What Banking Needs to Become

In this quarter's Strategy + Business Magazine, Vanessa Wallace and Andrew Herrick discuss the significant changes in the banking industry over the past few years and how bank's business models, capabilities and practices must change as well. In their very good article, they emphasize that the purpose of banking and the needs of the customer have remained relatively consistent with regards to safe havens for savings and consistent access to credit for investment.

The environment has changed, however, with the competitive landscape changing, the regulations increasing and the public trust eroding. In addition, the times of high growth have ended.
They argue that banks will need to revert back to a much more simple value chain, where there are far fewer intermediaries between the customer and the bank. In short, banks will need to get closer to the customer.

From a marketing perspective, they propose that leading banks will need to sharpen their capability for capturing customer information in a timely manner. This means analyzing customers’ product holdings, cash flows, behaviors, and personal circumstances. Depth of relationship will be more important than breadth. It will be more valuable for a bank to have an 80 percent wallet share of 1 million customers than a 10 percent share of 8 million customers. Greater wallet share permits greater insight into buying patterns, credit risk, and loyalty, enabling a stronger, more profitable lifelong customer relationship. For their part, customers will find that scarce credit lines are more accessible when they concentrate their banking activities among fewer providers.

In addition, banks will have to innovate to better serve the needs of their more loyal customer base. This will take the form of better cash flow management tools that utilize multiple channels. In addition, the emphasis on insurance and investment services will most likely increase since the goal will be to serve all of the client's financial service needs.

Consumers will be rewarded for their loyalty with better rates, fewer fees and easier access to scarce credit.

Interchange Amendment Could Change Reward Programs

As if we haven't seen enough regulatory changes over the past 12 months with the Card Act and Reg E, now there is the possibility that Washington will limit interchange fees for debit transactions.

As noted in a recent Client Briefing from Celent Research, part of the proposed legislation requires the Fed to determine a “reasonable and proportional” interchange fee, which is no easy task given that interchange fees are there to balance the incentives in the payment system and tend to cover such difficult-to-quantify items as the payment guarantee and convenience.

In other words, the government can't look at just the operational and fraud prevention costs. In addition, current interchange fees differ by sector and are not standardized currently.


As was the case with the other two payments legislations already enacted, the idea behind the interchange amendment is to protect the consumer and lower prices (in this case, the thought that merchants will pass the banking savings on to the consumer). Given the financial times and the narrow margins at many retailers, the passing along of reduced costs is unlikely. In reality, the consumer is likely to lose on many fronts.

If interchange income is legislated at a lower level, banks will most likely raise fees on alternative services to compensate. So instead of the merchant picking up some of the burden, the consumer will be directly impacted. In addition, with more and more banks heavily promoting rewards programs on debit cards, these programs will need to be significantly restructured or eliminated altogether. This may have a bigger impact on smaller banks and credit unions than larger banks where costs can be spread. Some banks may be forced to stop issuing cards which is why community banking associations and CUNA are aggressively fighting this proposed bill.

In the end, banks will most likely be forced to find alternative revenue sources and potentially new ways to structure rewards programs with stronger merchant involvement. New programs such as that offered by Cardlytics (covered on April 29) or fee-supported rewards programs such as the program at KeyBank may be viable alternatives.

PNC Uses Social Media to Support Reg E Efforts

It appears PNC Bank is leveraging all available channels in their effort to capture as many opt-ins as possible. Today, I received a Tweet from PNC Virtual Wallet offering a description of the difference between overdraft protection and overdraft coverage. The message directed me to my Inside the Wallet Blog within the Virtual Wallet online banking site.

On the Blog, PNC innovation and Virtual Wallet leader Michael Ley, describes the options a customer has as to whether to opt-in or not with his post, "To “Opt In” or not “Opt In”… What is the Question?". Illustrations are used to help describe the options a customer has.

If after I read the Blog posting from Mike Ley, I still want more information, I am directed to the PNC overdraft solutions landing page for all the answers to Reg E questions as presented using a video presentation from the head of deposit products at PNC, Todd Barnhart. In addition to the very clear video, further descriptions are provided around overdraft solutions, including several overdraft protection options (with direct links) as well as the pricing schedule for overdraft protection. The site also has an extensive FAQ section and more ideas around managing money.

Overall, the integration of online and social media communication in addition to traditional direct channels used by PNC will most definitely improve the bank's Reg E opt-in rate. It will be interesting to see the ways in which other banks get their regulatory message out and the success rates experienced.

