Where Is the Innovation?

This article was originally published on June 2, 2014 via the BankThink section of the American Banker website 

Banks have always been quick to integrate new technology. Since the advent of the personal computer, they have made excellent use of this technology internally and externally. The PC and Internet eras have produced successful customer-facing products and services. Most basic retail banking no longer needs to be conducted in a branch. Retail deposit accounts can be opened and closed without the customer ever setting foot inside a bank. Most checks can be deposited via a smartphone.

Despite these successes, banks have failed to deliver innovation fueled by new technology to their retail deposit customers. The digital product and service revolution has yet to happen in the banking industry.

Part of the reason is retail deposit banking is still based on centuries-old checking and savings products. There are certificates of deposit, safe deposit boxes, and other ancillary products and services that have all been around for decades. Where is the digital revolution for these? Viewing the balance of a checking account on a connected device instead of manually tracking the balance in a checkbook register is not innovation. Neither is paying bills with a bank-provided online bill-pay service. These just provide more efficient access to the old products.

Much has been written about innovation from nonbank entities. The companies that provide peer-to-peer (P2P) lending, like Prosper or the Lending Club, are considered innovators. P2P lending is another centuries-old practice that was originally between family and friends. These companies use technology to make P2P available to anyone who wants to get a loan or use their funds to lend to others. They are proof that technology and innovative thinking can create new retail banking opportunities.

What about the retail deposit products offered by the neo-banks, such as Moven, Simple or T-Mobile’s ‘Mobile Money’? They provide a better customer service experience and user interface. They make better use of banking data than most banks. But the neo-banks are not innovating anything in banking, they are just doing it better.

One example of deposit product innovation is technology that provides FDIC insurance for one customer account for tens of millions of dollars. Promontory Interfinancial Network, LLC has two products, Insured Cash Sweep and Certificate of Deposit Account Registry Service, that provide this service to approximately 3,000 banks. Here is how: A client opens just one account at one bank and the service takes care of all the operational work of creating the other FDIC insured accounts. The founders of this company saw a problem and solved it using technology driven by innovative thinking.

Another example of technology that banks and bank core providers use provides business or investment customers with multiple sweep type accounts that automatically move funds based on pre-defined criteria between accounts to cover disbursements or to move excess checking balances into multiple other checking accounts or interest bearing accounts. These are typically known as zero / target balance accounts and money market sweep accounts.

Despite such small steps, innovative thinking in retail deposit products, particularly checking and savings accounts, is long overdue. Why? It’s not a regulation problem as those challenges can be resolved. It is not a problem that gets solved with application programming interfaces. The banking industry needs to break with old deposit banking product conventions and re-boot banking. It is our industry and we are the ones best equipped to make it better. We now have more help available via the technology industry than any other time in history. There are FinTech communities in Silicon Alley, Silicon Bridge, Silicon Prairie and Silicon Valley.

One way to re-boot retail checking and savings accounts is to emulate what others have done, use technology to improve the aging product. The systems that drive business zero balance and sweep accounts could be adopted for retail customers to provide a better banking product set. Instead of a customer opening a checking account for payments and a savings or money market account for savings, a customer could open one master account. Depending on each consumer’s profile, multiple child accounts would be opened by the system. For example, a customer with a basic bank account could receive child accounts for bill pay, debit card, emergency savings, a defined savings goal, and excess cash. Each pay day, the consumer’s pay would be deposited into the master account. The system would then populate payment accounts with enough money to cover expected bills or debt transactions. The savings accounts would increase by a pre-defined percentage. A learning algorithm could analyze past transaction history and modify the transfer of funds based on real-time analysis to automatically manage the flow of the customer’s funds between accounts. The savings models would dynamically increase or decrease savings based on the real-time analysis of each customer’s cash flow.

This would allow banks to increase the duration of the retail balances earmarked for payments and increase the balances saved for their customers. The increased average deposits could lower the need for alternative pricier funding for loans.

The road to re-booting retail deposit banking starts with modernizing the basic checking and savings account and by thinking differently, as Apple Computer did many years ago when it told us to “think different.”

I recommend you follow @TimBunch for today’s #FF

This week I am recommending you follow Tim Bunch on Twitter.

