Traditional Banks At Risk Due to Digital Disruption

According to two recent reports from Accenture, 35 percent of banks' market share in North America could be in play by 2020 as traditional branch banking gives way to new digital players. The research also indicates that 15 to 25 percent of today's roughly 7,000 North American financial institutions could be gone as a result of consolidation before 2020.

To combat this shift, Accenture recommends that traditional providers take a radically new approach to distribution, combining a simpler yet more comprehensive branch offering with integrated digital services.

"Digital technology and rapid changes in customer preferences are threatening full-service banks that do business primarily through branches," said Wayne Busch, managing director of Accenture's North America banking practice and author of the report, A Critical Balancing Act: Retail Banking in the Digital Era. "Given the scale of these disruptions, traditional full-service banks, as a group, could lose significant market share by 2020 -- to banks that reorient around digital technologies and to new entrants from the retail and technology sectors."

Digital Disruption

New digital technologies, emerging digital competitors and the extremely rapid changes in customer preferences are threatening to dramatically impact those full-service banks that limit themselves to products and services that get distributed primarily through physical branch channels. The outside disruptors tend to be more agile and more innovative, while traditional banks are weighed down by unprofitable branches, legacy back offices and inefficient silos. 

Business as usual is no longer an option in an industry that could see up to 25 percent of U.S. banks disappear completely.

In conducting online interviews with more than 2,000 US retail banking customers of the 15 leading retail banks in the U.S., Accenture found that 71 percent said they were “satisfied” with their bank and 68 percent said they would be “extremely likely” to recommend their primary bank to a friend, family member or colleague. In addition, only 9 percent of those surveyed switched institutions over the past year.

This loyalty is fragile, however, since more than a quarter (26 percent) of bank customers who remain with their primary provider do so simply because they consider switching to be a hassle, while about half said they haven't seen a competing offer that was attractive enough to make them move. The survey also found that two-thirds of bank customers would consider a branch closure as inconvenient and nearly half would switch banks as a result.

Source: 2013 Accenture Retail Banking Survey

This not only exposes the tenuous relationship banks have with their customers. It also confirms that the right offering and approach can induce them to switch. "The core challenge for banks: how to build a seamless digital customer experience -- and optimize its power with a better and more cost-effective complimentary offering in the branches that customers find so attractive," concludes Accenture.

The Disruption Has Already Begun

According to Accenture, many banks have already begun losing their customers to digital disruptors. The survey showed that customers acquired 34 percent of traditional banking services such as CDs, money market accounts, personal and auto loans and even new checking and savings accounts from institutions other than their primary bank.

Source: 2013 Accenture Retail Banking Survey

While traditional players have the innate advantage of extensive branch networks that the customer still says they value (nearly 60 percent of new product sales are still closed in branches), these same players should be concerned about the the transition to an online sales environment.

The growth rates in online sales since 2012 are strong in several categories, with online auto loans growing from 11 percent to 21 percent in the past year, online sales of mortgages rising from 15 percent last year to 25 percent in 2013 and sales of personal loans through the online channels jumping from 8 percent to 24 percent in only one year.

Source: 2013 Accenture Retail Banking Survey

It is clear that the most fundamental question in the post-financial crisis environment has changed from "how do I find my future customer' to 'how do my future customers find me?" As discussed in my recent post, Is Your Bank Ready for Customer 3.0, digital shifts inside and outside the industry are rapidly changing the information flows and the way that financial firms and customers interact. It is imperative for banks to become an integral part of customers' lives with a ubiquitous presence wherever customers are.

The branch banking conundrum continues, however, since customers still use branches due to proximity. Branches continue to be the number one reason for loyalty and 78 percent believe they will use their branch as often or more often in five years' time. Conversely, with increased use of services like mobile deposit, there has been a 50 percent increase in the number of customers indicating they are using mobile banking in 2013 (32%) than in 2012 (21%).