DDA Under Siege

As part of the planning committee for this year's BAI PaymentsConnect 2011, I would love to take credit for the great title of this program track, but I am not sure even the great minds at the BAI could have foreseen how apropos "DDA Under Siege" would be for bankers attending this year's conference that wraped up today in Phoenix.

If there was a unifying theme from the many sessions I participated in this week, it was that revenue lost from last year's Reg. E and this year's Durbin amendment can not be completely recaptured through repricing. Instead there needs to be a stronger focus on targeted customer acquisition, share of wallet growth strategies, retention, product innovation and cost containment. While everyone at the event seemed to be interested in what others were going to do around checking repricing, the energy was definitely focused on building a stronger platform for the future.

Sessions at the conference started with a review of the BAI/Finacle Innovation Imperative Customer Sentiment Study completed last Fall, which found that while there is still a ways to go in the customer's confidence in the economy and the banking industry in general, the view of bankers is more closely aligned with the consumer than in the past couple years. This uniformity of beliefs should assist as banks try to build messaging around their checking repricing and try to improve the customer experience. The study also found that the customer's perception of their bank being 'innovative' tends to correlate with satisfaction, product ownership and overall confidence in their bank.

Steve Mott from BetterBuyDesign followed the BAI research presentation with a very fast paced competitive overview of the payments industry, including a discussion around Google, PayPal and several potential payments platforms from the U.S. and even China. His message was that it will be up to the banks to leverage their customer relationships, distribution network and trust advantages to maintain some level of ownership of the consumer payments continuum. He emphasized, however, that the bank 'ownership' of payments is anything but guaranteed.

David Stewart, Senior Expert from McKinsey & Co. expanded on his recent BAI Banking Strategies article, emphasizing the continued importance of the debit card in the bank's payment product arsenal. In addition to providing financial metrics around the value of the debit customer and the real impact of repricing with net interest margin and other fees are included, he emphasized that trying to move mindshare or marketshare from debit to credit may be close to impossible in today's economic environment. David also shared the view of McKinsey that the potential for merchants to 'steer' payments from one payment vehicle or another was unlikely since doing so may actually cost the merchant more in discounts than could be retrieved in interchange savings.

David also left the attendees with the following strategies for trying to reposition the debit product in the future:

• Base debit strategy on new debit economics as opposed to the old economics
• Price products for competitive advantage
• Rationalize customers on the relationship level not just checking level
• Remember that the debit product is still sticky and builds customer engagement

Ending the morning sessions was a presentation by Hitachi Consulting around the findings of their semi-annual Consumer Payments Preference Study released last Fall. Some of the highlights included:

• The millennial generation provides a good opportunity for growing payment volume (especially around mobile)
• Ease of use and convenience drive payments behavior
• Debit is still the preferred payment method
• Credit for online purchases expected to increase
• Micropayments will continue to increase

Hitachi also emphasized that security continues to be a concern of consumers and is impacting the take up rate of mobile for payments.

The afternoon sessions revolved around ways that banks are trying to take back the payments franchise and extend relationships beyond just the DDA, with speakers from the Federal Reserve, Fiserv, Comerica, Fifth Third, Peak Performance Consulting, Novantas, TD Bank and Huntington Bank all providing unique viewpoints. It was clear during these sessions that the days of every bank having close to the same product set are over. While some of the larger banks may retain a Free Checking program (PNC's decision was referenced often during the conference), many are completely revamping their deposit product portfolios in a way that reinforces their brand and leverages their customer franchise. All of the banks were also bullish on credit products as well as the need to continue to capture increased share of wallet.

Hank Israel from Novantas stated that banks should segment their customers based on channel preference and will most likely price their product set in one of the following ways:

• Keeping Free Checking (hoping to make it up on volume)
• Fee for services (make it up within the checking product set)
• Product bundling (packaging product sets based on customer needs)
• Relationship pricing (drive value from relationship perspective)

A strong case was made for all banks to move more to a relationship focus that can optimize customer profitability and focus on customer needs.

Tuesday's sessions focused on how banks can go on offense through mobile banking, prepaid debit and mobile payments as well as how institutions can better defend their customer base through onboarding and rewards. Some of the key takeaways from the mobile banking session presented by FIS and M&I Bank included:

• Smart phones will be used by the majority of consumers by the end of 2012
• Mobile banking will surpass online banking by 2015
• Remote deposit capture is the 'power app' that engages the customer (more are needed)
• Mobile banking customers have a 53% lower attrition rate (Tower Group)
• Mobile banking customers decrease VRU use by 55%

The speaker from M&I Bank also emphasized the need for banks to build mobile banking critical mass quickly, with a focus on expanding the solution set coming after 'getting the basics done right'. He referenced that mobile banking customers at his bank had higher balances, increased check card usage, and a better bill pay adoption rate than similar customers without mobile banking.

