Banking.com: Strategies to Meet the Future

Like many tradition-bound bankers, Bill Cooper has long been skeptical of the Internet and its supposed impact on the industry. Back in 1996, when online banking was just getting its feet, the chairman and chief executive of Minneapolis-based TCF Financial Corp. vowed not to offer online banking services until my customers can program their own VCRs.Fast-forward four years. As we enter the new millennium, people haven`t become much better at taping their favorite television programs, and Cooper says there`s still no great outcry for banking services on the Web. I don`t get many letters saying, You don`t have Internet banking; I`m not banking with you.“` But-surprise-he`s also done an about-face. Early next year, $10.3 billion TCF will begin offering customers account access, balance transfers, and bill payment options via the Internet. It has become clearer to us where this is heading, Cooper says unapologetically. Nobody is making any money in the Internet banking business, and they probably won`t for a long time. But what is going to happen is that those companies that offer bricks-and-mortar, telephone banking, ATMs, and Internet banking-all those different channels together-will prosper. It`s a wave that`s arriving, he adds. You could end up in the buggy-whip business if you`re not careful.Increasingly, banks of all stripes are similarly concluding that they must follow their customers-and, in some cases, lead them-into the realm of Internet banking, or risk seeing someone else do it. Today, about 1,000 banks and thrifts, and an equal number of credit unions, have transactional websites. By 2003, that number is expected to balloon to nearly 16,000 banks, thrifts, and credit unions, according to a 1999 report by International Data Corp. In many cases, those banks will merely be heeding the stated desires of their own customers. Internet tracking and research firm Gomez Advisors predicts that 48.3 million Americans will do at least some of their banking via the Web by the end of 2003, compared with 11.1 million today. Of those, 31.8 million will be active users, tapping into the Internet at least once a month to pay a bill, transfer money between accounts, or do some other kind of transaction. On the surface, decisions over whether, when, and how a bank moves onto the Internet might seem to be more of a topic for technology geeks and management than directors. But in reality, the investments made on the Internet front can have potentially staggering strategic implications for banks, demanding full board attention. For all of its potential, no one is actually turning a direct profit on Internet banking yet, and probably won`t for a long time. Building the technological and support infrastructure to offer truly transactional Internet banking capabilities in a customer-friendly way can cost millions of dollars and sap precious management time from other pressing issues. And the risks to banks, and directors themselves, can rise exponentially with the potential lack of control and security threats of a transactional website. But bank boards that ignore the Internet`s soaring popularity, or devote only half-hearted attention to it, might do so at their own peril. While proponents concede there are still bugs to be worked out, they also assert that those who position themselves as technology leaders will win out over the long haul, retaining customers and, perhaps, adding new ones. Today, most large banks-34 of the top 50 institutions-and a growing number of smaller ones boast websites capable of allowing customers to view account balances, make limited bill payments and, in some cases, originate loans. In the not-too-distant future, experts say, online presentment and payment of customers` bills, tax information, and brokerage account information will become widespread realities. ,p>Such functionality will make Internet-ready customers even more willing to jump on board. Based on a November survey of 16,500 Internet users, Gomez projects that more than 21% of the estimated 87 million bank customers with Web access, or about 18 million people, are at least very likely to begin banking online this year. Many of these customers are now customers of banks without Internet banking operations-presenting good opportunities for those institutions to jumpstart their Web operations, or to lose those customers to banks that are better prepared. It`s not cheap or easy, and the competition is fierce. Customers that use Web banking products rank among the wealthiest and most profitable in the typical bank`s portfolio. The Gomez survey shows that they are not only better educated than non-Web users, they also have higher median incomes and net worths. The bad news is, they`ve got feet-a mobility made all the more easy by the power of the Internet itself. As Internet penetration increases and customers prove more willing to manage their financial relationships online, failure to execute (a Web banking strategy) quickly and effectively puts a large and lucrative customer segment at risk of defection to banks that can deliver superior Web banking services, according to the Gomez report. Brook Newcomb, a senior financial services analyst for Forrester Research Group, a technology tracking firm, takes that a step further, saying that the loss of such relationships could quickly gut the core value of a banking franchise. He says foot-dragging banks must proceed with haste. The early adopters are moving online for their banking services now, and the rest of the population isn`t far behind. Those people are going to set up shop somewhere, and if it`s not with you, it will be very difficult to win them back when you finally do decide to set up your own Internet operations. That may be. But the truth is that despite the groundswell of opinion from technophiles that Americans will move en masse to online banking, no one really knows for sure what will actually occur. Projections for Internet banking volumes vary widely, and even the current usage numbers are subject to debate. Internet hurdles

