The biggest banks are spending billions on technology, but community banks can level the playing field by choosing technologies that personalize and enhance their interactions with customers, as Michael Carter, executive vice president at Strategic Resource Management, explains in this video. He shares how data and voice-enabled technologies could help community banks provide the digital experience that customers want.
Leveraging Data to Enhance the Customer Experience
A few weeks ago, The Wall Street Journal published a story that struck a nerve with community bankers.
The story traced the travails of National Bank of Delaware County, or NBDC, a $375 million asset bank based in Walton, New York, that ran into problems after buying six branches from Bank of America Corp. in 2014.
It’s not that things were going great for NBDC prior to that, because they weren’t. Like many banks in small towns, it had to contend with stiff economic and demographic headwinds.
“As in other small towns that were once vibrant, decades of economic change altered the fabric of Walton,” Rachel Louise Ensign and Coulter Jones wrote in the Journal. “The number of area farms dwindled and manufacturing jobs disappeared.”
“Being located in, and serving, an economically struggling community could bring any bank down,” wrote Ron Shevlin, director of research at Cornerstone Advisors, in a follow-up story a week later.
NBDC hoped the branches acquired from Bank of America, for a combined $1 million, would revive its fortunes. But the deal only made things worse.
The branches saddled NBDC with higher costs and $12 million in added debt. Even worse, half the acquired deposits quickly went elsewhere, provoked by a poorly executed integration as well as, ostensibly, NBDC’s antiquated technology.
“Technology is causing strains throughout the banking industry, especially among smaller rural banks that are struggling to fund the ballooning tab,” Ensign and Jones wrote. “Consumers expect digital services including depositing checks and sending money to friends, which means they don’t necessarily need a local branch nearby. This increasingly means people are choosing a big bank over a small one.”
This echoes a common refrain in banking: that smaller regional and community banks can’t compete against the multibillion-dollar technology budgets of big banks—especially JPMorgan Chase & Co., Bank of America and Wells Fargo & Co.
Community bankers took issue with the article, Shevlin noted, because it seemed to portray the story of NBDC, which was acquired in 2016 by Norwood Financial Corp., as representative of community banks more broadly.
“This is so misleading,” tweeted Andy Schornack, president of Security Bank & Trust in Glencoe, Minnesota. “Pick on one under-performing bank to represent the whole.”
“Community banks are profitable and thriving,” tweeted Tanya Duncan, senior vice president of the Massachusetts Bankers Association. “Most offer technology that makes transactions seamless.”
Schornack and Duncan are right. One doesn’t have to look far to find community banks that are thriving, with many outperforming the industry.
A textbook example is Germantown Trust and Savings Bank, a $376 million asset bank based in Breese, Illinois.
Germantown has generated a higher return on assets than the industry average in 11 of the past 12 years. The only exception was in 2013, when it generated a 1.52 percent pre-tax ROA, compared to 1.55 for the overall industry.
Germantown’s performance through the financial crisis was especially impressive. While most banks reported lower earnings in 2009, with the typical bank recording a loss, Germantown experienced a surge in profitability.
Germantown has gained local market share, too. Over the past eight years, its share of deposits throughout its four-branch footprint in Clinton County, Illinois, has grown from 27.8 percent up to 29.7 percent.
This is just one example among many community banks with a similar experience. For every community bank that’s ailing, in other words, you could point to one that’s thriving.
Yet, there’s another, more fundamental issue with the prevailing narrative in banking today. Namely, the data doesn’t support the claim that the biggest and most technologically-savvy banks are gobbling up share of the national deposit market.
In fact, just the opposite has been true over the past five years.
Let’s start with the big three retail banks—JPMorgan Chase, Bank of America and Wells Fargo—which are spending tens of billions of dollars a year on technology.
