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Online Banks Outgrowing Brick-and-Mortar Rivals

When Andy Collins walks through a crowded suburban shopping mall, he doesn't see shoppers all around him. As the vice president of emerging payments for USAA Federal Savings Bank, a direct financial institution without a single traditional branch to its name, what Collins sees is perambulating banks.

With smartphones capable of depositing checks, monitoring balances and moving money between accounts, Collins explains, "all those people walking around potentially have a bank in their pocket."

Direct banking, once a clunky adjunct to traditional banking that involved the phone, the Internet, attractive interest rates-and lots of calls to the help desk-is going mainstream.

Advocates of traditional banks may have seen ING Direct's recent sale to Capital One as a sign that the direct-bank model was finally getting its comeuppance. But that was no fire sale, and in fact there is evidence that the country's four major direct banks, Ally Bank, Discover Bank, Capital One 360 (as ING Direct was recently rebranded) and USAA, are starting to nibble the lunch of their brick-and-mortar competitors, and not just the big banks and large regionals but community banks and credit unions as well.

In a new study by research firm TNS, direct banks stood out as the only category of banks to gain share in the past decade among retail customers establishing or moving their primary banking relationships. The share of new relationships captured by the large, national banks, the regional banks, and even the community banks and credit unions was flat to down. But the direct banks, which a decade ago attracted about 3.5 percent of new, primary retail banking relationships, have since increased that share to about 8 percent.

Deposits at the major direct banks have more than doubled over the past five years-a growth rate that is three times the industry average for the period. Ally Bank, for example, says its deposits hit $35 billion last year, up 25 percent from 2011, while deposits at Discover Bank reached $27.9 billion in 2012, up 5 percent for the year, according to the company.

Even Barclaycard US, the latest entry in the direct banking field-which, because it launched last May, was not included in the TNS survey-is off to a fast start, garnering $1 billion in deposits by October and $1.5 billion by January of this year.

"This is going to be an important funding source for our $14 billion credit-card operation," says Steve Carp, head of deposits at Barclays US. "That's what we were hoping for and it's one of the key reasons we got into this direct banking business."


Besides selling into a customer base that is increasingly comfortable with the idea of banking mainly by phone or online, direct banks have shown some success in attracting consumers with desirable demographics.

Customers of the four big direct banks skew young (a full 45 percent are in the 25-to-44 age bracket) and wealthy (according to TNS, 36 percent have household incomes of $100,000 or more, something that can be said of only 23 percent of American households overall).

These customers also have significant assets. Nearly 40 percent of them have at least $100,000 to invest. Only 28 percent of all U.S. households have $100,000 or more in investable assets, according to TNS' study.

As Morningstar equity analyst Dan Werner points out, the growth rate for direct banks, while healthy, is on a small base. According to the TNS study, direct banks only hold about 5 percent of total primary banking relationships in the United States, compared to 30 percent for community banks and credit unions, 27 percent for regional banks and 37 percent for the big banks-but at the same time, theirs is the only share that's growing.

"The brick-and-mortar banks will have to figure out how" to compete, Werner says. He says it will be a challenge for them to match the savings and loan rates offered by banks that have no branches in their cost structure.

"We are growing at the traditional banks' expense. That's true," says Collins at USAA, which is the oldest and largest of the four big direct banks, with a market share greater than all its direct banking competitors combined. "Even as the traditional banks try to enter the field of direct banking, we think we can continue to be a fierce competitor."

Discover Bank's president of consumer banking and operations, Carlos Minetti, is similarly optimistic. "We believe that the direct banking model is very viable, and that it will prevail," Minetti says.

Discover has one physical branch, located in its headquarters state of Delaware. "It's a great branch," Minetti says, hastening to add that even so, there are no plans to replicate it.

"Physical branches will become irrelevant," he predicts. "I think you'll continue to see a role for small branches on the business banking side, but we're a totally consumer banking company, so we don't see any need for that."

His vision of a branchless future may be starting to take shape already across the Atlantic in Scandinavia, where direct banks have been making a sizeable dent in the retail market. "I've never seen branches closed so fast as they're doing there," Morningstar's Werner says.


(1) Comment



Comments (1)
The direct banks are leveraging their low operating costs to cherry pick higher balance accounts (and younger, more affluent consumers), leaving traditional branch-based institutions with lower balance, high cost-to-serve business. And their growth and market share aren't constrained by physical footprint. The trends cited in this article will only persist, and most likely accelerate.
Posted by MrPotter | Monday, March 11 2013 at 12:49PM ET
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