Ever since banks have been online, they've employed knowledge-based authentication questions as a secondary layer of security. But there's a growing problem with this type of credentialing.
The days of relying so heavily on traditional credit scores to evaluate customers are gone.
There's a perfect storm brewing for small businesses looking for more help from their bankers with financial analysis.
Customers famously revolted a year ago when Bank of America floated the idea of charging $5 a month for using a debit card.
Lawyer Scott Pearson had successfully represented consumer finance companies in more than 70 class actions, but he was getting frustrated by the increasingly adversarial relationships he saw developing between banks and their outside counsel.
Mobile strategists, listen up. Within five years, mobile is going to be the hub of the customer relationship.
Banks of all sizes are loosening the purse strings when it comes to technology.
In the wake of the storm damage and lengthy, widespread power outages brought to our shores by Hurricane Sandy, it's a good bet that natural disaster preparedness has been high on the list of discussion topics this winter for management and boards at banks across the country.
Just look around your bank. Chances are your colleagues represent a diversity that gets diverse-ier the lower down the totem pole you look.
1. Augment How You Authenticate
Name your favorite movie. Recall the address of the place where you worked five years ago. What was your high school's mascot called?
Ever since banks have been online, they've employed these kinds of knowledge-based authentication questions as a secondary layer of security, requiring the customer to come up with an answer that only he or she might know to gain digital entry to their accounts.
But there's a growing problem with this type of credentialing. Much of the information used for these purposes (a mother's maiden name, for example) has become widely available. More consumers willingly disclose clues to their personal information on Facebook, while criminal rings have gotten better at compiling information from third-party data mills and manipulating security procedures at financial institutions.
"A few years ago it was a lot more reliable," says security analyst Avivah Litan, a vice president at Gartner. "This data is not so private anymore."
There's also a cost to the high failure rate of challenge questions, which is somewhere in the range of 10 percent to 15 percent, according to Gartner. The failures most often are a case of legitimate users forgetting their not-so-immutable answers to questions about a favorite food or sports team-or getting stumped because of outdated or incorrect credit report file data connected to the places where many challenge questions arise. Litan, who is divorced, noted she was once asked challenge questions by her bank regarding her ex-husband's second wife.
These snafus usually wind up costing institutions $12 to $15 per incident since authentication problems for customers usually escalate up the call-center chain to supervisors. This not only increases customer aggravation, but may encourage frontline workers to let their guard down on security measures as a good-faith (and cost-saving) measure that allows an opening to fraud, such as when criminal rings use publicly available information to masquerade as a customer.
Besides the less-than-challenging questions in today's socially connected world (where hometowns, old street addresses and pets' names are easily discovered), there also are droves of new customers (such as immigrants) who banks are taking on with thin credit files or none whatsoever, which makes it more difficult to build questions around credit-bureau data.
Given the problems with traditional challenge questions, it's easy to ask why banks don't just dump them, especially when there are more secure, multi-factor authentication options available like tokens, text-delivered access codes, device or IP address identification and geo-location software.
But replacing knowledge-based authentication completely is off the table for most banks, according to Litan, who says that its established use as well as its low cost means "there will always be a place" for it. But that doesn't mean banks can't incorporate additional layers of identity proofing following a log-in or transaction request, by tracking user credentials throughout a session, verifying caller ID or risk-scoring a user's activity, for example.
"I don't think [knowledge-based authentication] should just be totally thrown away," Litan says. "But you just can't count on it alone."
2. Harness Untraditional Data to Widen Your Customer Base
The days of relying so heavily on traditional credit scores to evaluate customers are gone.
At least, that's the way many upstarts in the financial services industry look at it. And increasingly, banks, credit unions, mortgage lenders and card issuers are coming around to the idea, too.
Roughly 88 million consumers in the United States have little to no credit history, which makes them unscoreable, says Steve Ely, the CEO of eCredable in Alpharetta, Ga.
Many of these consumers don't interact with banks. But in an industry under increasing revenue pressure, writing them off is not an option.
"You're talking about 35 percent of the adult population. You can't ignore those numbers," says Ely, whose company grades people's creditworthiness based on their payment history with rent, utilities and other bills.
"You've got to think about ways to engage this consumer and try and have them as a future customer," Ely says.
Some traditional lenders are starting to do just that, looking not just at bill payments but payday lending history and other information to supplement traditional measures of creditworthiness.
