Death to the Branch, Long Live the Branch: North America’s Virtual Banks

Retail e•Financial Services September, 1999 Research Brief Analyst: Dana Stiffler dstiffler@meridien-research.com 617.796.2836

Background
The pressure for North American financial services institutions (FSIs) to establish a meaningful online presence has led to the emergence of the branchless bank. The branchless institution serves customers via the Internet, post, and call centers, eschewing the physical branch in favor of more direct, albeit electronic, contact. Over the past three to four years, two types of branchless bank have emerged in North America: • • Start-up banks, built from scratch (e.g. Security First Network Bank, CompuBank); and Branchless banks that function as independent subsidiaries of existing financial institutions (e.g. ING Direct, WingspanBank).

Table 1 lists selected branchless banks in North America, indicating which began as start-ups (1), and which as Internet-only initiatives launched by established banks (2). Table 1 by no means tells the whole story, as it lists only institutions that have been live with online banking for at least three months. As of this writing, we are aware of at least three other branchless banking initiatives that are scheduled to launch within the next six months. The size and range of institutions involved run the gamut. Behemoth Citibank is piloting branchless Citi f/i, while community banking company Brookline Bancorp (Boston, USA) prepare to launch Lighthouse, a branchless bank that will target New Englanders. Non-bank financial services companies like American Express are also moving to establish branchless bank subsidiaries.
Table 1: North American Branchless Banks
Bank Date Launched # Accounts Technology Provider(s)

2
Canada

Citizens Bank of Canada ING Direct mbanx American Express Membership Banking CompuBank First Internet Bank of Indiana Net.B@nk Principal Bank Security First Network Bank Telebank USAccessBank USABancShares WingspanBank

January 1997 April 1997 October 1996 July 1999 October 1998 February 1999 October1996 February 1998 October 1995 November 1997 February 1999 August 1999 July 1999

NA 225,000 160,000 NA NA 3,100 30,000 6,500 20,000 60,000 NA NA 80,000

Vancouver City Savings Credit Union (parent) NA NA S1 Technologies Prologic Virtual Financial Services, Inc. Prologic, NCR In-house (parent) S1 Technologies, BroadVision S1 Technologies Edify NA Edify

2 2 1 1 1 1

USA

2 1* 1 2 1 2

Source: Institutions, Meridien Research estimates Note: 1 - Start-up, 2 - Subsidiary of FSI,*SFNB, a start-up, now owned by Canada’s Royal Bank Group.

© 1999 Meridien Research, Inc. All rights reserved, worldwide Retail e•Financial Services September, 1999

establishing or purchasing a branchless bank is also a strategy favored by traditional banks wishing to gain entrance to a foreign market. mbanx’ high total assets reflect the fact that it has more credit products on its books than other branchless banks. Assets 8 7 6 Assets (US$ bn) 5 Telebank mbanx 160.000 1 2 3 4 5 Years in Existence size of circle = number of accounts Source: Institutions. Years Since Launch vs. a Dutch banking group.000 accounts. has entered the Canadian market in this manner. Start-ups perceive that certain needs are not being met by traditional banks. even those that have been online for some time. worldwide Retail e•Financial Services September.000 4 3 2 1 0 -1 0 -2 60. All rights reserved. some FSIs seized upon the branchless model. The success of E-Trade and others marks a significant shift in the retail finance landscape: customers have indicated their willingness to enter a trusted financial relationship with entities that do not have roots in traditional financial services. largely due to an effective marketing presence. Start-ups have also taken note of the enormous splash that branchless brokerages have made. they are beginning to realize that traditional ways of dealing with the customer do not translate well on the web.g.000 30. 1999 . Motivations for Going Branchless “Pure” start-ups and Internet-only subsidiaries are rushing to go branchless for different reasons. sustainable deposit rates and premium customer service. Royal Bank of Canada’s purchase of Atlanta-based Security First Network Bank. Certain IT costs for these de novo banks are a fraction of what they would have been five years ago. Canada’s ING Direct is another great marketing story. E-Trade’s purchase of Telebank). Inc.Page 2 Figure A: Comparing Top Six Branchless Banks in North America Number of Accounts vs. some institutions that were eager to establish branchless banking simply did an end run.000 Netbank S1 Network B ank 20. ING. Taking a tip from the start-ups.000 Wingspan Bank 80. spending millions. choosing to purchase a start-up (e. Launched © 1999 Meridien Research. As the Royal Bank purchase indicates. call center support. Through trial and error.000 ING Direct 225. and even back-office processing. given the emergence of the Internet as a viable delivery channel and the availability of outsourced back-office solutions to suit every palate and pocketbook. establishing independent subsidiaries with their own Internet application servers. one that has a strong chance of succeeding due to its generous. Meridien Research Figure A illustrates how the top six branchless banks compare in terms of asset size (Y axis) and customer base (circle size). Wingspan Bank already boasts approximately 80. that existing processes and organizational hierarchies were slowing progress and alienating web-savvy customers. Despite being in its infancy. Traditional banks have recognized this trend too. Recently.

