Relative to the population as a whole, a dispro-I portionate percentage of CCO customers are

l-young'lwm:YlliJ~, alld .c,lonot have bank ac-counts. Limited access to banking services and

i the convenience ofCCOs appear to be the mosti important factors governing their use.

IThis profile of CCO customers is drawn

from two recent surveys. One, a survey by theII Consumers Banking Association (CBA), fo-I cused on consumers cashing paychecks. A sec-I ond survey, conducted by the New jerseyI

IDepartment of the Public Advocate, concen-

I trated on those cashing public assistance andI social security checks,lR

IThe CBA survey found that CCO cus-

tomers were younger and poorer than the gen-

t

eral population and more likely to be a racialIIIinori ty. Th irty-seven percen t of respond en ts

! were bel:\veen the ages of 18 and 30, and 29I percent reported a household income of lessI than $ J 5,000 a year. The median reported

118. There are several reasons why neither the Consumer BankersI Association's survey nor the New Jersey Department of the Public

Advocate's survey is alone likely to be broadly representative of thecustomer base of the check-eashing industry. The Department of

the Public Advocate survey limited its study to the use of CCOs byrecipients of government aid programs and ignored people cashing

Ipayroll checks. In the case of the Consumer Bankers Association(CBA) survey, customers who visit a CCO during a heavy payroll

I period are unlikely to be representative of customers generally; thatI is, they are more likely to be employed and have higher education

I and income levels. They are probably also more likely to maintain

i a deposit account.I

I

household income in the survey was $20,400 as !compared with a 1985 national median family!income of $28,906. While 33 percent of re-Ispondents were white, 47 percent were black.and 18 percent hispanic. i

The survey found that customers' reasons!for using a CCO revolved around their access i

to hank services, Two-thirds of customers sur-veyed had deposit accounts at hanks or otherfinancial institutions. Only 1.3 percent of thesecustomers used CCOs regularly,.citing conven- I'

.ience .and. reacly a<;:ces~.to .casi], In contrast,the one-third of CCO customers without bankaccounts made more regular use ofCCOs. Forthose customers, lack .9Lnu.!ch t~)..Il}aintainbank minimum balances and high bank serv-ice charges were cited as thc main reasons foruse of CCOS.l~

The study by the New jnscy Dcpartmentof the Public Advocate provirles a somewhatdifferent portrait of the customer base of thecheck-eashing industry because it focuses onthose cashing public assistancc and social se-curity checks.10 The Departmcnt interviewed750 recipients of government transfer pay-ments. In contrast to the CBA survey, 92 per-ccnt of those interviewed said that they didnot have a bank account. Fifty-scvcn percent Iwere cashing Aid to Families with Dependent:Children (AFDC) checks. Another 20 percentwere cashing social sccurity checks, and therest were cashing unemployment benefits, vet-

Ierans assistance, or state disability checks. I

In the New jersey survey, 79 percent of I_____________________ i

19. For additional evidence on reasons consumers may not use :

banks, see Canner and Maland. I20. According to the data in Appendices P through S of the study,

CCOs in three New Jersey counties (Camden, Essex. and Mercer Icounties) cashed about 1,5 million checks in 1986, about 13 percent

of which were AFDC checks. By examining 4,842 canceled AFDC 1

checks from three counties, the Department found that 47 percent

of them were cashed at banks, 32 percent were cashed at CCOs, I12 percent were cashed at local businesses, and 9 percent were !cashed by friends, relatives, or landlords. Of the AFDC checks

cashed at banks, 75 percent were cashed at banks that serve asdepositories of county funds and are required to cash AFDC checksfor nondepositors without a fee.

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those interviewed stated that they never go toa bank to cash their government checks and,of these, 61 percent said they only go to eeos.When asked why they were using a eeo tocash their government check, respondentscited lack of access to bank services and theconvenience of eeos.

Factor. Behind ceo Growth

Knowledge of who uses eeos and why is im-portant for understanding the rapid growthin the industry during the I980s. ehanges inthe economic situation of households mayhave led to an increased demand for check-cashing services. At the same time, regulatorychanges may have increased the cost of bank-ing services.

