JAMES HARRIS OF BRENTWOOD National Bank is at a crossroads. Mr. Harris, who is Brentwood's president, his board of directors, and his employees are on the verge of a decision that could fundamentally affect their bank's role in Brentwood, an affluent suburb of Nashville.

The question is simple, but with myriad implications: Should Brentwood National offer mutual funds to its customers?

"It's just so different from anything we call community banking," Mr. Harris said last week. "In the long run, I think it's extremely dangerous."

Thousands of community bankers share Mr. Harris' concerns. And over the next decade, as the mutual fund industry targets banks as the next great frontier, those bankers will face the issues he's grappling with now. Massachusetts Financial Services Inc., a Boston mutual fund company, estimates that only 30 percent of the nation's 10,954 community banks offer mutual funds to their customers.

The $84 million-asset Brentwood, founded in 1987, has lost millions of deposits in the past two years to alternative investments, Mr. Harris said. Much of the money is going into mutual funds, the hottest investment vehicle in the land.

In recent months, Mr. Harris and his board have entertained several proposals from mutual fund providers, eyeing a typical third-party contract that would put an investment representative in the bank.

"My concerns are deep," he said. "You have the potential for moving deposits into investments that are outside of the community. It's a huge change because it takes us out of our role as a financial intermediary for this community. Also, a third party is going to be very aggressive in trying to get our depositors' money."

|A Valid Argument'

This "disintermediation" -- the outflow of community-based bank deposits into alternative investments -- is already going on, however. It leads Mr. Harris to wonder: If he can't beat them, shouldn't he join them?

The mutual fund companies "all say that," Mr. Harris noted. "It's valid argument."

He is also worried about alienating customers if investments go sour. His board is split on what to do, he said.

First International Bank in Watford City, N.D., went through all this seven years ago. The $100 million community bank started offering a family of mutual funds through a third party in 1986.

First International President Stephen Stenehjem said that disintermediation got so bad in the mid-'80s that he was forced to look to mutual funds.

Competition from the broker-dealer in his bank, who represents Investment Centers of America, is not a problem, Mr. Stenehjem said. And, he said, the mutual fund service has apparently not speeded the outflow of deposits. "Interest rates are a bigger reason, not the availability of mutual funds," he said.

Jeremiah Potts, head of the financial institutions division at Massachusetts Financial, which markets loaded mutual fund services to banks, understands Mr. Harris' fears. Mr. Potts was instrumental in his firm's recent deal with the Independent Bankers Association of America to offer mutual funds to community banks through the trade group.

Responsibility to Customers

"Clearly, the community bank has a responsibility to fund the community," Mr. Potts said. "But it has a responsibility to its customers to assure certain things ... things that a deposit alone can't provide."

Brentwood's management is still tentative, however. Mr. Harris said the bank will continue to sell fixed annuities a while longer before making a decision about mutual funds.

"It's a conservative banker's approach," he said.

Subscribe Now

Access to authoritative analysis and perspective and our data-driven report series.

14-Day Free Trial

No credit card required. Complete access to articles, breaking news and industry data.