Greg Schreacke from First Federal Savings Bank and Robert Gitner from Velocity Solutions discussed the market potential for prepaid debit and how a bank could build a checking product set around the card. Research was presented that showed the following characteristics of a prepaid debit user:

• 53% have a checking account
• 50%+ want a prepaid debit because of overdraft fees
• 47% want immediate access to funds
• 46% believe they can get better service at a retailer than a bank
• 43% have had a previous problem that limits their ability to open a traditional checking

In the mobile payment presentation done by Calvin Grimes from Fiserv and Emmett Higdon from Forrester Research, the impact that mobile banking has on the customer relationship was again emphasized. It was shown that not only is a customer who uses mobile banking 30% more likely to stay with a bank, but the customer is also 26% more likely to recommend their bank. The team emphasized that now was not the time for banks to stand on the mobile financial services sidelines, but instead should be searching for ways to move their mobile solutions from being simply informational to being more transactional.

While many banks are still trying to build the business case for mobile payments, the following benefits were shared:

• Customer acquisition and retention benefits
• Lower cost of servicing
• Revenue generation potential and revenue retention
• Competitive parity
• Better customer experience
• Deeper customer engagement

It was also mentioned that, while security and privacy concerns still remail around mobile payments, these concerns will eventually work in favor of traditional financial institutions since customers inherently trust banks more than companies like Google, Apple or even their phone company.

The presentation that I did in partnership with Bill Stamp from KeyBank focused on the market trends around onboarding as well as the basics on development and implementation of a successful onboarding program. Interestingly, when the attendees were informally polled as to their current onboarding programs, while the majority were doing something, less than half were using more than one communication channel, very few were leveraging three channels, and only one bank was communicating with their customers more than 5 times in the first 90 days. It was stressed that this lack of a focused and consistent onboarding process could hamper organization's objectives of improving customer engagement, increasing fee income and definitely hurt cross-sale and retention efforts.

Bill's presentation around KeyBank's onboarding program illustrated that developing and managing an onboarding initiative is an ongoing process where testing of offers, channels, and communication sequence and cadence is continuously needed. Bill also shared how an onboarding process can reinforce cross-selling done at the new account desk and the importance of reinforcing engagement with services before the cross-selling of other products.

To further reinforce the importance of engagement and retention in a highly competitive and revenue challenged marketplace, Tom Brooks from Regions Financial Corporation, Lynne Laube from Cardlytics, and Aaron McPherson from IDC Financial Insights showed how a highly innovative merchant-funded rewards program may be the answer for banks looking to move away from a 'reactive' interchange funded program to a 'proactive' program that could be bring higher value to the customer and even make money for a bank.

Lynne Laube discussed two macro trends in the banking industry that has paved the way for a merchant-funded program:

• Digitization of payments (where and how payments are made)
• How customers relate to banks (>50% have online banking with 7 visits a month to their online banking site)

The benefits of a program like Cardlytics offering shared by the panel included the ability to target actual transactions for incremental growth and engagement. The benefit to the customer is that offers will always be relevant, while the merchant benefits from only providing offers to people very likely to be interested in their services. Since the targeting potential is so strong, more valuable offers can be developed as opposed to when a merchant is discounting to the masses.

While the program at Regions is relatively new, the benefits included:

• No enrollment is required (all customers with online banking and electronic statements are included)
• Ease of value transfer (no coupons are needed since the customer can electronically 'activate' an offer and 'redeem' the offer simply by using their debit card)
• Immediate notification of earnings/rewards
• Rebates deposited directly into account
• Offers are targeted and relevant
• Integrated user experience
• Fully funded as opposed to being a contingent liability like with points programs

The success of this innovative rewards program was probably best illustrated when Lynne mentioned that Cardlytics is partnering with 2 of the top 5 banks already and expect their customer base to grow from 15M today to more than 60M by the end of the summer. For more information on Cardlytics, read my earlier blog on the company done last year.

Without a doubt, this was a well-timed conference covering a broad range of topics on the front burner of many banks. On each attendee 'to do' list upon leaving, I am sure there will be a review of any pricing changes not yet implemented, a strong focus on ways to engage and retain new and existing customers we can ill afford to lose, and a much more accelerated movement to future payment products like mobile and even P2P.

