The Zero-Paper Advantage

Virtually every bank in the industry straddles the two worlds of paper- and imaging-based check processing, needing to manage the transition to electronics while simultaneously supporting a paper processing operation. For most institutions, this dual burden represents additional cost and diversion of management attention.

One exception: NetBank Inc., one of the early pioneers in all-online banking and today a $5 billion-asset institution based in Atlanta. Since its founding in 1996, NetBank has built a base of 166,000 retail and small business customers in all 50 states who transact 100% of their business online, or through other remote channels such as ATMs. While its competitors nationwide are necessarily focused on Check 21 and its multiple business process implications, NetBank can remain disinterested — it has no worries because it processes no paper checks whatsoever.

In a year in which NetBank's growth was sufficient to propel it to Fortune magazine's 2004 list of the 100 fastest-growing U.S. companies, Banking Strategies asked chairman and CEO Douglas K. Freeman for his views on the industry's transition toward images — and about NetBank's competitive advantage as a zero-paper payments processor.

Banking Strategies: What effect do you expect Check 21 to have? Will it increase the number of customers using online banking, for example?

Freeman: Obviously, any time you replace paper with electronics or images, you move the payment infrastructure further down the road to an all-electronic environment. So, from my perspective, Check 21 is absolutely going to spur growth.

But the bulk of that growth will probably come not so much from consumers but rather from small and mid-size businesses that will replace checks at the point of presentment, whether that means at the merchant's location or later when the bill for goods or services is remitted. These small business and middle-market customers will realize that this is a faster, better and cheaper way to get their money and settle their transactions. In my opinion, that's going to feed tremendous growth.

Consumers, of course, are going to lose float, since checks will clear faster. So check imaging brings pluses and minuses for the consumer. Check 21 will certainly make them more aware of online banking, and therefore drive some adoption.

But overall, the real winners with Check 21 are clearly the merchants. They win because they collect their money faster. And they'll also be able to drive down the cost associated with their banking transactions. They won't have to deal with so many fees for non-sufficient funds (NSF), for example.

Say you're my dentist and do a root canal on me and I give you a $1,000 check that bounces. Both of us get charged $30 for depositing an NSF check. But with imaging, you replace a transaction that had two to eight days' worth of float and NSF possibilities with one that clears the next day, in many cases, and no possibility of NSF fees.

So the clear winners with imaging are people who have checks presented to them, like the power company and grocery store, because all those checks are going to start to behave very similarly to debit card transactions, from the customer's perspective.

Banking Strategies: Will the use of image replacement documents (IRDs) — Check 21's intermediate step to full imaging — help or hinder in this regard?

Freeman: 100% of our customers today receive images. If they want to see a copy of their check, they access their account online and we show them an image. We don't send paper statements back; we post an electronic file that they can download, print and save on their hard drive.

So taking images of checks and then printing paper versions in the form of IRDs doesn't impact our business model at all, although we think it's going to impact other people's business models. Having to present the paper, in the form of IRDs, drives up the operating cost of handling a consumer checking account. Processing IRDs costs more than just processing an additional paper check.

But we don't present or return paper at NetBank. We just create images of the checks and provide electronic statements over the Internet, so our competitive advantage just widens over people who are heavily into the paper world.

Banking Strategies: Given the competitive advantage that you enjoy in this arena, what have you learned about providing electronic images that others may not know?

Freeman: The benefits of imaging are well known, such as faster, cheaper data storage and delivery of information. The trick is implementing the processes when a bank has to deal with legacy systems and customers who are not accustomed to receiving information in a paperless format.

Banking Strategies: Until recently, small businesses were also accustomed to dealing with paper statements. Has it been difficult to transition them to imaging?

Freeman: In many respects, our small business customer base closely mirrors that of our retail customers. In fact, we have a high percentage of small business clients that maintain personal accounts with us. And we learned through our research with small businesses prior to launching our services — and it continues to be reinforced through surveys of our existing customers — that small businesses are very willing to forgo the paper world if their needs can be met alternatively.

Some of the ways we're doing that include offering an automated online application that we can process and approve in as little as two minutes.

We also provide dependable, convenient access to account information while providing advanced user functionality. For example, we offer the business owner the ability to provide tiered authority for different users on the account. The business owner can add "delegated users" and define exactly what permissions they should have, such as inquiry only on one account, full disbursement on another, etc. This is all done online.

We do enable our customers to interface with accounting programs. Small businesses are often understaffed and really appreciate having ways to cut down administrative time, such as not having to re-post deposits that they just made onto their accounting system.

We also maintain a personal relationship with each customer by providing dedicated relationship managers. And then we respond to industry changes quickly — Check 21, for example — by providing new options for making deposits.

Banking Strategies: What's your interest in ATM imaging?

Freeman: We are in the early stages of exploring those opportunities. As more progress is made in this area by ATM manufacturers, we feel we will be well positioned to take advantage of it.

Banking Strategies: Do you have lower operating costs than your competitors? What does that mean for you?

Freeman: Our operating costs are below the industry average because we use technology to operate more quickly, more efficiently and more cost-effectively than our competitors. It means a significant cost savings for us, which allows us to provide our customers with higher deposit rates and more free account services.

Banking Strategies: How long do you expect your zero-paper advantage to last?

Freeman: In today's banking environment, you've got to be able to implement change immediately. One of the reasons NetBank has been successful is we're not saddled with legacy systems, so we can deploy new technologies very quickly.

That's why we were ready for full image exchange on October 28. By contrast, the larger institutions have huge investments tied up in their paper-based systems. So it's going to take them some time to disassemble those systems and move away from paper-based banking.