Several readers responded positively to our last newsletter focusing on the opportunity for banks to adapt McDonald’s recent management practices to their own institutions.
Taking us in a different direction, one commenter from a bank in Minsk wrote: “They always say that every great discovery is inspired by nature contemplation…Have you ever found banking analogies in nature?” In fact, without pushing the analogy too far, considering nature in the context of today’s branch systems offers some helpful insights.
Non-U.S. readers should understand that in recent years an explosion in branch growth has occurred. For example, in the last three years, Wachovia’s branches have increased in number from 2,700 to more than 3,100, and Bank of America’s from 4,300 to about 5,800. Branch proliferation also extends to mid-sized and community banks across the country. The total number of branches in the U.S. has gone from 75,159 in 2003 to 91,407 in 2006, about an 18 percent increase.
Bank management has seen de novo bank growth as a way to plant marketing and sales seeds. In areas such as New York City, banks like North Fork and Commerce correctly viewed their entry as an attractive opportunity to replace dead or tired plants, namely big banks offering mediocre service.
Darwin Comes to Banking
The nationwide focus on branches resulted from management’s belief that being close to the customer was a key to success, and the most successful de novos focused on deposit generation. Until the last 12-18 months, that was an attractive approach due to the significant gap between short and long-term rates.
However, branch banking is now entering a Darwinian phase where only the hardiest survive a much tougher operating environment. The changing circumstances include an inverted yield curve and branch saturation. Walk down any major street or drive through any suburban town and you see branch after branch after branch. Both the numbers and common sense tell us that the industry has over-expanded, in effect planting seeds too closely together and, therefore, not allowing them to thrive. Further, the big banks have improved their service, in some cases substantially. In most markets, the days of easy competitive pickings are gone.
A Changing Customer
One other factor may also be diminishing the impact of new branches. Ten years ago, a significant number of analysts predicted that customers would eliminate their use of the branch, conducting their banking activities online. The timing of that prediction proved to be way off. However, today, the tipping point may have finally been reached, whereby an increasing number of customers are disintermediating the branch by using alternative channels.
At many banks, branch transactions and deposits have declined significantly. While additional metrics need to be evaluated as part of a branch-wide analysis, management needs to understand why this has happened. Oftentimes, it is because customers have increased their online banking or because that branch’s marketing execution is failing. An insufficient number of customers are going into the branches that were built to pull them in.
De Novo Branch Disparity
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Tom Brown, an industry analyst and fund manager, recently cited an FDIC-report that evaluates the deposits generated by branches opened in 2001: “They imply that 70% of the bank branches opened five years ago are losing money…Branches opened since 2001 went into even more marginal [and increasingly expensive] locations and entered a marketplace that’s even more crowded. They figure to do even worse than the class of 2001. What’s more, deposits at those five-year-old branches grew at just a single-digit rate last year. That means that not only are the branches not profitable now, they will likely never be.”
Just as Brown’s data indicates, our client work shows a vast and disturbing disparity in branch performance, typically even within the same bank, whether from de novos or established branches. Many banks do not seem to have a good handle on the factors driving individual branch performance, and they have been slow to diagnose and address poor performers. Given the expected tougher operating environment for branches, management needs to move much faster to avoid bloodletting on the bottom line.
Of course, not all banks will suffer losses and new openings can still be the right strategic move. However, only a relative handful of players emulate best practices and demonstrate excellence at the fundamentals of branch banking, including location selection, competitive assessment, and outbound sales and marketing.
Prune the Branch System; Consider Planting Elsewhere
Now is the appropriate time for bank management to take stock of the state of its branch system: How are the branches performing across key metrics? What are the recent trends? Given likely rate scenarios, what level of performance should management expect? How does the branch’s profitability respond to various economic stress tests?
In addition, management should develop an approach to contrast the return on a dollar of de novo branch investment with that from alternative choices. For example, should the bank be investing more in online capabilities or, if it wishes to attract younger customers, establishing a mobile banking capability? (The U.S. remains far behind other parts of the world in offering this channel.) Organizationally, silos need to be broken down between branch management and those responsible for alternative channels.
Concluding Thoughts
We do not think the branch is dead. But we are saying that its value to the customer and the bank’s stakeholders may be changing faster than many of us have previously realized. Banks have bet big sums on their branches and, for many, the payoff has not been there and will not be there.
To return to the nature analogy suggested by our reader from Eastern Europe, once a tree branch is dead, it is too late to provide it with nourishment. Banks need to evaluate their branches, particularly de novos, and act now to address performance laggards.