One factor contributing to the growth ofeeos may have been the strong growth in.payroll employment following the 1982reces-sion. From 1983to 1989,total civilian employ-ment increased 16 percent (Economic Report ofthe President). Unlike the economic expansionsof the I960sand 1970s,however, employmen tgrowth in the 1980s was accompanied by afall in employees' real incomes. For example,average weeklyearnings of private sector, non-agricultural, industrial workers fell from $408in 1978 to $346 in 1990.21 Because the cus-tomer base of eeos is disproportionately low-wage and mod.erate-wage workers, .lower reaJincom.esmelt. h~~~~.9.1g!:ib~!!ed_!..Qt.!:!.<;_de_~and.for eco services~

More generally, the 1980ssaw a fa)l in_.~~~~~J:!Q.ardof living for many low-income fami-lies. From 1979 to 1988, the mean real familyincome of families in the lowest incomequinti1e fell 5.4 percent (Bradbury, p. 26).And, the number of families falling below thepoverty line rose from 24.5 million in 1978to 31.9 million in 1989 (Er-onomic Report of thePresident). To the extent that poorer families

21. Both figures are expressed in 1990 dollars.

had increased difficulty in accumulating fi-nancial savings to maintain bank balances,they may have had an increased incentive touse CCOs.

The 1980salso sawchanges in the cost andsupply of banking services. In 1980,the federalgovernment enacted the Depository Institu-tions Deregulation and Monetary Control Act.Among other things, this act began a phaseoutof ceilings on the interest rates banks couldpay on deposits. The Act also required theFederal Reserve System to begin chargingbanks for a number of services it had previ-ously provided for free.

Another factor was a. change in the atti-tude of bank regulators at the federal and statelevels toward competition among banks. Priorto 1980, regulators often looked unfavorablyon a proposed branch that would be locatedin a community already well-served by otherbank branches. However, after 1980,in an at-mosphere much more favorable to free-market competition, regulators began to con-sider the increased competition provided byan additional community bank to be a positivefactor in approving new bank branch applica-tions (Spong).

Following these changes, banking becamea much more competitive business. Banks re-acted by pricing services based_?."~.the cost ofproviding those services. Thus, they began tocharge for accounts with high transactions vol-ume and small balances, significantly raisingthe cost of using banks for many low- andmoderate-income consumers (U.S. GAO).Bankers also reacted to the increased competi-tion by' closing branches in unprofitaQk ...Qrmarginally profitab~e_ar~a.~,which were oftenlow-income areas, and opening branches inthe more desirable, higher-income areas al-ready served by other banksY Combined,these changes worked to make banks both

22. For evidence on branch closings. see Obermiller. and Avery.L..... . • . -'

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more expensive and less convenient for manylow-income and moderate-income consumers,and likely contributed to a growing demandfor commercial check-cashers' services.

Finally, the rapid growth in the check-cashing industry in the 1980s may have beenstimulated by an increased awareness of themarket potential of the millions of Americanswho do not regularly use the baliking systemfor their financial transactions. Beginning inthe mid-1980s,journalists, academics, and pol-icy analysts began to write about bank closingsin low-income neighborhoods and the largenumber of households not using banksYThese reports may have captured the imagina-tion of entrepreneurs and fed the expansionof nonconventional financial institutions serv-ing those whose needs were poorly met bybanks.

Public Policy Issues

Recognizing that CCOs are playing a moreimportant role in the U.S. financial systemraises a number of public policy issues con-cerning CCOs and the delivery of affordablefinancial services to low-income households.This section considers the trade-offs in regulat-ing CCOs and the role they could play in thefinancial system.

Regulation of ceo.Bank closings in low-income communities, in-creases in bank fees on small deposit accounts,and the rapid growth of the check-cashingindustry have made the policies of CCOs farmore relevant than the policies of banks formany segments of the population.

This observation has led to suggestions

23. For example. the U.S. GAO (1988, p. 19) estimated that about16 million American families did not have banking accounts of anytype in 1985. Also see the articles by Canner and Maland, Gross,

Zamba. Lueck, Obermiller. and Bartlett.

that the check-cashing industry be morewidely regulated. Those advocating that morestates, or perhaps even the federal govern-ment, should regulate the industry point outthat many check-cashing customers are rela-tively unsophisticated consumers, with littlesocial or economic power. These customersmight be grossly overcharged by an unscrupu-lous operator, some of whom may have localmonopoly power. Thus, there is concern thatmany poor and moderate-income individualscould spend a large percentage of their lim-ited disposable incomes for basic financialtransactions.

