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Chief Investment Officer
The Retail Banking Challenge
No matter what, there is no way retail banking could become profitable over the last 9 years. Incredibly low interest rates (remember when we all said it was unsustainable five years ago?) rendered deposits, particularly interest-free ones, barely profitable. No cost reduction effort could turn the red figures into black ones. One analysis I’ve seen credited absolute interest rate levels with 83% of the decline in retail banking profitability.
This issue was compounded by the abundance of deposits to fund languishing loan demand for the first five years post-crisis, coupled with a marked decline in customer visits. Customer still wanted branches; they just didn’t visit them as much.
The saving grace for some banks was their cross-sell ratio, making the most out of every retail customer; however, then the Wells Fargo fiasco threatened this income stream as well.
Against this background, the following facts are particularly meaningful:
• Check usage has been declining steadily as a form of payment, from over 40% of the payments in 2001 to only about 10% how.
• Credit as a payment vehicle became dominant as cash declined, inching toward the 30%, with debit not far behind.
• Chase estimates that this year 25% of their deposits will be made through the mobile channel, 51% at the ATM, and 24% at the teller line. This is the result of a concerted effort to build customer trust in remote channels and technology, using new services and intense advertising campaigns to do so. Chase has been consistently reducing its number of tellers throughout the period.
• The number of branches per 100,000 adults in the US is the highest in the world, and has only started declining in 2011.
• Deposit levels of de novo branches in the US, per SNL Financial and SCAS Research, have reached $30 million median levels after 12 years; the top quartile achieved nearly $60 million, and the bottom quartile hasn’t broken $20 million.
• Even more telling is the next statistic from the same source: less than 10% of underperforming branches moved above the median even after 12 years. Time doesn’t heal ALL wounds…
• Most banks do not analyze their branch networks sufficiently to bite the bullet and shed underperforming branches. A simple four-cell matrix (small and fast growing; small and slow growing; large and fast growing; large and slow growing) is an excellent tool to identify what percent of your branches is small and slow growing. This is the drag on your retail network effectiveness, and, as we’ve seen from the above analysis, rarely do these branches gain momentum and break out of that pattern.
• Bank customer attrition rate has been stable at 8-10% per year over the past ten years, but the attrition has changed. The highest customer attrition is among regional banks (as per A.T. Kearney, as of 4Q2015), lowest among credit unions, and second lowest among universal banks.
• The customers that switch banks are disproportionately younger and lower income. In 2015, 20% of customers with household income <$25,000 between the ages of 18-44 switched banks, while only 2% of people 65 and older who make $100k or more did. Overall, 19% of people aged 18-24 changed banks over that year.
• 57% of Chase’s new account acquisitions are between the ages of 18-35.
• Per JP Morgan Chase, the average annual service costs of a digitally-centric customer are roughly half that of all other primary relationships. Customer attrition is also meaningfully lower among the digitally-centric customers.
Thus far I haven’t told you anything you don’t know. The question is, what can we do about this? Here are some of my thoughts.
1. Execute Patronage. Most banks assign new customers to the branch where the account was opened and never change it. This leads to major errors in calculating branch size and profitability, which ultimately lead to closure decisions. Patronage is an approach to customer domicile decision-making that is driven by customer behavior. Using a set of prescribed rules, the entire customer base is scrubbed periodically (some do this as often as monthly) and reassigned based upon where they actually do their banking instead of where they opened their account. This approach can wreak havoc in your incentive compensation if it is based on branch deposits and customer count, so one must add decision rules for to prevent penalizing branches for customer movement (unless it’s massive, indicating branch service problems.) Accurate patronage leads to better branch resource decision-making (open/close, ATM deployment and staffing decisions).
2. Understand your network effect. Branches are but a part of your network. Any place that has your name and sign on it contributes to customers’ perception of your ubiquity. While not all touch points were created equal, they are all relevant to your network. For example, a smart ATM (ITM) is a distribution point that is more impactful than a machine without the human behind it, but perhaps less impactful than a branch. Develop a good understanding of the network vs. individual distribution points, since it will give you more flexibility to eliminate some of these touch points without harming customer well-being and sales opportunities.
3. Consider your market share vs. your opportunity. I have always used a very simple ratio: your branch share (percent of deposit share over % of branch share - number of bank branches out of the entire branch universe in the market). This crude and rudimentary figure can help you assess whether your branches are getting more than their fair share in their markets (if the ratio is over 1) or less than their fair share. You can then make informed decisions about resource allocation and branch closures.
4. Be informed about the opportunity in each market. Do not close branches in high opportunity markets. You may want to relocate them or change their staffing, but if the market has promise but your execution is flawed, correct for the execution. There are numerous services that measure market opportunity and can advise you on it.
5. Consider meaningful branch network configuration. Typically banks assess each branch individually and then close a couple at the margin. I advocate a comprehensive approach to retail distribution which takes into account all the factors above, as well as customer activity and the opportunity to deploy technology to serve the market.
6. Plan branch closures carefully. Customer loss at branch closure isn’t ordained. It depends on how you handle the situation as well as your total network. Customers in many parts of the country have accepted branch changes and closures as the industry continues to morph. A campaign to inform customers of the impending closure and help them find their banker (or an alternative) elsewhere in your network can achieve >90% retention of customers of closed branches.
7. Learn from the big guys. Chase, the best large bank retailer I know, and others, share openly with their analysts and the public aspects of their retail strategy which can help us all. For example, Chase shared in February 2016 their consumer and community banking expense allocation. You’d be surprised how much they invest in branch transaction migration and digital adoption vs. marketing and payments innovation. I realize none of you are in Chase, and that we do not want to compete with them on their own grounds. At the same time, their investments in R&D can serve as good indicators of where the industry will migrate eventually. The pace of change of customer behavior varies widely around the country, but the direction is consistent throughout the US.
8. Strategize for account acquisition among Millennials. This segment doesn’t have much money, but they do swipe a lot for fee income. Further, they are quickly approaching financial maturity, and are also most likely to switch banks. Waiting until they reach full financial maturity might not pan out for you, because their interest switching diminishes meaningfully as they get older. Currently, big banks are winning in net customer acquisition, largely due to their digital strategy and targeted acquisition efforts. Us, the community banks, scoff at the big banks for offering large amounts of money to acquire these “non-profitable” customers. However, as we saw above, the cost to service these customers is far lower than the cost to service others, and their retention and satisfaction levels are far higher. We cannot ignore this segment; it’s our future. Focusing on acquiring them using the unique tools available to community banks is key to future success, prosperity and valuations.
The above are just a few ways the community bank sector can work to make retail banking a profitable venture once more. What is your bank doing today to make this move?
New in the Nest:
This column will offer fool proof recipes, restaurant suggestions and other foodie tidbits for your consideration and consumption.
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