Central Wisconsin Federal Credit Union, in Plover, Wis., uses data from FactorTrust to vet customers for its two-week loans. Frank Hunt, the president of the $30 million-asset credit union, said it began offering them about five years ago to compete with the payday-lending stores that started popping up in the neighborhood.
FactorTrust, a credit reporting agency founded in 2006, tracks data from alternative lenders to maintain histories on 10 million underbanked U.S. consumers. "It's like a subprime credit bureau," Hunt says. "We can find out if the individual has another outstanding payday loan, or if there's been any chargeoffs on previous payday loans."
Greg Rable, the CEO of FactorTrust, says the consumers tracked by his Roswell, Ga., firm are worthwhile prospects for mainstream lenders. Most are employed, typically earning between $30,000 and $50,000 a year. And two of the top eight employers of consumers in the database are actually major banks.
FactorTrust provides data to several hundred customers, but is just starting to talk to banks and credit unions. In contrast, eCredable targets consumers with its service, offering to verify their bill payment history and grade them from 'A' through 'F.' Those who earn an 'A' or 'B' can be referred to its partner companies for an auto loan or mortgage.
eCredable also is starting to talk to banks, in the hope that they'll offer its service as a benefit with their prepaid debit cards to help customers build a credit history.
Craig Focardi, senior research director for retail banking and cards at CEB TowerGroup, says many large banks and card issuers, such as Capital One, already are using some alternative data for their own valuations and custom credit scoring models. "In addition, the bureaus have been either buying or building these kind of assets internally or partnering with other firms to deliver it."
He says an interest in using alternative data initially emerged before the financial crisis, but petered out as lenders shunned riskier borrowers. Focardi thinks this year the use of such data will become more widespread.
"There's a market need as well as a regulatory imperative," he says.
3. Look into E-Invoicing
There's a perfect storm brewing for small businesses looking for more help from their bankers with financial analysis.
With lending in a rut, banks are eager to serve small-business clients in other ways, such as helping them to understand their cash flows better. And on the back of growth in cloud computing and social media, new technologies are cropping up to facilitate real-time analysis of the data gleaned from their transactions with customers and suppliers.
"Most of these businesses don't have professional CFOs," says Bill Holt, executive vice president of business banking for SunTrust Banks. "It really comes down to, more than ever, 'I'm looking for a banker to help me get in deep on those issues.'"
Holt, whose bank has nearly 500,000 small business clients, says that with many of these customers sufficiently liquid now, lenders can stay relevant by helping entrepreneurs get a handle on their operations.
Emerging technologies offer some intriguing possibilities. Consider Tradeshift, which allows businesses of all sizes to send each other electronic invoices free of charge. Not unlike Facebook, the Danish company's strength is its ability to leverage information based on the connections that businesses form with each other.
"What matters is who your customers are and what transactions you are doing," says Tradeshift co-founder and CEO Christian Lanng. "That kind of data is something we provide."
Lanng's platform has already been adopted by 150,000 organizations, including Great Britain's National Health Service, several large logistics companies and many small businesses. It is adding 1,000 to 2,000 new users per week.
They are drawn in part by access to Tradeshift applications like the one offering instant payment on e-invoices, with interest rates on the funds based on real-time credit assessments. No more waiting 30, 60 or 90 days for cash.
Lanng says the company is talking to several banks about potential relationships and already has partnered with several European financial institutions.
"Suddenly a small business has access to a lot of information about trading relationships-all this stuff you can leverage to really optimize the business," he says. "You get much better credit, run much better processes. That's one of the beautiful things about the business cloud."
4. Think Differently on Fees: They Don't Have to Be Punitive
Customers famously revolted a year ago when Bank of America floated the idea of charging $5 a month for using a debit card. But Beth Robertson of Javelin Research says consumers often are willing to pay bank fees. Just not for the basics.
To make pricing more palatable, "banks introducing a new fee should be thinking about how to not make the fee appear punitive," Robertson says. "This is very possible, with adding new services or new fuctionalities or new packaging to show the consumer that there's value added that is worth the fee."
In other words, focus on charging clearly stated fees for features that are helpful to customers, rather than dinging them for missteps.
One possibility is bundling a checking account with additional services, such as identity-theft protection. Another is offering expedited payments. Same-day and next-day payment options can help people avoid being late on their bills. In this case, many would think that getting the payment there on time is worth the cost. As Robertson points out, a lot of billers in the market already charge for expedited payments, "so consumers are comfortable with paying a fee."