Source: 2013 Accenture Retail Banking Survey

"The internet is now the most frequently accessed distribution channel on a monthly basis . . . well above the branch. And mobile use has soared in the past year, almost overtaking the ATM in its perceived importance to customers," says the survey.

While the migration to online and mobile channels has been somewhat additive as opposed to a complete transition of behavior, online and mobile banking will continue to weaken the branch's stronghold on the consumer as better applications and more seamless experiences are developed. This migration is imperative due to the high cost to build and maintain a branch and the misalignment between the cost and value of the branch channel.

A Path for the Future

In light of the digital disruption in the marketplace, and as expanded regulation, more onerous capital requirements, economic volatility and consolidation continues, banks need a lower cost operating model that can generate more predictable and sustainable revenues. Branch networks need to be restructured, reducing the number of large footprint offices and increasing the number of 'light' branches and kiosks.

And while some industry observers believe we are quickly moving to a 'branchless' industry, Accenture and others (myself included) believe the environment will be more of a 'less-branch' scenario, at least in the next five to ten years (Chase continues to add branch locations as do other large and mid-sized organizations). But there must be a response to the customer-centric capabilities of the digital players who can leverage big data and analytics to build a better customer experience.

Move to Digital

With inertia being the main reason current bank customers don't switch, traditional banks need to quickly mimic the new digital banking leaders. Agility and a stronger innovative culture will be required to compete effectively as our industry invests to upgrade our legacy back offices and deeper customer insights will need to be leveraged to provide real-time solutions to customer needs. 

As mentioned in my recent post, Bank Product Proliferation: Too Much of a Good Thing, banks and credit unions will also need to eliminate antiquated products, streamline offerings and build new services that leverage the new digital delivery capabilities. By using digital capabilities to track transactional and channel behavior, banks will be able to develop better services and offer new solutions in real-time. This enhances cross-sell opportunities and can increase share of wallet.

Restructure the Branch Network

According to the Accenture research, the top 25 U.S. banks spend more than $50 billion per year to maintain oversized and poorly placed branch networks. While Accenture acknowledges the importance of a branch network, they propose a less costly branch banking model that can balance the sales capability with the digital opportunity:

• 'Light' branches: Oriented primarily to sales, these offices represent less than a third of the network and are highly automated with a minimal staff and reduced real estate footprint leveraging remote advisory specialists.
  
• Kiosks: Representing up to half the total network, these units include feature heavy ATMs with video, and can handle routine transaction activities.
  
• Full-service 'hubs': Similar to conventional branches (but fewer in number), these offices offer full sales and transactional support with extended hours and specialized advisors for services like mortgages, investments, business banking, etc.
  
• Flagships: A minimal number of strategically located flagships will serve as the center of service-excellence, combining a full range of capabilities including expanded self-service tools.

While many banks are already experimenting with more open and flexible branch formats, there doesn't seem to be a silver bullet yet in response to the digital disruption occurring. A bigger question may be which branches to close or reconfigure, especially with the looming eyes of the Community Investment Act (CRA) regulators looking over the industry's shoulder.

"The acceleration in consumer acceptance of digital banking in the past year -- particularly in the areas of mobile banking and online banking product sales -- foreshadows the need for a very different banking landscape in 2020," said Goodson from Accenture. "Branches remain vital to banks, but they need to be reimagined as one one aspect of a radically new approach to consumers. It is an opportunity to recover profitability, reduce costs and to establish a much more sustainable relationship with customers into the future."

The Best of Both Worlds

Given the scope of disruption impacting our industry, organizations need to start their transformation today if they want to be relevant in the year 2020 according to the complimentary Accenture report, Banking 2020: As the Storm Abates, North American Banks Must Chart a New Course to Capture Emerging Opportunities. 

The winning formula may well be to combine the advantages of the traditional bank with the benefits of the digital bank. By reducing the cost structure of branches and optimizing the products and services provided, yesterday's banks can move into the future leveraging a core strategic asset (a reconfigured branch network) complemented by an enhanced digital experience across all channels.

