Has Digital Banking Reached a Tipping Point?

Digital banking continues to gain ground as consumer behavior and demands rapidly shift along with technological capabilities. In November, Consumer Reports revealed that more than 90 percent of its subscribers do at least some of their banking online. And mobile banking usage has increased by 77 percent since 2011: Thirty-nine percent of mobile phone users with a bank account now use their phone for banking transactions, according to the Federal Reserve.

“Digital banking is becoming banking,” says Stephen Greer, an analyst with the research firm Celent.

Some banks are finding a middle ground between traditional bank models and the financial technology firms working furiously to eat the industry’s lunch. It’s unlikely that financial institutions will go the way of former video rental chain Blockbuster-banking is a much stickier business, requiring customers to untangle accounts and related activities like direct deposit and bill payments-but these banks aren’t taking any chances. They’re taking the digital bull by the horns.

Digital banks aren’t new: The first wave of online banks arrived in the mid-1990s. The legacy of these institutions is mixed: Netbank failed in 2007 due to mortgage defaults as the housing bubble collapsed, and Security First Network Bank lasted just a few years before its acquisition in 2002 by Royal Bank of Canada. (Security First’s founder, Chip Mahan, now runs Live Oak Bank, a small business lender with-you guessed it-no branches.) Yet Jacksonville, Florida-based Everbank Financial and San Diego’s BofI Holding both have strong track records.

Consumer attitudes toward banking and technology have evolved dramatically in the almost 20 years since Netbank made its debut. One in 10 of Consumer Reports’ membership has opted for digital banks. Digital banks have grown impressively, with the 10 largest generating $175 billion in new deposits in the six years from March 2009 to March 2015, according to Cornerstone Advisors. These mobile and online-focused institutions may not have carved out a significant share from the biggest banks-at least not yet-but that’s missing the point. Digital banks have developed an efficient, streamlined and profitable way to keep their customers happy.

However, customers who choose a primarily digital banking experience aren’t necessarily doing so because they’re captivated by the technology. Most banks offer online and mobile banking, and you can still pop by a branch for advice or assistance from an actual human being. What digital banks do offer, due to a more streamlined internal structure, are above-average rates for deposit accounts, and minimal or even no fees. And their customers are happier with the experience, leading to the highest satisfaction levels in the industry. Ninety-three percent say they’re highly satisfied, according to Consumer Reports, which rated the industry on customer service, communication, consumer complaints and fees.

Ally Bank emerged from the ashes when GMAC Bank reorganized and rebranded amidst the crisis rocking both the banking and automotive industries in 2009. Diane Morais, Ally’s chief executive officer, says the loss of the GMAC brand-which was tied to its former corporate parent, General Motors-allowed Ally to start from a blank slate. “You very rarely have an opportunity to create a new brand,” says Morais. “Our mantra at the time was: ‘The world doesn’t need another bank. It needs a better bank.’” Ally’s leadership identified customer frustrations based on research and personal experiences within the industry, and worked to develop a more satisfying experience.

“They’ve been very clear about their brand to the consumer,” says Steve Williams, a principal at Cornerstone Advisors. “For a place that came out of GMAC and [was] funded by [Troubled Asset Relief Program] money, they have done an excellent job of creating a consumer friendly brand.” Ally Financial received more than $17 billion in TARP money from the U.S. Treasury, which just a few years ago owned about three-quarters of the organization. Ally exited TARP in December 2014, with the U.S. government earning $2.4 billion on the investment.

Ally Bank’s motto is “No Branches = Great Rates,” and Ally offers savings rates of 1 percent with no monthly fees, in addition to competitive rates for checking, money market accounts and certificates of deposit. Deposits have grown by more than 150 percent since 2009, to $64 billion as of the third quarter 2015, and the bank recently exceeded 1 million customers.

In contrast, most big banks pay 0.01 percent in interest for a savings account, and may charge a monthly fee if certain conditions aren’t met, such as a minimum balance or a link to other bank products. Steve Beck, a managing partner with the consulting firm cg42, says that the top 10 retail banks stand to lose $4 billion in revenue in 2016 to smaller institutions, according to the firm’s bi-annual study of retail banks. Many of these customers are seeking competitive rates and limited or no fees.

