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Transforming Consumer Banking Through Internet Technology

A Guide to develop successful online banking solutions through the use of Internet technologies

Introduction

Internet Banking Comes of Age
For more than 15 years, industry experts have predicted that home electronic banking would finally reach a critical mass of consumer acceptance and that it would soon be commonplace to pay bills and access financial accounts from home. And every year, the banks and financial institutions that believed the predictions spent millions of dollars developing, marketing and supporting their early home banking systems. The investments they made weren't just the multi-million dollar expenditures for the custom consumer software applications that many developed. They also had to create massive new IT departments to design and support the proprietary back-end systems, and install and maintain the hundreds of dial-in lines and racks of modems their customers would use for access. Virtually without exception, these home banking systems failed to meet expectations and were soon scaled back in scope or abandoned entirely.

Today, online banking is finally a reality, both in rapidly growing consumer acceptance and in the financial results being seen by institutions that are deploying state-of-the-art electronic banking.

What is different this time around? First, the huge investments required in proprietary IT have disappeared almost entirely. With the rise of the Internet and standard TCP/IP networking, banks can now offer online banking without dial-in lines, modems and all of the necessary equipment and people needed to support them. All that's needed now, from an IT standpoint, is a standard connection to the Internet, at a cost that can be as low as $1,000 per month.

Second, the development of universal standard protocols such as OFX and Integrion Gold make it easier for financial institutions to support online banking without any investment in client software development. In the past, the development of software for consumer use was one of the major expenditures in delivering an online banking solution. In addition to the costs of developing and testing software were those incurred in duplication, distribution, technical support and maintenance upgrades. Banks also had to decide if they were going to target sophisticated banking customers by including full budgeting and financial planning features. Or they could target less sophisticated users by offering only simple transaction processing, bill payment and account statement access. Either choice limited the market's acceptance of the solution.

Today, developing an online banking solution using OFX, for example, allows a bank to please both types of consumers while removing all of the costs associated with the development, distribution and support of client software. A well-designed solution will automatically allow users of the predominant consumer financial software packages such as Microsoft Money™ and Intuit's Quicken™ to access statements, pay bills and initiate transactions. At the same time, the system permits access via the Internet for customers who don't need full financial planning but want a full range of transaction and account access features such as bill payment, fund transfers and statement review. In both cases, the burden of client software support and development has shifted to either the Web browser developer or the financial planning software developer. The bank is free to focus on the critical areas in which it can add value for its customers: back-end system functionality, product design, marketing and customer support. More importantly, both the bank and its customers can begin using online banking.

The third major change affecting the acceptance of online banking is the availability of effective and reliable transaction security systems. One of the biggest concerns about online consumer banking has always been the security of the systems and the protection of sensitive transaction data. While security remains a major issue for both the bank and its customers, there are solutions today that are cost effective and permit an unprecedented degree of security, reliability and protection from misuse.

This white paper explores the growth in online banking and the ways in which financial institutions can take advantage of Internet technology to offer cost-effective banking solutions. It outlines how the Internet is affecting banks, thrifts and financial services companies today—and what some of the opportunities will be in the future. Next, it introduces a four-phase framework for understanding the different ways banks can get online—and the advantages of each level of online commitment. Finally, it offers some suggestions for developing an Internet banking offering. The paper concludes with a few tips for implementing an effective online strategy.

The Growth of Internet Banking
Internet banking is growing faster today than most financial services institutions had ever expected. Today, roughly 4.5 million households use Internet banking and or bill payment at least once a month, and that number is expected to increase to 33.5 million—nearly 31% of all U.S. households—by 2005.

What's contributing to this growth in online banking and bill payment? First, Internet usage is on the rise. Today, more than 100 million people have Internet access worldwide, and that number is increasing daily. Second, improvements in technology and customer acceptance have propelled the role of electronic commerce. More than 10 million people have made a purchase online, and that number is expected to grow. And third, more banks, thrifts and other financial institutions are realizing the benefits of online banking and are developing a presence on the Internet.

A USWeb study of 1,000 of the largest financial services companies in the United States (all with annual sales of at least $250 million) revealed that 93% of banks plan some type of Web development within the next few years. The question for the banks, thrifts and other financial services institutions that have yet to incorporate the Internet into their business plans has shifted from "Should we get online" to "How should we get online?"