To succeed, traditional banks must become significantly more agile (no more three year planning cycles), embrace an innovative culture (see my post Banking Innovation: Not Made in the U.S.A.), focus on simplification and optimization while delivering an exceptional customer experience . . . in real-time. This is a very lofty ambition for an industry that historically moves at a snail's pace, but there really are no options.

More importantly, traditional full-service banks must shift their operating philosophy from being a product-oriented organization to being a customer-centric organization with the ability to engage with customers anywhere, anytime they want.

The goal is to become a bigger part of our customers' daily lives and to become integrated with other industries in a seamless manner that reduces friction. Unfortunately, organizations such as PayPal, Square, Google and others are already moving quickly down this path, assuming the role of payments facilitators, supplanting a link to merchants and consumers the banking industry once owned.

Additional Resources

A Critical Balancing Act: Retail Banking in the Digital Era - Accenture (Nov. 2013)

Banking 2020: As the Storm Abates, North American Banks Must Chart a New Course to Capture Emerging Opportunities - Accenture (Nov. 2013)

Say Hello to Customer 3.0 - Accenture (October 2013)

Banking Innovation: Not Made in the U.S.A.

For the third year in a row, I attended the BAI-Finacle Global Banking Innovation Awards ceremony that takes place as part of the BAI Retail Delivery Conference. This year's program, which recognizes innovation excellence in the banking industry, drew more than 200 nominations from institutions based in over 30 countries.

The two overriding impressions I have had each year when the finalists and winners were announced were that 1) despite industry challenges, there are amazing innovations happening in the banking industry that impact the daily customer experience and 2) with the exception of Citibank in 2011 (for their 'Smart Banking Branch), no other U.S. bank has ever won the award.

Traditionally, the financial services industry in the U.S. has been slow to innovate compared to many other industries due to compliance and regulatory obligations, dependence on large internal and external infrastructures and the need to focus on security and privacy. In addition, the lack of a formal structure or process for innovation or dedicated funding also inhibits initiatives.

Despite these limitations, the industry globally continues their effort to innovate, with varying degrees of success. Some institutions are recognized regularly for their efforts, with some regions (Asia Pacific) being hotbeds for new ideas and innovation. In addition, social media banking innovations are being found in places like India, Brazil and Nigeria.

The Efma and Infosys Finacle sponsored study, Innovation in Retail Banking: Simplify Technology to Innovate provides a good perspective on global innovation trends, ways banks can overcome some of the barriers to innovation and why some banks have been so successful in their efforts. This year is the fifth year of the study and it appears that banks worldwide are increasing their investment in innovation and beginning to structure organizations in a way that is more conducive to innovative practices.

While defining innovation continues to be a challenge, examples of new ideas globally illustrate the need for banks to measure not only against domestic competition but also against global standards. The key findings of the study were:

• More banks have an innovation strategy: 60% had a formal strategy in 2013 vs. 37% in 2009.
• Investment in innovation is increasing: In 2009, more banks were decreasing innovation investment than increasing. Today, 77% of banks say they are increasing investment vs. 5% decreasing (personally, I am concerned about the definition of innovation investment in this study).

• Most banks believe they are becoming more innovative: 76% believe they are becoming more innovative vs. 6% who said they were becoming less innovative.

• Performance metrics are focused on revenue and customers: Measurement of profitability from innovation is less common.
  
  
• IT systems and culture are the biggest barriers to innovation: IT systems were the biggest barrier to innovation for banks of all sizes. Culture and silos are issues with large banks more than smaller organizations. Silo based IT systems have a huge impact on time to market for large banks.

• Business processes need development: Speed, agility and efficiency is an area in need of development.
  
  
• Additional factors can improve innovation: Other capabilities that would improve innovation include the ability to personalize products, seamless multichannel integration and having a single customer view.

The study also measured the current status of innovation deployment in mobile and online and found that:

• On average, out of 10 mobile and online innovations measured, deployment averages around two per bank, with larger banks averaging around 3 innovations and smaller banks having only 1 of the 10 innovations deployed on average.
  
