E-Brokerage's Integration Challenge

By John R. Engen

Banks hope an online blend of banking and brokerage will help them crack the investment market, but synergies are elusive. Will they stay the course?

Wells Fargo & Co.'s Web site is applauded as one of the industry's best, with features and functionality that allow customers to pay bills, transfer funds and even apply for loans. But what really excites senior vice president Shelley Freeman is the icon in the lower left corner of the screen, which connects to Wells Trade, the San Francisco-based company's e-brokerage unit.

Clicking on this icon transports the customer into a world of $29.95 per-transaction stock trades and a full menu of price quotes, news and information that could soon rival the offerings of E*Trade Group or Charles Schwab & Co. An added client convenience is the ability to transfer money directly from a Wells bank account into investments. "Customers want one place where they can manage their entire financial picture as seamlessly as possible," asserts Freeman, who manages Internet investment services at Wells. "If we can put it all together in an integrated way, that's customer nirvana."

Such is the dream of many bankers. But behind the scenes, integrating banking and brokerage services in a truly synergistic manner is fraught with operational and organizational difficulties. As Wells demonstrates, Internet technology does make possible an integrated offering. Being federally-insured depositories, however, banks are burdened with some unique privacy and legal concerns. Limitations on sharing information between banking and brokerage units force institutions to erect costly technical and organizational firewalls. That hinders effective cross-selling between the two units.

Perhaps even more daunting, banks are latecomers to the e-brokerage party. Nonbank companies such as Schwab, E*Trade and Fidelity Investments are already dominant in the market and continue to improve their technology and products at a blistering pace. Few banks can muster the level of investment and managerial commitment required to catch up.

But for banks that are up to the challenge, the rewards of mastering e-brokerage can be substantial. Such capabilities can pay off in stronger customer relationships, particularly among the more affluent segments. Many bankers and experts believe that as the various sectors of financial services gradually converge, customers will gravitate to providers who can blend banking and brokerage into one compelling value proposition.

If banks don't capture that business, their nonbank competitors certainly will – by offering bank products. "The long-term customer-attrition risk faced by banks on the Internet is enormous," says John Weisel, partner and head of the financial services practice at Andersen Consulting. "The e-brokerage players are only going to get better and better."

To compete in e-brokerage, banks must beef up their systems to handle the higher volumes generated by Internet trading. They must integrate banking and brokerage offerings in ways that simplify things for the customer, and also improve their marketing efforts. And to pull this off, banks will need to develop entrepreneurial cultures that foster rapid innovation. "Banks will have to implement at a faster pace," says Weisel, who is based in New York.

A shift in strategic orientation will also be required, and this perhaps is the hardest part. Many institutions tend to regard e-brokerage as an add-on service, so they delegate decision-making to product managers who are narrowly focused on the performance of their own units. Until banks transcend this traditional product-silo thinking and organize their businesses around customer segments – with management and incentive structures to match – they will find e-brokerage to be tough going, no matter how technically adept they might be.

Given the level of company-wide orchestration needed for optimal performance, e-brokerage "has to be recognized as a top priority at the highest levels of the bank," says consultant Octavio Marenzi, chief executive of Celent Communications, Cambridge, Mass.

Two-Front War

Banking's rush to e-brokerage is part of a long-running campaign to offset the flow of deposits into alternative investments. According to the Federal Deposit Insurance Corp., bank deposits made up only 30% of households' liquid assets at the end of 1998, versus 38% eight years earlier. By contrast, the level of equity, bond and mutual fund holdings has soared. Banks want to manage more of those instruments themselves, instead of letting all the business go to nonbank organizations such as brokerage houses and mutual fund companies.

"Today's customers have a definite equity mindset when it comes to savings," says Michael Bastian, CEO and president of Action Direct, the brokerage unit of Toronto-based Royal Bank of Canada. "If banks want a greater share of wallet, they need a brokerage offering that is sufficiently attractive to encourage customers to consolidate their financial accounts with them."

