Banks questioning how much to invest in electronic delivery and payment systems will find it comforting to know that branches aren't going to vanish any time soon. Even so, PC banking and electronic bill payment are expected to experience steady growth in the next four years. The bottom line: Build a technology infrastructure that supports an integrated product distribution strategy. What follows are excerpts from The Tower Group's new report, "Trends in U.S. Consumer Financial Product Delivery Systems," which limited its research to retail banks and excludes financial products sold by related businesses, such as finance companies and mutual funds not sold by banks. A number of factors influence the volume of transactions that are processed by U.S. retail bank delivery channels including consumer acceptance, convenience, availability and cost. This research discusses how financial product delivery channel transaction volumes will change between 1996 and 2001. Changes in transaction volumes are driven by both usage and economic factors. This study assumes that population will grow at 1.5 percent per year and that the percentage of unbanked households will decrease from approximately 15 to 10 percent as a result of government legislation which will require Electronic Benefits Transfer (EBT) for all government transfer payments by 1999. As a result, overall banked households will increase by approximately 2.7 percent compound annual growth rate (CAGR) by 2001. This will not create a 2.7 percent CAGR in transaction volume because these new customers will use substantially fewer financial services than the average customer. Tower estimates that the effect of this economic growth on transaction rates is between 1 and 2 percent. Banks support several different distribution channels for the delivery and servicing of financial products and services. Banks wishing to compete in the broad consumer market must offer all channels in order to remain competitive. Banks choosing a more niche- oriented strategy can be more selective and offer a limited number of channels. Although the newer electronic channels are significantly less costly than traditional channels, they do not offer the same set of services, flexibility and sales effectiveness as the traditional branch channel. Most importantly, many consumers are still not comfortable performing all of their financial transactions through electronic channels. The growth of approximately 7 billion direct channel delivery transactions per year is generated by relatively small shifts in consumer behavior. A portion of the transaction volume increase is generated by population growth and an increase in the percentage of banked households within the population. These two factors will increase the number of transactions by between 1 and 2 percent. On a per household basis, the transaction volume increase equals a total of 3.5 additional transactions per banked household per month. Bill payment, a new product and completely additive to the total transaction volume, contributes approximately 1.3 new transactions. The balance of transactions, 2.2 per household per month, is caused by increased usage. The increase in direct channel transactions is generated by an increase in bank payments and the wider availability of electronic channels. Relatively small movements from cash payments to bank payment mechanisms, such as debit/POS, will cause an increase in the number of transactions necessary to service the higher bank payment volumes. Tower estimates the average per household bank payment usage will increase by 16 transactions. Branch, back office and on-premise ATMs constitute the traditional delivery channels. The on-premise segment of the ATM market has remained relatively stable for the past five to seven years. Recent and future growth will be in off-premise deployments. The new channels (off-premise ATM, call center, remote PC banking and bill payment) are still growing strongly, and will take an increasing share of transaction volume over the next five years. Overall, the number of direct channel transactions will grow from 32 billion to almost 39 billion over the next five years. All of this growth will be focused in new channels. Total branch volume will remain stable but branch sales and service transactions will decline as transactions move to teller and call center channels. Back-office transaction volume will decrease substantially during this time as banks reorganize their operations to use call centers more extensively. The mature cash dispensing channels (teller and ATM) were the two largest generators of transactions with a combined share of 63 percent in 1996. Although their share will decline slightly to 60 percent by 2001, the volume will increase from 20.2 billion transactions in 1996 to 23.1 billion transactions in 2001. The branch channel was the largest generator of transactions in 1996 with 12.2 billion transactions and 38 percent share. Branch transaction volume will remain almost stable at 12.6 billion in 2001, while declining to 33 percent of total transactions. ATM transactions will exceed branch transactions in 1998 as the inquiry and account maintenance transactions are migrated from the branch into the call center channel while ATM transactions grow. It is important to note that approximately 60 percent of all ATMs were located in branches in 1996. The transaction volume from the branch sited ATM machines when combined with branch teller and sales and service transaction accounted for 18.6 billion transactions and 58 percent of the transaction volume in 1996. This transaction volume will remain level over the