Internet Banking as a Strategic Necessity
Given the wealth of opportunities the Internet creates for financial services companies, and the accelerated pace with which banks are going online, having an Internet presence will become a strategic necessity for most banks, thrifts and other financial services institutions.

To understand this, consider the affect of ATMs on the banking industry. From 1977 to 1988, Citibank, an early adopter of ATM technology, increased its market share in New York City from 4% to 13.4%. Many analysts agree that ATMs were a substantial driver of that impressive growth. Indeed, in its early stages, the ATM was a source of strategic differentiation for Citibank and other early adopters. But, as the technology was deployed more widely, the source of value associated with having ATM technology shifted. Today, ATM technology doesn't differentiate a bank—it's expected by consumers as a basic service offering. ATMs have migrated from a differentiator to a strategic necessity.

There's no question that Internet banking will soon follow the same path as ATMs, migrating from a strong competitive differentiator to a basic and expected service. Consumers will expect to be able to check balances, pay bills, transfer funds and review transactions from anywhere, much as they now expect to be able to retrieve cash wherever they go in the world. And they'll expect that they can do this from any Web browser, or from whatever financial software package they've selected. Although Internet banking is following the same path as ATMs, the speed with which it is being adopted is dramatically different. While ATMs took approximately 15 years to be widely accepted, Internet banking will take a fraction of the time.

With Internet banking on track to become a strategic necessity for all financial services companies in the next few years, the window for making it a strategic advantage for banks is rapidly closing. For a bank to remain competitive and properly service the needs of its most attractive customer base, it must plan and deploy an online banking strategy that is consistent with its overall goals.

The Opportunity for Internet Banking

The Internet poses enormous opportunities for banks, thrifts and other financial services institutions to fundamentally reshape their organizations. The benefits of the Internet permeate an organization—from marketing and sales to back office and operational functions. These benefits have caused financial organizations to view the Internet as more than a marketing communications tool and to begin to successfully employ the Internet as a new channel for their services. Some of the most relevant benefits of Internet banking follow:

Increase Customer Satisfaction
Internet banking allows customers to access banking services 24 hours a day, 7 days a week. Like ATMs, Internet banking empowers customers to choose when and where they conduct their banking.

An American Banking Association and Gallup Poll survey revealed that the primary reason customers maintain an account with a particular financial services institution is convenience. This implies that in order to retain customers today, banks need to offer their services through multiple distribution channels: physical branches, telephones, ATMs, kiosks, screen phones, PCs, and the Internet. The more delivery channels a bank offers and the more functions available on an Internet site, the more convenient it becomes for customers to conduct business—and the higher the rate of customer acquisition that a bank is likely to experience.

Expand Product Offerings
Internet banking allows financial services institutions to capture a larger percentage of their customers' asset base. Today, banks and thrifts compete with brokerage houses, insurance companies and mutual fund companies for a growing share of consumers' financial assets. The Internet allows banks to offer new services—brokerage, mutual funds, insurance, mortgages, car loans and credit cards—either directly or indirectly from their Web sites. Banks or branch offices that don't offer these services have the opportunity to co-brand offerings with specialty companies. These limited co-branded specialty offerings are often pre-packaged turnkey solutions that require limited marketing attention but provide immediate benefits. For example, many community banks offer instant approval of consumer and mortgage loans via the Internet and telephone. Rather than build this capability themselves, they outsource the processing of the data to a third-party loan processing company.

In many cases, relationships can be structured to allow institutions to participate in the revenue stream that is being created between their customers and the partner organizations. Perhaps most importantly, they allow institutions to maintain and control the relationship with their customers, while offering superior services that they might not otherwise be able to provide.

Increase Customer Retention
One of the primary reasons people change banking institutions is that they have relocated from one area to another and, as a matter of convenience, desire a bank that provides access and services in their new location. While many banks offer ATM, bank-by-mail and telephone banking services, customers often find that these services do not meet all of their needs. With the rise of Internet banking comes the ability to conduct most, if not all, of a typical customer's banking online, either via Web access or through personal finance software. The services that are offered online may be exactly the same as those available through a combination of telephone, ATM and bank-by-mail. However, customers using an online "branch" do not report feeling the same degree of isolation or the perception of being "second-class" banking customers. When a comprehensive online banking system is designed, an online "branch" gives customers the perception of actually visiting the bank, interacting with employees and conducting business, rather than trying to use the services of some physical branch from a remote location. Online branches have been shown to dramatically reduce the loss of customers due to relocation.