• Mobile P2P payments have been deployed by 29% of the banks and mobile NFC payments by 23%. Mobile location offers have been deployed by 18% of the banks with an additional 51% planning on deploying.
  
• Direct-only banking has been deployed by 23% of the banks, but only an additional 21% have this in their plan.
  
• Gamification has only been used by 9% of banks.

Innovation in the U.S.

So why is it that in the USA, where more banks and some of the largest banks in the world exist, is true innovation so difficult to find? Here is what some of the people who watch innovation regularly told me.

"Many U.S. Banks are so invested in their legacy business models that it makes it very hard to undertake truly disruptive innovation projects. Banks in emerging markets have to be innovative to reach their customers, many of whom don't have access to the broad range of choices that Americans have." - JP Nicols, co-founder Bank Innovators Council

"While there are many reasons U.S. banks are innovation laggards, I think legacy technology, regulation, compliance, and risk aversion have to top the list of reasons why we're not seeing more movement." - Bradley Leimer, Vice President, Mechanics Bank

"The US is a major leader in internet innovations but, outside this, it has been behind most other regions of the world on mobile developments. This is largely due to the tariffs and state splits between cellphone usage and providers which, when you get to China or Africa is a totally different position. These newer markets do not have the old systems in place and therefore saw mobile as a leapfrog for digital services to the customer. American banks just don't see it that way, and see it more as an overlay to what's already there." - Chris Skinner, Author of the new book Digital Bank

The Efma/Infosys study found that 73% of banks in the Americas (they did not break out the U.S. specifically) were increasing investment in innovation in 2013 compared to 2012. This is less than for banks in Middle East, Africa and Asia Pacific but is more than Europe. By far the biggest area of increase for the Americas was in 'channels', with the 'product' category being the lowest area of increase.

Interestingly, 86% of banks said they had become more innovative in the last 12 months, though this may be from a lower base than in other regions. Again the 'channels' category was the area of highest increase, with 71% of banks saying they had become more innovative.

The innovation performance self-assessment scores were the lowest in the Americas out of the four regions – just 4.08 on a scale of 1 to 7. Innovation performance in 'channels' was the highest, and innovation performance in 'products' was the lowest (a big difference from Middle East and Africa where innovation in 'products' is the strongest area for banks). Overall, it is clear that the focus in this region is on channels.

 

Barriers to Innovation

In contrast to the other regions, the main barrier to innovation for the Americas, according to the Efma/Infosys study, was culture rather than IT systems, which was only the third largest barrier. Regulation was the second most significant barrier. The least important barriers were senior management and organization silos.

In conversations with my counterparts in the industry, here are the barriers they mentioned.

"Two things. The first is that innovation is simply not in the DNA of most bankers. They've been trained throughout their whole career to identify and avoid risks, and innovation is about taking small risks and failing fast and cheaply and learning from those mistakes to get to the right answer quickly. The second is analysis paralysis. Most banks have too many silos with conflicting agendas, and that makes it hard to actually put new ideas into action. Consequently, those few innovators who do exist in banks find themselves surrounded by the 'business prevention department'." - JP Nicols

"The U.S. market is plagued with many more problems than its international peers - we have a more complicated system of financial players, embedded legacy technology and processes for everything from acquisition to money movement, from telcos to payment providers - and in spite of changing client behavior, we continue to prop up legacy financial services like paper checks." - Bradley Leimer

"Lethargy and lack of competitiveness. Lethargy embraces everything from 'oh, the regulators won't allow it' to 'if ain't broke, don't fix it' to 'but the legacy, the legacy, the legacy'.  If Barack Obama ran a typical bank, he'd ask 'can we fix it?' and the team would answer 'why bother?'" - Chris Skinner 

BAI/Finacle Innovation Winners for 2013

This year's awards were presented to the following organizations in the following categories:

• Product and Service Innovation: CaixaBank (Spain) and Hana Bank (South Korea)
• Channel Innovation: Alior Bank (Poland)
• Innovation in Internal Process Improvement: ZUNO Bank (Slovak Republic)
• Innovation in Societal and Community Impact: Standard Bank (South Africa)
• Disruptive Innovation in Banking: Hana Bank (South Korea)
• Honorable Mention for Disruptive Business Model: Jibun Bank (Japan)
• Most Innovative Bank: CaixaBank (Spain)

To learn more about the winners and their innovations, go to www.baiglobalinnovations.com.

