Retail Banking 101

While investment banking and commercial lending conjure up images of pin-striped executives engaging in intense, high-stakes deals, retail banking is more likely to evoke images of soccer moms standing in line to make deposits. No, retail banking is not exactly glamorous. And yes, the sums of money involved in any one transaction are likely to be in the hundredsu00e2u20ac”not tens of thousands, or millionsu00e2u20ac”of dollars.

These are not the only hurdles retail banking faces to get more respect. For years, it has been viewed as a commodity business. Interest rates paid on deposits often differ so little from bank to bank that they are almost meaningless to consumers. And aside from signage, most bank branches tend to look numbingly alike, with their teller windows on one side and platform desks on the other.

In the past couple of years, however, bank managers have been opening their eyes to greater possibilities in retail banking. A few factors have played into this new attitude. One is the huge hit to investment banking and trading that many banks took at the end of the dot-com boom. New York-based J.P. Morgan Chase & Co. is a prime example of an institution trying to decrease its reliance on investment and trading income by expanding into retail banking. Late last year, it announced it would acquire Chicago-based Bank One Corp., a retail banking stalwart in the Midwest.

Another factor has been a general slowing of acquisition activity. Though acquisitions have picked up in recent months, for the past few years banks have discovered a greater need for organic growth in their customer bases. That need has led them to pay new attention to the branch as the linchpin for solidifying and strengthening customer relationships.

Kenneth D. Lewis, chairman and CEO of Bank of America Corp., for example, announced in 2001 that the bank would strive to grow by expanding existing relationships rather than acquiring new ones. Though the bank recently announced it would buy FleetBoston Corp., it has been working for the past few years on innovative branch designs that would appeal to customers, as well as programs to improve customer satisfaction.

Vele J. Galovski, the bank’s core capabilities and customer delight executive, says Bank of America has increased the percentage of customers who give it a nine or 10 on a 10-point satisfaction scale from 40% to 51%, an improvement of 25%. These customers, he says, are four times more likely to recommend the bank to family or friends and three times more likely to expand their relationship with the bank.

These new big-bank attitudes about the important role retail banking can play in drumming up business are becoming more apparent in banks of all sizes. Community banks, of course, are naturals at providing great retail banking service. But with new delivery channels and technologiesu00e2u20ac”not to mention competition from the big banksu00e2u20ac”the business is becoming more complicated than ever before.

Although board members rely on the CEO and managers to keep the retail banking operation humming, they have a duty to ensure that the value of the institution is being leveraged to its highest potential. Periodically, the board may want to consider posing the following questions to management:

– How profitable is retail banking for our institution?
– What are the drivers of our retail banking profitability?
– How should we measure our success?
– How can we better promote sales and profits?
– How should we motivate our branch employees?
– In terms of technology, what’s the “next big thing” we need to invest in?

The bottom line is that the entire industry is realizing that an efficiently run retail banking operation can be highly profitable and offer less-volatile returns than other areas of banking. Given the importance of retail banking to maintaining customer stability and profitabilityu00e2u20ac”and its relationship to enhancing shareholder valueu00e2u20ac”the following provides some key discussion points for boards and management to consider together.

Just how profitable is retail banking?

Retail banking comprises various deposit productsu00e2u20ac”including checking, savings, and time-deposit accounts such as certificates of depositu00e2u20ac”as well as various asset-based products, such as auto lending, credit cards, mortgages, and home equity loans. Big banks are likely to be in all of these businesses, and smaller ones mainly focus on deposit gathering while offering mortgages and home equity loans. On its face, deposit taking may not appear to be particularly lucrative, but it can be. “Deposit gathering is a pretty huge market,” says Peter Carroll, managing director at Mercer Oliver Wyman in New York. “Most bankers don’t know that.”

Carroll says that about $5 trillion in deposits exist in the U.S. market. Since there is no credit risk associated with taking in deposits, banks need less capital to run this business than, say, mortgage lending. The proper amount of capital required, Carroll notes, is about 1%, which translates to about $50 billion for the industry. The return on this relatively small investment, meanwhile, is 35% to 50%, or a minimum of $18 billion for the industry. “It’s a very profitable business,” he says.

In contrast, Carroll says, total outstanding balances in the credit card industry amount to about $1 trillion. Since this business is riskier, it requires more capital to run, and the resulting profits are about $12 billion to $13 billion for the industry, he says.

There is a reason why credit card lending appears to be more of a moneymaker than deposit gathering. The business is concentrated among the biggest banks: The top 10 lenders hold 85% of the credit card balances, Carroll says. The business of deposit gathering, meanwhile, is split up between thousands of banks. The numbers indicate there is ample opportunity to generate significant profits simply by gathering depositsu00e2u20ac”but it requires being one step ahead of the thousands of other banks out there also searching for deposits.

