Banking Innovation Basics
All the financial-services innovations since the Templars—including letters of credit, checking accounts, travelers’ checks, credit and debit cards, ATMs, online banking, and direct deposit—have addressed the same three basic needs:
- The security and safety of capital, and access to that capital when and where it is needed.
- Leverage, or access to capital to fund growth (either personal or for an enterprise).
- Deployment of excess capital in search of greater returns. Although this activity is highly important to the enterprise holding the capital, it is needed by only about 20 percent of banking customers.
Those needs may not change, but the ways in which banks satisfy them can change dramatically, and often do. The FS institutions that thrive during the next few years will be the ones that understand which aspects of their business are subject to complete disruption—and which aspects will remain intact.
Even 10 years ago, it was possible to see how technologies such as broadband, mobile phones, and Internet video would change the delivery of financial services. As electronic transactions grew more popular, the need for paper (cash and check) transactions and face-to-face interactions would diminish. Much of this shift has already come to pass. Digital download speeds have evolved from 56K dialup modems to 4G mobile capabilities. As of 2011, according to CTIA–The Wireless Association, the total number of wireless subscribers in the U.S. (328 million) exceeded the population (316 million). The default choice in many retail transactions is home delivery. Face-to-face has come to mean anytime and anywhere, via Skype, video chat, or, soon, Google Glass. And currencies? Facebook credits, mobile payments, and Bitcoin all demonstrate the rapidity with which digital currencies and frictionless exchanges can emerge.
In that context, it is astonishing how slow many FS firms have been, compared to other industries, in adapting to technological change. While music stores, electronics stores, and other retailers have reduced or even eliminated physical distribution, large banks have expanded it, either through acquisition or by opening their own bricks-and-mortar branches. Even as firms have consolidated, the number of bank branches in the U.S. has risen steadily, reaching a peak of almost 100,000 in 2009. From 2002 to 2012, the top four banks doubled their number of branches. To be sure, all of the largest banks in the U.S. now offer some form of online banking, but most have added branches at the same time. Based on the measurement of deposits per branch (which is a good proxy for the number of customers, because deposits are the core of FS relationships), these new branches have not translated into operational efficiency or a much larger customer base. I know of one major bank which led the industry in deposits per branch in 2004 (more than $300 million) and then lost that leading position to its rivals as it built up its branch network and ignored its digital distribution. Its efficiency ratio of deposits now stands at about $150 million per branch, half its 2004 ratio. Dependence on branch distribution has also been complicated with the Dodd-Frank Act; as revenue streams have disappeared, branch managers seeking a balanced P&L have pushed more aggressive cross-selling of products, even if those products are unprofitable.
In short, although every bank can point to improved performance in some respect, the performance that matters most has grown fastest for the banks that pruned their branch networks and expanded their digital capabilities—especially since 2009. Having fewer branches does not cause customers to flee, nor does it lower assets; it is the first step toward survival.
Yet, many financial institutions and their managers still cling to the myth that customers bank with them solely because of their branch-based distribution. Their consumer research suggests as much. But any good researcher will tell you that consumer behavior often differs from research responses. When Citibank introduced ATMs in New York City in the 1980s, market research found that 99 percent of consumers would never use one to get cash. In the late 1990s, 99 percent of consumers said they would never trade or bank online. Yet today, virtually every bank account holder uses an ATM, 90 million U.S. households bank online, and about 22 million households trade online.