Increasingly, that entails going online. Last year's fourth quarter saw the opening of 1.8 million new e-brokerage accounts, according to Stephen C. Franco, an analyst for U.S. Bancorp Piper Jaffray. Online trading volumes rose a record 55% from the previous quarter, while customer assets in such accounts grew by 35%, to $900 billion. By 2003, Franco predicts, some 25 million Americans will trade online, nearly double today's total.

To accommodate this growing market, most of the nation's large banks – and more and more small ones – are hustling to form an e-brokerage operation. The strategies vary. Some, such as FleetBoston Financial Corp. and First Union Corp., have leveraged recent brokerage acquisitions. Others, including Wells, are building in-house capabilities. Many smaller institutions have chosen to partner with ostensible enemies, such as Ameritrade Holding Corp. subsidiary Amerivest, to offer e-brokerage services on an outsourced basis.

None of these U.S. banks has yet to make a dent in the market share tables. Canada's T-D Waterhouse, owned by Toronto-Dominion Bank, ranks fourth with 1.3 million accounts. That compares with Fidelity's 3.5 million accounts, 3.3 million at Schwab, and 1.8 million at E*Trade, according to U.S. Bancorp Piper Jaffray. FleetBoston's Quick & Reilly unit has only 86,000 accounts, by contrast, and Mellon Financial Corp.'s Dreyfus subsidiary, 44,000. Testifying to the tremendous distance the market leaders have established against the rest of the pack, the top five e-brokerages executed 70% of all online trades last year.

Banks, then, have their work cut out for them if they ever hope to break into the upper tiers of a business where costly technical skills and branding initiatives define the winners. At the same time, they are forced to fight a two-front war against nonbank competitors who are muscling into their markets. Both E*Trade and Schwab have recently acquired banking units (Telebanc Financial Corp. and U.S. Trust Corp. respectively) while credit card giant American Express Co. offers banking products to its online customers. Even old-style brokerage Merrill Lynch & Co. has embraced the Internet and is now selling federally-insured cash management accounts.

The good news in all this is that banks still enjoy some competitive advantages, such as their far-flung branch networks. Surveys consistently find that online customers prefer a physical access point to complement the virtual delivery channel. Consumers also place far more trust in banks than other financial services providers and view transactional accounts as the foundation of their financial lives.

Gomez Advisors Inc. predicts the number of people who perform a transaction at least once a month via a bank Web site will mushroom to 31.8 million by the end of 2003, up from just 5.9 million today. Based on survey results, 45.5% of those so-called "active Web bankers" would prefer to consolidate their financial activities with a bank, compared with 13% who favor consolidating with a brokerage. "If banks go about it the right way, they can gain some serious market share," says Chris Musto, senior financial services analyst for Lincoln, Mass.-based Gomez.

Seamless Experience

Bankers hope that a blended online package of banking and investment services is just the sort of "killer app" that will win customers. Such a combination, they note, is facilitated by last year's financial modernization legislation and the continuing development of the Internet as a mass-market technology.

The sheer increase in Web traffic overall should boost customer contacts at bank sites. But getting those customers to consolidate their banking and brokerage accounts with a single institution requires a seamless online experience. William Veeneman, a senior vice president and manager of online services for U.S. Bancorp, Minneapolis, envisions an offering that enables customers to log-on once, at their bank site, and manage their entire financial lives from there. Such an offering would include balance statements of both brokerage and banking accounts, total net worth statements, easy transfers between bank and brokerage accounts, and financial calculators that download existing customer information.

As U.S. bank managers attempt to build such systems, they might look to Canada, which razed the walls between banking and other financial services in 1987. Royal Bank's Action Direct was launched in 1993 as a bank-linked discount brokerage and went online in January 1998. Since then, Bastian says, customers and account balances have soared, as have overall visits to the company's Web site. Eighty percent of Action Direct's 400,000 customers also hold bank accounts, and 20% of all brokerage transactions involve a transfer from a customer's bank account. Most encouragingly, Action Direct itself now turns a profit.

Bankers must be clear about the numerous risks lurking in e-brokerage, however, and temper their expectations with reality. Despite the Action Direct example, consultant Weisel doubts that banks will ever make much money directly from e-brokerage because the service is quickly becoming commoditized. Instead, he argues, banks should establish as their primary goal the generation of traffic for their overall Web operations.

