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The chief executive of one of Europe’s biggest banking groups shakes his head in disbelief. “The US is one of the most technologically advanced countries in the world,” he says. “But its banking services are some of the most backward.”
Welcome to the backwater that is US consumer banking. This is the country that spawned the technological heroes of modern commerce – the Apples, Googles, Facebooks and PayPals that play such a role in our daily lives. And yet many of the people and businesses that use US banking services find themselves with systems and access that would be rejected by their counterparts in most so-called developing world countries.
How can it be that while other countries’ consumer banking industries embrace digital innovation – building mobile payments technology, supporting mandated faster payments, implementing chip and pin (EMV) technology, and adding greater transparency around fees – the world’s richest economy has failed to follow suit? According to a study by AT Kearney, the US ranks behind the UK, Denmark, Sweden, Singapore, Norway and Australia in terms of having a regulatory environment that can support digital banking.
Even the country’s authorities realise that there’s a problem.
“There is so much innovation happening in payments systems outside of this country. The US banking system is not on the leading edge,” says Sean Rodriguez. He heads the Federal Reserve’s Faster Payments Task Force that was set up this year to examine how the country can join the rest of the world in moving to faster payments.
The US is not among the 18 countries that have now implemented same-day payments. In 2012, NACHA (the National Automated Clearing House Association) on behalf of its 11,000 US financial institutions, voted against a move to same-day payments. In the US payments still take two to five days to move between banks, with many same-day payments requiring a wire transfer that comes with a minimum $30 fee.
Payments are just one part of a larger picture of a US consumer banking industry where banks have delayed innovation in fear of losing out on fees. Rodriguez calls it “inertia”. Some might call it protectionism.
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These are smart people. They don’t want to be disintermediated and that is their motivation Sean Rodriguez, |
The big US banks – all of which Euromoney asked to interview for this article – declined to comment.
But the likes of Uri Levine, co-founder of FeeX, have plenty to say. “Financial services are more expensive in the US than in Western Europe. We have to ask why is that?” says Levine. “The realization will dawn soon that the industry is just so strong that it allows the banks to make huge profits at the expense of the US consumer.”
FeeX is attempting to reduce the $600 billion in annual fees the global financial industry charges. One of FeeX’s backers is none other than Vikram Pandit, former chief executive of Citigroup (one of the banks that declined to answer our questions).
Fortunately for the US consumer, innovation means that alternatives to the traditional US banks have appeared. Peer-to-peer lenders offer loans at 7% rather than at credit card APRs of 15%. New online banks have zero ATM fees. Online savings banks offer 100 times the interest of a large retail bank. Payment transfer firms like Venmo allow consumers to bypass banks and make peer-to-peer payments for free.
At last, such start-ups are hitting the bottom line of the Luddite incumbents. In 2014, for the first time in five years, the US banking industry posted a yearly decline in profits.
“It’s going to become more and more embarrassing for the US banks and credit card companies as they fall further behind their foreign competitors and the fintech innovators,” says one banker.
Some argue that unless the US banks move fast it will be more than just an embarrassment. It could knock them out of the global financial race entirely. “If the Federal Payments Task Force does not succeed in innovating the US banking payments system, its country’s banks will be left behind and outside of the banking framework that the rest of the world has adopted,” says Josh Reich, founder and CEO of online bank Simple Bank, one of the new banks aiming to gain market share from the branch-based incumbents.
Complexities
How did it come to this?
To say the US payments landscape is backwards due solely to the attitudes of the country’s banks would be unfair. The evolution of the banking system in the US, coupled with the country’s vast size means the payments system is far more complex than that of many other countries. “We have 12,000 financial institutions of all sizes and all business models so it is hard to make a comparison to other countries,” says Rodriguez.
Robert Flynn, head of payments in North America at Accenture, says much of the complexity stems from a glut of M&A activity in the 1990s. “US banks were so busy focusing on integration that they simply left alone the payments space and could end up having five ACH systems operating at one time. Europe was already ahead in branch banking and the customer experience, and now has been able to move a long way ahead in payments.”
The US has also ignored the retail banking industry to some extent. “It’s a case of it’s ‘good enough’. But we might no longer be competitive with foreign firms,” says Brian Knight at Milken Institute. Those foreign firms are gaining traction in the US. Spanish bank BBVA acquired US online bank Simple Bank last year. Dutch bank ING has also been expanding in the US but in commercial banking.
Jimit Aora, vice president at consulting and research firm Everest Group, says that regulation in the US has instead focused on fixing the capital markets rather than consumer banking. “Dodd-Frank has consumed the financial industry and innovation has revolved around capital markets. Banks have taken their eye off of what needed to change in consumer banking. This is why our consumer experience rates lower than what we see in Europe.”