Introducing new services for mobile users opens up other revenue opportunities. Banks could charge a small fee for the convenience of allowing customers to deposit a check by taking a picture of it with their phone. Many institutions offering the service do so for free, to lure customers to mobile banking. But some charge 25 cents or 50 cents per check.
Remote bill capture is rolling out, too. Similar to remote deposit capture, it lets customers pay a bill by taking a picture of it. The $4.3 billion-asset First Financial Bankshares in Abilene, Texas, is one of the first to try it.
First Financial wants the new service, called Picture Pay, to be a source of fee income, though it has not specified how much customers might be charged. It announced a pilot of Picture Pay from Malauzai Software and Allied Payment Network in November, and at press time intended to begin offering the service to customers by the end of December.
First Financial, which has many rural customers, says the convenience of being able to pay bills so easily from just about anywhere should make them feel comfortable with paying a fee.
Robertson says she expects to see more of this proactive approach to fees across the industry, though not a sudden sea change. "I think banks are moving in the direction of thinking proactively," she says. "But it's also a struggle, because usually there are a lot of people involved in the pricing decisions."
Nonetheless, she says banks in general need to do a better job of communicating how they add value.
Fees are a key factor in why consumers switch banks. In a Javelin survey last spring, about a third of switchers cited too many fees as their main motivator for going to a new bank, making it the top reason over such factors as poor customer service and a move to a new area.
"The problem is: what has kind of gotten into the consumer mindset is that they're being taken advantage of instead of that they're getting value for their money," Robertson says.
5. Become a Legal Black Belt
Lawyer Scott Pearson had successfully represented consumer finance companies in more than 70 class actions, but he was getting frustrated by the increasingly adversarial relationships he saw developing between banks and their outside counsel. "What I saw particularly over the last 10 years or so and especially after the credit crisis hit is that legal departments at every bank in the country are under enormous pressure to cut costs," while law firms have been doing all they can to push through billing rate increases to attend to the needs of their own bottom lines.
This summer, Pearson left his longtime employer, Stroock & Stroock & Lavan, to join the Los Angeles office of Seyfarth Shaw, a law firm that uses old-line thinking about efficiency and quality control-borrowing from the Six Sigma system championed by Jack Welch and the Lean approach developed decades ago in the auto industry-to help clients keep their outside legal bills in check.
The cost cuts don't come from practicing law on the cheap. They come more from tools like process mapping, which can root out repetitive tasks within areas like litigation.
For example, in moving for summary judgment, depositions, transcripts and documents in a case typically will be re-read for any relevant details that can be included in the motion. But if the process is set up so that details that might be pertinent to a summary judgment motion are compiled as the case progresses, the efficiency gains can be meaningful, Pearson says.
U.S. banks reported about $6.7 billion in legal expenses just for the first nine months of last year, according to SNL data, eclipsing the $5.6 billion spent in 2010 and on pace to exceed the $6.9 billion reported for 2011. Strategies for shaving just a few minutes off of an expensive process could reap big savings, especially when they are applied again and again to loan enforcement matters, foreclosure lawsuits or other forms of the routine, repetitive litigation that banks tend to have a lot of.
Pearson, a yellow belt in the Six Sigma vernacular, says clients that have used Seyfarth for legal services and its Six Sigma-based consulting services have cut their costs between 15 percent and 50 percent. He says he's not yet aware of any other large law firms taking a similar approach, but he suspects that if enough clients demand it, the technique will catch on.
"To me, this is something that everybody ought to be doing," he says.
6. Think Mobile for Sales and Marketing
Mobile strategists, listen up.
Within five years, mobile is going to be the hub of the customer relationship, says Peter Wannemacher, an analyst for Forrester Research. It will be the way that most customers-particularly the young and the wealthy-interact with their bank most often. And it will be an increasingly important touchpoint for noncustomers, as they search for information.
So Wannemacher foresees an emphasis on sales and marketing in the mobile channel, which is largely absent so far. As it is, mobile is mostly designed for existing customers, though this is starting to change.
He cites BB&T as an example of what the future holds. The design of its new mobile website features a central login area surrounded by six categories-such as "rates," "offers" and "find us"-that can be clicked without logging on, customer or not.
Most other sites are less accessible to noncustomers. After a recent look at mobile offerings from five of the largest brokerage firms, Wannemacher says, "I was shocked at how hard it was to do anything using their mobile websites or mobile apps if I didn't already have an account with them. That's because today we're thinking about mobile as only a service touchpoint."