The reality is that established online trading firms possess a three- to five-year head start in terms of building a branded e-brokerage presence on the Web. These nonbanks have also made more progress in solving the technological problems involved with online trading. Finally, their corporate cultures are better suited to the brokerage world, which moves at a much faster speed than traditional banking. It's likely that nonbanks will do a better job at marketing banking products on the Web than banks will do at selling brokerage, investment or insurance products.

Firewalls

For one thing, brokerage firms don't have to worry about some of the privacy and legal issues that bedevil banks. For example, federally-insured depository institutions must post lengthy disclosure statements about what is and is not guaranteed by the FDIC.

To avoid running afoul of the various restrictions on sharing customer information and tying banking and brokerage operations, banks have had to construct costly technical and organizational firewalls between the two sides of the house. Bank-owned e-brokerages, for instance, must have separate management teams. The units must also pay fair market prices for any service provided by the parent company – no freebies or discounts allowed, according to Ronald Glancz, a partner and chairman of the financial services group at law firm Venable, Baetjer, Howard & Civiletti, Washington, D.C.

Such restrictions, while ostensibly customer-friendly, limit the ability of banks to offer the kind of seamless service they envision. What good is a financial services supermarket if you can't use loss-leader pricing in one category to entice customers to buy products in another area? Eager to avoid regulatory and legal tripwires, most banks are reluctant to allow customers to view their banking and brokerage accounts via a single logon. Those customers first have to log-on to the bank site and then click a button to log-on separately to the e-brokerage site. "We're still looking for more regulatory direction," says Veeneman at U.S. Bancorp.

Pulling together customer data in a manner that respects legal requirements and customer privacy sensitivities is considered by most bankers to be their toughest hurdle in e-brokerage. "Presenting an integrated picture to customers sounds very simple, but it's a huge, complex challenge," says Neal Wolfson, head of Internet banking for FleetBoston. "We're drawing data from many sources while trying to deal with security and all the other things going on behind the scenes."

Another operational hurdle is managing the extra demand on already-overtaxed systems. Separate customer service operations, manned by licensed securities experts, must be built and maintained for e-brokerage. And while a typical Internet banking customer might visit a site once a week to make a payment or check balances, many online investors log-on hourly to get quotes, research, news and other information. If the system goes down for even a few hours during a market sell-off, a bank could be sued. "The brokerage piece is very dynamic," Bastian says. "Bankers have to understand the frequency of use and other requirements of investors, and scale their operations with brokerage volume in mind."

Many banks claim significant progress in building their e-brokerage units. But Marenzi says the industry continues to experience trouble on numerous fronts, including systems architecture, vendor selection and management oversight. Meanwhile, the pace of customer adoption has been frustratingly slow, given the investments made.

FleetBoston, for example, reportedly spent tens of millions of dollars linking Internet banking customers to its Quick & Reilly e-brokerage site. The combined offering, which was launched in November, boasts a single logon (one of the few that does) and enables customers to view both their banking and brokerage balances on the same page. While the site is lauded by analysts as a cutting-edge example of banks' potential in the e-brokerage arena, only 5,000 bank customers were actually using Quick & Reilly as of last February.

With time, however, e-brokerage operations could prove rewarding for at least a few banks. Perhaps a dozen of the top 100 banks will successfully adapt their organizations and product offerings to the online world, predicts Marenzi, who adds, "It's a massive opportunity for banks to finally get into a business that has been stealing their best customers for years."

Another law of nature is that big companies can't get excited about small opportunities. It's not that their managers are bad. It's just that for a $40 billion company, for example, achieving 10% growth requires that it find $4 billion of new business next year. This causes managers of large organizations to either dismiss or overly pressurize innovations, most of which appeal only to small markets at the outset. If a company is committed to renewing itself, it must approach innovation within the proper context. Rather than a cure for short-term earnings problems, innovation is the long-term means of gaining footholds in new markets – and should be nurtured as such.

Mr. Engen is a freelance writer based in Minneapolis.

Copyright © 2003 by Banking Strategies, published by BAI.

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