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Two-tier banking


There are very strong trends in consumer banking towards dis-intermediation and fragmentation with regard to product distribution. The main driver behind this is the Internet and a rapidly emerging class of people who are technologically enabled and who are focused on extracting the maximum service benefits from the emerging distribution channels. There is no doubt whatsoever that the Internet based banking facilities are creating a new paradigm which is changing the face of banking universally. This raises the question whether the traditional type of consumer banking is heading towards extinction or we are likely to see an environment of two-tier banking in the developed world.

Consumer Banking
Typically consumer banking throughout the developed world has been based on branch based networks, where the consumer has paid substantial charges for current account facilities and even heftier fees for buying and selling shares. Return on savings accounts has been minimal along with complex conditions for minimum balances and notice periods. In the 80s a number of European banks came up with telephone banking, offering an alternative form of banking without reference to a specific branch and provided a better level of service with lower transaction charges. The banks who invested in this form of distribution channel wanted to identify and retain a certain type of (profitable) customers who were likely to need a more responsive service and whose needs could be satisfied easily by a remote back office with reduced transaction costs. This new form of distribution channel based on call centre banking, although a bold move towards customer oriented solution, is coming under tremendous pressure from net based entrants who are creating a service model which combines low transaction charges, high savings rate and a quality of service which branch based banking systems are unable to match.

Prudential's Internet based Egg savings account has revolutionised the savings accounts in the UK by paying an interest rate which is greater than the prevailing interest rate. The Egg savings account service started life as a telephone cum Internet based banking service but is now wholly based on the Internet. Similar distribution channels are now operating successfully by Virgin and Standard Life. More recently First-e, an off shoot of Paris based Banque d'Escompt has launched a Europe wide Internet based banking service offering savings, current and investment banking at extremely attractive rates to discerning consumers. It is estimated that over the next 5 years Internet based banking systems will capture 60% of the retail savings and mortgage accounts. All major high street banks are creating net based banking systems, Barclays bank claims that 1m customers already have opened net based accounts and within the next 12 months this number will go up to 10m.

Private Banking
Private Banking remains a specialised banking service for high net worth individuals (HNIs) who are willing to pay at least 1% of the total value of their portfolio in fees to their bank for the privilege of having their wealth managed by professionals.

Up until recently this sector of business has been quite stable and free from threats. The relative stability of client revenues, the generally lower levels of credit risk involved and a rapidly increasing population of HNIs, have pushed the business to the top of the list of priorities for a large number of banking groups around the globe.

In a survey by Merrill Lynch, around 6 million people across the world were found to have liquid assets in excess of $1m. Indeed in some banking groups Private banking Business is the most profitable area of business. Here too the economics of the business are changing as customers become more demanding, in service levels and in investment performance. Some studies show that people who inherit their wealth are more likely to delegate the management of their money but people who have created their fortunes are more interested in pro-actively managing their wealth. There is a frequently quoted anecdote about Barbara Streisand waking up at 6 am everyday to manage her portfolio on-line. In any case the Private Banking business is no longer a safe, stable business sector the domain of oak panelled offices and gentlemanly Client Advisors.

New entrants on the net are offering services and facilities for HNIs where investment management becomes a self managed and pro-active business activity. If the private banking institutions want to prevent their customers from switching over to net based private banking services, they will need to focus more on the returns they produce, the quality of information they provide to their customers and the fees they are charged.

Investment Banking
Typically a £5,000 telephone trade in the UK by a private investor to buy or sell a stock with a high street bank costs £75 in commission. Increase the size of the trade and you may end up paying several hundreds in dealing charges. Even for this level of charges the banks do not provide any electronic portfolio management and the customer is expected to pay for custody charges in addition to dealing charges. On the net however, the service levels and transaction charges change dramatically. For those who are technologically enabled, on-line trading and portfolio valuation as well as much reduced dealing costs is a service model they are rapidly becoming accustomed to. In the UK, there are more than a dozen discount brokers who provide on-line trading facilities where trading charges a fraction of what is normally charged by traditional brokers and the investors can enjoy real-time prices and index quotes as well as instant credit to the value of existing investment or a multiple of the value of the portfolio.

The Internet based consumer facilities, banking or otherwise, bring out in to the open two extremely important constructs: “Quality of Service” and the “Transaction Cost” of the service.

It is impossible to predict how the entire consumer banking business will look like in 15 or even 10 years time due to the rapidly evolving impact of the web and the mobile telephony. However, it is obvious that in the developed world we now have and will probably continue to have for the next 10 years at least, a two-tier service model in finance and banking. The traditional type of service model as we have known for decades is not going to disappear and will continue for most of us, where we pay high levels of charges for financial services obtained through expensive, inefficient brick and mortar based banking houses in the high street.

A number of segments in the general population will remain attached to this service model, including the pensioners, the under privileged or those who do not possess the capability to surf on the net or those who do not bother about too much about the service charges.

Then there will be a parallel service model for people who are technologically enabled and who have the financial acumen to look for the best of breed, via the Internet in terms of quality of service and the fees they are expected to pay. They will be the winner as they will pay minimum charges and obtain the best returns from their savings and investments.

The new entrant will continually chase this select band of customers by offering better quality of service globally with less and less charges. Banks that do not provide the services of a quality and at a cost the customers want, will find that customers will shop around by using the net and jumping ship.

Customers in both of these service models will want information quickly and the service providers will need to minimise their transaction costs. An ordinary checking account customer, a high net worth individual as well as a private investor will demand information fast and more accurately and will have the choice from global institutions such as Charles Schwab, E*Trade and First-e. This demand for fast and accurate information and reduction in transaction processing costs requires technology based solutions.

For the traditional service model we need solid and accurate back office systems which provide straight through processing at low transaction costs coupled with real time access to information by front office people. For the new net based service model we need seamless solutions where customers, front office staff as well as prospects, can extract information on real-time basis reflecting movements in the market place, carry out order management and perform portfolio valuation. However, the system most banks offer remain in their infancy and it is estimated that tens of million of dollars of investment is required to provide solutions which embrace the net based service models with the back office functionality in a seamless manner.

Mahmood Hameed
ERI Bancaire London offic




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