Ally spokesperson Andrea Puchalsky confirms that a significant percentage of Ally’s customers come from the biggest banks.

“Who’s getting a bad deal from traditional banks? It’s people with meaningful amounts of savings,” says Nick Clements, co-founder of MagnifyMoney, a website focusing on consumer financial product education. A $5,000 savings account could earn $50 in interest annually at Ally, compared to $5 at a traditional bank.

Bucking public perception that digital banking is largely for millennials, Morais says that Ally’s customers represent a broad range of ages and income brackets. “The thing that all of our customers have in common is that they are comfortable using technology, [and] they want to be in control,” she says.

Ally’s website and mobile app are designed to make the experience “as seamless and simple as possible for the customer,” says Morais. While the emphasis is on digital banking, Ally offers a call center to address concerns in-person, 24 hours a day, seven days a week. Some customers like to know that they can pick up the phone to speak with an actual human being about their questions or concerns. “We see a tremendous amount of favorable feedback from customers who have interacted on our call center, and we do think that is a differentiator,” she says.

Some legacy banks are providing digital-only solutions while holding onto their traditional models as well. Capital One Financial Corp. purchased ING Direct in 2012, which was then renamed Capital One 360. (Capital One’s more traditional banking charter has branches in the mid-Atlantic, Virginia, Louisiana and Texas.)

Spinning off a digital brand has its advantages. Developing an innovative culture can prove problematic for traditional institutions. Thirty-five percent of board members and senior-level bank executives cite culture as the greatest obstacle to innovation within traditional banks, according to Bank Director’s 2015 Fintech Disruption Survey, conducted in November 2015. A separate digital unit can allow innovation to flourish. “Let’s incubate the disruptive strategy and the new model first, and not let the management of its development be smothered by our legacy process and our legacy strategy,” says Williams.

Innovation also requires a different talent set, something more akin to a startup mentality than a traditional banker. “It’s really hard to change ourselves from within,” says Somesh Khanna, a director at McKinsey & Co. A separate digital brand can also allow for two different pricing and product strategies.

Capital One CEO Richard Fairbank has been very vocal about Capital One’s focus on digital, saying in the company’s second quarter 2015 earnings call that “banking is an inherently digital business and is ripe for transformation…we can’t simply bolt onto the side of our existing business or port analog banking services to digital channels.”

Wyomissing, Pennsylvania-based Customers Bancorp, with $7.6 billion in assets, built BankMobile, the digital-only division of Customers Bank, from scratch in early 2014. Customers Bank is a mid-Atlantic brand, and focuses primarily on business clients through 15 branches in Pennsylvania, New York and New Jersey, and two loan offices in Rhode Island and Boston. BankMobile may have even bigger goals, aiming to create a national brand focusing on consumers through free, no-fee checking accounts, savings accounts advertised as paying at least 0.25 percentage points annual percentage yield above that of the four largest banks, and personal lines of credit. Customers Chief Financial Officer Robert Wahlman said the unit is on track to meet its goal of 25,000 customers in its first year, per the bank’s third quarter 2015 earnings call.

Luvleen Sidhu, BankMobile’s chief strategy and marketing officer, says the unit’s growth has come on a minimal marketing budget. Fittingly, digital marketing and social media play a strong role, along with in-person marketing at street fairs and through college ambassadors. A membership program allows potential customers to get to know BankMobile, and delivers financial education via email. An affinity marketing program targets professionals such as firemen, teachers and police officers, which Sidhu credits with helping BankMobile extend its reach beyond millennials, who currently comprise 70 percent of BankMobile’s customer base. “We no longer live in a world where geography defines the banking community,” says Sidhu. “It’s more about shared values.”

BankMobile’s team occupies its own office space, away from the main bank. “The management team at Customers Bank overall is very visionary in nature, but it gets very easy in banking to [adopt] the traditional, stodgy bank mentality. BankMobile is created from a team of forward thinkers,” says Sidhu. While the division operates more like a fintech startup, it has the backing of Customers’ banking charter, and accounts are insured by the Federal Deposit Insurance Corp.