As can be seen from the winners (and finalists') entries, much of the innovation that was recognized dealt with moving from traditional to digital and mobile channels. In addition, it is important to note the impact of culture as it relates to innovation. Not only did Hana Bank and CaixaBank have multiple entires for this award, but CaixaBank has been named the most innovative bank two out of the last three years.

Congratulations to the winners and I am sure we will soon see more examples of innovation in the U.S., either by traditional financial institutions or by one of the many newer neobanks that have been created or from some of the financial intermediaries that are providing the tools for U.S. banks to serve customers better.

When asked about the dearth of U.S. representation, Debbie Bianucci, president of the BAI stated, "Each year the BAI-Finacle Global Banking Innovation Awards program receives numerous submissions from innovative U.S. banks, and there have been finalists from the U.S. in both 2011 and 2012. Each year we receive over 200 submissions from banks from around the world, all who have inspiring stories to tell about how they serve their customers differently. It’s a very competitive program with just a few finalists and winners. We will  encourage U.S. banks to continue to submit their innovations for the 2014 awards program, which begins in January, 2014."  

Which bank(s) do you believe are the most innovative in the United States? Who has a chance in 2014?

I would love to hear your comments.

Additional Resources

Finalists Announced for 2012 BAI-Finacle Global Banking Innovation Awards - BAI-Finacle (2013)

Innovation in Retail Banking: Simplify Technology to Innovate - Efma and Infosys Finacle (Sept. 2013)

2012 BAI-Finacle Global Banking Innovation Awards Announces 2012 Winners - BAI-Finacle (2012)

2011 BAI-Finacle Global Banking Innovation Award Winners Announced - BAI-Finacle (2011)

Are Bankers Ready For The Bank 3.0 Reality?

In an exclusive interview about his newest book, Bank 3.0, Brett King discusses how change occurring in the banking industry is inevitable, speeding up and disruptive. 

From the mobile wallet wars to the impact of social media, tablets and the 'de-banked' and digital consumer, Bank 3.0 shows why banking is no longer a place you go to, but something you do.

A great deal has happened since Brett King wrote Bank 2.0 in 2010. Two years ago, banks were under siege as the foundation of the banking system was close to collapse and the image of the industry as a safe and secure environment was being challenged. The impact of social media was just beginning to be understood by the financial services industry and mobile technology as we know it today was in its infancy. Heck, King even referenced his (now long gone) Blackberry in the first chapter of Bank 2.0.

With Bank 3.0, King discusses how consumers are less likely to view their retail banking provider in terms of capital adequacy, branch network, products and rates. Instead, customers are more likely to determine their banking partners by how easily they can access their accounts when they need to, and how much they trust their provider to execute business on their behalf. For those who read Bank 2.0, King's new book retains some of the foundation and case studies, but updates several areas based on what has occurred (and will be occurring) relative to digital delivery, payments, social media, and the power of 'big data'.

On the eve of the introduction of Bank 3.0 in the U.K. (introduction in the U.S. is scheduled for early November), I interviewed Brett King about his new book and about how he views the banking industry today.

What has occurred in the marketplace that warranted the publishing of Bank 3.0 just 2 years after your successful book, Bank 2.0?

Brett King: The marketplace has changed significantly around how consumers are engaging with their financial institutions. Compared to two years ago, traditional banks are challenged more than ever from a distribution perspective because of the movement to mobile and digital channels, and because they are not well positioned with their current bricks and mortar networks for a positive customer experience. 