These three banks saw their combined share of domestic deposits swell in the wake of the financial crisis, climbing from 21.7 percent in 2007 up to 33.2 percent six years later. Since 2013, however, this trend has gone in the opposite direction, falling in four of the past five years. As of 2018, the three biggest banks in the country controlled 31.8 percent of total domestic deposits, a decline of 1.4 percentage points from their peak.
The same is true if you broaden this out to include the nine biggest commercial banks. Their combined share of domestic deposits has dropped from a high of 47.6 percent in 2013 down to 45.6 percent last year.
Given the number of branches many of these banks have shed over the past decade, it’s surprising they haven’t lost a larger share of domestic deposits. Nevertheless, it’s worth reflecting on the fact that, despite the gloomy sentiment toward community banks that’s often parroted in the press, their current and future fortunes are far from bleak.
Implementing new software may seem like an expensive and time-consuming challenge, so many financial institutions make do with legacy systems and workflows rather than investing in robust, modern technology solutions aimed at reducing operating expenses and increasing revenue. Unfortunately, banks stand to lose much more in both time and resources by continuing to use outdated systems, and the resultant data entry errors put institutions at risk.
The Scary Truth about Data Entry Errors You might be surprised by the error rates associated with manual data entry. The National Center for Biotechnology Information evaluated over 20,000 individual pieces of data to examine the number of errors generated from manually entering data into a spreadsheet. The study, published in 2008, revealed that the error rates reached upwards of 650 errors out of 10,000 entries—a 6.5 percent error rate.
Calculating 6.5 percent of a total loan portfolio—$65,000 of $1 million, for example—produces an arbitrary number. To truly understand the potential risk of human data entry error, one must be able to estimate the true cost of each error. Solely quantifying data entry error rates is meaningless without assigning a value to each error.
The 1-10-100 Rule is one way to determine the true value of these errors.
The rule is outlined in the book “Making Quality Work: A Leadership Guide for the Results-Driven Manager,” by George Labovitz, Y.S. Chang and Victor Rosansky. They posit that the cost of every single data entry error increases exponentially at subsequent stages of a business’s process.
For example, if a worker at a communications company incorrectly enters a potential customer’s address, the initial error might cost only one dollar in postage for a wrongly-addressed mailer. If that error is not corrected at the next stage—when the customer signs up for services—the 1-10-100 Rule would predict a loss of $10. If the address remains uncorrected in the third step—the first billing cycle, perhaps—the 1-10-100 Rule would predict a loss of $100. After the next step in this progression, the company would lose another $1,000 due to the initial data entry error.
This example considers only one error in data entry, not the multitude that doubtlessly occur each day in companies that rely heavily on humans to enter data into systems.
In lending, data entry goes far beyond typos in customers’ contact information and can include potentially serious mistakes in vital customer profile information. Data points such as social security numbers and dates of birth are necessary to document identity verification to comply with the Bank Secrecy Act. Data entry errors also lead to mistakes in loan amounts. A $10,000 loan, for example, has different implications with respect to compliance reporting, documentation, and pricing than a $100,000 loan. Even if the loan is funded correctly, a single zero incorrectly entered in a bank’s loan management system can lead to costly oversights.
Four Ways Data Entry Errors Hurt the Bottom Line Data entry errors can be especially troublesome and costly in industries in which businesses rely heavily on data for daily operations, strategic planning, risk mitigation and decision making. In finance, determining the safety and soundness of an institution, its ability to achieve regulatory compliance, and its budget planning depend on the accuracy of data entry in its loan portfolios, account documentation, and customer information profiles. Data entry errors can harm a financial institution in several ways.
Time Management. When legacy systems cannot integrate, data ends up housed in different silos, which require duplicative data entry. Siloed systems and layers of manual processes expose an institution to various opportunities for human error. The true cost of these errors on an employee’s time—in terms of wages, benefits, training, etc.—add up, making multiple data entry a hefty and unnecessary expense.
Uncertain Risk Management. No matter how many stress tests you perform, it is impossible to manage the risk of a loan portfolio comprised of inaccurate data. In addition, entry errors can lead to incorrectly filed security instruments, leaving a portfolio exposed to the risk of insufficient collateral.