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Uri Levine, co-founder of FeeX, says: 'If we create transparency then the market equilibrium will move to a different place and that money will be returned to the people' |
The UK is one of the 18 countries that has moved to real-time payments. Michelle Whiteman, a spokesperson at Payments UK, says being a smaller market made it easier to collaborate and gain support for faster payments efforts. Where the UK further benefitted is that the regulator stepped in. A task force was set up in 2005, with the initial launch taking place in 2009, and regulation coming into effect in 2012.
According to a survey by Swift, of the 18 countries that now have a real-time payments system in operation, 14 countries implemented this as a result of a regulatory initiative.
“Banks generally update their capabilities based on consumer demand and regulation that mandates change,” says Travis Ledwith at IBM Financial Services. The latter is unlikely to happen in the US.
Indeed the US banking system does not often accept government interference unless it is clear that it will not dent profits. In 2004 the government did introduce the Check 21 Act that mandated check imaging for deposits – that ended up being a cost benefit to US banks. A 2010 research paper from the Federal Reserve Bank of Philadelphia estimated the savings to the payment industry to have been worth more than $1 billion in those first six years.
The cost/benefit to banks of faster payments is less clear to US banks, which may explain their inertia. Rodriguez says that their biggest concern is how to adapt the business model to retain profitability.
So Rodriguez is taking a soft approach: “In the US we look to the private sector to drive innovation in the payments system. But given the innovation happening worldwide we need to look at the whole value chain and help get the country moving. Our strategy is to try to help the US payments industry come together and have a dialogue about what could and should be our collective focus. That approach culminated in our strategies paper in January. We have 300 people now sitting on the faster payments task force so feel we have been successful in building energy and enthusiasm.”
The task force’s 300 members comprise merchants, financial institutions, consultants and fintech companies with a third representing financial institutions. It is charged with developing on the themes laid out in the January paper – identifying effective approaches for implementing a faster payments capability in the US.
Motivation
NACHA reversed its move at the end of last year to support the discussion for same-day payments and join the task force.
Rodriguez is confident that the task force will provide a solution to the US payments challenge. “The incentive is there for sure. These are smart people. They don’t want to be disintermediated and that is their motivation. They see the innovation happening and understand what the user wants. Consumers manage their accounts on a real-time basis and so want to know that the money they see in their account when they log in, is the money they have.”
It’s hard to gauge what the US banks think about the move to faster payments. They aren’t speaking about it. One person on the task force points out: “First rule of task force is, you don’t talk about task force.”
Not everyone is convinced it will work. “We will see. Three hundred people can stall progress. In the end I think the Fed will need to put its foot down,” says one task force member.
It’s easy to be sceptical. The track record of the US consumer banking industry is one that has focused first on profits and second on changing business models. Even in light of competition and foreign advancements it is hard for US bankers to talk about a new business model when alarm bells of lower profits are ringing in their ears.
Ledwith thinks that consumers will have to be the driving force for banks to change. That may happen.
The US consumer is beginning to wise up. Real-time payments would help to reduce the $35 billion in overdraft fees that US consumers pay each year. Many overdraft fees are incurred simply because customers cannot see their account balances in real time and make mistakes with their budgets. Expensive mistakes. A $6 overdraft at Bank of America for six days will cost you $70.
The whole issue of fees in the US is being thrown into the spotlight thanks to new entrants and innovators. It’s late in coming. The average fee on an interest-based checking account in the US rose from $10.74 to $14.76 from 2006 to 2014 according to personal finance website Bankrate.com. Alongside that, the average balance required to avoid the fee more than doubled to $6211 from $2660.
“In non-interest checking accounts only 38% are now free, down from 76% in 2009,” says Greg McBride, chief financial analyst at Bankrate.com. “Fees have been going up for years.”
He thinks that trend is unlikely to reverse. If that is the case, US banks will lose out. Innovators and foreign banks are demonstrating that, in the new order of digital banking, fees actually kill business rather than grow business.
Simplicity
Simple Bank, an online bank that launched in the US in 2012, is proving that the focus on fees for revenue generation is an outdated business model. Simple has hundreds of thousands of customers and charges no fees on anything – not even international ATM withdrawals. Josh Reich is an Australian national who co-founded Simple.
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I used to think that bankers were just nefarious people thinking of ways to screw over their customers. But… Josh Reich, |
“The real frustration I had in the US was that the large banks make money because their customers are confused,” he says. “The fees and charges are unaligned with what the customer truly wants. Not only that but those fees are designed to prey on consumer psychology. And when the consumer rails against the fees, the fees simply get moved elsewhere – like onto ATM withdrawals,” he says.
