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From Payments to Cash management:

The NexT BIG IDeA?

by Rick SpitleR

Payments can once again be a foundation of profitable revenue growth, but only for institutions that can innovate to serve customers larger needs.

onsumer and small business payments are the traditional foundation of retail banking, but the economics of this business are shifting dangerously. In turn, banks need to rethink their payments strategies and operations as part of a total customer value strategy that encompasses lending, fee-based services and other revenue opportunities. The benefits of strong payments relationships are understood. Banks that are central to their customers payments activities have better retention rates and can capture data about customer activity that enables more effective cross-selling. The economics of payments, however, are clearly under pressure. The industry is awash in low-margin deposits, and banks cannot count on rate increases any time soon. Meanwhile, general economic conditions have depressed customer demand for credit, and regulatory action has decimated fee revenue. This leaves banks in a situation where they still handle the vast majority of consumer and small business payment transactions, yet with a sharply reduced revenue stream. Most banks have reacted to this shift with short-term tactical

moves, including revising checking fee schedules in the wake of Reg Q, closing the weakest 3% to 5% of branches and paring staffing. While these moves may have been necessary, they are not sufficient. Cost structures remain misaligned with the reduced revenue opportunity there is way too much branch capacity (and therefore expense) devoted to handling paper-based transactions. And while cross-sell opportunities are still there, most banks have made insufficient progress in realizing the potential value of their core payments relationships. Looking forward to 2013 and 2014, retail banks will need to make a series of strategic structural changes. Payments can be a foundation of profitable revenue growth, but only for institutions that can find effective ways to meet customers total cash management needs and realize the full potential value of consumer and small business relationships.

Four Priorities
To revive their position in payments, there are four priorities

that banks need to pursue: delivery systems. Branch networks and staffing must be manPlastic (and mobile) over paper. Banks must further aged much more closely than in the past, and much more encourage the customer migration from check-based payclosely aligned with local market opportunity. As customers ments to card and mobile payments. Not only do these migrate away from the branch to virtual channels and the services provide added convenience for both payors and economic and regulatory environment continues to exert payees, but they are less expensive for banks to facilitate, profit pressures, bankers cannot afford to waste resources on compared with moving paper. The debit card will continue poorly optimized distribution systems. to play an important role despite the reduction in interCustomers who deal with the bank through direct, virchange, it still contributes substantial fees to a bank but tual channels need to be embraced and targeted for crossbanks must also aggressively pursue mobile and peer-to-peer sell through the channels they prefer. This implies not only payments options. more precise resource allocation of staffing and branch Rethink the role of payments. Banks need to rethink the investments, but also better cost accounting to carefully track structure and positioning of fees within payments product financial performance relative to channel usage. lines, which will require a deeper understanding of the cusrestarting Fee revenue growth tomer needs they will be fulfilling. Customers do not need As banks look beyond this year to 2013 and 2014, we see a checking account per se they need a way to make at least three main types of fee-building and -substitution inipayments. Banks should re-categorize their payments prodtiatives that need to be started now in order to bear fruit by uct lines as part of a consumer and small business cash then. These include campaigns to increase debit and credit management offering (see sidebar, Parsing the Payments card transaction volume; financing innovations that will help Business). By focusing on the demand side rather than the households to meet spending contingencies; and new sermechanics of the supply side, banks can address a much vice propositions centered on prestige and specialized value broader set of customer needs. (Figure 1). Link lending to payments. For example, the unsecured Interchange. The Feds action on signature debit interline of credit (ULOC) is a dramatically underutilized product change will have a lasting impact on the card business but category in U.S. banking. Formerly eclipsed by home equity shouldnt be viewed as fatal. There still is an interchange lending, the ULOC may now be an attractive alternative for stream of revenues to be nurtured, with possibilities to improve many borrowers who are credit-worthy but have less home adoption and usage patterns among regional banking cusequity following the housing crash. tomers. The bottom line for the debit card is that even at a While the ULOC has been challenging to sell on its own, sharply lowered average of 26 cents of interchange revenue banks should reconsider this neglected product line as part of an overall household cash management offering. When integrated with the cash management account, ULOCs can potentially claim the same prominent position in customers wallets as the core checking The payments business actually encompasses two key value-added services: account itself. 1) the transaction itself, which is the exchange of value; and 2) funding balThe demand for shorter duration loans ances, which includes the deposits or loans that back the payment. Borrowing can also be met via an integrated cash from the corporate world, the two together should be more properly termed management offering. Product possibiliconsumer/small business cash management. ties include deposit advance; fee-based By itself, the payment transaction generates little value for the bank, and deferred payments; and real-time, transacall of that activity typically is a break-even exercise at best for the typical tion level installment lending. While some of institution. By contrast, the high-return portion of cash management is the these offerings are not common in the U.S. funding part (holding the balances). Although retail banks handle more than retail banking market, they have solid prec80% of the transaction volume and payments value for core customers, they edents in other parts of the financial services claim less than 45% of the associated revenue streams, mainly because they industry and other parts of the world. are badly under-represented in unsecured consumer credit. Optimize distribution effectiveness. Rick Spitler Ongoing shifts in the payments market will require retail banks to reengineer their