Inaccurate Reporting. Data entry errors create unreliable loan reports, leading to missed maturities, overlooked stale-dates, canceled insurance and other potentially costly oversights.
Mismanaged Compliance. Data entry errors are a major compliance risk. Whether due to inaccurately entered loan amounts, file exceptions, insurance lapses or inaccurate reporting, the penalties can be extremely costly—not only in terms of dollars but also with respect to an institution’s reputation.
Reduce Opportunities for Human Error An institution’s risk management plan should include steps intended to mitigate the inevitable occurrence of human error. In addition to establishing systems of dual control and checks and balances, you should also implement modern technologies, tools, and procedures that eliminate redundancies within data entry processes. By doing so, you will be able to prevent mistakes from happening, rather than relying solely on a system of double-checking.
What sets today’s lending environment apart is the potential for banks to collaborate with technology platforms to manage their risk more effectively and efficiently, explains Garrett Smith, the CEO of Community Capital Technology. In this video, he outlines how banks of varying sizes are diversifying their loan portfolios, and he shares his advice for banks seeking to buy or sell loans on the secondary market.
The need for stable, low-cost deposits is driving deals today, and the increasing use of technology is changing how banks should approach integrating an acquisition. In this video, Bill Zumvorde of Profit Resources shares what prospective buyers and sellers need to know about the operating environment. He also explains how bank leaders can better integrate an acquisition and how potential sellers can get the best price for their bank.
If there’s one takeaway from the Federal Deposit Insurance Corp.’s latest annual report, it’s that there’s a new sheriff in town.
The sheriff, Jelena McWilliams, isn’t literally new, of course, given the FDIC’s new chairman was confirmed in May 2018. Yet, it wasn’t until last month that her imprint on the FDIC became clear, with the release of the agency’s annual report.
In last year’s report, former Chairman Martin Gruenberg spent the first half of his Message from the Chairman—the FDIC’s equivalent to an annual shareholder letter—reviewing the risks facing the banking industry and emphasizing the need for banks and regulatory agencies to stay vigilant despite the strength of the ongoing economic expansion.
“History shows that surprising and adverse developments in financial markets occur with some frequency,” wrote Gruenberg. “History also shows that the seeds of banking crises are sown by the decisions banks and bank policymakers make when they have maximum confidence that the horizon is clear.”
The net result, wrote Gruenberg, is that, “[w]hile the banking system is much stronger now than it was entering the crisis, continued vigilance is warranted.”
Gruenberg’s tone was that of a parent, not a partner.
This paternalistic tone is one reason that bankers have grown so frustrated with regulators. Sure, regulators have a job to do, but to imply that bankers are ignorant of the economic cycle belies the fact that most bankers have more experience in the industry than regulators.
This is why McWilliams’ message will come as a relief to the industry.
It’s not that she disagrees with Gruenberg on the need to maintain vigilance, because there’s no reason to think she does. But the tone of her message implies that she views the FDIC as more of a partner to the banking industry than a parent.
This is reflected in her list of priorities. These include encouraging more de novo formations, reducing the regulatory burden on community banks, increasing transparency of the agency’s performance and establishing an office of innovation to help banks understand how technology is changing the industry.
To be clear, it’s not that Gruenberg didn’t promote de novo formations, because he did. It was under his tenure that the FDIC conducted outreach meetings around the country aimed at educating prospective bank organizers about the application process.
But while Gruenberg’s conversation about de novo banks was buried deep in his message, it was front and center in McWilliams’ message, appearing in the fourth paragraph.
“One of my top priorities as FDIC Chairman is to encourage more de novo formation, and we are hard at work to make this a reality,” wrote McWilliams. “De novo banks are a key source of new capital, talent, ideas, and ways to serve customers, and the FDIC will do its part to support this segment of the industry.”