The philosophy of banks, with their secure firewalls, operational structure and compliance mindset, is counter to how any other industry engages with customers in the digital space. Since Bank 2.0, the competitive environment has also changed a great deal, with partnerships being developed, alternative players and new bank start-ups being introduced, underbanked segments emerging, and social media merging with bank service engagement. People are beginning to take a functional and utility view of banking, which is why I say in the subtitle of the new book, 'banking is no longer a place you go to, but something you do'.

In Bank 3.0, you discuss that despite these marketplace and behavioral changes, traditional banks in the U.S. have made only minor changes to their distribution models. Where do you see bank branch distribution going in the near and mid-term?


Brett King: We have already seen a number of new players enter the market, especially in the payments space such as Isis, Square, PayPal, Google Wallet, etc. In addition, prepaid cards have become much more popular and represent the fastest growing deposit product in the U.S. This is significant since most bankers do not consider the product to be 'real banking'. From the consumer's perspective, however, prepaid cards are real banking. This is the mistake traditional bookstores and movie distributors made when new distribution alternatives emerged. They didn't take the challenge seriously. Bankers need to realize that prepaid cards are changing the way people are viewing bank relationships on the grassroots level. 

Finally, as transactions continue to migrate to online and mobile channels, we will see more and more banks reconfigure their traditional branches to reflect the new digital reality, with many banks also starting to close unproductive (and economically deficient) branches. These trends will only escalate going forward due to the costs of delivery and the reduced revenue potential.

No new U.S. bank charters have been issued in the recent past. What challenges are faced by start-ups like Movenbank related to regulations and other outdated barriers to entry?

Brett King: The challenges we've had have not been from regulators, but from the risk and compliance areas of the financial organizations we are trying to partner with. In fact, we've met with the Fed, the Treasury and the CFPB and they have all been overwhelmingly supportive of what we are doing. They understand the changes occurring in the marketplace, and have liked the financial literacy built into our product, our engagement model and the value we bring to the overall banking experience.

Alternatively, the banks themselves are having difficulty innovating . . . moving from the way they have done things in the past, using paper applications, signature cards, etc. to using web signatures and online authentication (which is much safer).

Do you see the cost of mobile innovation discussed in Bank 3.0 being an additional 'market disrupter' impacting the ability for smaller institutions to succeed and ultimately survive?

Brett King: The problem is that there are so many start-ups in the financial services and payments space that are impacting the way people view financial services that significant technology projects need to be undertaken by traditional banks just to keep pace. Investing in a technology layer, combined with the new costs of compliance, will be a challenge for smaller institutions. That doesn't eliminate the potential for smaller organizations to collaborate or to build partnerships to respond to market realities, but I don't see this happening.

With the rapid acceptance of tablets, how do you see tablets changing the way people do banking and the services banks may provide leveraging this technology?

Brett King: As we have seen in the retail space already, mobile will change the context of banking including where and how a consumer conducts business. For instance, the process of buying a home and securing a mortgage becomes much different when the shopping for the mortgage is done online significantly before a customer enters a branch (if they do so at all). A tablet can also provide a rich user experience due to the real estate of this device compared to a smartphone and the tactile capabilities compared to online interaction.

Turning this around, if a customer can get this experience on a tablet, why can't that level of experience be replicated at the ATM, as part of online banking and even in the branch? In the end, I think the growth in tablets will force banks to build enhanced customer experiences across all channels.

You have a section in your book dedicated to the impact of social media in financial services. How do you see social media changing banking in the future?

Brett King: Currently social media is impacting banking in a couple ways, including servicing and social dialogue. Customers are increasingly expecting to be able to reach their bank regarding service issues using Facebook or Twitter and get a response immediately. Many banks are falling short in this area, not providing adequate support for 24/7 social channel access.

In addition, consumers are using social media to follow and engage in dialogue about brands (both positively and negatively). If a brand performs well, this can lead to advocacy which in turn can lead to referrals and new business. This positive dialogue becomes critical in restoring trust in an individual bank's brand.