Parsing the Payments Business

June 2012

From Payments to Cash Management: The Next Big Idea?

per transaction, it still is a valuable component of the retail DDA account. Liquidity alternatives. The goal for the bank is to build substitute revenues by meeting household liquidity needs in innovative new ways. To reach the broadest set of customers, short-term credit offers can be tailored across three dimensions, including 1) channel access; 2) situational payoff preferences; and 3) pricing. One of the most visible new offerings is the deposit advance product. We believe this is a partial solution, however, and the developmental effort should be broadened to include all customer segments for the full range of near-term liquidity needs (e.g. instant installment lending from the checking account). Prestige/value. A further source of transaction revenues lies with premium offers based on special functional value and/or prestige. These work better when positioned as extensions of

cash management, versus checking account add-ons. While the market potential is more modest, successful firms have reached up to 10% of their transaction base with the right combinations of offers, including: 1) concierge/platinum services; 2) situational insurance programs; and 3) enhanced information and linking services.

innovations in unsecured Lending

Along with natural advantages in marketing and managing credit within a relationship context, regional banks also have opportunities to redefine the market for unsecured lending. By filling in important product gaps, they can broaden the base of eligible borrowers and also capture a larger household share of wallet (Figure 2). With unsecured credit lines, for example, banks can provide interim credit for the many households that, while on

Figure 1: Avenues to Build Fee Revenues

Card usage and unsecured lending will play especially important roles in addressing the current fee revenue crisis.
Card Usage & Interchange

Drive improved adoption and utilization of credit and debit cards, further eroding cash and charge cards.


1836 Months

Credit Balances

Develop propositions on unsecured lines to capture balances outside the bank e.g., unsecured lending, responsible deposit advance programs, and structured installments for the credit wary.


1836 Months


Develop value-added propositions for customers around prestige and add-on services, including: Concierge / Platinum Card Travel, dental, purchase, and ID theft, etc


1836 Months

Terms & Conditions

Increase behavioral requirements or relationship requirements on transaction accounts, or raise maintenance fees.


1 Month

expedited Services

Increase fees for transactions that represent conveniences, for example: ATMs, Wire Transfers, Stop Payments and Returned Items.


1 Month

Channel Pricing

Charge for premium service channels that do not provide sales or relationship benefit to the customer, for example paper statements and Envelope-less ATM/ or mobile check deposit.


1 Month

Source: Novantas, LLC

sound financial footing, do not have significant home equity. Canadian banks are achieving double-digit growth in this category. Worldwide, it has been a staple in the consumer/ small business banking product set for a long time. A more fundamental innovative opportunity lies with short term cash flow-based lending to consumers. Customers liquidity and payment deferral needs are not adequately served by overdraft, deposit advance and credit card solutions. Banks are well positioned to offer dynamic liquidity lines, which provide a line of credit for short term borrowing and adjust based on household cash flow characteristics. Such lines provide valuable spending flexibility for customers without creating needlessly large exposures for the bank. These concepts, like everything related to consumer credit, benefit greatly from the payments-related information advantage inherent in the primary bank relationship that regional banks enjoy with many of their customers. Most regional banks could strongly improve their credit card businesses by taking much fuller advantage of customer relationship strengths. In targeting, customer access, underwriting and risk management, they have many advantages over monoline card issuers, and there is no reason for these strengths to lie fallow.

marketing through the traditional branch channel. A further challenge with virtual customers is figuring out what to do with the physical branch network in an era of plummeting customer traffic and transaction volume. Most banks are making tough decisions about branch capacity and staffing without the full picture of customer transaction patterns in each local market. Also there are opportunities to harness the channel migration trend for cost reduction. Channel preferences are shifting by as much as 3% to 5% a year. This raises the need for an explicit channel migration strategy that promotes convenience and minimizes transition hassles. It also suggests that branch staff will increasingly be occupied with problem solving and advice (versus account opening and check cashing), which will be a challenging cultural transition for many banks.