To this end, the FDIC has requested public comment on streamlining and identifying potential improvements in the deposit insurance application process. Coincidence or not, the number of approved de novo applications increased last year to 17—the most since the financial crisis.
The progress on McWilliams’ second priority, chipping away at the regulatory burden on community banks, is more quantifiably apparent.
The FDIC eliminated over 400 out of a total of 800 pieces of outstanding supervisory guidance and, in her first month as chairman, launched a pilot program that allows examiners to review digitally scanned loan files offsite, reducing the length of onsite exams.
Relatedly, the number of enforcement actions initiated by the FDIC continued to decline last year. In 2016, the FDIC initiated 259 risk and consumer enforcement actions. That fell to 231 the following year. And in 2018, it was down to 177.
“We will continue [in 2019] to focus on reducing unnecessary regulatory burdens for community banks without sacrificing consumer protections or prudential requirements,” McWilliams wrote. “When we make these adjustments, we allow banks to focus on the business of banking, not on the unraveling of red tape.”
Another of McWilliams’ priorities is promoting transparency at the agency. This was the theme of her first public initiative announced as chairman, titled “Trust through Transparency.”
The substance of the initiative is to publish a list of the FDIC’s performance metrics online, including call center response rates and turnaround times for examinations and applications. In the first two months the webpage was live, it received more than 34,000 page views.
Finally, reflecting a central challenge faced by banks today, the FDIC is in the process of establishing an Office of Innovation that, according to McWilliams, “will partner with banks and nonbanks to understand how technology is changing the business of banking.”
The office is tasked with addressing a number of specific questions, including how the FDIC can provide a safe regulatory environment that promotes continuous innovation. It’s ultimate objective, though, is in line with McWilliams’ other priorities.
“Through increased collaboration with FDIC-regulated institutions, consumers, and financial services innovators, we will help increase the velocity of innovation in our business,” wrote McWilliams.
In short, while the industry has known since the middle of last year that a new sheriff is in town at the FDIC, the agency’s 2018 annual report lays out more clearly how she intends to govern.
Bank leaders focus on a number of issues when M&A is on their radar—but they shouldn’t overlook the bank’s core contract. Proactively negotiating with the core provider to account for a potential sale or acquisition can make or break a future deal. In this video, Aaron Silva of Paladin fs shares his advice for negotiating these vital contracts so they align with the bank’s strategy.
How Core Contracts Derail Deals
How to Mitigate Their Impact
Why and How to Conduct a Merger Readiness Assessment
In the landscape of innovative disruption, the public’s attention is often focused on bitcoin’s impact on financing and investment options. However, it is important to understand that blockchain, the underlying technology often conflated with bitcoin, carries an even greater potential to disrupt many industries worldwide.
The attraction of blockchain technology is its promise to provide an immutable digital ledger of transactions. As such, it is this underlying technology—an open, distributed ledger—that makes monetary and other transactions work.
These transactions can include bitcoin, but they may also include records of ownership, marriage certificates and other instances where the order and permanence of the transaction is important. A blockchain is a secure, permanent record of each transaction that cannot be reversed.
But with all the positive hype about its potential implications, what are the risks to banks?
The Risk With Fintech One of the most disruptive effects of blockchain will be in financial services. Between building cryptocurrency exchanges and writing digital assets to a blockchain, the innovation that is occurring today will have a lasting effect on the industry.
One of the principles of blockchain technology is the removal of intermediaries. In fintech, the primary intermediary is a bank or other financially regulated entity. If blockchain becomes used widely, that could pose a risk for banks because the regulatory body that works to protect the consumer with regulatory requirements is taken out of the equation.
This disintermediation has a dramatic effect on how fintech companies build their products, and ultimately requires them to take on a greater regulatory burden.
The Risk With Compliance The first regulatory burden to consider concerns an often-forgotten practice that banks perform on a daily basis known as KYC, or Know Your Customer. Every bank must follow anti-money laundering (AML) laws and regulations to help limit the risk of being conduits to launder money or fund terrorism.