“Customers has been one of the banks that’s been willing to think a little bit outside the box,” says Bob Ramsey, senior vice president, equity research at FBR Capital Markets Corp. “It’s consistent with their strategy to find some attractive niches to serve customers better, but it is not tied to the legacy bricks and mortar, branch-based banking piece of business.” But as Customers approaches $10 billion in assets, he believes that Customers and BankMobile will need to restructure or part ways. The Durbin Amendment restricts interchange fees at that size, which would impact the profitability of both.

“We envision [once Customers hits $10 billion in assets] that we would be exiting, in one form or another, the BankMobile business,” says Wahlman. This exit could mean spinning BankMobile off as its own company, or selling the unit to another bank.

Sidhu envisions BankMobile’s future as “a fintech company with a bank charter.”

“Our mission is to really develop and impress our customers with an extremely effortless, awesome user experience, where banking really becomes like your Fitbit, [and] you can check your financial pulse on a daily basis,” says Sidhu.

Operating free of the legacy brand means a bank can create a new customer experience, and test new technology and design, says Stessa Cohen, research director at Gartner Inc. Eventually, this can lead to change in the legacy institution. “Once we prove that this bank works, we’re going to move the rest of our customers there,” she says.

Digital units like BankMobile are possible for forward-thinking banks, and not limited to the largest retail institutions. “You don’t have to be a huge bank to do this. BankMobile is one, and I think you’ll see more legacy banks create these new digital brands,” says Cohen.

Khanna warns that banks should take care not to treat these separate, more innovative units as mere side projects that produce small returns compared to their expense, with minimal benefit to the overall organization. “Those that are doing it intelligently are ensuring that they continue to learn from it so that they can adapt the mothership,” he says.

BankMobile isn’t a slam-dunk for Customers yet. “It’s still in the ramp up phase, so it’s certainly losing money currently,” says Frank Schiraldi, an equity analyst at Sandler O’Neill.

Customers’ Wahlman said that he expects operating expenses for BankMobile to reach $6 million in excess of revenues in 2016. Customers reported $216 million in year-end revenue in 2014.

Banks-particularly large banks-are increasingly investing in, partnering with and acquiring fintech firms. Madrid-based Banco Bilbao Vizcaya Argentaria (BBVA) has been particularly active in working with the fintech community. In November 2015, BBVA bought a 30 percent stake in British mobile-only Atom Bank, gaining two seats on the bank’s board. In the U.S., BBVA purchased Simple in 2014, a “neobank” based in Portland, Oregon, which offers deposit accounts and budgeting tools to its users. A few months later, BBVA CEO Francisco Gonzalez told Fox Business Network’s Maria Bartiromo that he sees opportunities for his bank in the U.S. “[The U.S.] has a very digitalized society, but the banking system is a bit rudimentary. There is a gap that someone has to fill, and BBVA wants to be one of the players,” he said. “You have to have a business model that gives customers the possibility of getting to the bank anywhere, anytime, and with any device, while receiving real responses in real time.”

BBVA executives hold half of the seats on Simple’s board, but otherwise the company operates autonomously. Simple’s leadership remains more or less unchanged, including CEO Joshua Reich. Venture capitalist Matt Harris, an early investor in Simple, serves as an independent chairman. For Simple, BBVA gives the startup an opportunity to expand. Simple will soon have access to BBVA’s real-time core processor, says Simple’s head of communications, Krista Berlincourt. The upgrade means Simple will be able to look into expanding its product offering and improve the user experience. “We’re taking our little Jetta engine and putting a Hemi in it,” she says.

Simple currently partners with $4.5 billion asset The Bancorp, a white-label banking provider which holds Simple’s accounts and covers them under its FDIC insurance program. In 2016, Simple will begin opening and transitioning accounts to BBVA’s U.S. subsidiary, BBVA Compass Bancshares.

