One quarter of all Americans households are not maximizing their banks’ services — or going to a bank at all — choosing instead to use such substitutes as check cashers, payday lenders and refund anticipation loans.

Although these 34 million households are ostensibly on the radar of banks that could gain them as customers, the Federal Deposit Insurance Corporation’s (FDIC) second biennial “National Survey of Unbanked and Underbanked Households”indicates that the number of these consumers has actually increased since 2009. (The one in 12 households that are unbanked have no formal relationship with a bank or traditional financial institution. The one in five underbanked might have a checking or savings account, but do not use the higher-level services these companies offer.)

While financial literacy advocates stress that traditional banking relationships are key to sound money management, banks trying to reach these consumers have discovered that there is no magic formula to do so. “They are an untapped group, but I think the market still needs to figure out a way to provide services that are not predatory to the customer base and, at the same time, are profitable to the firm,” says Shawndra Hill, a Wharton operations and information management professor.

Reaching out to these unbanked or underbanked consumers may become even more complicated due to an unintended consequence of the low interest rates set by the Federal Reserve in an effort to jumpstart the U.S. economy, according to a story published in The Wall Street Journal this week. As a result of the Fed’s move, the story notes, banks are earning less on individual transactions, which means they will have to come up with new ways to make money. That might include raising fees for services, which in turn could lead to more consumers being priced out of doing business with traditional financial institutions.

Although the FDIC notes that the unbanked and underbanked sector in the U.S. tends to be composed mainly of “non-Asian minorities, lower-income households, younger households or unemployed households,” this group is not a homogenous section of the population. Instead, they represent a range of races, incomes and ages “with different sets of needs and different challenges,” notes Raul Vazquez, CEO of Progress Financial, a community-based financial services company targeting Latinos.

One of the primary reasons these individuals choose not to have a bank account is that they feel they do not have enough money to open one — a concern that Wharton management professor Keith Weigelt has seen firsthand while teaching adult financial literacy classes in Philadelphia. Some consumers are also increasingly wary of doing business with traditional banks that have been widely blamed for causing the financial collapse of 2008. Additionally, in reaction to a provision of the Dodd-Frank Act that limits the amount of money banks can collect from merchants, a number of financial institutions have tried to recoup the lost revenue by imposing fees on products and services aimed at consumers. “Many people do not like banks because they are tired of being charged fees that were explained in small print that no one reads,” Weigelt points out. “They feel banks rip them off.”

Alternatives to Banks

While the FDIC study seems to place a negative stigma on using alternative non-bank financial products, most experts agree they fill a void that many banks tend to ignore. For example, after states across the country instituted severe restrictions or prohibitions on payday lending over the last decade, studies showed that areas with such regulations saw increases in overdrafts, bounced checks and bankruptcy filings as lower-income consumers sought other means of obtaining short term credit, according to a November 2012 Urban Institute analysis of alternative financial product use.

Vazquez says that in order for the unbanked to begin relationships with traditional financial institutions, it might be necessary for them to first use community based organizations like Progress Financial and other alternative products. The reason: Going straight to a traditional bank might be too cost prohibitive for both the customer and the financial institution. “A bank is not necessarily built to meet the needs of these customers,” he notes. “With the overhead [banks] carry and the fees they impose on accounts, [the cost] might be too high for an independent banking relationship.”

And technological developments over the last decade have made it possible for several new non-bank financial solutions to pop up. No longer are the financial alternative options simply payday lenders that typically charge astronomical rates for short-term loans, or check cashing outlets that charge fees 10 times higher than banks for the same service. Even the relatively recent development of refund anticipation loans, which offer consumers their tax refund early for a hefty fee, are becoming passé.

These new alternatives include FlexWage, which works with companies to give employees advances on their paychecks based on accrued hours; ImpulseSave, a website and mobile application that allows consumers to direct money toward particular goals set within the savings and checking accounts offered by the application; and the dozens of prepaid debit cards offered by retailers like Wal-Mart and 7-Eleven. Earlier this month Wal-Mart announced a partnership with American Express to start offering the Bluebird Card, a no-fee prepaid debit card that is being billed as an alternative to a traditional checking account with features like mobile bill pay. In fact, the FDIC “Underbanked” study looked directly at prepaid cards, noting that the number of unbanked and underbanked households using them jumped from 12.2% in 2009 to 17.8% in 2011.

Still, Kim Manturuk, a senior research associate at the University of North Carolina’s Center for Community Capital, points out that the fees and level of customer service vary dramatically for these developing bank alternatives — and that the more predatory ones have yet to be weeded out. “The underbanked served outside of the mainstream financial world have good-quality services available,” she says. “But in order to find them, you would have to do a lot of homework.”

