Don’t be so quick to close that branch.
It’s no secret that banks are shrinking their branch networks at a rate of 2-3% a year as customers find other ways to interact with their financial institution. So far, the impact has been mostly positive for the banks: low attrition rates, low costs to replace any lost deposits and reductions in operating expenses have made their way to the bottom line.
But rising rates are changing the equation, making the prospect of customer attrition much more significant in terms of branch shutdowns. With the marginal cost of funds (mCOF) for many regional banks ranging from 3-5%, the cost of replacing deposits that are lost when a branch closes can wipe out a significant portion of any savings in operating expenses. Banks also often don’t consider the negative impact that comes from the loss of potential new customers when a branch closes.
As a result, many branch closures that were previously no-brainers are now unprofitable.
It’s clear that banks need to keep closing branches, but Novantas believes that banks need to take a more disciplined approach to this consolidation. This can be achieved using robust consolidation analytics, forecasting and scenario analysis and revinvestment plans that support customer and deposit growth.
THE MECHANICS OF CLOSED-BRANCH ANALYSIS
When evaluating branches for potential closure, Novantas ignores traditional profitability measures and prefers to model the financial impact of an individual branch that is removed from the network. In addition to the one-time costs associated with closure, Novantas analyzes the expected customer attrition resulting from the closure as well as sales that are lost when a branch is removed from a local market. That is because Novantas has found that customers who remain with the bank following a branch closure wind up purchasing additional products at the same rate they did prior to the closure.
Novantas believes, therefore, it is more accurate to assess lost sales based on the loss of potential new customers to the bank.
Using these consolidation analytics, it is readily apparent that the changing deposit landscape has significantly altered the calculus. As an example, Novantas has analyzed the financial impact of two types of branch closures: one in a typical suburban location and one in a rural market.
SUBURBAN VS. RURAL
To analyze the two branch closures, Novantas used a deposit-cost replacement of a modest 50 basis points and a current level of 200 bp.
While both branch closures result in lost deposits over the five-year period, the consolidation financials shift more dramatically for the rural market exit. The five-year NPV for the suburban closure is cut in half, while the NPV for the rural closure flips from positive to negative. That means the higher rate of attrition in the first year, combined with the cost of replacing these core customer deposits, makes it clear that the rural consolidation isn’t the best idea.
By Andrew Hovet | Director, New York | firstname.lastname@example.org
Just as the economics of branch closures have shifted dramatically in a rising rate environment, they can shift again in an economic downturn.
In a downturn, banks will search for ways to boost earnings and will likely resort to more branch closures. Assuming the rate environment subsides at that time, this will make consolidations more financially viable — which will further accelerate the pace of closures.
With customers continuing to shift their activities toward digital channels there will still be significant excess branch capacity in the market. In the U.K. there are only a third the number of bank branches as there were 30 years ago.That level of compression hasn’t been seen in North America, but bad economic cycle could push us in that direction.
Regardless of the cycle, banks need to pursue a thoughtful and analytical approach to ensure that they aren’t chasing away valuable deposits — a key reason why Novantas recommends the use of scenario analysis as a critical component of network planning.
THE ECONOMICS OF BRANCH CLOSURES AMID THE SHIFT TO DIGITAL
With the industry moving through a period of widespread uncertainty about interest rates and digital disruption, such scenario analysis helps banks better prepare for a variety of potential outcomes. An assessment that includes the shift to digital sales, the continued progress of transaction and service migration and the future interest-rate environment can all impact network financial models.
For example, if new-to-bank consumer checking account sales emulate the shift in credit cards to digital sales, the value provided by bank branches in acquiring new-to-bank customers will be severely impacted. Alternatively, if rates continue to rise, the cost to replace deposits lost through branch consolidation will make even more branch closures untenable.
The ability to forecast the range of potential outcomes and understand the interaction between financial drivers will help banks develop a network plan that has the flexibility to adapt as the pace of change becomes more clear. This flexibility can often take place in the form of managing branch lease renewals.
Another important consideration when evaluating branches for consolidation is the bank’s plan to reinvest some of the operating expense savings to ensure continued customer growth. As noted previously, branch closures lead to customer attrition and lost “new-to-bank” customer acquisition.
It is true that many banks are taking the expense savings from branch closures right to the bottom line. While that may be helpful in the short-term, forward-leaning banks reinvest a significant portion of savings into ATMs, digital, marketing and highly targeted denovo branches. Plowing money into these areas can support customer acquisition efforts, helping to replace the new-to-bank sales that are lost when a branch shuts down.
These investments don’t necessarily need to be made in the same markets as the shutdowns. They can be targeted to markets that provide the best opportunity for the bank to accelerate customer and balance growth.
After all, investments to drive core customer growth and low-cost deposits are more important than ever when the cost of funds is rising.
Changing customer behaviors and changes in the rate environment (especially for banks with higher funding costs) are increasing the importance of market planning. Banks shouldn’t stop closing branches, but they should ensure they apply the appropriate rigor to make the right near-term and long-term network decisions.
Director, New York