E-Trade and The Future of Web-Based Banking

Suppose you’re sitting on a little cash. Should you put some in a CD? Sock it away in a money market account? Now imagine you can visit your bank’s website to figure it out. Using an online tool, you can move the money around and examine how your earned interest and rates will change, depending on where you put it. Colored bar charts representing the amount of interest earned in a year shift up and down depending on your choices. When you decide on the right mix, you can open a new account with a few key strokes.

One might assume every bank would offer such a tool, but few provide customers with anything close. The application described above, called the “intelligent cash optimizer,” was introduced last year by E-Trade Financial. E-Trade was given up for dead after the dotcom bust, but the online brokerage resurrected itself by sharply cutting costs and embarking on a diversification plan that included acquiring a Web-only bank and linking it with its core trading operations. E-Trade’s net interest income, a significant portion of which derives from its banking operations, accounted for 51 percent of its revenue in 2005. Analysts say the company’s success derives in no small part from its customer-friendly services. The company reported earnings of $1.7 billion in 2005.

And E-Trade is giving brick-and-mortar banks a run for their money. According to a June 2006 study by the Pew Internet and American Life Project, 43 percent of Internet users, or about 63 million American adults, now bank online. And a survey released early this year by IT consultancy Keane found that financial institutions consider customer satisfaction with online services key to their revenue growth through cross-selling of products to existing account holders. Yet many banks offer little more than rudimentary services such as the ability to check an account balance or pay bills electronically.

“Very few banks don’t realize at this point that online banking is big business,” says Matt Poepsel, VP of application management at online benchmarking company Gomez. “But many banks are still finding their way.” Banks need to offer more online information and advice that is tailored to the individual account holder, as well as more sophisticated, easy-to-use online tools, experts say. However, Keane found 49 percent of banks surveyed considered their technology platforms to be the primary obstacles to improving their online customer experience.

“At some level, E-Trade shouldn’t exist,” says the company’s CIO, Greg Framke. “If big firms had embraced the Internet as a channel, we wouldn’t have had a chance.” Instead, industry experts point to E-Trade as a model for how banks should run their online operations and prepare to serve the emerging generation of customers raised on the Internet.

The problem for most traditional banks is that they have grown up as a group of autonomous silos, with loan departments working separately from brokerage and cash divisions. Many have also built their branch, call center and Internet divisions as separate units and are now struggling to provide service and sales across all channels. CIOs at these banks have a tough time integrating their back-end systems, notes Rusty Wiley, global banking industry leader for IBM’s business consulting services. “The way banks have built their channels independently has created an inconsistent user experience from the Internet to the call center and the branch.”

Some major banks, including Wells Fargo, Bank of America and Wachovia, are well on their way to integrating systems and offering sophisticated online tools (see “Big Banks That Get the Web,” this page). But “E-Trade takes it to the next level,” says Brad Strothkamp, a senior analyst with Forrester Research. “They leave no stone unturned and [they] sweat the details when it comes to integrating their offerings and providing more functionality.” Here’s how they’ve done it.

The Right Business Model

E-Trade’s first online business model was a bust. After the stock market crash of 2000, the Internet broker’s stock price plunged from more than $60 at its peak to less than $3 in 2002, while the company lost a total of $428 million. Among its problems, E-Trade had a bloated staff and lacked financial discipline, as did many dotcoms. But when Mitchell Caplan, now E-Trade’s CEO, joined the company in 2000 as its chief banking officer, he was convinced that despite the gloomy mood among Internet companies, E-Trade had a future as an online bank. In 1989, Caplan had founded Telebank, a savings and loan that had no physical branches. Telebank offered banking products and services via a toll-free call center and later online.

E-Trade bought Telebank, and the move was seen in the marketplace as an early attempt to offer brokerage and banking services on one site. With the subsequent crash, however, enthusiasm among investors for such online integration quickly faded. Caplan persisted, however, and his bet seems to have paid off. Banking helped E-Trade return to profitability. The company now boasts 748,950 bank accounts—seven times the number of accounts it acquired from Telebank.

As a bank, E-Trade is still relatively small. (Wells Fargo, in contrast, has 7.9 million active online consumer customers, who account for 59 percent of its consumer checking accounts.) But Caplan and Framke attribute E-Trade’s success in a competitive marketplace to the company’s use of open-source technology (for example, Linux on Intel servers, serving webpages with Apache and its supplement, Tomcat) and its early adoption of a services-based approach to software development. When E-Trade built its technology infrastructure, says Framke, service-oriented architecture was a “promising building block” for providing transaction processing. It suited E-Trade’s business model—which emphasized convenience for customers—because it allows the company, by reusing software services, to provide the same experience to account holders whether they are checking a balance or applying for a loan.

“There was something compelling between what we wanted to provide our customers and this emerging technology,” Framke says.

Total Integration

At the core of E-Trade’s technology strategy is a simple idea: that it should be easy and appealing for customers to open accounts with E-Trade, and once they do, it should be easy for them to manage these accounts without having to log in to multiple systems.

“It shouldn’t matter where you are or what kinds of accounts or products you have,” says Caplan. “You want the [online] experience to be the same. That kind of service requires integrated systems.” This is a goal that many banks are striving for right now, but E-Trade is well on its way to achieving it. For example, the company provides customers with a single sign-on for accessing all their accounts during a banking session. In early 2005, E-Trade launched E-Trade Complete, a tool that allows customers to get a single view of their cash and investments on one screen. Conceptually, it’s similar to an online dashboard, and it’s possible because E-Trade uses Web services to knit together customer data from multiple back-office systems enabling the systems that support checking accounts and investment accounts to use the same customer information.

