The New Bank Branch: Internet CafÉs and Rent-a-Rooms

Editor's Note: This story reflects new information provided by BofA on the number of new ATMs.

In Charlotte, N.C., residents like to joke that there's a church or bank branch on virtually every street corner—which is fitting, since both are viewed as houses of worship in a city that until a recent merger boasted two of the nation's five largest banks. Charlotte isn't alone in that regard, because during the housing boom of the past decade commercial banks everywhere threw up new branches as fast as they could. From 1990 to 2006, the number of bank branches in the U.S. roughly doubled, to more than 90,000—or one for roughly every 2,200 adults in the country.

But now that the housing bubble has burst, the banking industry is awash in too many branches—a problem it is looking to correct. On July 28, Bank of America (BAC) confirmed reports that it will close an unspecified number of its 6,100 branches over the next several years, though industry experts say a 5% to 10% reduction wouldn't be surprising. What's fueling the cutbacks is not just the drop in mortgage-generated business, but new technologies—introduced by the banks—such as Internet bill-paying and mobile banking, as well as the proliferation of automated teller machines that do far more than their predecessors.

Next up: small check-reading apps for smartphones, PCs, and others devices that allow consumers to deposit checks anywhere they have an Internet connection, as is already the case for customers of USAA Savings Bank, who can make deposits even by iPhone. "These new technologies really level the playing field for credit unions and small banks, which need a way to compete with the expansive branch networks of the big banks," says Bob Meara, a senior analyst at Boston-based financial research and consulting firm Celent.

Liam McGee, head of consumer and small-business banking at BofA, notes that while 33% of all deposits made at a bank branch by the bank's customers were made via its network of 18,500 ATMs as recently as January, that figure has jumped to roughly 40% as the bank has rolled out the first wave of 12,800 new ATMs that give customers a receipt that includes printed images of the checks they just deposited. "There's been a significant change in our customer behavior, and it has happened at a very rapid rate," McGee said in an interview with BusinessWeek. "We want to give customers the ability to do transactions when and where it's convenient for them."

Another motive: avoiding new regulatory oversightWhile the housing bust and the rise of new technologies are clearly having an impact, some analysts think there may be an ulterior motivation for banks to quickly start slashing their branches: the Obama Administration's plan to create a new Consumer Finance Protection Agency, which Rochdale Securities analyst Richard X. Bove views as "a major threat to banking profits." In a report to clients on July 28, Bove notes that the new agency "will have power over all aspects of consumer banking," including pricing, and "the power to tell a bank that it must keep an unprofitable branch open."

As a result, Bove expects banks to close thousands of marginable branches in low-income neighborhoods before the new agency is formed, and he takes issue with BofA's claim that it's closing branches because consumer preferences have changed. "These banks are being closed for economic reasons and to avoid excessive regulatory problems." Responds McGee: "Regulatory dynamics have nothing to do with what we're doing. Our commitment to low- and moderate-income communities remains stronger than ever."

Still, there's no disputing that the economics of bank branches have changed. As recently as the 1980s, banks considered branches to be a necessary but money-losing part of their business. All that changed when interest rates began to drop sharply earlier this decade. With banks able to cut the rates they paid customers on deposits down to as little as 0.001% and demand for mortgages allowing banks to keep the rates they charged relatively high compared with their funding costs, the spread between a 30-year fixed-rate mortgage and a six-month CD had risen to above 5 percentage points. That was more than double the 2.5% norm over the prior 35 years. That, in turn, boosted the internal rate of return at most bank branches to 22% to 25%, Bove estimates. (McGee declined to discuss the profitability of branches at BofA.)

Consumers say they want branchesBut mortgage demand is expected to be more muted, and mortgage returns will be much smaller, Bove predicts. Besides cutbacks, industry consultants say that trend is also forcing banks to reinvent many of the branches that remain. Celent analyst Meara believes the traditional branch, with Greek columns and steel vaults, will give way over time to smaller, sleeker, and more inviting branches intended less for depositing or check-cashing (transactions that banks may in fact charge for, experts say) and more for selling high-margin products such as CDs, mutual funds, and annuities. That reflects the findings of a 2003 Booz Allen Hamilton study, which found that consumers say they still view a bank branch as the setting where they want to make significant transactions, such as getting a credit card or a mortgage. (The Booz Allen study also revealed that 90% of customer relationships are formed, and lost, by the quality of service they receive in a bank branch.)

As a result, experts believe the traditional army of tellers will likely be replaced by smaller teams of trained service reps who can help solve each customer's needs—and in some instances are designed to fit better into the fabric of the communities they serve. Among the pioneers in this area is Oregon-based Umpqua Bank. With 151 branches, Umpqua has in recent years unveiled a new generation of branches that sport touchscreen video walls providing product information, Internet cafés, and conference rooms that any business, charity, or community group can reserve at will. Umpqua branches also sell CDs and other goods by local musicians and artists, a gesture the bank hopes will further position its branches as community hubs.

"It's all contrary to what you might find in a bank," says Lani Hayward, executive vice-president for creative strategies at Umpqua. But deposits at the branches Umpqua has converted are up an average of 30% since the changeovers, and the average number of products sold to each household is double that at the traditional branches, she notes. "We decided we couldn't beat the bigger banks on rates, so we had to make personal finance more personal. And this was a way for us to do just that."

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