2017 was a series of ups and downs for banks. The recently passed tax bill lowered their rates which will boost their bottom line and any interest rate hikes will goose their lending revenue. But new competitors lurk around every corner as technology giants such as Amazon, Facebook and Apple are launching consumer-facing financial products that chip away at the relationship between banks and their customers.
Competitive pressures are driving banks of all sizes to find the latest software to help generate new revenue or build a firewall around exisiting businesses that are under attack.
Wealth management accounts are usually funded by retail accounts but many banks are having trouble retaining deposits from their smaller clients. Most of the assets that could have gone to bank wealth offerings are being sucked out by asset management behemoths such as Vanguard, Fidelity, and BlackRock, according to Drew Sievers, CEO of digital advice provider Trizic.
Charles Schwab's robo-advisor platform is a distant number two to Vanguard, but since they also own a bank, a portion of that inflow is just money being moved out of one pocket and into another, Sievers observed.
Banks are searching for new sources of revenue outside of lending as they lose deposits, since they also lose the net interest margin (NIM) on their lending business, Sievers pointed out. The mid-tier and smaller banks are the ones under the most pressure, he added, because the top 40 banks have other revenue sources such as debit and credit cards.
Full-service wealth management firms are falling behind retail banks in the general use of digital applications across the enterprise, Sievers reported. This is particularly evident in mobile where banking apps are some of the most downloaded, primarily due to their remote deposit functionality, he noted.
There is a "Game of Thrones" struggle going on between retail banks and wealth management firms as to who owns digital-first customers, Sievers claimed.
Consumer-focused giants such as Facebook, Microsoft and Amazon have been investing heavily in artificial intelligence (AI) to improve how their products can predict their customers behavior and preferences. Amazon has been plowing profits into this technology for the past twenty years and has made significant strides in AI fields such as big data and machine learning.
In machine learning, algorithms are "trained" to make predictions from large sets of data without having to be reprogrammed for each new set. Amazon uses machine learning to automatically predict prices for millions of products and for forecasting recommendations based on customers' purchase history. This has been one of the biggest drivers behind Amazon's incredible 29% average sales growth over the past ten years.
The Seattle-based e-commerce giant has extended their reach into many bank markets including payments, cash management, small business lending, consumer credit and a recent push to encourage customers to shop with Amazon using their debit cards. Research also shows millennials have no love for traditional banks and would rather manage their money with a more reliable and "fun" brand like Amazon, Facebook or even WeChat.
US banks are still in the first few innings of the digital advice game and are lagging behind other countries in some areas, according to InvestCloud's Chairman and CEO, John Wise. However, the US is moving the fastest and our financial institutions have a history of reacting quickly when market opportunities present themselves. Europe and Australia are ahead, but do not have a significant advantage, he estimated.
Retail banks with wealth management arms who plan to implement digital advice channels should select technology that offers a flexible product recommendation engine, Wise stressed.
InvestCloud was mainly known as a provider of client portal software before purchasing UK-based Babel Systems and their multi-currency trading and portfolio accounting platform early last year. Their system provides a configurable engine where a bank's CIO can define relationships between products as well as the rules that determine which ones to recommend based on what a customer buys, Wise explained.
Multiple asset classes including loans and insurance are supported in InvestCloud, which counts JP Morgan Chase as both a client and an investor after they recently took an equity stake in the financial technology provider.
Fee compression has been an industry concern for quite a while. It started moving into crisis mode with the explosion of robo-advisors with their transparent, rock-bottom pricing.
Up until now, wealth management firms have been able to spare their advisors from feeling too much fee compression by squeezing rates paid to asset managers and reducing home office platform fees, noted Randy Bullard, General Manager at SigFig.
Both banks and wealth management firms need a digital advice solution to better scale their business and service more clients without increasing costs. Advisors are also driving the move towards passive investments to protect their own fees, but the next 50 bps reduction will eventually have to come out of their pocket, Bullard insisted.
Offering additional value-added services, such as active tax management, are one of the best ways for advisors to enhance their offering. From my article with Rich Dion, How Advisors Can Use Technology and Service to Fight Fee Compression:
Active tax management is an excellent example of a premium service that reinforces and expands the value proposition of the advisor, generating additional revenue in the process. Most notably, it does so without additional expense and/or overhead while the client experiences a higher level of personalized portfolio management.
Fee compression isn't happening as fast as people think, Sievers argued. Most of Trizic's clients are still charging full fees, but they are also preparing for future downward pressure by implementing technology to lower operating costs as well as adding financial planning, he elaborated.
Small Accounts Strategy
As advisor fees have been coming down, account minimums have also moving in the same direction, even faster in some cases.
However, advisors can no longer just take on loads of small accounts as lottery tickets and then underserve them since they don't make enough money, Bullard warned. Their choice is to either stop taking on small accounts or service them through digital advice, he stated.
Digital advice can enable support for small accounts in retail banking, Wise explained. A good digital strategy drives costs down for customers that might not have been interested in before, making the wealth business more interesting for banks, he pointed out.