In spite of the promised conveniences and cost savings-and the fact that the banking industry as a whole has emerged as a leader when it comes to Internet security-many consumers remain leery about the security risks and other perceived complexities of putting their financial lives online. One recent study by New York market research firm CyberDialogue found more than 50% of people who tried Internet banking stopped, either because it was too complicated or they were frustrated with the level of customer service. Overcoming such reticence and garnering critical mass is vital to the success of an Internet operation. If customers don`t flock to your website, it could translate into a painful waste of money and draw the wrath of shareholders. If they do, the challenges could be even more daunting: Many of the key revenue streams on which banks have become dependent, such as those related to checking, could be placed in jeopardy if the masses take to the Web. The industry`s relative slowness in this area betrays some misgivings. If there are no huge cost savings-and few short-term revenue generators-in delivering products and services over the Web, then the Internet can look like just another costly delivery channel to be built and maintained (u00c3 la the ATM) rather than a magic bullet to spur profitability. Many bank boards, already under heat from investors to boost returns in a challenging environment, appear understandably hesitant to make such investments. John Weisel, a partner and head of the financial services practice at Andersen Consulting, says that banks should plan on spending about 10% of noninterest expense on their Web strategy. It`s expensive, notes Shelley Freeman, a senior vice president for Wells Fargo & Co. and a member of the San Francisco-based bank`s Internet services group. It`s not easy for any bank to come up with the resources to deliver this kind of capability to its customers. Perhaps even more chilling, banks with Internet operations don`t have the same control over growth that they enjoy with traditional brick-and-mortar operations. Nor can they regulate customer access in the same way. Without the proper controls, someone from Hoboken-or Hong Kong, for that matter-could deposit $50 million then withdraw it the next day, wreaking havoc on your balance sheet. Worse, a hacker could break into your site and make off with bank funds. Although no lawsuits have yet been filed against banks or directors in connection with Internet banking operations, shareholders and regulators wouldn`t be very happy if a security breach or some other Web-related mishap occurred. The Internet presents tremendous dangers to banks, and the buck stops with directors, says Ron Glancz, a partner and chairman of the financial services group at the law firm Venable, Baetjer, Howard & Civiletti in Washington, D.C. If a bank were to fail because it set up a transactional website and didn`t have the correct software or management in place, you can bet your life that the FDIC is going to sue those directors. With these issues at the forefront, balancing the risks of Internet banking with its potential rewards has become a top priority in boardrooms across the nation. The Internet itself isn`t likely to be a profit center for some time, and bankers that have done it say it`s impossible to know exactly how many customers you might retain by adding e-banking capabilities. But banks have found two important things: their most profitable customers are the ones most drawn to using it, and those customers become even more profitable when they make use of lower-cost technologies. For banks that have yet to make the leap, the good news is that most customers, given the choice, would just as soon use their own bank`s Internet capabilities, provided its features and functionality are good enough. Customers in the Gomez survey indicated that they are generally satisfied with their primary bank, and are much more interested in consolidating their online financial activities with a bank than with an e-brokerage or other financial services provider. Issues for directors

