The business of check cashing

Patrick McKenzie (patio11)
The business of check cashing

Happy 2024! I had been hoping to have a year-in-review for 2023 ready by now, but a combination of illness and travel bushwacked me in January. So instead of that, we’ll go with regular programming for today and return to that later.

Brief housekeeping notes: one, if you like BAM, you’ll enjoy an interview I did with Tyler Cowen. Two, I’m sketching out the year both for BAM and other professional commitments, and am shooting for the same 20-26 issues that I was shooting for in 2023. This year I do not plan on my family again immigrating to America, which crushed my productivity in summer and lead to not hitting that forecast in 2023. As always, if you have comments or concerns, the inbox is open.

Check cashing

One of the reasons I covered the checks as a payment method recently was to lay the groundwork for talking about some of the fascinating alternative financial world around them. In the main, this helps people at the socioeconomic margins turn payroll and other checks into cash (or otherwise immediately spendable value) in return for a fee. This is not how you, reader, probably deal with checks, and the existence of this industry / product have been controversial for many years.

Hopefully you’ll soon understand why, and why it persists in existing and its customers persist in using it.

A note at the top: check cashing is distinct from payday loans, despite overlapping customer bases, overlapping retail presences, and the centrality of checks to both enterprises.

An oversimplified explanation of check presentment

In an ideal world I would have one essay already covering the nitty-gritty of check presentment but I don’t and so we will here do the handwavy version.

Pretend you are a banked individual, which in the U.S. context means that you have a checking account in your own name trivially available to you. You are handed a physical check. You would prefer to have money. What do you do?

You deposit it with your bank, naturally. This could be at the teller window, through the ATM, or (most likely if you’re reading an essay about financial infrastructure) through the “remote deposit capture” feature of your bank’s mobile app. You might not know it by that specialized name, and instead think “I use my iPhone to take a picture of the check then money shows up.”

Regardless of how you send the check to the bank, the next process is the same: the bank will make an electronic copy of the check, which is exactly the same legally as the check. This was made possible about twenty years ago by the Check 21 Act. Your bank will then electronically communicate that copy to the bank the check is drawn on (i.e. the bank whose routing number is printed on the bottom of the check).

That bank will, generally speaking, pay your bank money on the next business day. I will be intentionally handwavy here as to how, since the miracle that is net settlement is not the focus of this essay. Just assume that money magically arrives tomorrow.

Now, if you’ve paid attention when cashing checks over your lifetime, you may notice some confusion here. It is highly likely that you’ve waited for longer than one business day to receive funds from a check before. It is also likely that many of you recall at times not waitingat all; you received either full or partial credit for the check the same day you deposited it. What is up with this discrepancy?

A full discussion of Regulation CC, the Expedited Funds Availability Act, and banks’ sliding scale of willingness to be accommodating will have to wait for another BAM. Instead, let’s focus on the most fundamental issue.

Depositing a check requires an extension of credit

As we’ve previously discussed, all a payment ever has been is a message about the status of a debt with some level of certainty associated with it. A check is a specially formatted message. The “movement” of money tomorrow is another message. But neither of those messages encode absolute certainty that the payer is certainly discharging their debt to the payee.

If something goes wrong in this process—the overwhelmingly most likely one is that the payer doesn’t have the funds to cover the check (NSF, or “insufficient funds”), but the check being fraudulent or unauthorized is also possible—that wrongness may not be discovered before money “moves” to your bank. And so that payment can be recalled from your bank to the bank the check is drawn on. This will likely result in the bank attempting to recall the money from your account.

And so by presenting your check, which you think is substantially terminating a transaction, you are actually creating a new credit extension with your bank. They are extremely aware that you just asked them to advance you money, even if you are not aware that you did that. They already partially underwrote this extension of credit; that is why you were not shooed out of the building when you originally asked for a checking account.