Some processes are still paper-based. and is likely to use this model to enter other retail banking markets. In addition to the marketing assault. Figure B: Growth of Branchless Banking in North America 40 total accounts (millions) 35 30 25 20 15 10 5 0 1996 electronic banking accounts branchless banking accounts 1997 1998 1999 2000 2001 2002 Source: Meridien Research Estimates Figure B illustrates this process. however. Already. Looking Forward Despite low bricks-and-mortar costs. branchless banks are looking at partnering with other online entities. Since establishing a viable brand is its only means of survival.Page 3 just a little over two years ago. many branchless banks require deposits of at least a thousand dollars to maintain free service. many have already acknowledged that high deposit rates are simply a customer acquisition tool. All rights reserved. and that they will lower rates once their account base has reached critical mass. What’s worse. © 1999 Meridien Research. worldwide Retail e•Financial Services September. many of whom are accustomed to being served in near real-time. Interestingly. the emphasis on slick marketing and designing a handsome web GUI sometimes masks the fact that the bank has not paid particular attention to its middle and back-office systems. that accounts and assets will grow only as long as deposit rates remain high and lending rates are competitive. most independent branchless subsidiaries will be absorbed back into the financial institutions that spawned them. this model is unsustainable. particularly those that are active in the same market as the parent bank’s standard retail operations. With the huge marketing investment that is required to establish a quality Internet brand. just five percent will be pure branchless bank accounts. there may end up being even fewer. Beware the Bottom Line For all the potential operational advantages branchless banks enjoy. Victims of their own success. It is clear. We believe the virtual bank is a creature of the moment. or by other Internet-only entities. The up-front fixed costs that are avoided with the branchless model arguably come back to haunt the start-up in the form of these disproportionately high marketing outlays. Independent Internet-only banks will likely be purchased by traditional financial institutions. 1999 . they are not likely to stay long. Inc. discover that their cyber bank is actually just a front end. Some have tried to use existing customers as a quasi-sales force. the branchless bank must sink millions into high-profile marketing campaigns. have taken the model full circle. Of the approximately 35 million North American online banking accounts we expect to see by 2003. Apparently the electronic customer relationship can only go so far. In fact. particularly the more successful ones. it is unlikely that the independent branchless bank will become a fixture of retail finance the way the discount brokerage has. offering referral bonuses. many branchless banks. What is not clear is that these high rates can sustain a profitable institution. they lack the reputation and resources of established institutions. that nothing inspires consumer loyalty like above market interest rates with free bill payment thrown in. to the point where they are beginning to establish mini-branches or cafes in order to establish real-world contact with their customers. such as personal finance sites. Furthermore. When web-savvy customers. ING Direct now boasts the largest account base of any branchless bank in North America (Figure A). showing that branchless banking will account for a smaller and smaller portion of the total online banking market.

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