next five years, but the share will drop to 48 percent in 2001. New channels grow very slowly because wide availability of a channel is necessary to promote broad usage. Banks, however, are reluctant to make infrastructure investments before they are assured of a high enough level of usage to make the investment profitable. Remote PC banking, bill payment and retail debit/POS have had difficulty gaining the critical mass necessary for broad consumer acceptance and reasonable returns on the large investments necessary to make these channels effective alternatives. The recent rapid growth of remote PC banking and bill payment is the result of increased PC and modem purchases for other purposes, such as: school work, games, information and entertainment from the Internet, and home business applications. Consumers have justified the relatively high capital cost of a PC and modem for these other uses, allowing banks to sell remote PC banking and bill payment for the small incremental cost of the service. The growth in transaction volume is focused in the non-branch channels, which account for 94 percent of transaction growth. Remote PC banking and bill payment have the highest rate of growth followed by retail call centers. The more mature ATM channel has a significantly lower growth rate, but because of its large existing transaction base, the growth of ATM transactions equals the growth of the fast growing channels. Over the next five years, attended transaction volume will be level while self service transaction volume will increase. As a result, there will be a 9.4 percent increase in the share of self- service channels. Within the attended channel group, banks are shifting transactions from the higher cost branch sales and service channel to the multi-product retail call center channel. Similarly, back office transactions are being shifted to both retail and product call centers primarily as a way to improve cross selling productivity and provide segmented levels of service. Consumers are opting for self-service Product call centersocredit card, mortgages, student loans, etc.oare fairly mature and will not grow as rapidly as retail call centers. Longer term, these operations will be combined into the retail call centers and provide second-level expert support in focused product areas. The self-service channels are all growing. The most significant growth will occur in the remote PC banking and bill payment channels, which are growing at a combined CAGR of 71.5 percent from a small base of about 200 million transactions in 1996 to 2.5 billion transactions in 2001. The interactive voice response (IVR) channels will grow proportionally with the expansion of the call center agent volume. Finally, the ATM channel will reach maturity over the next five years as it becomes more broadly accepted and continued deployments in off- site locations increases its availability. The number of workstations will decline at 1.9 percent CAGR from 748,000 to 681,000. The most significant loss will occur in the back- office channel as banks aggressively move transactions into call centers. Call centers will not add an offsetting number of workstations because IVRs absorb some of the transactions, and call centers operate for almost twice the number of hours at a higher efficiency level than the average back office workstation. A similar process is reducing the number of workstations in branches. Branches are being downsized, operating hours extended, and administrative transactions are being migrated to call centers. What's on the distribution horizon Administrative and financial transactions will grow by 6.3 percent and 4.1 percent CAGR, respectively, over the next five years. Administrative transactions will grow faster for three reasons: rapid growth of bill payment; increased use of bank payments such credit and debit/POS cards; and increased acceptance, availability, and convenience of electronic banking channels. Longer term, the remote PC banking channel could significantly reduce the number of statements mailed by banks. The legal issues regarding credit statements will delay the replacement of lending- related statements. Deposit account statements, which account for 1.8 billion transactions annually, could be substantially reduced through this channel. During the next five years, however, Tower believes that consumers will still want to receive printed statements in addition to the statements delivered through the remote PC banking channel. Consumer behavior changes slowly. Small shifts in usage patterns have a large impact on delivery channel volumes. New delivery channels are growing rapidly but traditional channels will continue to process higher volumes of transactions. Delivery channel strategy must be built on a flexible and balanced view of the strengths and capabilities of each channel. Revenue generation can be maximized and overall servicing cost can be minimized by optimizing the delivery channel mix. New channel transaction volume growth requires industrial strength solutions to meet high availability requirements. Broad consumer acceptance of multiple channels will require mass-market banks to support all channels. As consumers adopt multi-channel usage patterns, they will expect a unified system that provides accurate, consistent information at each delivery point. Traditional channels will continue to be major transaction sources beyond the 15 year investment horizon. Bob Landry, author of this report and a banking consultant with The Tower Group, can be reached at 617/965-9090, or via the Internet (rlandry

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