James McCormick, president of First Manhattan Consulting Group (FMCG) in New York, points to the startling difference between the top performers in retail banking and the rest of the pack. In recent research, FMCG found that among the top 40 banks, the best 20% of retail banking practitioners are growing deposits 4% or more a year. Meanwhile, deposits for the bottom 20% are shrinking by more than 3% a year.

Fortunately for the more competitive retail banks, many institutions do not take the deposit-gathering business very seriously. “A lot of banks don’t break out the profits of deposit gathering,” Carroll says. “Most think of deposits as a cheap source of funds to make commercial loans. The proper way to think of it is as a business.”
What are the drivers of retail banking profitability?

In most retail businesses, a lever for getting people to buy your products or services is to lower your price. Banks cut their prices by either raising the amount of interest they pay on deposits or reducing fees associated with accounts. Unfortunately, this basic rule of retailing does not have much effect in banking. “The sad thing for banks is that there’s not much evidence that price is a primary factor when consumers choose a bank,” Carroll says. Furthermore, don’t expect a huge inrush of new deposits from price changes. Price-slashing banks will “tend to undercut their profits more quickly than they boost volume,” he says.

One strategey to increase retail profits is to put branches in places where they will attract the most deposits. A bank able to attract $90 million of deposits will have much lower unit costs than one with only $50 million in deposits, given equal fixed costs. “A lot of leverage comes from having a network of branches that are well-located,” says Carroll.

Yet, reliance on branch location and penetration can muddy accepted retailing principles regarding pricing. In looking at money market, demand deposit, and one-year CD accounts in various metropolitan markets around the United States, Mercer Oliver Wyman found that banks with the highest market shares pay the lowest rates. Accordingly banks with the lowest market shares pay the highest rates. As Carroll reasons, “The larger banks are more convenient, and the smaller banks feel they have to pay higher rates to attract more deposits.”

But not everyone agrees that location plays a prominent role in retail banking profits. In fact, McCormick of FMCG calls that notion 100% false. In McCormick’s view, “service quality is crucially important.” He estimates that 80% to 90% of banks that are growing deposits are doing so because they offer superior customer service. The remainder are doing so because they have a distinct value proposition, such as very low prices, or they are serving a niche market particularly well, he says. McCormick gives an analogy of two restaurantsu00e2u20ac”one where it is difficult to get a table and one where it is easy. If both eateries decide to build a new restaurant 10 minutes away, McCormick argues, the one with the better reputation will ultimately be more profitable.

Les Dinkin, president of NBW Consulting in Westport, Connecticut, takes more of a middle ground. “You need to do a minimum of things reasonably well to be successful,” he explains. However, there is danger in being everything to everyone, and a good strategy is to identify very specific goals. “The institutions that have been successful have been good at doing a handful of core things really, really well,” he says.

How should we measure our success?

For shareholders, a company that is growing offers much more value than one that is not. Retailers of clothing, fast food, and other goods measure growth through “same-store sales,” which calculates sales at stores that have been open for more than a year. This data enables retailers and investors to track the profitability of individual branches, as well as determine what component of overall sales growth is due to opening new stores versus organic growth.

Same-store sales are also an important factor in determining how a company should modify its retail strategy. Although banks have talked for years about operating their branches more like retail businesses, few actually do. “The presumption in banking is that everyone is the same, and unless you’re really screwing up, you’ll get the same growth as everyone else,” says McCormick of FMCG. But in fact, FMCG data shows there is more variability among the performance of banks than in any other retail group that tracks same-store sales.

Ignoring same-store sales brings to mind an old adage: If you don’t measure it, you can’t manage it. “This is the quintessential measure of how well you’re doing with customers in the market,” McCormick says. “It shows whether you are winning or losing relationships to other banks.” If they haven’t already, bank managers should begin paying attention to same-store sales, he adds. “It’s the new number that banks should be obsessing about.”

How can we promote sales and profits?

The main way banks make more money in retail banking is simply by selling more products. But the formula for making this happen is far from straightforward. Most bankers agree it generally involves a combination of training, technology, and branch design. And increasingly, a new factor is emerging: improving the customer experience.

A survey published in March by consulting firm BearingPoint of McLean, Virginia found that 92% of financial services executives acknowledge there is a significant opportunity to enhance customer loyalty by improving the quality of their customers’ experience. This finding indicates banks are recognizing the importance of not just serving customers but of connecting with themu00e2u20ac”even giving them reasons to actually look forward to going to the bank.

This approach goes one step beyond the focus of the 1990s, when many banks were intent on installing technology, specifically customer relationship management systems, as a means of creating connections with customers. Now bankers are realizing the importance of building an atmosphere where customers can expect interactionsu00e2u20ac”not with technologyu00e2u20ac”but with other human beings. “We found a disconnect between what senior managers wanted from their CRM investments and what they got,” explains Christopher Formant, executive vice president, financial services at BearingPoint.