Twitter Profile: Web designer, developer and strategist. Helping shape the future. Husband, father, musician, believer.

Location: Boise, Idaho

Site Link: simplysmartmedia.com


Tim and I see eye to eye on many topics. We have had some interesting public and private conversations on Twitter and Google+. What prompted me to recommend Tim this week was his April 24, 2014 article he wrote for The Financial Brand titled, “Branch Locations Are No Longer The Key to Growth.”

Tim is not afraid to make his opinion known. I am aware of six articles he has had published on The Financial Brand. In addition to following Tim on Twitter, your should follow him on Google+.

Here are the links to five of his other articles on The Financial Brand:

The Future of Online Banking: The Flagship Branch - https://thefinancialbrand.com/24969/online-website-banking-flagship-of-the-future-tbunch/

The Future of Online Banking: Know Thy Visitor - http://thefinancialbrand.com/25464/future-of-online-banking-understanding-visitors-tbunch/

The Future of Online Banking: When Worlds Collide - http://thefinancialbrand.com/26511/future-of-online-banking-desktop-mobile-tbunch/

The Future of Online Banking: A Culture of Change - https://thefinancialbrand.com/27137/future-of-online-banking-culture-change-tbunch/

Why Your Social Media Strategy is a #Fail - https://thefinancialbrand.com/30406/bank-credit-union-social-media-strategy-fail-tbunch/

Why Should Bank Marketers Know and Care About Funds Transfer Pricing. A Q&A with @JeffMarsico

On Monday, September 23, 2013 Jeff Marsico and I unleashed our presentation and white paper “Product Profitability - Out of the Shadows" at the 2013 ABA Marketing Conference in San Antonio, Texas. In our presentation, the first part focused on "How is Product Profitability Made." Jeff and I are going to keep the conversation going by talking about one of the critical components of product profitability, Funds Transfer Pricing (FTP). We will share the why you need FTP, some challenges of using FTP and some recommended marketing and management uses of FTP data. The format of our dialog will be an interview format.

BACKGROUND

Question: Jeff, how long have you taught profitability at the ABA Bank Marketing school?

Answer: I’ve taught at the school since 2008. When I was first contacted to do it, I was a little surprised at the interest. It was the first step in the process of breaking my stereotype regarding bank marketers.

Why were you a “little surprised?”

I held the tried and true stereotypes of the differences between finance and strategy wonks (i.e. me), and marketing/creative types. But the school was dedicated to improving marketer’s ability to speak the language of the C-suite. And I applaud them for it.

Would you say that most of the students are shocked that they have to dust off their math skills?

I would say, that at least initially, I was the least popular instructor because my course could be taught in a spreadsheet versus a desktop publishing application.

Before you started teaching bank marketers, do you think you had your own set of biases as to what a marketer is?

Yes. I thought they ran the ad budget. Although true, it is a myopic version of the function. But if marketers were honest with themselves, I think they would admit they are more comfortable developing a business banking flyer than improving the profit trends of a business sweep account. When you are uncomfortable with the subject, that’s where growth begins. For both me and the students.

When these marketers start your course, what percentage of the class has ever heard of FTP? Know what FTP is?

Somewhere close to zero percent for those banks with less than $5 billion in assets. The larger banks have greater resources, both personnel and software, to deliver profitability information. And the marketing function has more specialists versus the generalists typically found in a community bank.

Wow! “Somewhere close to zero percent for those banks with less than $5 billion in assets” do not not know what FTP is? That assessment seems alien to me. My entire marketing career has always dealt with the math of profitability. My background is mostly non-banking. Do you think the financial services industry has typically devalued profitability in the marketing ranks?

I think profitability is devalued in all ranks because it is part art and part science. Sure we can calculate bank-level ROA, but do we drill down to the products that are most/least additive to ROA? Do we cross-reference to our customers and the products they use to identify profitable cross-selling opportunities? Profitability in community banks is starting to get some wind in its sails. But slowly.

WHY BANKS NEED FUNDS TRANSFER PRICING

Jeff, it has been my observation that many bankers look at deposits as an expense due interest paid customers on their deposit accounts and loans as income due to the interest collected on loans. Let’s get to the bottom of this misconception. So Jeff, what is Funds Transfer Pricing (FTP)?

