Retail has long been considered "the jewel in the banking crown," the one area of unquestioned profitability and the creator of considerable shareholder value over the course of a complete interest rate cycle.

Yet retail banking, and especially its branch component, which has historically been the source of most of that shareholder value, is threatened with what some have described as a downward spiral of declining profitability. One reason is that the branch-based business at present satisfies only one or at most two of the five basic financial need of the consumer.

As identified by Citibank some years ago, these five needs are for transactions, credit, investment vehicles, investment advice, and insurance protection. In the past, the branch met the need for transactions, credit, and investment (mainly through deposits), but was precluded both by law and custom from satisfying the need for advice and protection.

An Unmet Need

As matters now stand, the typical branch still satisfies the need for transaction services, although its preeminence in this area is being challenges by institutions poised to erode the banks' monopoly access to the payments system. It only peripherally satisfies the consumer's need for credit, although the rest of the retail bank takes reasonable care of the remaining demand in this area. Most importantly, the branch satisfies progressively less of the customer's need for investment vehicles.

A Growing Apprehension

Yet this need, as well as that for advice and protection, has never been greater. In large part, this is because middle-class Americans are becoming increasingly apprehension about the capacity of the Social Security system and private pension plans to provide them with a decent living standard when they retire.

It is well known that the ratio of active to retired workers is falling inexorably and will begin ratcheting downward even more sharply within about a decade and a half. This raises doubts as to whether there will be enough resources to meet commitments to future retires. Indeed, a survey of baby boomers conducted a few years ago revealed that 59% of those currently paying Social Security taxes did not expect to collect any benefits at all.

At the same time, the proportion of those Americans covered by private pension plans, which had risen steadily from 1950 to 1980, started to shrink measurably in the mid- to late-'80s Companies began curtailing once-generous pension coverage, while job changes resulting in large measure from the growing number of corporate restructurings, takeovers, and bankruptcies make it progressively more difficult for many to accumulate enough employment tenure to qualify for private pension benefits.

As a result, many formerly complacent middle-class American have become convinced that they must rely on their own resources to provide for retirement needs. And there is also a growing consensus that these needs cannot be met by simply accumulating comparatively low-yielding deposit balances in a bank.

Deposit Growth Stagnates

The upshot is that real deposit growth per capita virtually stagnated in the late '80s. And while there has recently been a spurt of deposit growth because of cyclical factors, few observers expect sustained secular growth in the '90s. It goes without saying that a continued stagnation in deposit volumes poses a grave threat to the prosperity of branch-based retail banking.

The best way to counter this threat is to reduce the bank's dependence on deposit-gathering returns, which may be declining not only because of the growing scarcity of raw material but also because of the prospective rise in deposit insurance levies. The bank must transform itself from basically a gatherer and processor of deposits into a purveyor of advisory services, perhaps offered through the existing, or very probably a streamlined, branch structure.

Ideally, the bank must transform itself into the preferred intermediary for directly and indirectly satisfying all five of the middle-income consumer's financial needs -- indeed, the intermediary that will in effect manage and protect the consumer's entire balance sheet pursuant to a financial plan that can be routinely updated to take account of the customer's requirements at various points in his life cycle.

In a sense, the key to preserving bank profitability in mass-market retail is very similar to that which is essential to achieving success in private banking. As Oliver, Wyman & Co. has previously noted, the sustained profitability to those who serve the affluent and wealthy depends on making a transition from a fragmented product-sales mode of conducting business to an integrated relationship mode. The same type of transition is needed in mass-market banking.

A Major Innovation

To be sure, many bankers would argue that the cost of managing the balance sheet of the middle-class customer is bound to be prohibitive and will far outstrip his capacity to pay for the needed services. Until recently, that observation was perhaps correct. But it may no longer be so. Creative minds are at work developing a technology that could provide the middle-income customer with a mathematically rigorous means of maximizing his or her financial well-being at an affordable cost.

Indeed, one firm claims to have solved the expense problem already. Proprietary Financial Products Inc. of Charleston, S.C., has recently introduced a patent-protected product -- the Home Account - that many financial institutions may find of compelling interest.

The underpinning of this product is a system for linking multiple accounts in order to allow the consumer to plan his investment and borrowing activities so as to maximize his aftertax returns and minimize his borrowing costs. Instead of having relationships with a host of financial service providers, each of which has only a partial and often incorrect view of his needs, the customer may be able to open a single account with a single financial institution, at an initial cost estimated to be about $300 to $400 a year.