And note that this credit relationship has two sources of risk. One is with the check writer: is that check going to “bounce” (be returned as NSF) after presentment? One is with the check payee: if the bank attempts to recover a bounced check from their customer, will that customer make the bank whole?

If you are banked in the United States, that means that a profit-maximizing institution looked at you and said “In expectation, almost all checks this person presents will be good, drawn legitimately on the accounts of individuals or firms who do not make a habit of bouncing checks. Of the tiny, tiny number of checks that this person deposits that will bounce, and honestly it will probably be zero over the lifetime of their account, we have high confidence that they will make us whole. They have credit here.”

There exist a variety of ways to be unbanked in the United States. One, which is socially awkward for advocates to take explicit notice of, is that a bank could look at a seeker of credit and say “Actually, in expectation, checks you present to us have a much-higher-than-baseline risk of bouncing. When they bounce, and our best estimate is you’ll bounce multiple times per year, our desired outcome is you make us whole and pay a modest penalty under our agreement. We assess that you present a material risk of not doing this. You might have gotten an A for 92% in school but if your checks are 92% likely to be good money that’s a hard no from us. We decline to extend you credit under this product. We may extend you credit in other fashions, if you ask. You’ll find that in those products credit costs a lot more than the cheap credit embedded in checking accounts, reflecting the elevated risk of doing business with you.”

Advocates at this point often call the banks racist, classist, and stupid.

Let’s pretend you asked decisionmakers in deposit franchises for their point of view here. They’d be happy to tell you. It would rhyme with this:

You know, we have been in this game for decades, and like to think we are pretty good at it. We did not make up that estimate of creditworthiness. We most definitely did not engage in illegal discriminatory practices, like inferring creditworthiness from zip code. We know that would be extremely probative data if we were allowed to use it, because we’re in the data and math business and good at our jobs, but egads. Can you imagine the fines we’d pay? The headlines? Compliance keeps a file to scare young analysts with. No, we paid a few dollars to get a report from ChexSystems, which said that the literal same person who wants us to extend credit ripped off the bank down the street for $450 a few months ago. If you were in consumer banking, and you’re not because we are having this discussion, you would recognize that as multiple years of the contribution margin of a checking account relationship. Do you want to extend them credit? Then bonne chance. We decline.

That is certainly not the only pathway to being non-banked, but it is an extremely common one. Often, consumers self-select out because they try banking for a while and then repeatedly get assessed high fees which they do not feel are legitimate, such as fees for overdrafting their accounts. To bang a very old drum, the decision to move from everyone-pays-a-Netflix-subscription-for-banking to banking-is-free-except-we-assess-high-fees-if-you-screw-up created winners and losers. We called that one "free checking." Descriptively it subsidizes the middle class by using fees assessed stochastically to people in persistent economic precarity. In particular, young members of the middle class (college students and recent graduates in their least-well-off years) benefitted a lot.

So let's look at something that recent college grads very rarely encounter.

How cashing a check works if you’re not banked

You begin with a physical check. You generally physically walk it into a local business, which in Chicago are most commonly “currency exchanges” but which can in principle be done in many businesses known by many names (much like e.g. Western Union transfers). You ask to cash it. You speak to a clerk with a high school education, who likely remembers you from previous interactions. The clerk asks you to endorse the check, a ritual we’ll return to in a moment. She swiftly pays you cash from a drawer and retains the physical check. She offers you a receipt, and you do with it exactly what you do with a receipt from McDonalds. 

The cash does not match the value printed on the check. The fee you were charged is prominently disclosed on the receipt, on the wall, and in printed material you are passively offered but do not take, for the same reason that you’ve never walked home with a McDonalds menu.

That pricing grid looks something like this:

Check Type Fee Below $100 Fee Above $100
Public assistance 1.50% 1.50%
Government check (e.g., EITC*) 2.40% + $1 2.33%
Printed paycheck 2.40% + $1 2.33%
Personal check 2.45% + $1 3.00%
All other 2.40% + $1 2.40%

A brief aside about endorsement

Apologies to non-Americans who are wondering whether they’ve wandered into Westeros, with clearly medieval payment methods plus a likelihood of being beset by monsters, but let me explain a traditional ritual of our people.

