Smaller banks forced to evolve in the wake of the pandemic

A BMO Harris Bank branch and ATM.

Digital transformation

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  • The coronavirus pandemic is transforming how regional and community banks think about physical and digital retail banking.
  • Regional consumer banks like Citizens Financial Group and BMO Harris are pushing the envelope on their digital offerings.
  • Companies like BrightFi, Glia, Blend, and Mantl are sensing the opportunity, creating tech, and raising millions in venture capital to help those regional banks exploit it.
  • Meanwhile, physical bank branches are expected to suffer continued closures, fueled by digital adoption and public-health concerns.

For all the attention the big banks get, plenty of people still entrust their savings to local financial institutions.

Community banks and credit unions, whose total assets are typically less than $1 billion, hold about 20% of total deposits in the US, the FDIC says.

But while their market share hasn’t changed much over the past few years, the total number of community banks has been steadily declining since the financial crisis of 2008.

Similar trends have been playing out at regional banks, whose total assets are typically more than $10 billion but less than $1 trillion, are also under pressure to cut costs. In some cases it’s led to consolidation. In 2019 two of the biggest regional banks — BB&T and SunTrust — combined to create Truist in a deal valued at $66 billion at the time.

And the coronavirus pandemic is poised to intensify the headwinds that both community and regional banks have already been facing, experts say.

While cost pressures are being felt even at the biggest US banks, those huge firms have had more money to throw at digital transformations. That’s been a help in navigating sudden changes in consumer behavior prompted by the pandemic — namely, a surge in online banking that’s changed how banks think about their strategies for costly brick-and-mortar locations.

“I do believe that we are over-branched in the US and you won’t see as many retail locations as you see today,” Beth Johnson, the chief experience officer at Citizens Financial Group, told Business Insider. “I do think you will continue to see the industry shrink the number of physical locations, and even more aggressively than we saw pre-COVID.”

Coupled with public-health concerns that stem from routine activities like going into a branch or exchanging paper cash, both regional and community banks are in a precarious position.

These factors have spawned “a time of anxiety for banking,” Johnson said, “because this is a time when consumer behaviors are changing quickly, and we need to respond to that.”

To combat the mounting threats of consolidation and branch closures, regional institutions like Citizens Financial Group and BMO Harris have come to stake their bets on a handful of fintechs like Blend, Glia, and BrightFi.

Citizens and BMO Harris are two examples of how regional banks are hoping that upgrading their tech can help them navigate complex digital waters — and perhaps gain a leg up in the asymmetric war that they’ve been fighting against their more resource-rich global banking rivals and upstart challenger banks.

“What we’re seeing right now in the market is banks have to shift,” said Chris Thomas, a principal in global technology practice at the consulting firm Deloitte, who leads the professional-services firm’s US banking cloud-services team.

Banks “have to adjust their cost model,” he added, “and they have to rapidly transform.”

Business Insider spoke with eight industry insiders at consulting firms, fintechs, and the banks themselves to understand the steps both regional and community banks are taking not to get left behind.

Regional and community banks are in the midst of a transformation

Johnson agrees that this is a moment of transformation for regional consumer banks. Citizens Financial Group is based in Providence and operates about 1,200 branches throughout 11 states, mainly in the Northeast.

“I think about times of disruption and change as times of opportunity,” she said. “History has shown us that when there are dislocations in the market, that’s when you’ll see the winner and losers shift.”

For its part, Citizens uses, among other platforms, products from the fintech Blend, a Peter Thiel-backed startup that raised $75 million in August in Series F funding.

Leaning on external products developed by fintechs, Johnson said, rather than building them in-house, has “just enabled us to think about, ‘How do you move at the pace you need to move?’ … and not be forced to build everything ourselves.”

Chicago’s BMO Harris, a subsidiary of Bank of Montreal that operates more than 500 branches in states including Illinois, Wisconsin, Kansas, and Indiana, uses Blend as well.

Specifically, the bank has seen recent success using Blend Close, a digital-notarization and loan-closing product, to streamline the otherwise tedious process of signing paperwork and obtaining financing for, say, the purchase of a home.

Even bigger banks, like Wells Fargo and US Bank, work with the fintech.

BMO Harris Bank has seen a “significant greater need for digital or contactless services” throughout the pandemic, said Tom Parrish, head of retail lending product management at the bank.

“Customers were asking, ‘What are my options? You know, I’m not comfortable going into a branch or I’m not comfortable potentially sending somebody out to your house,’” Parrish told Business Insider.

BMO Harris Bank has experienced an uptick in the use of Blend Close from customers seeking mortgages since the pandemic began, Parrish said. Before the outbreak “we were probably running in the 70% range … [but] during the pandemic, we’ve seen over 90% adoption of leveraging our Blend application,” he said.

Tech firms capitalizing on small banks’ demand for digital-banking tools

Banks of all sizes were forced to shift online earlier this year as the coronavirus pandemic prevented many consumers from visiting branches. And while some branches were open because they were considered an essential service, many customers opted to go fully digital.

But the largest global players have an asset against which it’s difficult for their smaller, community banking counterparts to compete: war chests of capital reserved for investments in upgrading tech.

In 2019, JPMorgan had a $11.4 billion tech budget. Bank of America and Wells Fargo spent $10 billion and $9 billion, respectively, with Citi rounding out the biggest banks with an IT spend of $8 billion. A significant portion of that money is often put toward maintaining massive amounts of old technology as opposed to actual innovation.

The banks also dwarf smaller players when it comes to total assets. The four major national banks all have more than $1 trillion in total assets.