Extend Geographic Reach
Many banks that have significant online banking systems report that in addition to increased customer retention rates after physical relocations, they are seeing new customer growth outside their home regions. And this growth comes from new customers who have never lived in the bank's home region and will likely never visit a physical branch. Supplemented by national ATM networks, bank-by-mail services and telephone banking, some banks have begun marketing their services nationwide without having any physical locations outside their home territory. This extension of a bank's geographic "draw" area to include virtually anyone on the Internet is often one of the most overlooked benefits of a well-designed, well-marketed online banking system.

Cross-Sell Services
Internet sites collect useful data in ways that are virtually impossible to collect through any other medium. Tracking software allows a bank to monitor which Web pages customers (and prospective customers) view—and how long they spend viewing them. This information, when combined with customer databases, allows financial institutions to target banking products and services more effectively to customers. The moment an individual logs onto a Web site, a customer database can identify what products they currently have in their portfolio, which products they have inquired about and which they are most likely to purchase. Then, using personalization software, the Web site can display a unique advertisement or promotion to capture the customer's attention. This advertisement might cross-sell a product, suggest a change in account status or provide some other form of valuable information. The Internet allows banks to develop sophisticated, personalized marketing campaigns and increase cross-selling success rates.

Identify Profitable Customers
As discussed earlier, the Internet allows companies to capture transaction and customer information more readily than any other financial services delivery channel. In addition to using this information to market special products and services, some organizations use customer data to determine whether or not a particular customer, or an entire customer segment, is profitable.

A comprehensive customer database facilitated by a Web site helps to identify which customers are most profitable and to target special offerings to maintain their loyalty. Not surprisingly, most banks find that Internet banking customers tend to be the most profitable ones. A 1996 Booz, Allen & Hamilton study showed that the average online banking customer uses 3.2 banking products (compared to two for the average customer). It also showed that in particular segments, Internet customers are on average three times as profitable as non-Internet customers. In addition, according to FIND/SVP, the average Internet user has a household income of more than $66,700, compared to $42,000 for the average U.S. household. Similarly, Internet users tend to be better educated than non-Internet users. This combination of statistics implies that the most attractive and profitable customers are most apt to demand online banking both today and in the future.

Reduce overall costs
Internet banking reduces a bank's costs in two fundamental ways: it minimizes the cost of processing transactions and reduces the number of branches required to service an equivalent number of customers. According to the American Banking Association, the average cost for a full-service branch transaction is roughly $1.07. Since an Internet banking transaction links directly to the back-end processing system, an Internet transaction costs roughly $0.01.

The savings associated with Internet transactions are even greater due to the small incremental cost of servicing additional Internet customers compared to the large cost of opening a new branch. It's important to note, however, that many banks don't anticipate realizing the true benefit of transaction cost reduction until a larger percentage of their customers use the Internet as a primary delivery channel.

Identify New Fee Services
Some banks use Internet banking as an opportunity to generate additional revenue from customers. Typically, fees range from free to $14.95 per month, depending on the level of service, number of transactions and type of account. It is still unclear whether or not banks will continue to be able to generate fee revenue from online banking. It's likely that Internet banking pricing will mimic ATM pricing. The cost to consumers will drop down to free but may eventually rise to a per transaction fee. However, given the new types of products and services an institution is able to offer and the increased ability to cross-sell and target profitable markets, it's likely that the Internet will generate increased fee revenue for most banks.

The Biggest Obstacle to Success

While there's little question that Internet banking offers substantive advantages to both consumers and financial institutions, the issue of security is often cited as a major barrier to widespread consumer adoption. While many of the actual security issues today have been addressed with recent technical advances, financial institutions may find that consumers still perceive a bigger problem than there really is. A comprehensive online banking solution must address real security issues as well as the psychological or perceived security fears of consumers.

The past two years have seen remarkable advances in the ability to provide cost-effective, highly secure transactions over public networks. With the widespread adoption of secure firewalls, 128-bit encryption schemes and digital certificates that accurately identify authorized users, online purchases and transactions have skyrocketed. In fact, many experts now say that a well-designed online banking system is less vulnerable to fraud and attack than a physical bank location or an ATM. While no system could ever be called "perfectly secure" any more than a branch office could be, the cost to the institution of providing extremely high levels of security is much lower for a complete online system than is typically spent to "secure" a single physical location.