The reverse of a check contains a small area where you can “endorse” the check. This means signing it and optionally leaving the bank an instruction as to what to do with the check. This is established by a combination of law and ancient practice.

One common endorsement historically is that you can endorse a check to another person, i.e. instruct the bank to make payment to the person you nominate, not to you. This enabled many use cases back in the day. A family might have two people earning wages but only one with title to a bank account; the second could endorse their wages to the first. A business could endorse a payment made by a customer to the business’ owner or to an employee or to a supplier. A common endorsement was simply “pay to cash.” (Banks hate that one and mostly don’t offer it any more. You can probably predict why.)

The practice of endorsing is why check cashing can exist as a business, because you can endorse your check to the check casher. As of that moment, by the magic that is the U.S. legal system, your payer no longer owes you money; they now owe the check casher money. The now-endorsed check instructs the check casher’s bank and the payer’s bank to cooperate to make this side agreement happen.

As long as we are on this tangent, have you ever written “For mobile deposit only at Your Bank Goes Here”? Wondered why?

This is to prevent an annoying fraud vector where someone takes a legitimate check and then deposits it roughly simultaneously at multiple banks. Each bank will come to the conclusion it is a legitimate check (because it is) paid to someone with an account with them (true as it goes). Then they will begin the process of crediting their customer. Only at some later point will it be discovered that the check was presented multiple times. If the actor is good at being bad, they can use this to extract money from the victim banks. Asking you to endorse the check in the above fashion spoils it for future fraudulent use at other banks. And there, now you know why you are subjected to a minor annoyance.

This is also why the app/bank can’t do this for you. They need you to physically spoil the specimen that only you have and prove you did so (with a photo of the endorsement).

Many people hate check cashing and everything about it

If you are reading this, you probably are relatively wealthy, are almost certainly of high socioeconomic status, and quite plausibly have never paid one red cent for check cashing in your entire life.

But that check cashing business exists, basically entirely, to siphon a small amount of dollars off of thousands of relatively poor people. It can’t make the math work any other way. Every time you see a currency exchange when driving around town, you can be safe in the knowledge that there were thousands of poor people paying the vig last month and the owner expects most of them to pay the vig this month, too.

Most of the customers of that check business are not in a position where they can afford to be indifferent to $9. And yet the check cashing business will rake the first $9 out of their monthly public benefits payments. Or it will take their wages for the first hour of every pay period at McDonalds. Or it will insist that, when the homeowner whose lawn was mowed by an immigrant offers a $100 Christmas bonus, that Scrooge must get his $3 first.

Advocates hate this business model with a passion unmatched by ten thousand burning suns. They like to quote statistics like “[t]he average unbanked worker in Illinois spends $574 a year to cash their payroll checks.” (I am not relaying this quote for its truth value.)

There exists a deep academic literature about the unbanked and underbanked, much of it written by scholars who are self-consciously advocates. They have the same degree of neutrality on the merits that historians of the Civil Rights movement have on Jim Crow. That is to say, their disdain oozes from the page.

Personally, I would not attempt to dissuade anyone from their aesthetic feelings with respect to this business model. That would not be a good use of anyone’s time.

Do I hate this business and everything about it? Eh, I hate poverty, certainly. Almost everything poverty touches will have terrible elements about it, because the definition of poverty is terribleness caused by scarcity. If you can’t find the terrible, you’ve either left poverty behind or you're not looking very hard.

And, not to put too fine a point on it, it’s really hard to expressively, passionately hate this business and not hate the young lady working in it, the decisions and life challenges of its customers, and similar. And if you hate one particular building in a poor neighborhood, and then start rigorously thinking about the liquor store, or the police station, or the supermarket, or the church, or the public school, or the home in the poor neighborhood, I think your mind will start going to some pretty dark places.

