Zelle and The Optionality of Bank Technology That Goes Overlooked

Banks think about technology as an added cost. Adding person-to-person payments, online account opening, a data lake, or any other piece of technology is sometimes talked in terms of “being defensive” and an “additional cost of doing business.” Not only is that 180 degree the wrong way to view technology investment but using that framework will lead to sub-optimal decisions that could potentially hurt a bank’s business model. In this article, we explore a person-to-person payment case study and show what we believe is a superior decision methodology.

The Project Cost

A typical analysis will go something along these lines – to move to a person-to-person (P2P) payment application cost an average of around $0.60 per transaction and $150,000 of integration costs. You do the math, and you figure that you have 10,000 customers that will use the application an average of seven times per month. However, you know the application will attract a different customer that will be a heavier user of the application, so you assume that usage will be closer to the top decile of the industry or around 15x per month. You do that math, and you calculate that 10,000 target customers using the application 15 times per month gives you a cost of $90,000 per month or a little over $1mm per year. You take a big gulp, and you feel the heartburn.  

That number will hurt the bottom line. “Why should we offer this product to lose money,” you think.

The Optionality of Channel Management

You stop and think, and you quickly realize that your customers have to get their money from somewhere. If your customer goes to the ATM to withdraw cash, that costs your bank about $0.75 per transaction. If they write a check, that currently costs you about $1.75 per item. If they walk into a branch to get cash, well that adds up to about $6.00 per transaction when you count teller time, cash management time and branch overhead.

Moving customers to a P2P application can save you incremental cost. Maybe not in the short-run, but in the intermediate term you can reduce the cash and servicing in the ATM, process fewer checks and have shorter branch hours.

Then there is the long-term. A P2P application as it reduces ATM and branch traffic can also alter the long-term branch strategy. That $1mm you are going to spend per year on the P2P application can help you put off building that next branch. Over the next five years, you can build fewer branch and maybe even close one or two if you can just save from building one branch, that more than pays for the P2P application.

Of course, if you don’t invest in a P2P application, you never have the option of moving customers to a more efficient channel.

You can calculate what that optionality is worth using a standard option’s model. In order to have the “option” of not spending a $1mm on a branch over the next five years in the future, that value is worth roughly $192,000 if you assume a 2.5% risk-free rate and about 15% volatility on your branch profitability. That is a material sum that often gets overlooked in bank technology analysis.  

The Optionality of Geography & Demographics

By the same token, applications help expand your customer footprint. Having a digital channel can move your direct branch service area from a three-mile radius from a branch to five our more miles. Having a digital channel gives you the “option” of markedly expanding your footprint. You may not want to bank someone in the northern part of the state, but if you have a full mobile banking suite, at least you have the option.

Along a similar dimension, you also have the “option” of picking up other customers in your current footprint. You might pick up more affluent, more mobile households or business owners that have previously gravitated to a national bank. Additionally, having more of a digital platform will also allow your bank to focus on a younger demographic. Again, you might not want to do this, but you don’t have that option if you don’t have the digital capabilities.

You can run the above through the same options model, but we are talking some really big numbers. Depending on your service area, that geometric expansion of geography or demographic can result in tens of thousands of new customers over the five-year planning horizon. Assuming you could pick up 50,000 customers over five years using your digital platform and each customer had a net lifetime value of $5,000, well that is potentially $250mm of lifetime value that your bank could accrue. Just having a shot at that works out to an option value of about $48mm. These kind of numbers start to make your $10mm in digital investment over the next five years look pretty cheap.

The Optionality on Balances and Brand

Finally, there is the optionality of product usage. Banks that have rolled out an application like Zelle report that their customers increase their engagement by an additional time per day. At a minimum, that is an additional time per day that your customer gets reminded of your bank’s brand and ability for your bank to cross-sell an additional product. Further, with more account usage likely comes more deposit balances. Instead of moving money via check or handing it over to Venmo, they keep the money in their account. This means the optionality of more float for your bank.  

Putting This Into Action

All this adds up to the optionality of strategy. If your bank continues to invest in the traditional branch channel that might absolutely be the right strategy. However, there is some probability that you are going to need a digital channel to be able to compete in the future. Without applications like P2P, mobile account opening, digital lending and more, you won’t ever have the option to compete.

The next time you think about a bank technology investment consider it the other avenues of revenue, customer acquisition, and engagement that the product might offer and what you could do with those capabilities. You might find that your return on investment is much greater than you additionally thought. 

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This commentary on this blog reflects the personal opinions, viewpoints, and analysis of the author and not CenterState Bank. This blog is only intended to provide general education about the banking industry, leadership, risk management, and other related topics and is not intended to provide any specific recommendations. Banks should consult their professionals and fully explore any opportunity and risk referenced herein.

CenterState Bank is a $16B (post-merger), publicly traded community bank in Florida experimenting our way on a journey to be a $25B top performing institution. Financial information can be found HERE. CenterState has one of the largest correspondent bank networks in the banking industry and makes its data, policies, vendor analysis, products and thoughts available to any institution that wants to take the journey with us.