Indeed, evidence supports the concernthat some check-eashing firms levy relativelyhi2'h fees. For example, the survey by the Con-sumer Federation of America (1989) foundthat II percent of the firms charge 3 percentor more for cashing government entitlementchecks. In New Jersey, for example, check-cashers are limited by law to charging 1.0per-cent on in-state checks and 1.5percent on out-of-state checks. Of 662 customers there whoreported the amount of the check they cashedand the amount of fee they paid, 49 percentwere charged more than the legal maximum(NewJersey Department of the Public Advo-cate, p. 29). On average, check-cashers over-charged by about 44 percent of the ceilingrate, and in some cases the excess charge wassubstantial. To cite two examples from thereport: a Hispanic woman who could notspeak English was charged $25 for cashing a$268 social security check, and anotherwoman was charged $16 for cashing her $525AFDC check.24

24. In a survey, by the author, of 42 check-eashing outlets acrossseveral states, a few charged 5 to 6 percent to cash government

and payroll checks. When asked why competition would not drive

firms that charge more out of business, check-cashers said manyof their customers just want their money as fast as possible andpay no attention to a difference of a few percentage points in the

fee charged. In addition, customer transportation costs may limitcompetition among check-cashing outlets.

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Interestingly, in its response to the studyby the Department of the Public Advocate,the Newjersey Department of Banking, whichoversees check-eashing outlets, reported thatit had received only one check-eashing com-plaint over twoyears (GAO, p. 9). It appears,therefore, that the vast majority of people whowere charged more than the legal maximumin New jersey did not complain to the over-sight agency, perhaps because they were un-aware of the overcharge, felt a complaintwould be ineffective, or did not know how tofile an official complaint or felt that the effortwas greater than the cost of the overcharge.25

Those who favor limits on check-eashingfees need to be aware of possible conse-quences, however. Mandating very low check-cashing fees could kill the industry and hurtthe low- and moderate-income people whohave no realistic alternatives for cashing theirchecks. Prior to 1989, for example, Delawarelimited check-eashing outlets to charging afee of 0.5 percent of the face value of thecheck or $0.25, whichever was greater. In1989, the state raised the limit to 1.0 percentor $4.00, whichever is greater, noting that noeeos were operating in the state under theold law.

On the other hand, it is clear that eeoscan flourish in urban areas when the ceilingrate isaround 1.0to 2.0percent.26 In NewYork,

25. The New Jersey Department of Banking told the New JerseyDepartment of the Public Advocate (p. 68) in 1987 that it relied on

the "honor system" to assure compliance with state limits on check-cashing fees. A 1991 telephone survey. by the author, indicated

that check-<:ashing firms in the state are now complying with the

law. perhaps because the Department of Banking increased the

resources it devoted to enforcement after the report by the Depart-

ment of the Public Advocate.

The author called several other state consumer advocate agen-cies and state banking departments to find out if there had beencomplaints against check-<:ashing outlets. In no state was this thecase. However. in unregulated states, it was often difficult to locateanyone in a state agency who knew where one would go to file

such a complaint or how it would be classified by the consumer

advocacy agency.26. If outlets are to cash very small checks or personal checks. ahigher fee may need to be permitted in these cases.

for example, the ceiling rate is 0.9 percent or$0.50,whichever isgreater. Yetover 400check-cashing outlets operate in the state. Illinois,which permits check-eashers to charge up to1.2percent of the face value of the check plus$0.90, has more eeos per capita than anyother stateY

The evidence suggests, therefore, that ifregulation ofeeOs isdeemed desirable, statescan set limits on check-eashing fees to protectconsumers against the highest charges and yetpermit the industry to flourish. The evidencefrom New jersey also suggests, however, thatthe state must devote resources to enforcingcompliance with the statute. In New YorkandIllinois, where the state banking departmentsconduct annual on-site surveysof eeos, firmsdo not appear to charge more than the legalmaximum. Presumably, annual license feesfrom eeos can provide the stateswith the reve-nue to cover the costs of monitoring the indus-try and enforcing state legislation.