These services bill themselves as an “alternative” to traditional financial institutions, but many are linked to a bank that holds customers’ deposits. For example, California-based Green Dot Bank performs this service for the prepaid cards at Wal-Mart and 7-Eleven. FlexWage issues its payroll cards through a partnership with a small bank in Davenport, Fla. And ImpulseSave encourages users to set up actual savings accounts through a small Massachusetts bank. “More people are getting familiar with financial instruments and are graduating to banks through places like Wal-Mart,” Weigelt points out.

Banking on the Underbanked

Banks are eagerly trying to attract a chunk of this “underbanked” population, but are still looking for the best way to do it. Their desire to serve this customer base may not be so much out of goodwill, Weigelt notes, as the desire for higher profits. Bringing in deposits is no longer an issue for banks because they can get cash from the Federal Reserve virtually free. What they need is income, and lower income consumers are more likely than the deposit-rich to fall below a minimum balance or use a non-bank ATM, thereby incurring a penalty or extra fee.

One way banks are trying to woo this customer base is by taking a page from alternative financial providers and offering prepaid cards. In June, the nation’s largest bank, Chase, launched its Liquid prepaid card and recently added mobile banking access for customers who use the product. Also this summer, Regions Bank in Birmingham, Ala., with $122 billion in assets, rolled out its prepaid Now Card — part of a line called Now Banking services that directly targets the underbanked with services like check cashing, Western Union bill payment and money transfers.

Some banks are trying to bring in the underbanked by offering checking accounts to those who might not qualify, with the caveat that the customer will go through financial counseling. Many banks, including Wells Fargo and U.S. Bank, also offer the controversial deposit advance loans, where consumers with direct deposit can borrow money against their upcoming paycheck deposit. “Banks have the ability to offer a full suite of services unlike almost all alternative financial services, and now they are thinking of [the underbanked] consumers and trying to find the kind of products that meet their needs,” says Rob Levy, manager of innovation and research for the Center for Financial Services Innovation, a Chicago-based advocacy organization for underbanked consumers.

As part of their full line of products, banks include something that few alternative services can reasonably provide — credit. While regulations have cut back on the number of payday lenders, experts agree that banks have yet to pick up the slack when it comes to offering small loans. For example, from 2008 to 2010, the FDIC piloted a small-dollar loan study in which 28 banks offered loans of under $2,500. All the banks successfully made the loans, but most reported struggles with underwriting and profitability. “Credit is much more complicated in this space. If you can’t get a credit card, then your only options are payday or pawnshop loans, and both are very expensive,” Levy notes. “Frankly, there is no credit parallel to prepaid cards.”

Lessons from Abroad

As banks look for solutions to reach the underbanked and unbanked, some experts point to other countries, notably in Africa, where mobile payments have delivered the concept of banking to millions of consumers. Wharton economics and public policy professor Jeremy Tobacman says M-Pesa in Kenya is one of the most dramatic examples of the mobile payment phenomenon. Just 18 months after Kenya’s largest cell phone provider introduced M-Pesa, more than 8.5 million Kenyans had registered to use the service and transferred $3.7 billion over the system (or the equivalent of 10% of Kenya’s GDP), according to a study titled, “Mobile Banking: The Impact of M-Pesa on Kenya,” from the National Bureau of Economic Research. “Places with robust wire payment networks have tremendous potential to provide [banking] access quickly at a relatively low cost,” Tobacman notes.

The scene may be set for a mobile payment renaissance in the U.S. Twenty-nine percent of the underbanked population have used mobile banking the last 12 months (compared with 21% of all mobile phone users) and 17% have used mobile payments (compared with 12% of all mobile phone users), the Federal Reserve reported in its March 2012 paper, “Consumers and Mobile Financial Services.”

But Vazquez says that for mobile payments to be successful, there need to be enough places in an underbanked or unbanked consumer’s world that accept this form of payment. He notes that for the Latino and foreign-born populations, cash is sometimes the only way they can pay for products and services. “The tricky thing with mobile payments — and even prepaid debit cards — is that they only work where electronic payments are accessible,” Levy adds. “The problem is that many of the underbanked still operate in communities where cash is highly effective.”

Still, Hill suggests that even if mobile payments are not the answer to meet the needs of the underbanked, companies can still learn from the experience abroad. “The context is different, but the potential impact for managing money is the same,” Hill says. In developing countries, “the value of mobile banking was obvious, and everyone jumped on board. So banks in the U.S. need to look more closely at the underbanked users and find out what they really value.”