Bankers are appropriately conservative. Nowhere is this tendency more evident than in the industry's cautious embrace of the Internet.
Many observers, especially the new Web entrepreneurs, feel the industry has been overcautious, loath to change its staid and steady ways, and too afraid to accept the Internet's unstoppable march on financial services.
The common assumption is that the industry's wariness is based on an unfounded fear of cataclysmic technology failure. Web proponents view these doomsayers as present-day Chicken Littles. The proponents argue that despite business disruptions, real or imagined - ransom-minded hackers, innumerable server crashes, and insidious e-mail viruses - consumer and business financial activity over the Internet has not ground to a halt.
For the record, the denouement of the Chicken Little story is that he, Henny Penny, and the rest of the barnyard fowl did succumb, not to the sky falling but to the wiles of the neighborhood fox. This wily animal took advantage of their misplaced fear - and failure to perceive the real danger - to persuade them that he would be an ally.
My point is that just because the fowl were worried about the wrong danger does not mean everything was swell in the barnyard. Chicken Little's real failure was poor risk analysis.
Internet skeptics have unwittingly deflected bankers' attention from the real risk: wasting significant time and money pursuing ill-conceived "new business models." Rather than fretting about a systemic technical breakdown, the industry should be concerned about the foxes of Internet banking. Advocates for these new models, motivated by the potential of an Internet get-rich-quick IPO, look suspiciously like foxes hungrily eyeing their prey.
The industry has every right to be wary of the business propositions of Internet entrepreneurs who talk nearly as fast as they lose money.
Take Web-based loan exchanges as an example. Proponents of loan exchanges ask bankers to believe that they can book more loans by letting an Internet site collect and route loan applications to them. What we have here is simply another form of indirect credit, as loans originated elsewhere are presented to the bank for approval.
For bankers willing to absorb the risk inherent in indirect lending, pay for the privilege of underwriting the same application 40 other lenders are looking at, and incur the cost of complying with the broker's technology interface and processing demands, perhaps this is a viable idea. Unfortunately, these are not the only problems with Web exchange schemes.
As the principal players in this service line admit, only 10% to 12% of applications received at their sites are actually converted to loans. Further, an exceptionally high percentage of the applicants fall somewhere well below subprime on any risk-rating scale.
The cost to generate these unqualified applications is horrendous. Marketing expense consumes 85% to 90% of revenues. No exchange operator has adequately articulated how this burden is going to be relieved.
Another faulty Web model is the deposit auction. Bankers, so proponents of this model argue, should be able to reduce their cost of funds by bidding at auctions for consumer deposits. The business case is based on the dubious assertion that the operating cost to open a simple certificate of deposit exceeds $100. Rather than the bank's incurring the expense of locating and booking CDs, it could instead bid at an auction site.
First of all, competing on rates as an approach for cutting costs is counterintuitive. Second, assuming that a bank is comfortable using what amount to brokered deposits as a major source of funding, some costs may indeed be saved. However, the only way that the entire $100 cost of acquiring a CD can be seriously affected is not only to eliminate all marketing, sales, and operating costs but also to drastically reduce the allocated costs that make up most of the $100.
Is there any scenario in which cutting such costs as executive salaries, occupancy expenses, or, for that matter, any other allocated expense is believable? Not in the real world.
Alas, a money desk is still a money desk, and brokered deposits are still brokered deposits, no matter how much they are dressed up in Web technology. The industry has a decidedly negative history with both, an experience that explains why branch acquisition deposit premiums are hovering around 10%. It is worth that much to acquire stable, local core deposits.
All the automation in the world is not going to help so-called new business models for Internet banking. The real danger to the industry is not that these approaches are technically flawed. It is that they are fundamentally bad ideas. Even if the infrastructure works perfectly, the underlying business cases have already failed bankers too many times.
"Let the buyer beware" should guide bankers' assessments of these old ideas' being repackaged in new technology.
Tom McGrath is managing partner of Bank Earnings International of Orange, Va.