You described the fundamental need for FTP. If you are a slugger for the NY Mets, provided they have a slugger, would it be fair that your performance bonus be based on the pitching staff’s ERA? No.

Therefore it’s not fair to credit the branch manager for how well the commercial lender performs. If you credit the branch manager the bank’s yield for the deposits they gather, you are effectively letting the commercial lenders’ performance impact the branch manager’s bonus.

In comes FTP, that isolates the performance of various contributors to the balance sheet. The branch manager receives a market rate credit for the deposits she gathers, and the commercial lender receives a market rate charge for the loans he makes.

Are there different types or methods of FTP?

Yes. The simplest FTP method being the single rate or pool method. Suppose your deposits have an average duration of 3.5 years. You then credit those deposit gatherers for a pool rate for a 3.5 year market instrument.

The best practice FTP method is matched maturity, or coterminous FTP. This transfer prices every instrument, at the account level, on the balance sheet for a market instrument of the same maturity. So if I’m a branch manager, and I book a 1-year 0.50% CD today, and a market rate such as an FHLB borrowing rate, for a 1-year instrument is 0.80%, then I book a 30 basis points spread for the life of that CD. Using this method, you isolate each instrument, and exclude interest rate risk from the equation.

What type of banks or credit unions do not need to have a FTP process?

Small banks and credit unions, perhaps under $300 million, that are not rapidly growing can effectively manage their institution using “top of the house” financials. But if the institution’s plan is to grow, they should consider implementing an accountability culture that delivers profitability information to business unit managers. If you want to measure performance at a granular level, then FTP is one of the tools to get you there.

MANAGEMENT CHALLENGE

Can the profitability of branches, business units, products, relationships, households, individual customers, etc. be calculated accurately without FTP?

Profitability information is part art, part science.

Can applying a bank’s cost of funds to the commercial loan portfolio be used to make decisions in that department? Probably, if it is consistently applied and the focus is on trend. But, as mentioned, you could be disguising performance issues in this department by using a superior low-cost deposit base in the measurement mix. Plus, what of the interest rate risk… i.e. borrowing short and lending long?

By not using FTP, you could be providing attaboys to your commercial team for the hard work your branches are doing, and the interest rate risk inherent in the balance sheet.

Jeff, you mention “disguising performance issues” and commercial lending team “attaboys.” Talk about that further. If the risks you mention are not being properly measured, what is the potential impact to a bank’s Return on Assets (ROA) and Return on Equity (ROE)?

Look no further than 2008 - 2011 where the trials and tribulations of the loan portfolio played out. Lenders were rewarded when they booked those loans in 2006 - 2007. If lenders were subject to profitability information, FTP that isolates their loan yields compared to a market rate, equity allocation based on risk of loan to calculate ROE (Risk Adjusted Return On Capital or RAROC), and a robust provision allocation based on Allowance for Loan and Lease Loss (ALLL) methodology, perhaps those loans would not have looked so good in 2006 - 2007.

TOP 3 STRATEGIC USES OF FTP DATA

What are the top three strategic capabilities a bank gains when they fully embrace the power of a FTP system into their financial DNA?

1) Pricing and operational discipline in day to day business development activities
2) Accountability at the business line level
3) A focus on the most profitable customer segments and not solely the ones with the highest balances.

Thank you Jeff. How would you like to summarize what you have shared?

Funds Transfer Pricing is one of the tools in an overall profitability reporting methodology. It does not stand alone. But those that use FTP, pushing institutional knowledge of precisely where their financial institution does and does not make money, and promotes an accountability culture for front-line employees to deliver profitable relationships and support staff to deliver efficient internal service to elevate profits at the account level, than how is this a bad thing? It’s not. But it is difficult to move from where you are to such an accountability culture. Bankers have to ask themselves, “is it worth the journey?”


SUMMARY

Funds Transfer Pricing is a necessity for banks today. Size does not matter anymore. Every area of the bank needs to understand the basics of how a bank makes money from each dollar of a deposit and a loan. For today’s relationship managers and branch managers, profitability can no longer be “devalued.” The same goes for commercial lenders.

It is great that Jeff teaches profitability at the ABA Bank Marketing school. Marketers need to embrace the power of profitability and the power they wield in improving the bottom line of banks. Marketing should no longer be considered an expense but rather an investment in improving the value of a bank. Jeff put it best when he said “Profitability in community banks is starting to get some wind in its sails. But slowly.”

