The New Financial Marketplace

What is this new era we are entering? Two of the forces that have brought us into the brave new world of financial services have been at work for several years: technology and competition. The third force-broader powers-has now received the blessings of lawmakers in the form of the Gramm-Leach-Bliley Financial Services Modernization Act.

What does the new law bode for your bank? I sense that bank senior managers and directors right now feel a little like recent college graduates. They`ve got a law that they worked hard to obtain. But What now? they ask, with growing apprehension about the world into which they are stepping.

Indeed, I`ve talked to many community bank directors and CEOs who wonder if this law will open up a can of worms. Maybe so, but let`s remember: Opening up a can of worms is the only way you`re going to catch fish.

The advantages

Perhaps most notably, the financial services modernization law repeals two provisions of the Glass-Steagall Act that have separated banking, insurance, and securities activities for the latter two-thirds of this century. The law creates a new financial services structure, the financial holding company, under the Bank Holding Company Act. Financial holding companies will be able to engage in any activity that is deemed financial in nature.

Henceforward, banks will be able to affiliate with securities firms and insurance companies within the same financial holding company and, through that structure, bring a broad array of financial products to the marketplace, including traditional banking products, investment products, insurance, and mutual funds.

The 400-page statute also contains myriad other provisions that will shape the way banks do business in the coming years. Let`s look at a few of the positives:

u Broadened powers are a plus for community banks that choose to pursue focused opportunities in new product and service lines, either in-house or through affiliates.

u Back-door intrusions into banking (for example, Merrill Lynch`s cash management account, which nearly everyone recognized as a banking product) will cease.

u Threats from nonbanks such as Microsoft (remember the banks as dinosaurs comment?) and Wal-Mart have been effectively cut off by the closure of the unitary thrift loophole.

u The privacy provisions incorporated into the law are relatively weak, giving community banks a golden opportunity to demonstrate to customers that they are not in the information-brokering business but the banking business and are, therefore, committed to protecting their customers` privacy.

u The changes to the Federal Home Loan Bank System will give community banks additional sources of funding.

u Banks are generally believed to be ideal distribution channels for insurance products. With their newfound insurance powers, conventional wisdom is that banks will someday dominate insurance distribution. In fact, for those community bankers who decide the kitchen may be getting a little too hot, the expected wave of insurance companies seeking to purchase banks could have a favorable impact on bank valuations in the not-too-distant future.

u Traditional trust and fiduciary activities can remain in the bank, subject to the supervision of the bank`s own regulator, and not be farmed out to a securities affiliate regulated by the Securities and Exchange Commission. This provision is of special interest to community banks that have begun finding new opportunities in the trust business.

Some disadvantages

The Gramm-Leach-Bliley Act has some negatives, too, and these tend to be especially relevant to community banks:

u After a lot of heat and smoke, little was done to reduce the Community Reinvestment Act regulatory burden on community banks, although CRA exams will be less frequent

for banks that receive outstanding or satisfactory ratings.

u The law almost invites state and local jurisdictions to override its privacy provisions with tougher requirements. The result could be a patchwork of privacy laws to complicate compliance for banks with multimarket operations.

u The expanded ATM fee disclosure provisions could irritate an already-sensitive public, which wants ATMs to be free utilities. Notice the recent public relations nightmare in California, whose citizens voted to prohibit ATM usage fees for noncustomers. The tea leaves are clear: Consumer attitudes nationwide are working against this source of fee income.

u A more openly competitive environment, ushered in by the modernization law, could spell the demise of community institutions that don`t have the capitalization, consumer base, or vision to grow with the opportunities.

Weighing the positives and negatives

So what are the options for community banks? There are at least three possible avenues to pursue as you stand at the crossroads of a new century and a new millennium:

u Do nothing. This has always been an option, and some institutions in insulated markets have been able to succeed fairly well at it-even during the fast-paced, highly competitive 1990s. But the problem is that technology has broken down the geographic boundaries that traditionally defined a bank`s territory. And now, broader powers have removed the market protections that formerly reserved the business of banking for banks.