ATM withdrawals pulled in $7 billion in fees last year for US banks. The argument retail banking heads make is that the high cost of real estate that an ATM requires means that other bank customers should pay to use them – and vice versa. Not only that, but US banks charge their own customers if they don’t use their ATM. The average cost of making an ATM withdrawal at a bank that is not your own in the US was $4.35 last year, according to data from Bankrate.com.
As US banks increasingly shut their branches to save costs, ATM fees will become more onerous for the consumer. Simple Bank has been smart in ensuring its customers have access to ATMs fee-free without the cost of running a branch. It has teamed up with STARsf ATM Networks, which has ATMs in convenience stores as well as large brand stores like Dunkin’ Donuts. Its purchase by Spanish bank BBVA last year means it now has access to BBVA Compass’s ATMs. That’s 55,000 ATMs in total that are free to Simple’s consumers. It’s not dissimilar to credit unions that also use ATM networks for their customers. They have some 50,000 ATMs. Compare this to Chase Bank that has 16,000 (down from 18,000 in 2012). Bank of America has a comparable amount.
So how does Simple make money? “Our revenue comes from interest and interchange, and as a company we’re lean,” says Reich. “We currently have 300 employees, and we operate on the cloud so data storage is less costly.” It could not be a more different model to the traditional US retail bank.
Reich says US bankers have to change their mindsets. “I used to think that bankers were just nefarious people thinking of ways to screw over their customers. But what I have learned is that banks are just poorly organized. In 1990 the average cost of processing a retail bank account on bank technology was $250. In 2011, it was the same cost. The biggest complaint by banks is the data they have to process and store, and they aim to minimize that.”
This is a grave error, he says. “We want more data – that creates a greater level of connectedness with your customer. They can upload and see the photos that correspond with the financial decisions they have made in their lives and they feel good and encouraged to make better financial decisions. Using cloud technology the marginal cost to store data is zero and it enables us to deliver a unique customer experience.”
Reich says the problem is that bankers think in terms of financial accounting, but that will no longer work. “They think about acquiring customers through branches or from acquiring other banks. They haven’t learned to compete on other vectors or aside from fees which is why new entrants are succeeding.”
He gives an example of the difference in the mindset of consumers versus bankers. “If you ask a banker – how do you get customers to save more? He will say – increase the interest rate on their savings account. Wrong. Our clients on average are 28 years old. Across the nation that age group has a negative 2% savings rate. With us that age group has a +10% savings rate.”
Simple does not pay a higher interest rate than average but rather has created an online and mobile planning application called “Goals” that allows consumers to set saving goals, and move funds immediately. “It tells you what you are safe to spend and how you can spend today without eating into your savings and it is interactive and feels personal,” says Reich.
Some 36% of the deposits with Simple are set aside by its customers for future purposes. That will mean bigger revenues as the number of customers grows and will allow Simple to move into lending – a future aim.
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Nick Clements, |
Savings accounts are also where banks are being disintermediated. Nick Clements was head of the UK consumer business for Barclaycard before leaving to co-found consumer banking education website MagnifyMoney.com. He says traditional US high street banks do not even try to service savers. That has opened up opportunities for online savers like Ally Financial and Synchrony Financial. “They offer 1.05% or higher for online deposits – that is more than 100 times the 0.01% that the four largest banks offer,” Clements says. “The banks are an expensive, inefficient intermediary between the borrowers and the savers. That’s going to be fatal in the long run for them. Deposits will move to where the best savings rate is yet banks are so focused on making customers pay for bricks and mortar when they should be getting rid of it.”
Clements also points to personal loans in the US as being ripe for disruption. “In the UK, banks will offer personal loans at 5%. Not so in the US when banks can make more money on credit cards. Which is why Lending Club and Prosper are doing so well in the US – they fill that gap for people to consolidate credit card debt at a lower rate. If an online bank could start to offer lower rate personal loans, then the traditional banks would really be squeezed out because lending revenue from credit cards would be under threat.”
Reich says that the gap between US banks and European banks needs to be reduced. “In Europe there are plenty of regions where there are very transparent fees and they are aligned with what customers want. US banks are flailing around offering snazzy mobile platforms or white label products that will not work as the consumer increasingly becomes aware of being nickel and dimed.”
And aware they will become – across every part of financial services as disrupters base their businesses on transparency. Disrupters like Levine’s FeeX. “$600 billion is paid annually to financial institutions in fees,” he says. “Half of bank revenues are in fees. A quarter of credit card revenues are fees. Money managers – it’s all fees. The consumer is unaware.”