Directors contemplating their own institution`s online moves must ask many of the same questions they ask on other fronts: Can this be done safely and soundly? Is the proper risk management structure in place? Do we have management with the technical skills to run this? Does the bank have enough capital to withstand some kind of security problem? Do our customers really want this?Judging by a letter sent to bank executives in 1997 by the Federal Deposit Insurance Corp., which characterizes the Internet as inherently insecure, some of these queries are particularly vexing when it comes to Web banking. The open architecture of the Internet can allow those with the right skills to modify data during transmission, and can permit outsiders access to parts of a bank`s internal systems that aren`t meant for prying eyes. While encryption technologies and user IDs and passwords can check the vast majority of the risk, those, too, can be compromised. The FDIC`s website is filled with information on Internet banking, and the Office of Thrift Supervision has published a manual on its potential risks that`s considered a must-read for directors contemplating such a move. Directors also should make sure that regulators are informed when an Internet operation is launched. The OTS recently levied civil money penalties against one bank that failed to do so. Given the risks, David Kennedy, director of research services for computer security firm ICSA.net, says smart boards encourage their managements to approach the Internet first as a security problem to be solved and then work from there to build functionality, customer service capabilities, and the rest. Banking, at its core, is a binary trust business: people either trust you completely, or they don`t trust you at all, he notes. Thus, while using outside vendors for technology is fine, a bank must hire its own full-time security staff`-which, depending on its size, could range from one person to two dozen. With good tech people in high demand, hiring just one good Internet security guru will cost the average bank about $100,000, Kennedy says. But it`s absolutely necessary. No matter how small you are, if you`re large enough to get onto the Internet, then you`re large enough to spend the money to get a security expert on board. The hiring probably won`t stop there. To shield itself properly, a board needs to ensure that management has the proper expertise. If you`re going on the Internet, you need a technology chief that has been there and done that, Glancz advises. That technology chief should be able to instill a culture that mirrors the Internet`s rapid pace. And the board also may want to set up a separate technology or e-commerce committee to monitor the bank`s progress. Moreover, if it doesn`t have one on the board already, it might want to recruit a director with e-commerce experience. Beyond that, directors must ensure that the right combination of policies and procedures are in place to manage the Internet operations. It also must gain an understanding of where management expects the Internet to take the institution-how fast it will grow, how much it will cost, and how it will be monitored-and how it will achieve those plans. Does your management team truly understand the implications of Net-centric technologies on the current business? Do they have the ability to chart a path forward, recognizing that the business model could change dramatically? Weisel asks. All the good ideas [on the Internet] are gone. This is purely an execution play now, and bankers need to be able to articulate a vision and adopt a different management style to succeed. Asking the tough questions of management isn`t easy, but it`s necessary to shield the bank and its board from potential liabilities. Directors aren`t expected to be Internet experts, but they must be able to demonstrate to shareholders and regulators that they are being diligent. Directors also have a role in overseeing the implementation of the strategy. Where should the technology come from? How closely should it be integrated with the rest of the bank`s operations? Should the bank encourage the migration of customers to its website, even though that might mean losing some physical-world revenues? How important will partnerships be in the strategy? How will you gauge the impact of adding a costly new technology on the bank`s overall performance? For some banks, such questions could result in a thumbs down. If a bank, for instance, has positioned itself in a way where foot traffic in the branch is uniquely important, it might not want to launch a website. But if the experts are to be believed, the vast majority of banks will be offering some sort of Internet option soon. Integrating e-banking

Bank on this: the move to the Internet will-or at least should-result in some serious changes to your bank`s overall strategy. Integration is a key buzzword on the Internet front, and banks that have already walked this road have found that, far from being some sort of island, Web banking works best when blended as seamlessly as possible with other facets of the bank-marketing, customer service, other delivery channels-to deliver a complete customer experience.This isn`t as simple as it sounds. Directors and their senior managers must remember that, for all the hype, Web banking is a means to an end, rather than an end itself-a way to solidify and expand customer relationships. Finding the technology to launch a successful Internet site isn`t hard. Dozens of vendors offer good off-the-shelf or outsourced solutions at affordable prices, and strategic alliance partners can help provide services that are too expensive to build in-house. But the strategy itself cannot be outsourced. Indeed, the biggest challenge for banks and their boards lies in effectively integrating a Web offering into the broader marketing, products, delivery, and customer service scheme. If you separate your Internet knowledge from your banking knowledge, it`s not going to build confidence and you`re going to have an underutilized service that could ultimately undermine your brand, says Chris Musto, senior financial services analyst with Gomez. If you don`t integrate it into everything else you do, then customers will become frustrated. If you do integrate it, then it gives you another way to develop a more-sticky relationship with customers and make them more satisfied. The integration must be multifaceted, covering everything from technology to marketing. New Web technologies must mesh almost seamlessly with the old legacy computer systems most banks use, making account balances and other customer information readily accessible online. Tellers and phone banking reps need to be taught about the Internet site and how to encourage customers use it. Customer service staff must be well versed in its intricacies and be able to answer queries that arise from a customer`s Web interactions. Customers like to be able to perform the same function in a variety of ways, says William Veeneman, senior vice president and manager of online services for U.S. Bancorp, a $79 billion institution with about 200,000 Internet banking customers. We think that customers should be able to touch us once and we should know them, no matter which channel they enter the bank through. Choosing the right front-end technology is crucial to achieving such goals. Peter Goldberg, senior vice president in charge of Internet banking for Cleveland-based Ohio Savings Bank, recommends that boards first form a clear picture of what they hope to accomplish on the Internet. Who offers the best service and the best way to meet your stated objectives? Which will mesh best with your present systems? Remember, this is part of the face your bank will present to the world, and it should receive no less attention than the design of your flagship branch. While management should do most of the legwork, a good vendor should be willing to make a presentation to the board, if for no other reason than to give directors peace of mind. Leaders of the pack