At the end of each chapter in your book, you provide key lessons and recommendations for banks willing to embrace change and take advantage of market opportunities. What is the biggest risk facing traditional banks as they move forward?

Brett King: The biggest risk facing traditional banks is the distribution and cultural bias towards physical branches. The difficulty in unwinding this investment is extremely difficult due the vast scale of branch networks. How do you turn such a ship in such a short time when you are so used to doing things in a certain manner? Leasing and rental contracts present a hurdle, but changing the branch-based culture at most banks may be a bigger challenge.

Your book contains dozens of case studies and references to financial institutions around the world that are innovating and developing new ways to engage with customers. Where is the greatest banking innovation occurring today?

Brett King: The countries that I believe are the best at this would include Australia, many of the Latin American countries like Brazil, some of the countries in the EU including some of the Danish banks and Swedish banks. In my opinion, the U.S. is definitely at a disadvantage due to their over investing in branch networks. The non-banks and new start-ups provide the best examples of innovation in the states."

Commonwealth Bank of Australia - Kaching Facebook Banking

Bank 3.0 is about the transition from banking dependent on a physical structure to banking that can be done at a time and place most convenient to the customer. It is about a new form of engagement and experience that harnesses the power of the internet without sacrificing the 'human touch'. It is about leveraging the potential of big data for better 1:1 interactions and more powerful marketing. 

Brett King's newest book emphasizes that consumer behavior is changing faster than ever before and that banks need to decide if they will embrace the change or be a victim of the change. Innovation and experimentation are no longer an option. They are the only way to do business.

Bank 3.0 was released today in the U.K. and is scheduled to be released in the U.S. in early November. In addition, Brett King mentioned that he will be offering free copies of his new book to Twitter followers over the next couple weeks on a first tweet, first served basis. Brett's Twitter handle is @BrettKing.

Banks Transforming Branch Networks to Improve Efficiencies

A lot has been written lately around the desire for banks to transform their branch networks given the consumer acceptance of alternative channels and the need to reduce distribution costs. In the past week, there has been coverage in both the American Banker as well as in BAI's Banking Strategies publication (see links to recent articles and white papers below).

One such report, published by the financial market research firm Fitch Ratings entitled, U.S. Banks: Rationalizing the Branch Network, expects that both fewer numbers of branches and different types of branches will be serving customers in the future. According to the report, the continuously increasing cost structure of banking, accompanied by a challenging revenue environment and higher capital requirements is prompting banks to evaluate all expense categories — especially their branch distribution system, which is one of the most significant expenses.

Past Branch Growth

For the past 30 years, branch growth continued unabated while the number of financial institutions declined by more than 50%. The growth occurred largely through consolidation and de-novo expansion, with the objective being to expand a bank's footprint and customer base and therefore low cost deposits and loans.

Expanding a bank's footprint was viewed by consumers as being synonymous with 'strength', and provided a bank the ability to market more cost efficiently. In the past, branches were also the primary form of distribution. The result was that markets with stronger economic activity became overbanked (similar to the growth of gas stations and car dealers in the past and drug stores today).

Branch Profitability

While in the past fees have subsidized branch networks, recent regulations (Reg. E and interchange regulations) have significantly reduced the ability to generate fee income (especially in lower income areas where branches were built to satisfy Community Reinvestment Act (CRA) requirements. Additional regulatory, human resource, real estate and compliance costs combined with the impact of a lower interest rate environment with lower spreads have further impacted the ability to support an expensive branch network.

As shown below, while non-interest income per branch has fallen off recently, non-interest costs continue to rise.

Changing Consumer Transaction Behaviors

As noted in my previous post, The Changing Definition of Convenience in Banking, a large percentage of consumers no longer equate branch distribution with convenience. While there are still some demographic segments who put a premium on the ability to transact at a local bricks and mortar facility (older demographics and small businesses), more and more consumers are banking from their desktop, ATM and mobile phone. 