I would love to hear from other attendees about their experience and takeaways.

Are Some Banks Too Small to Survive?

With increasing regulatory capital requirements, declining interest margins, a greater need for investment in innovation and new competition, there are many in the industry who believe that smaller banks may have limited opportunity for growth in the future. 

These pressures may lead to an acceleration of consolidation in the banking industry that impacts both small and mid-tier banks and results in a significantly reduced number of institutions in the future.

While attending both the BAI Payments Connect and CBA Live conferences in Phoenix last month, discussions often revolved around the heavy financial and organizational impact of new capital requirements and of regulatory compliance being faced by institutions of all sizes. It was also clear that the investment in advanced technology and the pace of innovation was creating a distinction between the 'haves' and the 'have nots'. While there were some exceptions, this line of demarcation appeared to be defined by the size of organization.

The question I asked several industry thought leaders over the past couple weeks is whether smaller banks are in a position to survive given the massive industry changes on the horizon. While their responses varied regarding the chances of survival for today's community bank (and smaller credit union), there was unanimity in their belief that smaller institutions must quickly adjust to the 'new reality' of increased capital requirements and regulatory pressures, a greater focus on revenue, and a need to innovate for an enhanced customer experience.

"The thing that keeps me up at night is that we will likely see an industry contraction in the next decade like we never experienced", states Bradley Leimer, vice president of the $3.2 billion asset Mechanics Bank in California. We are moving from over 14,000 financial institutions today to less than 5,000 in the next 10 years (maybe sooner). This is due to the changing nature of consumer behavior with the introduction of mobile and social and technological innovation, but also due to systematic changes to the banking model itself."

Also supporting my informal findings, Emily McCormick, director of research and writer for Bank Director, interviewed the risk officer of an $8 billion bank holding company for Bank Director's 2013 Risk Practices Survey. He told her that, while he found a lot of positives in the regulations coming out of Washington, this could be a challenge for smaller banks that lack the resources and staffing to keep up.

McCormick also believes there's a technology challenge, "Internally, smaller banks need the right resources to do things like manage risk, but they also need the resources to compete. While smaller banks have the significant benefit of connections within their local business communities - giving these banks a potential advantage in business lending - customer expectations for services like mobile and online banking will continue to rise."

Increased Capital Pressures

According to an Invictus Consulting Group report entitled, Buyers and Bleeders, more than half of today's institutions will need to participate in some type of M&A activity based on new capital requirements alone. This includes as many as 2,000 banks that should sell due a lack of financial return and/or a lack of capital. In addition, the report believes that as many as 3,500 institutions have enough capital, yet lack loan demand and therefore need to deploy their capital to acquire banks that will grow their business. Unfortunately, even some of these firms with capital may not have enough to spend to grow to the level to be competitive.

An interview of Adam Mustafa, managing director of Invictus, was done by Bank Director Magazine to discuss the research report findings. 

Impact of Increased Compliance

According to an October 2011 research report developed by Aite Group entitled, Reducing Banks' Compliance Toll, the annual cost of compliance for banks well exceeds $1B. Unfortunately, many of these costs (personnel, software, etc.) are 'fixed' infrastructure costs which place a heavier relative burden on smaller organizations who still must comply with many of the same regulations.

According to the Aite report, however, many institutions have failed to take advantage of technology and process improvement steps that could reduce redundancy and paper intensive processes that are a major contributor to these costs. Aite (and many other consultancies noted in the report), believe that the end game is an 'electronified' organization that can eliminate paper and enable real time information management.

Unfortunately, this automation of processes requires a substantial investment that may bring long term benefits, but is not affordable to many smaller institutions today given other priorities.

The Innovation and Distribution Imperative

While we could discuss for days whether or not the improvement of branch-based, web, online and mobile interactions should be considered 'innovation', there is no disputing the fact that the typical banking customer is expecting more services, delivered through more channels than ever before. As I experienced in person at the two conferences in Phoenix, the investment in innovation is both required and substantial.

According to Leimer, "If community based institutions are going to relevant going forward, they need to be much more agile and much more focused on partnerships with technology providers and other similar shaped financial institutions. We must work together to partner and innovate to deliver community based services in a hybrid model - centralizing resources, sharing innovations, riding on non-traditonal service frameworks - the type of cooperation these institutions haven't historically embraced." 