Remove the bank intermediary, however, and this important process now must occur before allowing customers to use the platform.
While some banks may choose to outsource this to a third party, it is critical to remember that while a third party can perform the process, the institution still owns the risk.
There are a myriad of regulations that should be considered as the technology is designed. The General Data Protection Regulation (GDPR), the European Union’s online privacy law, is a good example of how regulations apply differently on a blockchain.
One of the GDPR rules is the so-called right to be forgotten. Since transactions are immutable and cannot be erased or edited, companies need to ensure that data they write to a blockchain doesn’t violate these regulatory frameworks.
Finally, while blockchains are sometimes considered “self-auditing,” that does not mean the role of an auditor disappears.
For example, revenue recorded on a blockchain can support a financial statement or balance sheet audit. While there is assurance that the number recorded has not been modified, auditors still need to understand and validate how revenue is recognized.
What’s Ahead The use of blockchain technology has the potential to generate great disruption in the marketplace. Successful implementation will come to those who consider the risks up front while embracing the existing regulatory framework.
There has already been massive innovation, and this is only the beginning of a massive journey of change.
Over the past three years, the Federal Reserve has raised interest rates nine times and created an environment where banks can earn more on their lending portfolios, but also a heated battle to win deposits.
Compounding the issue is technology, which has made it easier than ever for customers to shop around for competitive rates and switch banks.
To grow and retain deposits, financial institutions need to be proactive in providing the rates and benefits customers want. But it can be a challenge to offer those benefits in a way that increases the quality and quantity of all-important core deposits.
Many banks have structured rewards programs so they reward a new product purchase or behavior, but they don’t incentivize long-term changes in customer interactions with the bank.
Institutions have long offered incentives such as hundreds of dollars of cash back for new account openings, or extravagant gifts for scheduling a recurring transfer of funds. However, these arrangements can often backfire. Once the customer receives their cash back, the newly opened account can languish unused and transaction-less indefinitely.
The expensive gadget the bank gave away doesn’t make financial sense against the $10 monthly transfer the customer automated from their checking account to their savings account.
Institutions like Leader Bank, a $1.4 billion asset bank based in Arlington, Massachusetts, and Opportunity Bank of Montana, a $700 million asset bank based in Helena, have solved this issue by incentivizing behaviors that build the habits of an ideal core customer. As for the rewards, they provide benefits that can be easily administered because they tie into the bank’s existing business model.
The types of behaviors that create habits for bank customers—and profitability for the bank—should be focused on the continuous utilization of bank products.
Here are some examples:
Use the bank’s debit card for 10 or more transactions a month. This moves the bank’s debit card to top-of-wallet and increases interchange fee income.
Sign up for a sizeable monthly direct deposit. Banks can require a direct deposit of $800 or $1,500—whatever amount makes sense in their local market. This behavior ensures that the account earning rewards becomes the customer’s primary account.
Sign up for e-statements. Even a simple behavior like opting into e-statements will save the bank money.
When all of the activities above are bundled together, these requirements for qualifying for rewards could transform a customer into a valuable core depositor.
In return for the customer meeting the bank’s qualifications, banks should go far to provide return value. One-time gifts and prizes are often not enough to drive consistent, ongoing customer behavior; the rewards must be ongoing as well.
Practical, local, ongoing benefits will help a community bank stand out and compete against mega-banks.
Consider these options:
Reimburse ATM fees. One of the primary benefits that a mega-bank has over the typical community bank is its national footprint. Banks of any size can offer ATM fee reimbursement as a reward. Not only does this expand the bank’s footprint by giving customers access to their cash from anywhere, it also reinforces the customer’s new habit to use their debit card more frequently.
Offer cash back on debit card transactions. Cash back signals to customers that your bank is grateful to have their business and mirrors offers by major credit card companies. Whether your bank can offer 1 percent or 3 percent, your institution can likely find a sweet spot for this attractive incentive that makes financial sense.