New technology will allow banks to offer more complex, commercial products through their digital advice platform, Wise added. These include letters of credit for business owners, which will provide new opportunities to gain business accounts through a self-directed channel, he described.
Most banks and wealth management firms have some form of digital strategy, Wise noted, but whether it is good or not is a matter of opinion. For example, just making your website prettier is not a good digital strategy, he joked.
Over the past few years, banks were watching the robo-advisor trend and feeling pressure to get "something" digital out there, described John Yackel, Executive Managing Director, Envestnet. Many of them wound up launching stand-alone digital advice tools that were not integrated with the rest of the bank's wealth management infrastructure, he noted.
These stand-alone digital advice implementations initially made sense to bank management since their advisory, brokerage and trust divisions were separate lines of business (LOB) with their own technology infrastructures, Yackel explained. However, due to margin compression and increased regulation, banks are looking to consolidate these LOBs into a single organization to reduce costs, facilitate compliance and provide more holistic client service, he observed.
Yackel proposed that success will require banks to implement horizontal integration of technology and a standard digital footprint across all LOBs and across all client segments; Mass Affluent, HNW, UHNW and Institutional. It is imperative to have the same digital strategy for all clients, not just those who are opting into it, he stressed.
Besides consolidating infrastructure across LOBs, banks should also look to avoid balkanizing their mobile solutions into separate retail and wealth solutions, Trizic's Sievers warned. Mobile banking has tremendous market penetration, he noted, and there is an incredible opportunity to add wealth services as well, But the top 250 banks want a single solution for all channels as part of an omni-platform strategy without any out of band interactions required, he insisted.
A major reason why omni-platform is so important is the high cost of client acquisition, Sievers emphasized. Some estimates of client acquisition costs for digital advice run as high as $1,000 per account. Being able to convert existing retail clients into wealth management clients is key for banks to maintain profitability.
Trizic's software can run digital wealth inside of a bank's mobile platform and enable opening and managing wealth management accounts, Sievers explained. This is due to their complete API-based solution that exposes all of their functionality and makes it accessible from other bank applications, he stated.
Trust is the Key
The brokerage side at most banks is growing faster than the trust side, Yackel countered. Because the brokerage business has more of a sales culture and the technology is better integrated
Trust accounting systems are meant to promote their line of custody, but that model is not working, Yackel countered. When the broker-dealer is growing at 3-4x than the trust division, the bank's back office systems need to be more supportive of brokerage accounts and processes, he declared.
Trust accounting infrastructure is usually more expensive to run based on the way their contracts were negotiated over their broker-dealers, Yackel explained. So, the broker-dealer custodians went to their bank clients and recommended that any new accounts that were agency only and did not require a trustee should be opened on their side instead of on the trust accounting system. They could handle them cheaper, faster and provide better technology, he asserted.
The average brokerage account is $300-$400K while the average trust account is $3-4 million, Yackel reported. It used to be that trust departments had minimums of $1 million and up. But new technology is enabling banks to create trusts for smaller account sizes, offering co-trustee services for existing clients that have the potential to receive inheritances.
Fidelity Private Wealth Group has done an excellent job locating next generation clients that are in line to receive inheritances and building stronger relationships with them, Yackel described.
Their recently announced partnership with FIS has provided Trizic with the opportunity to develop much tighter integrations with their popular trust accounting platforms (which they got from the Sungard acquisition) Charlotte, AddVantage and Global Plus, Sievers stressed. Since lots of banks with trust charters and brokerage have just one set of books and records, if they want to open an agency account, they still need to operate inside the trust accounting system, Sievers explained.
Hybrid Advice Will Win
According to a report from MyPrivateBanking, hybrid robo advisory strategies represent a paradigm shift in the pace and path of change in the wealth management industry. MyPrivateBanking estimates that hybrid robo services will by 2020 grow to a size of USD 3,700 billion assets worldwide; by 2025 the total market size will further increase to USD 16,300 billion. This number constitutes just over 10% of the total investable wealth in 2025.
Most full-service wealth management firms acknowledge the potential of hybrid advice (at least when there are no advisors around), SigFig's Bullard noted. But any digital advice product must avoid undermining advisors and also check the box so the board can say that they have an online widget.
A digital advice offering must elevate the advisors' value proposition, which requires complexity, Bullard asserted. Digital advice should be complimentary to the additional services that advisors offer so they can justify their 100 bps fee. If not, then advisors become only marginally productive, since they have difficulty justifying their cost when most of their work is handled through digital advice, he noted.
A Game of Thrones
Banks have an advantage because they don't have the same conflicts of interest as full service wealth management firms. Plus they have a large base of retail accounts where the penetration of wealth service is miniscule. If they can go from 1% to just 5% there is tremendous revenue potential, which is good for both clients and the bank's P&L. If any retail bank could convert double digits onto digital advice, they would become the next Apple in market cap terms.