While many consumers still prefer to perform account opening and more involved financial transactions at a branch, the Fitch Ratings report references Fiserv's 2011 Consumer Trends Survey that indicated that the vast majority of households with internet access (80% or 79M) use online banking, and that the growth rate of using this channel is increasing rapidly. The study also showed a substantial increase in the use of the mobile channel.

In short, changing consumer transacting behaviors combined with continued technological advances and the lower costs to the customer and bank associated with online and mobile banking, will continue to support a shift from traditional branches to digital channels.

In fact, Fitch expects increased technology spending over the near to intermediate term by the banks to continue to improve efficiency and streamline operations. While over the near term these additional technology expenses may offset cost savings from culling bank branches, longer term it should improve earnings and, therefore, returns to shareholders.

Impact of Reducing Branch Networks

Fitch views the reductions in costs, and therefore improvement in earnings, as the biggest near-term positive to the reduction (or at least the reconfiguration) of branches. Fitch also believes that larger banks with more resources are in a better position to benefit from both a technology spending and cost-savings perspective.

In the study, Fitch notes that financial institutions unable to transform their branch models in the near term may actually suffer declining market share and customer attrition since consumers are demanding new ways of transacting with their bank. Alternatively, the increased use of technology could have the impact of making it easier for customers to move funds from one bank to another, which could have the unintended impact of increasing customer attrition rates and decreasing the stickiness of deposits as banks encourage channel shift.

Branch Transformation Alternatives

With the increased cost structure of branches, changing consumer transaction behaviors and potentially negative impact of simply closing branch offices, what might be the new banking distribution model? Fitch and Infosys both believe that technology, innovation and channel integration will play a major role in the transformation of bank distribution.

While new banking entities such as Simple and Movenbank can build a truly branchless bank, traditional financial organizations will need to find the right balance of branches and alternative channels to maintain a physical presence while still moving to a more feasible cost structure for the future. And while the announcements of branch closings are becoming more commonplace (BofA, KeyBank, PNC, HSBC, Capital One) to various degrees of controversy, the decision to close or modify a branch location will not be an easy one.

Digitally Enabled Branches

Some banks, like ABN AMRO have introduced a high tech teleportal that utilizes interactive technology without the presence of any staff. The branch can conduct the majority of the functions of a traditional branch through the interaction with a 3D screen that provides an effective, albeit different, branch experience.

Banks wanting to maintain a reduced staffing model without eliminating all direct human interaction have integrated digital and video technology to supplement a reduced staff in a smaller facility. Phone banking, self-service teller stations, online banking stations (using iPad style devices) and video web conferencing are being used in some banks for loan processing and even cross-selling.

ATM Modernization

With ATM capabilities expanding rapidly, some banks are increasing the presence and utilization of ATMs to handle more customer needs. We have already ATMs that can accept checks, make bill payments, provide change and even issue stamps and movie tickets. Future advances will include the potential for live video interaction and customer support and new ways to access cash utilizing mobile devices. These expanded capabilities will allow banks to reduce (or replace) a traditional bricks and mortar branch.

Enhanced Branch Value Proposition

For those branches that remain, banks must extract a higher value from the existing real estate through improved cross-selling, expanded services (brokerage, advisory, insurance, community outreach, etc.) and an overall enhanced customer experience. Citibank has gone as far as developing branches inspired from the Apple store, integrating modern design with technology and high customer service to improve engagement and sales (see Citi Rolls Out Its Version of the Apple Store in The Financial Brand).

With banks needing to reduce and reconfigure their distribution networks due to cost and revenue implications, disruption in bank distribution will continue. In an environment where customer fees have recently increased and dissatisfaction with the banking industry is still at high levels, any perceived cutback in service levels will be met with quick and widespread negative publicity and potential for further regulatory push back. This will leave banks with having to balance their need to change their distribution strategies with potential negative public sentiment.

It will eventually fall on the shoulders of bank marketers to soften the impact of any negative response through effective (and proactive) communication using all available traditional and digital/social media channels.

What do you think will be the best near and long term distribution strategy for banking? What will be the impact of the new banking entities that will enter the marketplace without branches? I would love to know.

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