skiLLs & metrics

Along with new skills, the rapidly changing environment will require new measurement systems. The emerging market certainly will be different, but it is impossible to exactly predict the right winning plays, given the uncertainty of the economy and the regulatory environment. To cope with the changes, banks will need to invest in new guidance systems that will allow them to measure, track and deal with changing customer behaviors, changing product economics and changing regulations. Some of the capabilities that need to be strengthened include: Channel migration tracking. With the rapid shift in channel preferences, banks need to know who is using which channel, for what purpose, and the implications for profitability (for example, we have found that the virtual domiciled customer is only 40% to 50% as expensive as branch-centric customers to serve). To manage expensive sales and marketing efforts going forward, it will be critical to understand which products are originated online by which customer segments. In our experience in building such tracking systems, banks have not yet pushed customer management databases down to the level of channel/transaction patterns, and there is a need to substantially invest in this expanded capability. Better cost accounting. Branch-based payments businesses, i.e. retail banks, have near term, substantial fixed cost (perhaps only 15% is variable), yet with historically fat margins (as much as 40%50% ROEs). In former hospitable markets, careful costing has not been a strategic requirement. Given the rapid shift in customer behavior and the likelihood of razor thin margins going forward, however, banks need a far better understanding of cost dynamics to guide them through the transition

deaLing with virtuaL customers

Banks are pursuing a host of initiatives to improve sales and service productivity, and one of the most important is capitalizing on changing channel preferences. Branch transactions are declining annually across the industry as customers become ever more comfortable with remote alternatives. According to Novantas research, infrequent branch users, essentially virtual domiciled customers, now constitute from 20% to 40% of the customer base at various banks. While these customers may open accounts at a branch, they seldom return for subsequent services. This trend mirrors that of other retail industries, such as electronics stores and book store chains, which have seen sharp declines in storefront traffic. Over the past five years, in fact, our research indicates that among new retail banking customers, the majority are virtually domiciled. This development has caught many retail banks flatfooted, with no formal strategy for a multi-channel marketing that is now fully coming to life. Instead, many limp along with loosely coordinated functional teams branch, phone center, online, mobile that tend to operate autonomously and even as rivals. An immediate priority is to explicitly assign marketing and sales responsibility for virtual domiciled customers. Because of their usage patterns, they are rarely exposed to

June 2012

From Payments to Cash Management: The Next Big Idea?

Figure 2: New Ways to Serve Retail Customers and Leverage Core Relationships
Using the information advantages of core relationships, retail banks can field new credit products lines to expand the pool of eligible customers and deepen share of wallet.

Transaction Liquidity Alternative to credit card or occasional overdraft Positioned as integrated cash management and bundled with checking Dynamic line of credit based on track record

Size of balances and lines of credit

Unsecured line of credit (ULOC)

Home equity loans and lines of credit (HELOC)

Credit Card Dynamic liquidity lines & loans (DLL)

Overdraft coverage & deposit advance

Event-Based Loans Cross-sold; positioned as HELOC alternative Higher rates than HELOC; lower than credit card Fixed line based on household cash ow, lower than HELOC, higher than credit card


Source: Branch productivity benchmarking and analysis by Novantas, LLC

and identify and resolve problems. Multi-channel customer coordination. Multi-channel usage introduces the problem of multi-channel communication. This now becomes an essential capability in the brave new world. A grand plan for deploying such capabilities is probably too ambitious for most banks, so a targeted, gap-closing approach will be needed as banks invest more in direct-to-consumer marketing. New metrics. Each bank has its own favorite set of management metrics according to the strategy it is pursuing, yet fresh types of information will be needed at many perhaps most institutions. Some of the emerging metrics we believe should be considered include: Channel usage and migration characteristics (usage, account sales, satisfaction, etc.). New payment relationships acquired (gross and net). Profitability/potential of new relationships. Depth of relationships (mostly revolving and realtysecured credit). Return on sales resources (consumer and small business).

think diFFerentLy
Banks have built their retail franchises by providing payments functionality to consumers and small businesses. In turn, the industry now has 100,000 branches and billions in expenses to support across the country, largely in the service of funding the balance sheet. The retail expense base usually can be changed only gradually, given the critical need to preserve customer relationships. Yet the companion revenue streams have been quickly damaged by a number of factors, creating, in essence, the perfect storm. In righting the business, banks have completed the first round of responses this past year, largely crisis mode actions to trim costs and boost revenues within the existing product set. Longer term, banks will need to think differently about the retail payments category, both the products and the distribution system that will be needed to support the business and fund the bank.

Rick Spitler is a Managing Partner at Novantas LLC, a management consultancy based in New York City.