With the technical issues of security properly addressed, the institution must be able to reassure consumers that security and privacy problems have been solved. Financial institutions are turning their focus to educating their customer base about the types of security put in place on the Internet to protect their financial information and what to look for to ensure that their transactions are secure. Additionally, banks must be sensitive to issues of privacy and provide customers with written assurance that their personal information will not be exploited.

The Four Phases of Internet Banking

A bank typically considers four phases in developing an Internet presence:

• Phase One: Marketing and Promotion
• Phase Two: "Light" Interactivity
• Phase Three: Full Transactions and Services
• Phase Four: Strategic Usage

While most banks migrate from phase to phase in the order given, some skip Phases One and Two altogether and move directly to Phase Three: Transactions and Services.

The following table highlights some of the key distinctions of the four phases.

The resources required to pursue these phases are highly dependent on a bank's back-end processing system and technology infrastructure. There is not necessarily a correlation between bank size and the phase in which the bank is currently operating.

Phase One: Marketing
Launching a Phase One presence involves very little risk. Generally, banks consider Phase One to be a learning experience. They use existing marketing and promotional material, adapt it for the Internet and develop a Web site. Phase One requires minimal investment, limited maintenance and limited resources. Often only one or two employees are involved in creating and maintaining the Web site, thereby reducing the burden on the organization. In fact, many banks outsource the creation and management of the Web site to a qualified specialist or service firm. Engaging in Phase One provides the opportunity to learn about the Internet and to signal to customers the importance of the Internet while promoting traditional services to a wide audience.

Phase Two: Light Interactivity
Phase Two involves light interactivity. In this phase, banks enhance their public Web sites in an effort to provide more value to existing and prospective customers. Examples of services or functions offered in this phase include online loan calculators to help customers determine their payment schedules, credit card and loan applications, and stock or mutual fund information. Banks have experimented with regular articles about financial planning, as well as explanations of financial terms and products. These services are designed to support existing customers and keep them coming back to the Web site on a regular basis.

In addition, well-designed free services on the Internet give banks an opportunity to promote their services to new customers who visit the Web site to make use of these free tools. What distinguishes Phase Two from Phase Three is that in this phase there's no link from a bank's back-end processing system to its Internet Web site. A Phase Two deployment requires a larger investment than a simple marketing site but does not require the larger systems integration investment of a full online banking system.

Phase Three: Transactions and Services
Phase Three offers true online banking over the Internet, including balance transfers, account statement access, bill payment services, account applications, check image retrieval and customer service mechanisms.

As outlined in this paper, the benefits to a Phase Three deployment can be considerable, and there are many motivations for pursuing this phase. Some banks migrate to Phase Three to retain key customers; others to acquire new ones. Some banks consider it a defensive move—they fear they will lose their best customers if they don't offer online banking. Others are looking to reduce overhead costs either in physical branch operations or customer support resources. Still others consider Phase Three an opportunity to generate fee income and to offer services they otherwise wouldn't be able to offer, such as credit cards, mortgages and mutual funds.

Phase Three deployments are considerably more complex than those of Phase One and Two, because of the systems integration requirements in connecting a public Web site to existing transaction systems. In addition, Phase One and Two deployments do not have the security concerns of Phase Three, since actual account and customer information is not available. Fortunately, due to standard protocols and security products now available, a Phase Three banking deployment costs a fraction of what it did even a few years ago, while offering all of the benefits described in earlier sections of this paper.

Phase Four: Strategic Change
In Phase Four, banks revolutionize transaction processing and customer interaction. They replace investments in "bricks and mortar" with investments in advanced Internet services and Web technology. They develop sophisticated customer databases to enable advanced customer segmentation to increase cross-sell opportunities and customer retention. They build efficient targeted marketing campaigns that boast success rates far greater than direct mail campaigns. Web-enabled decision support systems within the organization improve the creation of both targeted online and direct mail campaigns by giving bank marketing departments access to critical information and the ability to query and run simulations against these sophisticated customer databases. These advances allow banks to experiment with new ways of exceeding their customers' expectations.

