There is an enormous but untapped potential for securities distribution through banking channels.

In 1991, banking institutions sold about $10 billion of proprietary and private-label mutual funds. Another $8 billion to $10 billion in mutual funds and $9 billion in annuities were sold through third-party broker-dealer marketing companies working with banks.

Emerging Industry

While these are respectable numbers for an industry that is only about 10 years old, a census conducted by my firm, American Brokerage Consultants Inc., suggests that the bank-brokerage industry is only beginning to emerge.

Over the next decade, banking institutions have the opportunity to become a true powerhouse in the brokerage business and the dominant distribution channel for mutual funds and other packaged products.

A Thorough Approach

Our census included 6,083 commercial banks and 1,556 savings and loans.

We decided to do a census rather than a survey because we wanted to find out what each individual institution is doing.

While a survey would have provided some broad statistical measurements of the industry as a whole, a census provides detailed data on each and every bank in the census population. We believe this is the only census of its kind ever taken.

Survey Methodology

We divided the banking institutions into five groups based on assets:

* $50 million to $100 million.

* $100 million to $250 million.

* $250 million to $500 million.

* $500 million to $1 billion.

* $1 billion to $10 billion.

In total, 39% of banking institutions are now offering brokerage services to their customers.

The percentage of institutions offering brokerage services increases with asset size.

For example, only about 31% of institutions with assets from $50 million to $100 million offer brokerage while about 57% of institutions between $1 billion and $10 billion offer these services.

An institution's size also has a big influence on the type of service offered.

Big Banks Offer Full Service

Full service, defined in our census to include institutions that employ registered staff who work directly with customers in making investment decisions, is offered by only 9% of the institutions in the group with the smallest assets and increases to 35% in the largest.

About 16% of banking institutions offer full-service brokerage.

One in Four a Discounter

Discount brokerage services are offered by 24% of all institutions.

The percentage is between 22% and 26% for all groups.

The appeal of full service against discount brokerage is more apparent, however, when institutions that do not offer any type of brokerage services are excluded.

For example, among those institutions that provide brokerage services, discount brokerage is offered by 71% of institutions with the smallest assets but only 39% of the institutions with the largest assets.

Conversely, among the institutions that offer some type of brokerage, full service is offered by 29% of the smallest institutions and 61% of the largest.

Entering the Business

As bank brokerage services have developed, many banks that entered the business by offering discount services have expanded the range of their services by subsequently offering full-service brokerage. In doing this, some banks simply switched from discount to full service.

However, many banks have continued to offer discount brokerage to service a particular market niche of investors and are also offering full-service brokerage to reach a distinctly different type of investor.

About 16% of the financial institutions that offer brokerage services offer their customers both types.

Smaller Banks Use Vendor

Not surprisingly, smaller institutions are far more likely to use a third-party vendor to provide brokerage services than are larger banks.

Of those institutions offering some type of brokerage, 78% of the smallest group use a third-party vendor and 21% use a bank-owned brokerage subsidiary or affiliate.

Among the largest-asset group, 38% use a third-party firm and 61% use a bank-owned subsidiary or affiliate.

Overall, 33% use a bank-owned conduit and 66% use a third party.

Advantages of Partnership

Over the past 10 years, the brokerage activities of some of the larger banks have followed a progression that began with offering brokerage services provided by a third-party firm and, subsequently, internalizing the program by forming a brokerage subsidiary and eliminating or reducing the services provided by the third-party firm.

By beginning with a third-party firm, financial institutions effectively avoid forming a brokerage subsidiary and performing most of the functions normally associated with offering brokerage services.

Another significant advantage is that it greatly reduces the regulatory, compliance, and business risks associated with starting a new business in an unfamiliar, albeit complementary, industry.

Making the Switch

However, as bankers' experience in providing brokerage services has grown and as their base of business has grown, many of the larger banks have questioned the need for continuing with a third-party arrangement.

As a result, some have chosen to take full control of their bank-brokerage program by forming a brokerage subsidiary and internalizing the services.

Long-term Viability

While there are ample reasons to believe this trend will continue, the statistical data derived from our census provides evidence of the long-term viability and continued growth of the third-party industry as providers of brokerage services to banks and their customers.

Even in the unlikely event that all financial institutions with assets over $1 billion were to internalize their brokerage services, the third-party industry would effectively be left to serve the remaining 7,100 institutions.

Of these institutions, 62% are not yet providing brokerage services.

Among banking institutions that offer brokerage, 49% have offered the services for more than five years and 51% for less. Using the number of institutions with five or more years as the base figure, the annual industry growth rates were 34% in 1988, 21% in 1989, 17% in 1990, 13% in 1991, and 21% in 1992. The cumulative five-year growth rate was 106%.

Room for Expansion

Notwithstanding the respectability of these growth rates, much of the banking industry remains untapped. For example:

* Of the 7,600 banking institutions with total assets from $50 million to $10 billion, 4,600, or 61%, do not yet offer brokerage.

* Of the 3,000 that provide brokerage services, more than 1,800, or 60%, provide only discount brokerage. Since discount brokerage is used by 20% to 25% of investors, upgrading to full service would reach the other 75% to 80% of investors and would greatly increase their volume of securities sold.

* Of the 1,800 institutions that provide discount brokerage, 950, or 52%, do not employ any registered employees to sell securities. These institutions have virtually no securities contact or continuing service relationship with those customers who use their service.

Small Vendors to Grow

Moreover, while the third-party industry is dominated by a relatively small number of firms, our census identified a total of over 400 third-party firms which are providing services to about 2,000 banking institutions.

Clearly, there are a large number of third-party firms that are providing services to only one or two institutions. As they gain experience in working with banks, it is inevitable that most will seek to increase their market share by providing services to additional banks in their market area.

From every angle and notwithstanding its success over its short 10-year history, the banking industry represents enormous future potential for distribution of securities products.

There is ample evidence to expect substantial growth in both in-house brokerage units and third-party firms.

The question for bankers who are still sitting on the sidelines is not if but when.

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