What it takes to build a digital bank

The typical financial institution sees digital banking as channels that give their customers options to connect via desktops or mobile phones.

Savvier bankers are starting to view mobile as the glue that connects all the channels together.

But the most forward-looking bankers are shedding the limitations of traditional banking and looking to build digital banks from the ground up.

Such an endeavor involves developing new products, new processes and entirely rethinking the way people interact with their bank, say those who have trod down this path. It is so much more than just creating a good mobile app.

“We designed the user experience before we even had the core system in place”, said Dan Dickinson, vice president of digital banking at Toronto-based EQ Bank. “The most important thing is that it’s a true digital experience, not something bolted on.”

While the number of digital-only banks in the U.S. is small today, it could rise in coming years as customers’ demands for exceptional digital services increase and as legacy technology makes providing such experiences tougher and more costly. For many institutions, building standalone digital-only banks might be their solution to putting existing customers through a painful core conversion.

Also, with the Office of the Comptroller of the Currency’s plan to create a special purpose charter for fintech firms, there likely will be startups trying to create digital banks, too, looking to some of the successful European challenger banks for inspiration.

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Last year Equitable Bank launched EQ Bank to connect with new retail customers. The unit strives to be its own independent entity as much as possible; it had its own cloud-based core system built specifically for the digital bank, by Temenos, and offers products completely different from its parent bank.

That last point is key for any digital bank venture, Dickinson said, because banks are hampered by legacy products just as much as legacy technology. Indeed, decades of consolidation have left some institutions with dozens – if not more – of deposit products, for instance.

Most financial products "don’t make sense to the average person; they only make sense to the bank’s balance sheet and the product owners,” he added.

EQ offers a “hybrid checking-savings account” with a high rate, no minimum balance and extra functionalities embedded like bill pay and money management features, Dickinson said.

“We don’t have branches and other legacy overhead other banks do,” he said. “That’s why we can offer a 2% rate on deposits, and not charge fees.”

Higher rates are often a cornerstone of digital-only plays, but some say that is merely a tactic to get customers in the proverbial doors; the experience is what keeps them there. For instance, ING CEO Ralph Hamers said in an interview in December that its digital-only bank continued to grow even when regulators forbade it from being in the top five rate payers after the 2008 financial crisis.

In the year since its launch, EQ Bank has added additional features, such as person-to-person money-movement capabilities. This kind of service is critical, Dickinson said, as consumers – especially millennials – have come to regard P-to-P payments services, such as Venmo, as essential to digital banking.

EQ customers can send money not only to non-EQ bank accounts using the longstanding Canadian Interac interbank exchange network, but also to other EQ customers, free and instantaneously, using the bank-created P-to-P payment system.

BankMobile, the digital arm of Customers Bancorp of Wyomissing, Pa., also offers a similar P-to-P service where customers can send money instantly to other BankMobile customers, or to customers of other banks via the ACH rails by email. It also features money management tools, adding new visual features such as graphics that let customers see how the money in their accounts is dwindling or growing, and how money is moving between accounts. (Customers Bancorp is expected to announce the sale of BankMobile sometime this quarter; it has cited regulatory issues for the divestiture.)

Services such as budgeting help are vital for any digital bank, as the user base is usually looking for something beyond the typical banking experience, said Luvleen Sidhu, president of BankMobile.

“We’re offering more than just a financial product, but we want to be a partner with our customers and help them succeed financially,” she said. The bank will add a “financial fitness score” later this year as another service to help customers manage their money better as part of a broader upgrade to BankMobile’s platform, she said.

“We really want to create a state-of the-art user experience with a very appealing design that’s aesthetically pleasing and helps customers visualize their money inflows and outflows,” Sidhu said.

BankMobile and EQ Bank say starting a digital unit of an existing bank gives them a key advantage over a true digital banking startup, since they have regulatory and compliance infrastructure in place.

“The hybrid approach of already having a bank charter and then leveraging technology to create a kind of internal fintech company within [the bank] is the best model,” Sidhu said.

But some digital startups say building from scratch is the way to go.

“A truly digital bank has to be designed digitally; you simply can’t digitize existing legacy structures,” said Marko Wenthin, co-founder of solarisBank, a German digital startup. “Rethink the purpose of your legacy processes, but then rebuild them from scratch. You will quickly see what has worked well in the past and hence could find its way into the future. But you will also realize that many processes and structures still exist without any real justification. These are the true roadblocks of having a modern structure.”

Wenthin also advises when starting a digital bank to bring on a team with varied professional backgrounds and not just those from the banking or finance industry. Otherwise, he said, “you just end up building another bank.”

“We built a diverse tech team with talents from all over the world, coming from digital companies and startups in the SaaS, adtech, fintech and e-commerce industries,” Wenthin said. “This ensured that no banking process is taken for granted, but everything is challenged at all times and eventually the best digital bank is built.”

Perhaps the best lesson for any digital bank startup is not to try to conquer the world at first but instead find a successful niche. For instance, BankMobile is courting millennials, while MemoryBank, the new digital startup by Republic Bank & Trust Co., is targeting Generation X.

“We expect to be one of many financial relationships a customer might have,” said EQ’s Dickinson, adding that the customer of the future will likely pick and choose among different banks and fintechs for different services.

“We’d rather be the right bank for a small number of customers, than a watered-down version for a larger number,” he said.