So maybe let’s move past the aesthetic revulsion, which you’re entirely welcome to, and just look at what is going on here.

The internal logic behind that pricing grid

There exist two sources of credit risk in cashing a check, as we covered earlier. The pricing grid directly prices credit risk for the payer of the check, via bucketing them. It is not the most discerning risk analysis ever conducted in the financial industry, because you need to be able to explain it to extremely unsophisticated customers and only barely more sophisticated staff.

The world’s financial system is predicated on the U.S. government being definitionally zero credit risk when denominated in dollars. Every other kind of debt in the world is defined in reference to a Treasury.

A portion of the price of every cell in that pricing grid is credit risk. Just like the spread between a bond and a Treasury of the same duration is a reflection of marginal riskiness, the spread between personal checks and government checks is a reflection of “the credit risk of the types of people who most commonly write checks to poor people.”

As you can see, by simple subtraction, this spread is non-zero but low.

Now what causes the price to be so hard high for the reference risk? Well, Treasuries certainly pay out to someone, but not everyone in the world who says they own $1 million in Treasuries actually does. Government checks don't have credit risk directly, they have operational risk which becomes a credit risk. In the case where either the person cashing them isn't the person named on the check, or where the government later comes to the conclusion that it didn't really want to pay them, that money could (at some risk) be clawed back from the bank, and therefore from the check casher.

It is also useful to understand that the consumer of this service is not solely paying for credit risk. A consumer of hamburgers at McDonalds is not solely paying for processed meat product. The physical storefront the transaction is conducted in pays commercial rent (in, given that this is a check cashing business, highly likely a low-rent area). The high school graduate who remembers you from last month, and who has many challenges of her own, wants a day’s wages for spending a day talking to poor people about money. Somewhere in the enterprise there exists a much more expensive professional who spent weeks of work writing up compliance procedures for a money services business, likely secured a license for the same, and then convinced a bank that it should accept the custom of one of the highest-risk legal businesses.

That bank does not cash the daily envelope of checks for free, either. It had a consequential commercial negotiation which took notice of the business’ risk profile, high operational costs associated with their custom, and the near certainty that they would be very annoying to work with. The bank ultimately quoted a price per check and, very likely, a minimum amount which would be assessed monthly.

How much? Eh, prices are prices. How much does a pound of potatoes cost? I don’t know. It depends on what kind of potato. It depends on where you live. It depends who you are buying the potato from. It depends an awful lot on whether you buy your potatoes by the pound or by the truckload or by the megaton. (Not an exaggeration if you are McDonald’s logistics system, right? Some check cashing businesses are owned by multi-state chains.)

But, as someone who has more professional experience with checks than with potatoes, if you twisted my arm I’d say “Indicatively, the bank charges 5 to 25 cents per check.”

Persistent identities as a KYC possibility

So we mentioned that there are two types of credit risk here, and how the payer credit risk is explicitly priced. How is the payee credit risk priced?

It isn’t. The check casher assumes that, as a first approximation, if a check bounces, they are going to lose money. Any other result is a windfall. Absorbing these credit losses is about 20% of the total costs of their check cashing operation.

That probably strikes you as pretty surprising, but if you earn $6 gross on a $200 transaction, and one out of every 250 checks bounces, well there you go. 40 bps default rate on 230 bps of revenue of which ~200 bps goes right back out the door.

The main procedural control for this that check cashers have is persistent identities. Your bank relies on a version of this, too, except in banking it is spelled KYC and is by regulation and practice excruciatingly formally documented. Many check cashing places will allow you to cash a check without having a government-issued ID, because many customers are from socioeconomic strata which routinely do not have a government-issued ID. Many check-cashing places will allow you to cash a check with a name which you are known by to the community but perhaps not what your teacher called out at roll call.