With the amount of time, money, and expertise it takes to build the technical linkages and cultural mindsets to enable an Internet strategy, it`s no surprise that the field has, with some notable exceptions, been dominated by the guys with deep pockets. As of January, the top five banks in Internet banking-Bank of America, Wells Fargo & Co., First Union Corp., Citigroup, and FleetBoston Corp.-boasted about five million customers, or nearly half of the industry total, according to Stephen Franco, an analyst for U.S. Bancorp Piper Jaffray. A growing number of Internet-only banks are vying for customers by offering higher deposit rates, but Musto says that after some strong initial growth, the number of customers using such services has plateaued at about 300,000. The experience of the past five years has shown that customers place a high premium on the their own bank`s branch and the people inside it. But they also like options-call centers, ATMs, supermarket branches, and now, the Internet. TCF`s Cooper believes, successful banks in the future will likely be those that offer all of those delivery channels [and perhaps others] to their customers. Most observers think that the ratio of Web customers eventually will tilt with time toward regional and community banks. Smaller banks don`t need to be Internet pioneers, and there are dozens of reasonably priced off-the-shelf solutions available. It doesn`t make sense to spend $20 million building something that might have to be changed, Cooper explains. Instead, TCF plans to use outsourced technology to build its Web offering. Like most traditional banks, Cooper views the addition of Internet capabilities as more of a defensive strategy-a necessary vehicle for meeting existing customer demands and deepening relationships, while keeping Internet-enabled competitors at bay. But done right, the addition of another delivery channel-one accessible from the home-can give banks a powerful way to learn more about customers in a relatively unobtrusive manner, such as by tracking the products they seek information about. It also allows customers to explore a bank`s products and services on their own terms-cross-selling, Web-style, if you will. It`s a very different dynamic from the physical world, Wells Fargo`s Freeman explains. When a customer comes into a branch and sits down with us, it`s much more of a sales process. On the Internet, the customer is making his own way, making his own choices, and picking the path he will follow. This might require a cultural shift and some rejiggering of products-and their presentation-but for many customers, the sense that they can make choices on their own terms, without sales pressure, could result in a greater willingness to forge deeper relationships. The Web also provides the chance to introduce new offerings, such as direct consumer-to-consumer payments or even e-brokerage services that could starkly solidify a bank`s relationship with the customer and increase its share of customers` wallets. Down the road, such services could be moneymakers, just as the ATM network has become today. Cooper observes that the ATM was initially viewed as a steep incremental expense with some cost-saving potential. Slowly, revenue opportunities that hadn`t initially been contemplated came to light: interchange charges between banks, customer fees for using other bank`s ATMs, access fees, and the transformation of the ATM card into a debit card, complete with all the merchant interchange revenues that entails. Internet banking will lead to new revenue sources, he says. It`s just not clear yet where they will be. Weighing the decision

Is it worth the effort and investment? In the short term, it`s clear that the Internet will sap vital resources and could even threaten some crucial bank income streams. In the worst case, some observers say, a strong Web banking capability could actually erode the very income streams it is meant to preserve. One example: electronic bill presentment and payment, a fledgling technology that many predict could eventually make the check obsolete. If customers pay most of their bills online, not having to process mountains of paper checks could save banks a lot of money. But it also could cut into a serious source of revenue. The Green Sheet, a checking industry newsletter, estimates that banks get about $60 billion in revenues annually from the float, fees, and low-cost funding checking accounts generate, including about 16 cents per check in overnight interest and $5.6 billion in bounced check fees. Deluxe Corp., the nation`s largest check printer, says banks get more than $1.5 billion simply from reselling checks. If customers pay their bills online in real-time, they won`t bounce checks, pay as many late fees, or order as many paper checks, slashing banks` fee income significantly. The flip side is that, with a host of other banks-and technology providers such as Checkfree Holdings-eagerly waiting in the wings to offer such services, an individual bank might not have much choice. That`s why many large banks are working to migrate customers to electronic payments, offering incentives to encourage usage. There is definitely a dilemma with the revenue stream, says Lou Anne Alexander, e-channels product director for First Union Corp. But there needs to be a realization at [the executive and board level] that the movement toward electronic payments is imminent. Your choice is to cannibalize yourself now and position yourself for the future or be left hanging onto a shell of the past. Such harsh assessments apply to the broader world of Web banking, as well. As boards lead their institutions into an electronic world filled with uncertainties, they`ll find that, on the surface at least, the short-term payoffs are minimal and tough to gauge, while the potential risks are high. In the longer term, however, most will find that they must enter the Internet fray for one simple reason: Their best, most valued customers want it. By implementing sound strategies that focus on sharp, seamless integration-and by staying abreast of industry trends, customer desires, and their own bank`s performance-directors will likely find that Web banking is a winner for both customers and shareholders. Those who resist the trend could be judged harshly by history. |BD|

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