For this fee the customer will gain access to a mathematical programming, or optimization, function, which, after recording data on his income, financial objectives, risk preferences, budgetary constraints, etc., will suggest to him a portfolio of investment and credit facilities and liability products to best realize his financial objectives over a defined time horizon.

A Key Arbitrage

The central credit facility of this product is a unique type of mortgage, separately patented, which allows the consumer to vary his amortization schedule. That is, upon reaching a prearranged loan-to-value ratio, the customer can stop amortizing the mortgage and continue to make only the interest payments. What he formerly paid to amortize the mortgage can then be allocated to, say, pension funds, thereby lowering taxable income and raising retirement savings by taking advantage of the accumulation of tax-deferred instruments like, say, a single premium life insurance policy.

Based on the tax savings and the fact that annual returns on both the pension and insurance investments are expected to be much higher than the after-tax cost of mortgage debt, this type of variable amortization mortgage product can greatly enrich the customer. Consider that the after-tax cost of adjustable-rate mortgage debt currently approximates 4% to 6%, while the average historical total return on mixed equity and bond pension funds has a amounted to between 11% and 13%.

This arbitrage is so powerful that a customer with a starting salary of $60,000 a year can be expected to attain a net worth of $3.6 million in 30 years, whereas the identical customer with only traditional mortgage and deposit products will be worth only $520,000.

Besides the variable amortization mortgage feature, this system features the following capacities. Presumably acting in conformity with the recommendations of his personal financial plan, which is a dynamic, constantly updated facility, the customer could, among other things, automatically transfer funds among accounts, sweep idle funds into the highest-yielding facilities, borrow against equity and debt securities, buy insurance, purchase and sell securities, commodities, and debt instruments, and transfer securities to a safekeeping account monitored by the system. Additionally, the system will churn out a single combined statement of all transactions, accounts, and positions on a periodic basis.

Serving Every Need

Equally substantial are the benefits of this type of product to the service provider. This of course need not be a bank. Indeed, banks could be disadvantaged in providing this service because of their high overhead cost structures, which are not easily rationalized. Nevertheless, people are accustomed to dealing with banks, and especially with branch personnel. And, despite some unfortunate experience, most people repose more trust in banks than they do in nonbank financial institutions.

Therefore, cost disadvantages notwithstanding, banks may be able to capture a substantial number of prospective customers for whom they will be able to take on the role of proxy balance-sheet managers. That is, the banks for the first time may be able to address all five of the middle-class consumer's financial needs, either themselves manufacturing the required products and service or, where manufacture is impossible or illegal, private labeling them.

The increased economic return to the bank provider of these services arises from three basic sources.

First, because it is integral to the realization of much of the consumer benefit, the variable amortization mortgage is likely to last far longer than the typical seven or ten years. Allowing the provider to earn the lush mortgage servicing fees for a longer-than-usual period on a larger-than-usual principal greatly raises the net present value of the mortgage product.

Second, the average annual fee of $300 to $400, while not steep, is still about 50% to 100% higher than the average of the fees now earned by typical providers of packaged financial services - for example, Merrill Lynch with its CMA account.

Third, whereas the run-of-the mill provider of packaged financial services rarely obtains access to more than 15% to 20% of the customer's wealth, the provider of this system can be expected to administer at least 60% of that wealth. This increased penetration will, of course, generate supplemental asset-management fees.

Building Loyalty

The combined impact of these sources is estimated to be as follows: Currently, the net present value of the profits from serving a customer earning a $60,000 salary with a home mortgage and a typical package like the CMA amounts to about $4,300. Factoring in the value of increased account duration and the extra fee dollars, the provider of the new integrated service can quadruple that discounted value, to some $17,000.

Beyond these tangible revenue gains are other benefits that will arise from heightened customer satisfaction and loyalty. The average consumer currently displays little loyalty to his many financial institutions, which bombard him with a spate of unorganized product offerings that he is unequipped to evaluate and which may or may not satisfy his individual needs.

Utilizing this new system, the average middle-class customer can begin to make intelligent choices about his financial future. As a result, his loyalty to the single provider of this account is bound to swell mightily. At the very least, this will enable the bank to reduce customer turnover, paring the onerous expenses of new-customer acquisition. At best, it will enable the bank to forge indissoluble bonds with its customer base -- bonds that will act as a formidable barrier to market entry by prospective competitors. All things considered, this kind of product seems like a win-win opportunity. Mr. Rose, formerly senior columnist for this newspaper, is now associated with Oliver, Wyman & Co., a management consulting firm in New York

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