Provide discounts with local merchants. Leader Bank partners with more than 20 local merchants who provide discounts to the bank’s rewards customers when they shop at their businesses. This type of reward can help the bank integrate deeper into the local community.
Offer higher yielding rates on companion savings accounts for core customers, but only if and when they meet the criteria.
Given that rising interest rates are a major driver in the battle for deposits, rates on savings accounts may be a key component to driving customer acquisition. But your bank may not have to pay that higher rate out every month.
With a technology solution, banks can manage their rewards in such a way that, unless a customer meets all of the criteria for rewards in a given month, they don’t earn rewards that month either. This feature optimizes savings for the bank and ensures that customers continue to engage with the bank like a core customer.
By playing to their strengths and rewarding the right behaviors, banks can create custom rewards programs that both make sense with their business model and provide the kind of marquee benefits today’s consumers are seeking.
Advanced data science technologies like artificial intelligence (AI), machine learning and robotic process automation are delivering significant benefits to many banks.
As part of their mandate to protect shareholder value and improve financial performance, bank directors can play an important role in the adoption of these promising new technologies.
Technology’s expanding influence With fintech companies generating new competitive pressures, most traditional banks have recognized the need to adopt some new techniques to meet changing customer habits and expectations. Declines in branch traffic and increased online and mobile banking are the most obvious of these trends.
Yet, as important as service delivery methods are, they are in a sense only the top layer of bigger changes that technology is bringing to the industry. New data-intensive tools such as AI, machine learning and robotic process automation can bring benefits to nearly all areas of a bank, from operations to sales and marketing to risk and compliance.
Advanced data analytics can also empower banks to develop deeper insights and make better, more informed strategic decisions about their customers, products and service offerings.
The power of advanced analytics Historically, business data systems simply recorded and reported what happened regarding a customer, an account, or certain business metrics. The goal was to help managers understand what had happened and develop strategies for improving performance.
Today’s business intelligence systems advance this to predictive analysis – suggesting what is likely to happen in the future based on what has been observed so far. The most advanced systems go even further to prescriptive analysis – recommending or implementing actions that increase or decrease the likelihood of something happening.
For example, AI systems can be programmed to identify certain customer characteristics or transaction patterns, which can be used for customer segmentation. Based on these patterns, a bank can then build predictive models about those customer segments’ likely actions or behaviors – such as closing an account or paying off a loan early.
Machine learning employs algorithms to predict the significance of these customer patterns and prescribe an appropriate response. With accurate segmentation models, a bank can tailor marketing, sales, cross-selling and customer retention strategies more precisely aligned to each customer.
Automating these identification, prediction, and prescription functions frees up humans to perform other tasks. Moreover, today’s advanced analytics speed up the process and can recognize patterns and relationships that would go undetected by a human observer.
Industry leaders are using these tools to achieve benefits in a range of bank functions, such as improving the effectiveness of marketing and compliance functions. Many large banks already use predictive modeling to simplify stress testing and capital planning forecasts. AI and machine learning technology also can enhance branch operations, improve loan processing speeds and approval rates and other analytical functions.
Getting the data house in order While most banks today are relatively mature in terms of their IT infrastructures and new software applications, the same levels of scrutiny and control often are not applied to data itself. This is where data governance becomes crucially important – and where bank directors can play an important role.
Data governance is not just an IT problem. Rather, it is an organization-wide issue – and the essential foundation for any advanced analytics capabilities. As they work to protect and build shareholder value, directors should stay current on data governance standards and best practices, and make sure effective data governance processes, systems and controls are in place.
AI, machine learning, and robotic process automation are no panacea, and banks must guard against potential pitfalls when implementing new technology. Nevertheless, the biggest risk most banks face today is not the risk of moving too quickly – it’s the risk of inertia. Getting started can seem overwhelming, but the first step toward automation can go a long way toward taking advantage of powerful competitive advantages this technology can deliver.