If you want to know more about how bank profitability is made and learn more about strategic marketing uses of this information, download and read the white paper that Jeff Marsico and I authored, “Product Profitability - Out of the Shadows”.

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Finally got the @PayWithIsis latest update on my @VerizonWireless @Motorola Moto X

Over the last few months I have been tweeting about mobile wallets

and getting my Motorola Moto X smartphone prepped for the national rollout of the PayWithIsis mobile/digital wallet. 

My phone has a secure sim so it was compatible with the PayWithIsis app and I installed the older version and configured the app. At the time I did not have a compatible credit card to use. The Google Wallet app works on my phone but not as a tap and pay device.

When Google released their latest Android operating system, Kit Kat, everything changed. This new version has built in support for a technology called Host Card Emulation (HCE) which allows a program, like Google Wallet, to emulate a card and communicate directly to a NFC enabled point of sale card reader. My phone was updated quickly and soon after the release, the Google Wallet app

was updated and I was able to use the tap and pay functionality. Since I have been in the Google smartphone ecosystem for a few years, the debit cards I typically use were already configured in my digital wallet. Making payments at NFC enabled point of sale devices has been easy.

The PayWithIsis app was released nationally and my phone was not included. Some speculated that PayWithIsis shut out phones that could use HCE. Well that is not true. Tonight (December 18, 2013) I received my Verizon PayWithIsis update. 

The new feature was compatibility with Android KitKat. After my app upgraded and I accepted the new user agreement (which was emailed to me for my records) I was greeted with this preferences menu over the login PIN. 


I had to set PayWithIsis as the default wallet. I initially selected no and was dumped out of the app. I went back in and changed the default.

The card selection menu was updated to include WellsFargo.

Since I do not have a compatible card I selected “Other card” and was presented with an offer to enroll with the American Express Serve pre-paid account and connect any of my cards or bank accounts. The nice touch was the $50.

The PayWithIsis app has a “Where to Pay” finder in the app.


It then launches the phones web browser

and produces a map. There are places on the map to use it. For me it is dominated by McDonald’s, CVS and RiteAid.

After exploring the PayWithIsis app I launched the Google Wallet app and was asked to change my wallet preference. I expected this.

I selected “No” and the Google Wallet app completed to open up. The main Google Wallet dashboard prominately displayed the fact that “Tap and pay will not work.”

I liked the fact that the Google Wallet app has a main dashboard option to switch the default back to itself.

Now I get to spend the next few weeks testing each of these mobile wallets in real world scenarios.

How the “Bar Rescue: Bankers Edition” blog post from @JeffMarsico started

My friend @JeffMarsico released a blog post yesterday called: 

Bar Rescue: Bankers Edition. After we wrapped up writing our white paper on bank product profitability I started thinking about one of my favorite reality shows on TV, Bar Rescue, and how one of the focuses is on financial management. Well I wrote the piece below and shared it with him. This short note led to his blog post that I strongly suggest you read.

Spike TV has a reality show called Bar Rescue. The host, Jon Taffer,

rescues a bar that has requested the shows help. Jon Taffer is an internationally recognized, award-winning restaurant operator, owner and concept developer. The opening credits mention 6,500 bars will go out of business this year. One of the first questions Jon Taffer asks the financially underwater bar owners is what is your liquor cost. What is liquor cost? It is a bar financial ratio designed to help measure the health of liquor sales. This is the formula:

Liquor cost =

(Start of period liquor inventory value - end of period liquor inventory value + value of purchases during period) / Liquor Sales during the period

I have yet to see an episode where a bar owner knows their liquor cost. Banking is different. Banks must publish financial information in a standard format to the government quarterly. What that means for banks is they always know their liquor cost. Any business that sells a product or service should have a process to calculate product profitability.

That is it for my note to Jeff. On Monday, September 23, 2013 at 11 a.m. in San Antonio, TX, @JeffMarsico and I will be speaking on bank product profitability. The title of our presentation at the ABA Marketing Conference is “Product Profitability - Out of the Shadows”. If you are going to the conference, Jeff and I would love to see you there.

@dmgerbino

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