What’s more, even before the advent of the pandemic, the six largest US consumer banks — Bank of America, JPMorgan Chase, Citibank, PNC, Wells Fargo, US Bank — were outpacing their regional and community counterparts in terms of digital engagement, according to a survey released in May by JD Power.

Bank of America, for one, has 40 million digital users and has seen record levels of digital engagement from consumers this year.

The JDPower survey found that nearly half (49%) of customers who banked with one of the six biggest US banks showed “high levels of digital engagement.” Among customers who banked with regional and midsize banks, the numbers were lower at 41% and 36%, respectively.

Community banks “have fractions of 1%” of the budget that the big banks have to spend on technology, said Michael Coghlan, the CEO of BrightFi, a fintech that allows any company, bank or otherwise, to launch lending, checking, and savings products.

But in spite of community banks’ more limited resources, consumers still demand digital-banking solutions from them, especially now as health concerns have made physical banking less attractive.

Nearly three-fourths of Americans (73%) said last year that they “most often access their bank accounts via online and mobile platforms,” according to a survey conducted in 2019 on behalf of the American Bankers Association.

Just 17% of respondents said they mainly used the physical branch.

“Because of the pandemic and the heavy reliance on these different digital channels, there’s been a massive surge in demand for digital customer service,” said Dan Michaeli, the founder and CEO of Glia, which offers a platform for video chat, phone, and text-based customer service.

Fintechs are responding to increased demand by raising millions from VCs

Fintechs are raising massive amounts of capital and rolling out new services in order to satisfy this growing consumer demand.

Blend raised $75 million in Series F funding in August, led by Canapi Ventures, bringing the company’s valuation to almost $1.7 billion.

“Financial institutions have traditionally taken time to modernize legacy systems, but digital is now table stakes,” said Jeffrey Reitman, a partner at Canapi Ventures, in the release describing his firm’s investment in Blend.

“Shelter in place and social-distancing mandates have forced banks and other lenders to accelerate digital transformation plans from years to months,” he added.

Other fintechs have raised money throughout the pandemic, too, planning to deploy the capital to enhance the digital banking experiences.

Mantl, a fintech company that works with banks and credit unions to improve back-office workflow and grow deposits, raised $11 million during the pandemic from institutional investors like Steve Cohen’s Point72. To date, the firm has raised $22 million in venture capital, its cofounder and CEO Nathaniel Harley told Business Insider.

The company saw its deposit base skyrocket by more than 700% in the second quarter during the early phases of the coronavirus crisis, Harley added.

Community banks maintain an edge over global institutions in fostering customer relationships

Large national banks have long offered digital platforms — albeit with varying degrees of success — and a broad network of branches across the country.

Meanwhile, most community and regional banks have digital footprints, but historically they’ve generally not been their primary selling point. Local banks use their role in their communities as a differentiator against bigger national players that might not have strong ties to businesses or individuals.

“These banks were riding the trend of presence in the local community, and selling that is enabled through physical presence and overall community involvement,” said Richard Walker, principal and US leader for regional banks at the consulting firm Deloitte.

Walker said that sense of community identity “has created a level of differentiation for them from the national banks.”

A masked woman walking past a few Wells Fargo ATMs.

Banks large and small are seeing increased interest in digital and contactless services. – Noam Galai/Getty Images

But with reduced consumer interactions and branch closures, that argument won’t be enough to buoy the community banks indefinitely. Now, Walker said, community banks are reworking their physical and digital channel strategies, and collaborating with partners to retool their tech stacks.

To ensure that they’re able to maintain customer relationships online, some small banks are turning to Glia, a digital customer service platform. Glia plugs into a bank’s existing digital infrastructure to offer chat-based customer service in lieu of call centers. Its customers include larger players like Deutsche Bank as well as community players like Ascentra Credit Union and Members 1st Credit Union.

Glia’s software is designed to work alongside a bank’s existing digital offerings. It’s able to help customers through self-serve digital platforms, and, equipped with existing customer data and the context of what the user is trying to do, it can prove more efficient than a call center.

The company has raised $29 million to date.

“These banks and credit unions are really relying on their digital experiences right now to provide an entry point for their customers,” Glia’s CEO Dan Michaeli said. It’s driving “a serious surge” in demand for his firm’s products.

“Serving them in this fashion is so powerful because you can actually practice anticipatory service,” he said. “You can meet them where they are, and you can then teach them how to use the self-serve experiences, and continue to empower the consumer to do that on their own without wasting time.”

Regional and community banks need to get on the digital bandwagon now, experts say

Despite all the steps regional and community banks are taking to try to evolve, various factors are conspiring to jeopardize the future for these smaller financial institutions.

For one, branch closures are a ubiquitous threat.

Retail branch closures have nearly doubled in less than a decade, to 1,947 in 2018 from 1,156 in 2012, according to SP&G Global.

If they fail at responding, retail banks that rely too heavily on their physical branches may lose key clients, leading to more branch closures and consolidation.

The Boston Consulting Group conducted a survey earlier this year that found that as many as one in four (24%) retail banking customers said that they would “use branches less, or stop visiting them completely” as a result of the pandemic.

The survey also found that nearly half (44%) of people age 18 to 34 had enrolled in online or mobile banking for the first time in the first few weeks that the epidemic in the US broke out.

Consumers’ changing outlook on banking underscores the urgency that community banks now face. Some industry experts, however, see this inflection point as an opportunity for smaller banks.

“Community banks are still behind, and the gap is widening,” Nathaniel Harley, the CEO of Mantl, said.

“But they just need the tools and technology to be able to compete, and ultimately capture those customers.”

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