The Role of ceo. in the Financial Sy.tem

The 1980s have seen increased emphasis onthe access lower-income households have toaffordable basic financial services. Legisla-tively,this concern has been expressed in con-gressional hearings or proposals to forcebanks to cash govenlment entitlement checksfor free and to offer "basic,"or "life-line,"bankaccounts (U.S. Senate, U.S. House 1989).28Such accounts would permit a consumer to

27. Other states should not automatically assume they can adoptthe New York or Illinois ceilings on check-<:ashing fees without

adversely affecting the industry. Both of these states use check-

cashing outlets to distribute welfare payments. which brings addi-

tional business to the outlets. Also. in both states. check-<:ashing

outlets are almost exclusively found in the dense urban areas. Stateswith less concentrated populations may find check-<:ashing firmscannot function profitably with a 1.0 percent ceiling.

28. Some policy analysts have also suggested reviving the U.S.postal savings system to ensure all communities have convenient

access to a deposit-taking financial institution. In fact, perhaps amajor reason check-<:ashing outlets do not exist in Europe is because

most European countries have postal savings systems with giroaccounts.

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conduct a limited range of basic financialtransactions for a very small fee or no fee.Regulators and community activists have alsoused the eommunity Reinvestment Act andother means to bring pressure on banks tokeep branches open in low-income areas andto improve banking services in these commu-nities.29

However, the possible cost or effectivenessof these proposals has also caused concern.For example, if banks are forced to providethese services without sufficient compensa-tion, the burden might not be shared equallyamong banks. Indeed, banks with existingbranches in low-income areas could be mostaffected. Moreover, imposing such policies onbanks but not their competitors could placebanks at a competitive disadvantage and, per-haps, lead to an acceleration of bank branchclosings.

Recognition of the growing importance ofI eeos, however, suggests that they might playa role in providing basic financial services tolow-income households. eeos specialize indelivering a narrow range of payments ser-vices. With experience, they have learnedwhich financial services are most in demandby lower-income households and have learnedto minimize the cost of providing these ser-vices. eeos already compete for locations thatare most convenient for the low-income andmoderate-income households that make uptheir customer base.

By viewing eeos as an integr!11~!1 Qf_the financial system, federal~tate, and lo<:al

overnments ma be able to work th.emto ensure that they deliver afford!lJ~!LQ~~~payments services. Indeed, a number of statesalready appear to be taking this approach,using eeos in the distribution of public bene-

fits and services. For example, residents ofNewYorkeity and ehicago can elect to receivetheir AFDe payments or food stamps throughlocal eeos. In New York, the state pays theeeo to distribute AFDe benefits in cash. InIllinois, the eeos handle the distribution ofAFDe checks for free, but if the recipientscash their checks at the eeo, they pay theregulated state fee. And, in Illinois, manyeeos have the right to handle automobileregistrations and title transfers.

The suggestion that eeos be used as deliv-ery points for government ser.'ices is linkedwith the view that they be more widely regu-lated. This is true for two reasons. First, in astate where eeo fees and ser.·ices are regu-lated, the industry is likely to have a betterpublic image and therefore is more likely tobe tlUsted for distributing public services. Sec-ond, because permitting eeos to distributeAFDe payments, handle automobile registra-tions, or provide other public functions isprofitable for eeos, such opportunities canbe traded for lower ceilings on the fees eeoslevy for basic financial services. I

Realistically, however, advocating broaderregulation and reliance on eeos for the deliv-ery of basic financial services docs not requireabandoning efforts to improve the accessihil-ity of banks for lower-income hous_d191ds.__While eeos provide some basic payment ser-vices, they are not substitutes for banks. eeosdo not take deposits, so residents ofa commu-nity serviced only by eeos would not have asafe and convenient outlet for their savings.And, eeos also do not make loans, so theeconomic development of a communityserved only by eeos may suffer.

Summary29_ See the 1986 policy statement on basic banking by The Federal

Financial Institutions Examination Council in Canner and Maland_ Int 989. federal financial institution regulators made provision of basic This article has surveyed the role check-<:ash-banking services a part of a bank's CRA rating. ing outlets play in the financial system. eeos

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provide basic financial transaction seIVicestomany low-income and moderate-incomehouseholds. And. measured by the number ofoutlets, eeos maybe the most rapidly growingsegment of the financial system. Householdsthat consistently use eeos appear to devotea larger fraction of their incomes on average topay for financial transactions than do familiesthat rely on banks. Some use of eeos appearsto be voluntary. Consumers may turn to themrather than to banks because eeos have amore convenient location or longer hours ofoperation. However, some consumers mayturn to eeos because they cannot afford tomeet minimum balance requirements atbanks.