Before FeeX, he co-founded Waze, the community-based navigation app that has more than 200 million users worldwide.
Levine, who refers to himself as the Robin Hood of fees, is taking on the retirement industry first. “No one knows what they are paying for their 401k but on average they will lose one third of their savings to fees.”
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Levine’s aim is to lower that $600 billion to $300 billion and put the money back in the hands of the consumer. “If we create transparency then the market equilibrium will move to a different place and that money will be returned to the people.” FeeX estimates its average user saves around $50,000 by using its free service, which has had about 30,000 users already. New firms such as Stratos Card and Plastc are also leading to greater transparency over credit card fees. Stratos, like Plastc, is a subscription-based card service that offers an alternative to mobile payments. Via their smartphone, consumers can load cards onto the one Stratos card to use as payment – typically a debit card, a credit card and a corporate card – but also loyalty cards.
It saves consumers carrying multiple cards but it also means that information on those cards is being collected in a central place. The biggest value is in the data and subsequent analytics – that will be the disruption. Consumers receive analysis on their cards used and the benefits and disadvantages of each card for each purchase.
“The unintended consequence of the analytics means consumers will be better informed about the costs and benefits of cards they use and they will become wiser,” says Thiago Olson, chief executive of Stratos. “It’s not hard to imagine that if a consumer is being constantly reminded about discounts, offers or fees to use with his cards, he will certainly make smarter decisions at the point of sale.”
It would be positive for both merchants and consumers. Banks have done a great job in turning the credit card into a method of convenient payment rather than purely for credit. That catches consumers out with fees but it also means that merchants are being hit more often with interchange fees for credit card payments. And US merchants pay larger interchange fees than those in other countries – typically 2% to 3%. Innovations in mobile payments and cards such as Stratos could reverse the trend back to cash and debit.
Competition
The US banking model has to change. What can it learn from overseas? Denmark’s Danske Bank, which launched its MobilePay service in 2013, which can be used by non-Danske Bank customers as well, still has fees but has moved to a package-based model. Mark Wraa-Hansen, head of MobilePay, says: “We don’t believe in increasing fees to get around regulatory costs. And we don’t believe in hiding from innovation in order to protect our fees. We do still have fees but we offer different packages depending on the services a customer requires. There is a choice and it is very simple and clear to the consumer what they are choosing.”
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Alfian Sharifuddin, DBS |
Alfian Sharifuddin, group head of consumer banking channels technology at DBS, says the Singaporean bank set up a digital banking unit 18 months ago that employs a wide array of technology and business professionals in nontraditional areas of expertise such as usability designers and data scientists.
US banks would also be smart to start buying competition rather than defending against them – otherwise fintech and foreign firms who are more open to innovation will move in. PayPal now owns Venmo for example. BBVA has Simple Bank.
Some could move to a business model more like a wholesale bank. As with Simple Bank and Bancorp, and now BBVA, traditional banks could provide the back end for online and innovative entrants. “It would be an interesting idea – for banks to become wholesale and let new online players build their front end, says one former banker. “The bank could end up with most of the margin, while the online front end ‘bank’ takes a share.”
If they do not adapt they will lose their most profitable customers, says Clements. “At the moment, millennials are most open to using digital startups instead of traditional banks. That is a risk for sure, but they are not yet the most profitable segment for the banks. The real disintermediation will come with the affluent customers. All of a sudden when those customers move $100k to a savings account with Ally for example because they will be getting $1,000 in interest rather than $10 at their bank – then banks will start to feel a lot of pain.”
On the other side, customers that incur overdraft fees or have large credit card balances will find alternative and cheaper options. Says Clements: “There is a risk that US banks will be left with their least profitable customers – customers who have low balance checking accounts but don’t borrow are getting a good deal and will probably stick around for a while, while people with either big savings or big loan balances will switch.”
The Fed’s Rodriguez says the financial institutions recognize the urgency to make changes when it comes to a more efficient payments system. “We first suggested a 10-year horizon but got the feedback that that was far too long. Now we are looking at three to five years.”
Even that may be too long. New payments firms are being developed daily that get around waiting for governments or the traditional financial industry to innovate. Abra, for example, offers person-to-person transfers without the bank in the middle by creating a marketplace via an app and digital currency.
Says founder and chief executive Bill Barhydt: “For a decade now we’ve been hearing that US banks will move to same-day payment. If they really wanted to adopt it, it would take only a few months. But with digital technology no one is prepared to wait anymore. Look at digital currency and cross-border payments. You can bypass central clearing. Innovation will simply move around the US banks and come up with solutions without them.”