Enrique Gonzalez, corporate relationship manager at Simple, works as the liaison between Simple and its big bank parent, providing Simple with resources and insights from BBVA. He also serves as a sort of guard dog to keep Simple free of distractions: BBVA staff are naturally curious about their hip fintech acquisition, and Gonzalez turns away a lot of unnecessary requests from BBVA to visit Simple’s offices.

“BBVA wants Simple to remain as a stand-alone business, to allow Simple to focus on its continuing success while allowing us to learn from a new business model. Of course there’s collaboration, but this approach means that Simple doesn’t get caught up in BBVA’s day-to-day operations,” says BBVA spokesperson Damian Peachey.

Of course, the fact that Simple no longer has to focus on where its funding dollars will come from leaves its team free to focus on shaking up the banking industry. For venture-backed companies, “your leadership is focused on staying alive, not dreaming what the future looks like,” says Berlincourt.

BBVA’s hands-off approach appears to be working: Simple had 100,000 customers at the time of its acquisition, served by 80 employees, says Berlincourt. Almost two years later, Simple has more than tripled its team, and serves “hundreds of thousands of customers” at a growth rate of 10 percent a month.

In its Fintech Disruption Survey, Bank Director found that 80 percent of bank executives and board members expect successful banks to partner with, acquire or invest in fintech firms in the near future. “Many of these fintechs represent capabilities that banks would very much like to have,” says Khanna. “I can see a lot of amazing solutions and choices coming at far better economic terms to the end consumer in the next decade.”

Big banks are certainly playing the digital game, too. Bank of America Corp. CEO Brian Moynihan revealed in the company’s third quarter 2015 earnings call that the bank has 31 million online users and more than 18 million active mobile customers. Mobile deposits account for 14 percent of consumer deposit transactions, and this shift to self-service means Bank of America is saving money. “[Mobile] is one-tenth the cost relative to processing at financial centers, and is more convenient for customers,” said Moynihan.

This could be bad news for smaller institutions outside the top 10 retail banks, whose customers are more likely to be frustrated with lagging mobile and online offerings, according to cg42’s study.

“Community banks and credit unions are fighting a street war,” says Williams. “I absolutely believe that community banks need to understand the digital piece, and the big banks scaling digital is a real threat.”

Digital banks have profited from the low rate environment. So what happens to these digital models after the Federal Reserve increased interest rates by a quarter of a percentage point in mid-December, with the likelihood of additional rate hikes in 2016? Since the digital banking model is already more efficient, the rates offered by banks such as Ally should continue to exceed those of traditional banks.

“When rates change, and as big banks continue to grapple with the overall costs of delivery with their branch systems, I would think the pace of market share gain [will] grow substantially,” says Williams. “The market share gains are going to shift some to the digital players over time.”

Morais says Ally’s customers are pleased with the digital experience and service, not just the rates. “We have competitive rates, but we’re not the top rate payer in any product, and haven’t been for years.” Ally is looking at future expansion beyond deposit accounts, based on customer input.

“Consumers of all ages and types [want] to do everything that they need to do in a digital way. I think it’s going to continue to overtake other, more traditional forms of banking, and Ally is well-positioned to capitalize on that,” says Morais.


Emily McCormick

Vice President of Editorial & Research

Emily McCormick is Vice President of Editorial & Research for Bank Director. Emily oversees research projects, from in-depth reports to Bank Director’s annual surveys on M&A, risk, compensation, governance and technology. She also manages content for the Bank Services Program. In addition to regularly speaking and moderating discussions at Bank Director’s in-person and virtual events, Emily regularly writes and edits for Bank Director magazine and BankDirector.com. She started her career in the circulation department at the Knoxville News-Sentinel, and graduated summa cum laude from The University of Tennessee with a bachelor’s degree in Spanish and International Business.

Join OUr Community

Bank Director’s annual Bank Services Membership Program combines Bank Director’s extensive online library of director training materials, conferences, our quarterly publication, and access to FinXTech Connect.

Become a Member

Our commitment to those leaders who believe a strong board makes a strong bank never wavers.