For many moderate-income and low-income households in urban areas, a ceomay be the most important financial institu-tion in their daily lives. This observation hasled an increasing number of states to regulateeeos and suggests that eeos might be em-ployed in the delivery of basic financial ser-vices and government benefits.

References

Bartlett, Sarah. 1989. "Bank Closings Discriminate,Report Asserts," New York Times, january 30.

Bradbury, Katharine L. 1990. "The Changing Fortunesof American Families in the 1980s," New EnglandEconomic Review, July/August.

Canner, Glenn, and Ellen Maland. 1987. "Basic Bank-ing," Federal Reserl'e Bulletin, April.

Consumer Bankers Association. 1989. "Check CashingServices Study," monograph of study conducted bythe Roper Organization Inc., December.

Consumer Federation of America. 1987. "NationalSurvey of Check Cashing Outlets," September.

---. 1988. "Bank Fees on Consumer Accounts:The Fifth Annual National Survey," manuscript,June.

---. 1989. "Check Cashing Outlet Fees: Still Highand Climbing," December.

---. 1990. "Ten Years after Financial Deregula-

tion: The Sixth Annual National Bank Fee Survey,"manuscript, June.

Economic Report of the President. 1991. U.S. Govern men tPrinting Office.

Gagerman,jerome S. 1990. "Professional Check Cash-ers and the Compliance Implications of the MoneyLaundering Control Act," manuscript, August I.

Gross, Laura. 1987. "Branch Cuts Seen Hurting Minor-ities," American Banker, February 23.

Illinois Department of Financial Institutions. 1980.Annual Rep01t.

---. 1989. Annual Report.Kemlage, Donald]. 1991. "More about Branch Bank-

ing and Check-Cashing Outlet~ in New York State,"Appendix G in Reeb et aI., Economic Profile of theCheck Cashe..-s'Industry, A report to the New YorkState Banking Department, May.

---, and Edward Renshaw. 1991. "Branch BankClosings in Low-Income Areas of NYC and Check-Cashing Outlets," Appendix F in Reeb and others.Economic Profile of the Cherie Cashers' Industry. A Re-port to the New York State Banking Department,May.

Lueck, TIlOmas. 1988. "Banks Shut in Poor Areas StirWorries," New York Times, August 17.

New jersey Department of the Public Advocate. 1988."Who's Checking?" Jan uary.

Obermiller, Phillipj. 1988. "Banking at the Brink: TheEffects of Banking Deregulation on Low-IncomeNeighborhoods," Business and Society, Spring.

Reeb, Donald, and others. 1991. Economic Profile of theCherk Cashers' Industry, A Report to the New YorkState Banking Department, May.

Renshaw, Edward. 1991. "Regulation of the DedicatedCheck-Cashing Industry," Appendix A in Reeb andothers. Economic Profile of the Check Cashers' !ndustIY,A Report to the New York State Banking Depart-ment, May.

Spong, Kenneth. 1990. Banking Regulation: Its Plllposes,Implementation, and Effects, Federal Reserve Bank ofKansas City.

U.S. General Accounting Office. 1987. "Banking Ser-vices: Changes in Fees and Deposit Account Inter-est Rates Since Deregulation," july.

---. 1988. "Government Check Cashing Issues,"October.

U.S. House of Representatives. 1989. "Consumer Ac-cess to Basic Financial Services," Hearings beforeSubcommittee on Consumer Affairs and Coinageof the Committee on Banking, Finance, and UrbanAffairs, October 17.

© McGraw-Hill.lnc_. 1994- T

I Caskey: Check-CashingOutlels in the U.S.Financial System

Iei

Wolf. In>ingJ. 1975. The Licensed Check Cnshillg Indns/I)' '[ill New YOIll City. MBA thesis at Pace University,Seplember.

Zamba, MichaelJ. 1987. "Closerl Banks Worry Neigh'lbars," Chris/ia1/. Sciellce Moni/or, May 8.

I

I';ay~:nt:-::d'F~r:i~-n-Exchange

U.S. Senate. 1989. "Government Check-Cashing, Life-line Checking and the Community ReinvesllnentAct," Group before The Subcommittee on Con-sllmer and Regulatory Affairs of the Committee onBanking, Housing, and Urban Affairs, Law G-7.