Banks also tend to think of retail customers as the target for mobile. Only a few, such as Citizens Bank, Union Bank and Wells Fargo, have mobile offerings specifically geared to small business customers. But Wannemacher says that in coming years, mobile banking for small businesses will explode.
Other trends on the horizon include a proliferation of mobile wallets-this will be the year banks start rolling them out in force, Wannemacher says-and improved functionality for digital money management.
7. Huddle Up
Banks of all sizes are loosening the purse strings when it comes to technology. A recent KPMG survey indicates that 50 percent of community bankers plan to invest more in IT in 2013, while Gartner projects that annual IT spending by the banking and securities sector worldwide will rise 3.5 percent to $460 billion.
But the IT decision-makers at banks won't be compiling their shopping lists alone. Many of them will be turning to peers in retail banking, marketing and other departments to see whether potential investments can benefit more than one area of the bank.
Call it the Enterprise IT Huddle.
"Almost every person we talk to says, 'I can't buy anything unless we get multiple benefits out of it,'" says CEB TowerGroup analyst Rodney Nelsestuen.
Recasting specific technology needs in a broader context is one way to help build support for a proposed investment.
For example, Nelsestuen says, a bank processing division may be looking at building a mobile wallet, but it may want to consider the powerful marketing aspects of a "mobile purse" instead, creating customer profiles-culled not just from credit card data but from spending preferences and personal information-that get carried from one end of the bank to the other. That's something that is more likely to be championed by a colleague in marketing or social media, he says.
As more banks blur the boundaries between mobile efforts and other digital platforms, it's easy to see how IT decisions would become a more collaborative affair.
Celent senior analyst Bart Narter notes that many large institutions already are considering their electronic channels in a more cohesive way. "It's really quite expensive to have a separate mobile banking platform from a tablet banking platform or from retail Internet banking or small business Internet banking," he says.
It isn't just the major global banks that have come to this conclusion. Narter says that in a recent visit to a $25 billion-asset institution, he was surprised to see the head of the bank's retail branch division sitting in on an early e-channel strategy session.
Getting more voices into the decision-making process perhaps might slow the IT selection process into a bureaucratic stalemate. But having more deliberative and cross-channel discussions could prevent banks from making bad decisions on early technology that is useful to too narrow a slice of the bank. (Think back to the push for consumer desktop remote capture, a hot technology idea four years ago that has now been entirely eclipsed by mobile RDC).
With the proliferation of new channels, Narter says bankers "need to think through this and come up with a digital channel platform through which they can serve their customers instead of going out with RFPs every time [they say] we need tablet now, we need Android, we need iPhone, we need Internet, and what's coming up next?"
8. Tighten Your Grip on Operational Risk
In the wake of the storm damage and lengthy, widespread power outages brought to our shores by Hurricane Sandy, it's a good bet that natural disaster preparedness has been high on the list of discussion topics this winter for management and boards at banks across the country-which is understandable, but not very comforting to those who would encourage banks to examine risk proactively.
"You've got to be more strategic in your operational risk reporting than that," says Edward DeMarco, director of operational risk management and regulatory compliance at the Risk Management Association.
This already has been understood for many decades in sectors where operational failures can kill people (think food, aviation or pharmaceuticals). Compared with those industries, operational risk management within banking is in its infancy. Institutions that regularly engage in it got on board maybe 10 or 15 years ago, but that was mainly with the goal of using it to make better capital allocation decisions.
Now is the time, DeMarco says, for banks to start examining operational risk for the purpose of actually managing it.
Start with your culture. Presuming you like it the way it is, allow it to inform your institution's tolerance for risk. And then communicate, communicate, communicate, so that everyone is with the program when it comes to policies and procedures, measuring and modeling, and monitoring and reporting on various operational risks.
Cyber security, reputation management and liabilities tied to third-party vendors all should be front-burner issues, along with the aforementioned topic of disaster planning.
In addition, if you're buying up competitors or even just preparing to, you may want to reexamine your due diligence process (this reminder courtesy of Hewlett-Packard and its purchase of Autonomy, which led to an $8.8 billion writedown tied to an accounting scandal at the acquired firm). And if your employees or customers are using Twitter or Facebook (hint: they are) then you'll want to monitor these sites for mentions of your bank, even if you don't have an official presence on social media.
In short, operational risks are accelerating at exactly the time when banks are clamping down on costs and struggling to keep pace with fast-changing complexities, which itself can accelerate operational risks. Given the environment, Comptroller of the Currency Thomas Curry noted in May that operational risk had floated to the top of the agency's list of safety and soundness issues.