Leaders in this area are launching bill presentment options and electronic commerce solutions, and they are experimenting with Smart Cards. They're creating intelligent agents that watch for particular trends in a customer's banking habits, or changes in financial or family situation, and then make recommendations for how to restructure investments or take advantage of new services appropriate for that particular customer's needs. They're using the inherent capabilities of the Internet and sophisticated databases for servicing their customers in ways that aren't possible with the traditional banking model.

For most banks, Phase Four is a vision of the future. However, it will also be the battleground of competition among financial services companies in the near future. The institutions that make the best use of the sophisticated data they have can service their customers better while improving their operating margins, and they will be the winners in the battle for customer assets. Investments in tracking, database and decision support systems to manage, analyze and use this data are wise investments for financial services firms today.

Developing an Internet Banking Offering

Regardless of which phase of online banking is appropriate for a specific financial institution, the development and deployment of a solution involves four major tasks:

• Step One: Strategy Development
• Step Two: Analysis and Design
• Step Three: Technology Development
• Step Four: Implementation

Step One: Strategy Development
In formulating strategy, it's essential to clearly articulate the objectives of the online presence. Is the institution attempting to increase margins, reduce costs, attract new customers, broaden its geographic presence or increase customer retention? Is the institution seeking to expand its own offerings to customers or partner with appropriate organizations to offer these services? Does the bank know who its most profitable customers are, and what those customers need and expect from an online banking solution?

It is also essential at this stage to carefully analyze the strategic landscape of the marketplace. Who are the bank's real competitors? What are their offerings?

A good strategy clearly defines the business reasons for developing a Web site and helps choose which phase of Internet banking to consider.

Step Two: Analysis and Design
With the strategic groundwork in place, a bank is prepared to identify technology requirements and plan the system architecture that supports those requirements. It is at this phase that the bank (or its consultants) will need a detailed understanding of the competing hardware platforms, connectivity solutions and financial transaction protocols used in the marketplace today. If the deployment is a Phase Three offering, much of the time and costs at this phase will be in the areas of connectivity with existing transaction systems, and in the careful planning of security and customer authentication systems.

A critical step often overlooked at this stage is the plan for how the system will be rolled out to existing customers and marketed to prospective customers. Issues such as the overall graphic look of the site, the online support and training information that will be necessary, and the marketing plan for attracting users to the system must all be contained in the roll-out plans.

At the end of Step Two, the project team will have detailed technical documents that delineate the overall system architecture and the functional specifications of the system to be deployed, as well as a comprehensive plan for how the system will be announced and introduced to the market.

Step Three: Technology Development
Once the functional specifications and system architecture plans are finalized, the system is ready to be built. At this stage, systems and hardware are acquired and deployed. This may take place either on site at the bank, at its transaction processing vendor's location or at a third-party hosting center, depending upon the strategy laid out in Step Two. The appropriate systems integration code will be written, tested and deployed to ensure that the relevant systems are able to communicate with each other effectively. The security and authentication systems will be deployed and thoroughly tested. At the conclusion of this step, partially or fully functional versions of the major components of the system will allow the solicitation of feedback and the identification of problems before the institution moves on to Step Four.

Step Four: Implementation
In the final step, the team assembles and tests the full production system from the technology components acquired or built in Step Three. Employees are trained in the use and support of the system. Also, the bank begins the execution of the roll-out strategy developed in Step Two to help customers understand the new offering. Finally, the bank will adopt systems for measuring the success of the project and develop a plan for maintaining and updating its Web site.

Web sites are rarely static. Once Step Four is completed, it's likely that the bank will return to Step One to update its Web site or to add functionality.

Conclusion

Online banking has finally reached the point at which it is being accepted by consumers and is financially successful for the offering institutions. In fact, banks are finding that a comprehensive online banking strategy is essential for success in the increasingly competitive financial services market.

Due to technology advances and the rapid growth of the Internet, an online banking solution can be designed today that is more effective and less costly than the proprietary systems of only a few years ago. Banking transactions can now be initiated and monitored via standard Web browser software or the major financial planning software packages. The software offers a range of features for both the casual user and the sophisticated banking customer.

In planning an online banking presence, an institution needs to consider various options, ranging from a simple marketing presence on the Internet to an advanced online banking system that revolutionizes the way in which the bank operates and the consumer conducts financial transactions. Regardless of the type of offering a bank decides to pursue, it is essential that the bank undertake a comprehensive analysis and planning process up front to ensure the success of the project