Some might take a picture of you the first time you do business with them. Some might simply rely on the social network and recollection of the young lady manning the cash register. Some will ask for and retain a copy of a government-issued ID or substitute paperwork, much like the DMV will. That could be a lease or utility bill or similar. Regardless, the purpose is the same: if you bounce a check, and you don’t pay it back, staff will be instructed that they don’t do business with this #(#%#($#)*$ anymore.

There are a spectrum of words that the staff and management could call you there, and none of them are phrased “defaulting customer” or appropriate for inclusion in this essay. All of them are, in fact, used at at least some establishments. As we’ve established, this is not a building in the part of town where people are ruthlessly socialized to not say really bad words about poor people. Compassion gets burned out of the owner and burned out of the clerk in basically the same ways that it gets burned out of everyone else in the neighborhood.

A brief discussion about class distinctions in America

One very real reason this type of business exists in the world is to be a firewall between social classes and the businesses that serve them. Check cashing establishments insulate banks, which are indispensable for cashing checks, from needing to talk to certain people.

A check cashing business is “alternative finance." It is alternative to the banking world of smartly dressed middle class employees, free coffee, and firm handshakes.

A check cashing clerk and a bank teller look to many to be similar jobs done by similar people and crucially they are not. Bank tellers do not make much money but know they must present as middle class. They work in a built environment where surveillance is absolutely ubiquitous and where deviant behavior (like using certain prescribed words) will have one referred to an alternative court system for swift and certain punishment.

That is to say: bank tellers work for an American corporation with an HR department. And bank tellers, in their hearts and in their actions, internalize the class that they must, must, must present as. There are classes of people that the bank does not want to do business with. (Banks are, as we have frequently covered, not allowed to say this in as many words.) The tellers do not want to speak to them, either, and this disdain radiates from them as palpable waves.

The clerk at a check cashing business is not a bank teller. She does not disdain talking to poor people; being able to do that in such a way that most poor people end up liking her is her job. Don’t take my word for it; take the customers’. We have studied this industry extensively. We ran surveys. The customers keep saying things like “I like my local check cashing place because the girl behind the counter is kind and doesn’t judge me like those #%*(#%( at the bank.” You can present as being kind to almost all of your customers and be obviously unemployable as a bank teller.

You will deal with thousands of customers. If you use “kind girl behind the counter” language about the 0.01% most aggravating customer once, you will not be a bank teller tomorrow. So bank tellers basically never use those words, and instead can inflect “Can I help you, sir?” in a way which leaves absolutely no doubt as to how welcome the new arrival to the branch is.

Then the economists running the survey typically scratch their heads and try to squeeze that feedback into homo economicus’ model of the world.

Readers might be thinking I am unnecessarily besmirching the good name of the field of economics here here, and so I will recount a representative sentence from a very good journal article verbatim:

To more effectively bring these unbanked individuals into the financial mainstream, it is essential for policymakers to recognize that these consumers have made these interdependent decisions in accordance with their marginal-cost-marginal-benefits calculations.

That is a lens of looking at reality, sure, and if you share that lens, you are welcome at my poker table any time. My marginal-cost-marginal-benefits calculations suggest your confidence in inferring ground truth from partial data is misplaced.

(Now you shouldn’t expect from me the level of academic rigor associated with scholars at e.g. Harvard; on the Internet, we cite our sources. That quote was originally published by the Chicago Fed and then the Review of Economics and Statistics. Full cite relegated to JSTOR for those interested. And again, as the literature in this field goes, that is a really strong entry. A particularly interesting finding is the relationship between being married and using check cashing businesses, which surprised me.)

Classes aren’t monoliths, of course. Many people assume you’d clearly never visit a currency exchange if you have a checking account. In time, the literature actually learned to ask that question and found that, decisively, no, some banked people do happily pay to cash checks. This observation caused some confusion. I am confused why this fact is confusing; some people who are capable of cooking have also been known to go to McDonalds, even though McDonalds isn’t free and doesn’t taste like a burger at home. That is, of course, one of the points of going to McDonalds.