"Some of our most seasoned supervisors, people with 30 or more years of experience in some cases, tell me that this is the first time they have seen operational risk eclipse credit risk as a safety and soundness challenge," Curry told the Exchequer Club in Washington. "Rising operational risk concerns them, it concerns me, and it should concern you."
9. Try a Reverse-Mentoring Program
You probably didn't need Nate Silver's election analysis to figure out that the demographics of this country are shifting fast. Just look around your bank. Chances are your colleagues represent a diversity that gets diverse-ier the lower down the totem pole you look.
If diversity is concentrated at the lower rungs, that might indicate a need to examine your promotion process-or it might just reflect the fact that new generations of hires simply are more diverse than the previous ones. Either way, you might do well to try out reverse mentoring, where senior executives get schooled in the various needs, mores and cultural attitudes of their staff, which have probably changed a lot in the years since they were the ones in the rank and file.
The classic portrait of a bank executive is of an older, white, straight male, but reverse mentorship can work for any leader who is paired with someone different from him- or herself, whether in terms of age, gender, race, religion, sexual orientation and so on. The mentorship relationship serves as a "safe place" in which delicate questions can be asked, with the answers hopefully leading to a work environment that is more comfortable for everyone, and that optimizes the strengths that diversity can bring.
"It's a paradigm shift to think that a mentor can be younger and less experienced and yet have something to offer," says Rajashi Ghosh, an assistant professor of human resource development at Drexel University. But she says that with younger workers having grown up in a more diverse environment than the preceding generation, being aware and respectful of people's differences is something "that comes to them naturally."
Colleen Taylor, executive vice president for treasury management and merchant services in the commercial bank at Capital One, says that of the many mentor roles she has played, the most interesting was the one in which she reverse-mentored a senior leader at a previous employer. She says that as a gay, black female, she had plenty of unique perspectives to share with her "mentee." At the same time, she got invaluable access to a key executive, making the relationship mutually beneficial.
Taylor says she saw an especially powerful example of reverse mentoring when a blind colleague in the program she was in helped a senior executive to more fully understand some of the daily challenges that people with disabilities can face in the workplace.
"Once you're connected to someone in a personal way, it very often changes your perspective on things," Taylor says.
10. Push to Re-privatize the Mortgage Market
Weaning the mortgage industry off government support might seem like a pipe dream these days. After all, Fannie Mae and Freddie Mac have been in conservatorship for more than four years, and the Federal Housing Administration may need a taxpayer bailout for the first time in its 78-year history.
With the government mired in mortgages (95 percent of all new home loans are backed either by Fannie Mae, Freddie Mac or FHA), many experts believe it's time for private capital to return. This idea has plenty of backers. The main obstacle has been how to create a plan and an infrastructure to get from here to there.
The Obama administration is trying to coax more risk-taking from the private market. So far, Fannie, Freddie and the FHA are raising guarantee fees that would make government-backed mortgages more expensive.
Throw in a rebound in home prices, and bankers and mortgage lenders just might get comfortable enough to take on credit risk again.
What's at stake-besides a chance for meaningful reform in a key component of the financial system-is perhaps the single greatest growth opportunity for U.S. financial stocks over the coming decade, according to the equity strategists at Keefe Bruyette & Woods.
One reason private firms have been absent from the market so far is that they are far less liquid than they were during the boom years. Since the government stepped in at the height of the financial crisis, the market capitalization of private mortgage firms has fallen to $53 billion at the end of 2012 from $163 billion in 2006. (At that time, Countrywide Financial alone had a market cap of $24 billion.)
"As the housing market recovers and the government moves to wind down the government-sponsored enterprises, we expect value growth to shift to nonagency real estate investment trusts, bank portfolio lending, mortgage insurers, and specialty mortgage service providers," Fred Cannon, KBW's chief equity strategist,wrote in a recent research piece.
That means it may be time to take another look at a slew of stocks including banks, special servicers, and real estate investment trusts such as Annaly Capital Management and American Capital Agency.
Of course, big ideas face big hurdles. The future of Fannie, Freddie and the FHA and the formation of a new housing finance system ultimately rests with Congress. And Washington moves at a snail's pace.
Earlier this year, the Federal Housing Finance Agency, which oversees Fannie and Freddie, released a 21-page white paper outlining how lawmakers could move forward with a plan to reduce the government's role. The title of the report neatly summarized a widely shared view: "The Next Chapter in a Story That Needs an Ending."