Under the modernization law, I think it is fair to expect that the larger banks will merge rapidly with brokerage and insurance companies and make further inroads into local banking markets. Smaller banks that take the do-nothing approach will, I fear, only help fulfill the prophecies of the demise of community banking.

u Take advantage of the favorable provisions of the law. The exciting thing about the post-reform era is that community banks now have the tools to compete with just about anybody. Smaller banks can leverage the new opportunities presented by the modernization law, take advantage of new technologies that extend market reach, deploy the power of customer relationship management to build profitable accounts, and use to their advantage the inherent strengths of a community-oriented financial institution.

u Merge. Selling to one of their enormous competitors is usually not an option for most community banks. But in many cases, a merger of equals might be the way to go. By merging, two or more small institutions become larger and more competitive while still maintaining the attributes of a community-oriented financial institution.

This course ascribes to the size matters philosophy, allowing the newly merged company to exercise the four Ps of a larger organization (pricing, product, promotion, placement) creating economies of scale, broader product lines, bigger promotional budgets, and more distribution channels. And don`t forget that by remaining a community bank, albeit a larger one, the company retains the considerable advantage of a fifth P: personalization.

Choosing to compete

I believe that bank CEOs and directors have to make some choices, and doing nothing is probably not a very good one. If instead you choose to brave the new financial marketplace and go forth to claim your rightful place, you have the chance to be heroic for your customers, your owners, and your employees. Here are some ideas bank directors should consider on how to be an effective competitor.

u Have a clear strategic direction in mind. Which of the many new opportunities do you want to pursue or should you pursue, given your customer base, assets, capitalization, and management talent? This step requires an honest self-assessment and some reliable market intelligence.

There is tremendous potential for growth in both investment services and insurance products. The American Bankers Association`s 1999 Survey Reports on Bank Retail Investment Services revealed that only about 20% of community banks are currently offering investment services. Among the smallest banks, a paltry 10% offer their customers retail investment services.

On the insurance side, there may be even more potential for profit growth. According to the 1999 National Survey of Bank Insurance Services sponsored by the ABA Insurance Association, life insurance premiums generated by banks accounted for only .007% of bank assets in 1997 and .014% in 1998.

u Exploit technology. Technology is the ultimate leveler of the playing field. Community banks have essentially the same access as their larger counterparts to automated customer information systems, data mining facilities, electronic banking, remote distribution, and the many other fruits of the information revolution.

u Embrace Internet banking. Within a few years, virtually every bank will be on the Net, and nearly all of them will be offering transactional banking services. Customers have moved from a patient, wait-and-see approach to demand mode. Don`t miss this boat.

u Utilize insurance and brokerage powers to the extent they fit your strategic direction. Banks have proven themselves to be effective sales platforms for mutual funds, annuities, and other nondeposit investment products. Thus, experts have every reason to believe that banks will step aggressively into insurance and brokerage activities now that the barriers have been removed. In fact, within the confines of permissible powers, banks have already made a dent in the insurance business. Consider these findings from the aforementioned insurance services survey:

-An estimated 3,700 banking institutions sold life insurance in 1997; that number rose to 4,900 in 1998.

-Bank life insurance premiums grew 91.7% from 1997 to 1998.

u Practice CRM. Through customer relationship management, identify your most profitable customers and shower them with your time and attention. Doing so will build the scope of your account relationships with them, provide one-stop shopping for all their financial services needs, and keep their faith through loyalty management programs.

u Redouble your efforts to serve your local community. A community bank`s fortunes will always be intertwined with the economic strength of its local community.

u Promote your brand image. You can still trade on the trust the public continues to reposit in the banking industry. Take advantage of it.

u Search for new sources of fee income. The Office of the Comptroller of the Currency has determined that noninterest income now contributes an astonishing 42% of operating income at commercial banks. Go after it, but be careful about managing your customers` perceptions.

Financial services convergence

Consolidation was the watchword of the 1990s, and community banks came out of that wave healthy and strong, having proved their lasting value to bank customers. The financial modernization law has likely unleashed the next wave: financial services convergence. Through the financial holding company structure and with the aid of technology and the Internet, any size bank can bring every conceivable banking and financial resource to its customers.

Community banks still enjoy the home field advantage, but how long that advantage will remain is anyone`s guess. So march bravely forward into the new financial services world while the door of opportunity is wide open. |BD|

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