Umpqua Bank of Portland, Oregon, for example, focuses on creating a different kind of customer experience in its branches known as “stores.” Bank officials say they are striving to create a “true destination point,” rather than just a place to withdraw money. Umpqua’s next-generation store features amenities such as an Internet cafu00c3u00a9, a flat-screen television for watching financial broadcasts, and the bank’s own blend of coffee, as well as retail-inspired elements including displays of hardback business books, Visa gift cards, and a complimentary Umpqua chocolate presented on a tray with each transaction.

Dinkin of NBW Consulting offers another strategy for increasing branch sales: Focus on a segment of the market that is disproportionally profitableu00e2u20ac”the small business market, where customers can be hugely profitable. In general, he notes, 40% to 70% of retail banking revenue comes from small businesses. “Business owners buy more stuff,” Dinken points out, such as insurance and cash-management products. “It’s a huge opportunity for small banks to just go to town.”

How can we motivate branch employees?

Ensuring employees provide friendly, courteous, and knowledgeable service 100% of the time is perhaps the best thing a bank can do to stand out. Employees should “serve customers really well, in the same way that they would like to be serviced,” says Dinkin. “It’s do unto others … it’s not rocket science.” Consistent delivery that makes the bank “unique and superlative” is also important, he adds.

Senior management can do its part simply by paying more attention to the needs of employees. Employee loyalty is a big factor in promoting customer loyalty, according to Dinkin. The banks that do the best job of promoting employee loyalty are the ones that have established a core set of values that do more than just take up space in the company handbook. These principles reverberate daily throughout the bank and permeate every activity employees undertake.

Take BB&T Corp. of Winston-Salem, North Carolina. Its mission statement says, “We exist to help our clients achieve economic success and financial security.” According to Steven Whitley, a senior vice president and the sales and cultural integration manager, “We say it every single day.”

Every morning, BB&T sales units gather for five-minute, “quick-start” meetings where they not only prepare for the day, but also talk about the mission statement and literally repeat it, word for word. “Over time, people buy in to the mission and realize that they’re here for a higher purpose than just being a banker,” Whitley says.

Done right, inspiring employees to be more loyal should not be a cost drain. Some banks are proving that more satisfied employees can lead to reductions in hiring and training expenses, higher customer satisfaction and share of wallet, and, accordingly, increased revenue. In a compelling demonstration of how improved employee loyalty can pay off, the former BankBoston (now part of FleetBoston Financial Corp. and soon to become part of Bank of America) projected in 1999 that a 1% increase in employee commitment could directly increase revenue by about $11 million and reduce hiring and training expenses by $15 million to $19 million annually, in one business line.

Helen Drinan, the former executive vice president of human resources who oversaw the BankBoston study, says that in increasing customer satisfaction, “products and pricing are dramatically important, but so also is the treatment customers get from your employees. If you’re not tending to that,” she says, “then you’re leaving so much opportunity on the table.”

Columbus, Georgia-based Synovus Financial Corp. agrees that nurturing employees makes good business sense. Since the late 1990s, it has been implementing a series of programs aimed at inspiring its employees to work toward consistent performance according to a well-publicized set of values. “If employees have a good relationship with their supervisors, then they’ll enjoy coming to work every day, and they’ll perform at a high level,” says Stephanie A. Alford, an executive vice president at Synovus.

Investing in retail: What’s the next big thing?

Sometimes what’s old is new again. After years of developing alternative ways of delivering services through automated teller machines, the Internet, and call centers, banks are once again paying attention to the branch. For some, this wave of “branch refreshment” may simply mean updating the look of branches with new carpeting and furniture. For others, it may mean installing new technology at the teller line or platform area to allow personnel to have a wealth of information at their fingertips. For still others, it may mean introducing entirely new retail concepts, such as Umpqua’s Internet cafes.

New legislation is introducing further considerations into some banks’ branch redesigns. The Check Collection for the 21st Century, or Check 21 Act, which will go into effect this October, for example, will give banks the opportunity to transmit images of checks, rather than actual paper checks, from branches to central processing locations. Doing so should significantly reduce back-office processing as well as transportation costs. But installing the required imaging equipment at bank teller lines potentially carries significant costs and also raises training issues. Whether branches will be redesigned to take over some of the duties of back-office check processing centers remains an unanswered question.

Carroll of Mercer Oliver Wyman believes technology on the horizon may allow banks to offer financial advice to mass-market customers in a cost-effective manner. Currently, dispensing expert advice is prohibitively expensive unless very wealthy clients are being served, he says. “There could be a breakthrough here.”

Carroll says his “cynical” view is that the retail business may go back to its “previous secondary status” as large banks experience stronger revenue from investment banking. But for now, that is unlikely, he says, given the recent acquisition activity of J.P. Morgan Chase and Bank of America, both of which reinforce a focus on retail banking. “Those two transactions alone will tend to shift the emphasis at the top to retail.”

Dinkin of NBW Consulting says he believes banks are well on their way to adopting a more productive attitude toward retail banking. “There is a recognition that retail banking is a retail business, and banks increasingly are acting, looking, and behaving like retailers,” he says.