In addition, as consumers embrace the smartphone and do more of their banking online and through mobile devices, additional negative dynamics occur. According to Sherief Meleis, partner at financial consultancy Novantas, the reduced importance of local branching means that banks are moving from being primarily local retailers (where the average community bank could simply out-local the big banks), to product/marketing organizations where there are indeed economies of scale. 

"In an environment where the branch importance is diminishing from a transaction perspective, it’s difficult for smaller banks to afford the required fixed cost (just like with regulation and compliance). Our analysis suggests that super-regionals and national banks have substantially higher returns to branch network position, due to their ability to invest in product innovation and brand marketing."

This position was shared in a recent American Banker article entitled, "Why Regional Banks Are The Right Size Right Now" where the case was made that regional banks benefit from the scale to absorb compliance and regulatory costs better than their smaller brethren, yet are nimble enough to develop new technologies that can improve service delivery and efficiencies. This was evident in their chart showing the ROE for different sized organizations.

Power of Shared Services

As shown above, critical mass is a "sine qua non" for success in today's highly competitive market place. One of the impediments to small size is that it gets difficult to embrace new technologies and improve your operating margin as investments in technology do not give the same payback as it would for the larger banks. Therefore small banks need to take advantage of some one else's strength and critical mass and deal with a service partners and business process outsourcers that are able to improve efficiency ratios.

According to Nicole Sturgill, research director for retail banking and cards for CEB TowerGroup, "Small banks have the opportunity to take advantage of single supplier discounts (i.e. using one solution for branch sales and service, online banking, mobile banking, etc.). In addition, there are a number of solutions that cater to the community bank and credit union markets, which offer lower pricing because they are selling to thousands of institutions (i.e. mobile RDC and PFM)." She adds, "While these solutions may not offer all of the wiz bang functionality of a large bank solution, the increased focus on personal service that a smaller bank provides may give them parity if not an edge on the larger banks."

While there are some very good banks of all sizes, the efficiency ratios get better as we have some critical mass, according to Sankar Krishnan, global banking engagement head for business process outsourcing leader, Sutherland Global. "Companies that provide operations and technology services to banks and are able to improve the operating metrics have a great role to work with the smaller institutions (Community, Regional etc). They can provide industry best-in-class knowledge and help support their efforts to get better on efficiency ratios and operating margins."

Some Small Banks May Survive . . . If They Have a Plan

There is very little doubt that, given the economic environment and the paucity of available capital for smaller banks, the number of banks will certainly decline over the next several years. This decline may simply be a continuation of recent history – or the consolidation of the banking industry could accelerate. While most of the advisors I contacted agreed that small banks must take an aggressive stance to increasing sales and reducing costs to survive, they also believed that some smaller institutions may be positioned to succeed in the future. 

Mary Beth Sullivan, managing partner of Capital Performance Group, thinks that earnings pressures for smaller banks will be even more significant in 2013 than in the past but states that many banks may not simply succumb to the pressures to consolidate. "Smaller banks are sometimes odd characters . . . many will continue to hold onto their independence as long as possible."

Serge Milman from Optirate warns that deploying technology and/or introducing products and services without the benefit of a comprehensive business strategy is an effort that is likely to disappoint.  "Just look at institutions that have deployed these tools and most will show little or no improvement in profitable customer growth, increased wallet-share and certainly, not higher ROE.  This approach is analogous to attempting a cross-country drive without a map (or GPS) --- no one would try this, yet Bankers do exactly this every day of the week!"

Milman continues by saying, "The journey to growth, profitability and customer loyalty must begin with a sound strategy that is supported with a measurable and implementable operational plan.  Community Banks can succeed, but to do this, they must embrace the reality that the world has changed and they must willing to adapt."

"There's only one strategy that makes sense for smaller banks: get more sophisticated about analyzing customer feedback and leverage the voice of the customer to prioritize which initiatives to pursue," stated Steven Ramirez, CEO of communications consulting firm Beyond the Arc in an email interview.

"Smaller banks have the potential to gather deeper insights about their customers, but few of them do. Since small banks can't invest in everything, they need to focus on what really matters in their local market."

Brad Leimer probably summed up the conundrum of smaller banks best when he said, "There is space for community minded institutions in the financial marketplace of the future - but they will look and act much differently than today - simply because the banking model has seen a significant shift."

Additional Resources

Buyers and Bleeders: Invictus Group (March 2013)

Bank Director 2013 Risk Practices Survey: Bank Director (March 2013)

Reducing Banks' Compliance Toll: Aite Group (October 2011)

Why Regional Banks Are The Right Size Right Now: American Banker (April 2013)

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