Anyhow, if you want to dive deeper into that topic, look how various groups/papers/etc delineate between unbanked and underbanked. It will frequently come down to “Underbanked means you’re not unbanked but you still eat at McDonalds consume alternative financial services.” See this representative example.)

Check cashing on phones

So if we’ve identified the costs associated with retail establishments as one reason why check cashing costs money, and that many unbanked or underbanked customers do not have happy human interactions with financial service providers, you might wonder if technology can successfully cash checks while being cheaper and less judgemental about one’s presentation of class.

Yes, it can.

As always, I’m not endorsing any particular provider here, but let me point you towards a couple of models.

In one, a pure-play company like Ingo Money has both a direct-to-consumer offering and some ability to whitelabel it. (A whitelabel arrangement means that some other firm does the work of attracting the customers and then uses Ingo’s technology stack, financial rails, licenses, or any subset of the above to provide the check cashing service. To the customer, this feels a lot like they're "just" using the partner the whole time.) Ingo lets you essentially do remote deposit capture but instead of the deposit being to a bank account and there being a hold period, deposit is to an alternative financial product (like e.g. a prepaid card) and the funds are released basically instantly.

Take a look at Ingo’s fees and compare them to the representative fees for brick-and-mortar cash checking. For a $500 paycheck, it’s $5 versus $11.65 in favor of the app. This is the fintech dream; the delta is basically entirely “your costs are our margin.” Because the fintech nightmare is “our costs of customer acquisition explain why people still pay rent for commercial locations in high-traffic areas”, there is a loyalty program which gives steep discounts for repeated use.

And then there’s one decision which I just love aesthetically: if you’re willing to wait ten days, Ingo will discount your fee straight to zero. Why ten days? It is past the window where fraud discovery will result in the funds being clawed back plus (ahem) a bit of annoyance tacked on as a product decision.

I expect very few of their customers take them up on that. Most McDonalds burgers are not consumed by people who can cook a burger at home. They lack that capability; understanding this is an important part of understanding their life and the role of McDonalds in it. But free check cashing being available now where it wasn’t before is a straight-up win for the customers and the world.

Another model is embedding the check cashing into a larger suite of services. Cash App is a notable standout here (and, IMHO, probably the most interesting financial product the tech industry has created for the un-/underbanked.) On the backend, Cash App has simply convinced a bank to have a wider risk envelope as part of the price for working with a client who represents a very large portfolio of customers. The most useful thing Cash App can convince those users to do, which it spends substantial effort on doing, is signing up for direct deposit to their Cash App. (Really, it is to the partner bank, but from the user’s perspective eh it shows up in Cash App and all their friends use Cash App and you could turn it into actual paper money so does it really matter what some bank in Nebraska thinks? Nobody there will ever talk to you or talk down to you, so no.)

This is not, by itself, a full solution to the headaches implicit in banking people who are above average risk. You can read elsewhere about some of the implications.

There exist other models here, too, and other factors which are reducing need for this form of financial service. The continued march of direct deposit and earned wage access products keeps more of the wage pie in the pockets of workers, even those in diminished circumstances.

One useful thing the advocates (and others) accomplished over the last twenty years was convincing public benefits distributors to not solely use checks to distribute benefits. For example, "electronic benefit transfer" (EBT) replace the monthly check with a specialized variant of a pre-paid card which can be refilled. This sometimes results in the cost of distribution falling less on beneficiaries. Sometimes.

What do you want me to write about next?

The recent focus of checks has been a bit on the classical side of the financial industry and a bit depressing (see above). I’m eagerly accepting nominations for topics in 2024. Drop me an email or hit me up on Twitter (@patio11). As always, the writing calendar is driven by some combination of what people ask me about, what I find myself puzzling about on any given day, and what fills obvious holes in the Internet for the sort of people who’d read Bits about Money.

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