Wednesday, January 13, 2010

Online Banks-Fate of Brokers

As a finance student, who has worked in the banking industry, I have seen a trend that not many people seem to follow or agree with and that is the future of retail banking is unclear. To explain more about what I mean I will use the example of stock brokers.

During the 1990's if one would want to purchase stocks of a company or invest money in the stock market, they would have to discuss the matter with their stock broker. Stock Brokers were known to be fat money eating traders who constantly gave their clients bad advice. Individuals or corporations would have to either call their broker or go into their office to purchase shares of (ex) Microsoft. There would be a lot of paperwork involved and stock brokers would take a heavy commission for performing the trade. The job of a stock broker is pretty simple: they are a middleman. The customer comes to them to purchase stocks, they fill out the paperwork and contact the company to purchase the stock. In doing so they would charge terribly high prices.

Over the past decade since 2000, we have seen a shift from having to go to a stock broker to facilitate a stock trade to being able to directly going online and trade shares yourself. Online stock brokers charge commissions ranging anywhere from $3 to $20 for the most involved trades. In todays day an age, someone maybe laughed at for using a personal broker charging exuberant commissions. More so, major online brokers provide research and analysis that allows individuals to easily research their own stocks and not have to rely on the advice of anyone else.

Lets take a look at retail banks and where the trends have been going. Before we look at where banking is going in the future it is important to take a minute to understand how banking works and the simplicity. Banking is a very very simple idea that has grown exponentially. The basics idea of banking is that similar to stock brokers. If an individual has $10,000 that they do not plan on using immediately, they can go to a bank and deposit that money into an account. Bankers are essentially the middlemen; They take in deposits and reinvest and loan out money charging a higher interest rate. So the bank may take your $10,000 and loan it to someone looking to buy a car. The person may promise to pay the bank 6% interest or 10,600 after one year. Traditionally a bank should take a small portion of the interest for facilitating the trade (maybe 1%) and give the depositor the rest of the interest (5%), as an incentive to deposit more money. Now this concept is pretty basic and easy to understand, the part I do not understand is: How come the bank his charging 10%+ to loan out money and depositors are getting >1% interest. This to me is a major flaw and will backfire on the banks.

Just like stock brokers, I have begun to see a transition in which most banking will be done online. Because more people have been using traditional retail banks for longer time period than stock brokers, this online banking transition will be gradual and slower. I will give an example of how online banking can be implemented. I recently opened an online account with a bank named Etrade (FDIC insured). You may have heard of them as the stock brokers. I have never set foot in an Etrade bank nor have I seen one. I filled out my application online and received a call confirming my identity and that I am the one who actually opened the account. The process took less than 30 minutes and I was able to open the account from the comfort of my own home.  Within 2 days, I received my account opening information and my Visa Check Card.   I have been using Etrade for over a year and have yet to encounter a problem with them. Once again, I would like to emphasize I have never gone to an Etrade bank since I opened the account.

Many people may question this concept as it seems a bit far stretched. First question that comes to mind is "how do you know your money is safe?" Well as i mentioned before, Etrade is actually a bank and is FDIC insured. I did my research. If you don't believe me, here it is.  Another question someone may have is "how do you deposit money?"  There are many different ways.  The three most popular are:
1) Transfer money from another bank account
2) Mail them a check
3) Direct deposit from your employer.
Now depositing may be a little more involved, but withdrawing is as can be.  Etrade refunds any ATM withdrawal fees at any atm.  Because they do not have to incur the high cost of stand alone branches, they can  afford to refund your fees.  As you may or may not already know, you can use your visa check card anywhere like a regular credit card.  Getting your money from the bank is not an issue.

Etrade also offers a higher interest rate than most of the other banks right now.  This is probably because, like I said before, they do not have to pay for big branches with lots of tellers.  Their major costs may be ATM fees, customer service centers in one or two locations, and any additional government fees or costs.  As a result, Etrade is able to loan out money an give me more interest due to lower costs.

Credit Unions have also become popular but I do not feel they will kick off anytime soon.  I like the concept of Credit Unions but unfortunately they have fallen behind banks. Credit Unions are groups in which institutions can enlist their members in.  They have less costs and as the members run the Union, all profits are returned to them therefor offering higher interest rates.  They still require lots of tellers, buildings and other additional costs.

Bank of America has recently added unique advance features to their ATM's.  I use Bank of America ATM's on a regular basis.  The ATM has the ability to scan checks and detect the amount on the check.  More so, I can put up to 40 currency bills at once and it will accurately count the money and deposit.  If an ATM has the ability to do all of these tasks, the stand alone job of a teller has essentially been eliminated.  I love not having to wait in long lines, or deal with annoying customer services representatives.  (No offense to tellers, as I was one myself).  Disclaimer: I do not mean to sound like a salesman for Bank of America and Etrade-rather they are meant to be examples.  No one pays me to write these blog posts.  

There have also been a rise for online "peer to peer lending."  This may also be a new trending in banking.  Peer to Peer lending is a system in which depositors can pick people or groups that they would like to lend their money too. These sites gives people the ability to post pages to request loans and allow investors to read their request and invest as the like.  People can earn very high interest rates by doing this.  Such sites have already started to creep up such as Prosper and Lending Club.

With the recent economic crisis people have started really hating banks.  Banks essentially took in depositors money, charged bogus service fees on their accounts and started playing poker with their money.  People are beginning to loose trust in banks and wonder why they are getting a quarter for every $100 saved-why save in the first place?  Retail banks need to drastically change to stay in the game.  They can not afford to have huge bank buildings and employee dozens of tellers.  Maybe this may take decades to fully change, but we saw how fast people began using online stock brokers.