Building on the E-Trade Complete function, the company introduced the Intelligent Cash Optimizer later in 2005, followed by similar tools to help customers find loans and fine-tune their investment strategies. All of these tools reflect E-Trade’s focus on integrating services to create a smoother customer experience. For example, the company repurposed a feature that allowed customers to transfer money in and out of cash or checking accounts in order to enable QuickTransfer, which allows transfers in and out of any other account, too. “The key is to bring together everything to allow customers to navigate between different types of products and see for themselves if they want to save more money or make more interest on their cash,” Framke says.

Traditional banks, on the other hand, “are bogged down by legacy systems,” observes Framke, who has also worked for investment banks Morgan Stanley and Deutsche Bank. The older banks have separate systems for processing loans, managing cash and purchasing investments, and online customers often have to toggle between applications in order to conduct transactions. Experts agree that the type of application and data integration that allows customers access to different products from a single interface will help other banks develop their online offerings. Most large banks are working on this problem, but integrating multiple applications and merging customer information into one database is not an easy task. “Getting the holistic view of a customer’s assets, liabilities and balances is not easy when you have silos,” says Peter Nikonovich, managing director at BearingPoint.

Banish Bureaucracy

Most banks got started with a single purpose. They were either retail banks, commercial banks, mortgage companies or credit card providers. Then, as the economy evolved and the banks grew, they added new lines of business. Each line of business, or unit, would build its own systems, thus banking became an industry in which most large firms were a collection of separate silos. Add to that history the recent wave of bank mergers, and most large financial firms are working not only with a complicated set of systems and databases that don’t talk to each other, but with business units that don’t collaborate.

By contrast, E-Trade—perhaps because it began as an online-only bank and is relatively new—has been able to more easily integrate its lines of business just as it has integrated its IT applications. Unlike traditional banks, E-Trade does not have a separate Internet division and, says Framke, there are no barriers between the company’s trading, lending and cash management operations. “All retail technology is done in the same organization,” Framke says. “There is no distinguishing between brokerage, lending or cash.”

With fewer layers of bureaucracy to wade through, E-Trade executives can make quick decisions about getting new services up and running. For example, in 2004, Framke gathered with Caplan and other top E-Trade executives to present a plan for using multifactor authentication to identify customers. At the time, the use of at least two types of authentication—generally something a person knows, such as a password, and something they have, like a hardware token—was emerging as a safeguard against identity theft. Framke knew customers were concerned about online security, and he wanted his company to respond to these worries.

After Framke’s presentation, the group decided on the spot to move forward with the plan, which involved giving tokens from security vendor RSA to E-Trade customers in addition to a user name and password. That type of nimble decision making is typical at E-Trade, where in contrast to practices at most large banks, Framke oversees all Internet technology and plays an important role in executive decision making. That contrasts with some larger financial companies in which the Internet division is far removed from top management and which, experts say, accounts in part for the lack of progress deploying multifactor authentication by the industry as a whole.

Having separate channels “makes it easier to deal with customers from a line of business perspective,” says Carter Hansen, senior VP of user centered design at Wachovia’s e-commerce division. “The challenge is, how do we come up with the best customer-centered recommendation in the online channel and avoid the impulse to do what’s best for the line of business?”

Listen to Customers

The challenge for banks, then, is to do what customers want, even if it seems counterintuitive. The more tools and functions that are available to customers in a straightforward way, the more money they’ll bring to the bank. That’s the lesson E-Trade learned after it introduced QuickTransfer, a function that allows customers to transfer funds free of charge between accounts within E-Trade or outside the company.

“We were early in the industry to open our door,” says Framke, noting that there was some initial concern that customers would use the transfer function to take money out of E-Trade. However, the opposite occurred. According to company data from the first quarter of 2005, 750,000 customers initiated QuickTransfer and for every $2 transferred to outside accounts, $3 came back to the bank. According to Rob Shenk, senior VP of retail strategy at E-Trade, customers adopted QuickTransfer because it provided a more efficient way than traditional wire or check requests to transfer funds. “It’s also a statement to the customer that our products are not ’roach motels,’ where your cash is trapped within one financial institution,” Shenk says.

According to an equity research report on E-Trade issued earlier this year by Keefe, Bruyette & Woods, “it appears E-Trade customers are choosing to place more cash with the company rather than their traditional bank as some of the largest contributors of net inflows are Bank of America, Chase, Citibank and Wachovia.” Shenk says this information is proof that customers and their cash are drawn to the easy-to-use and effective functions such as QuickTransfer.

Adds Framke, “Our bet has been that if we give our customer the functionality to see what they are making and to move their money around as they see fit, we will bring more money in.” He adds, however, that it’s also important not to overwhelm the customer with too many options. “You need to walk the line between offering sophisticated functionality but not too much,” he adds. For example, he notes, E-Trade would rather offer fewer, highly effective functions like QuickTransfer than a wider variety of more run-of-the-mill ones.

Framke cites E-Trade’s move to offer token-based “multifactor” authentication as another such key function. When the company introduced the RSA tokens in March 2005, it was the first financial company in the United States to offer multifactor authentication to U.S.-based customers (the technology is now strongly recommended by banking regulators). E-Trade customers who choose the service use a token that displays a new six-digit number every minute. The number acts as an extra, onetime password that matches with an identical number generated at the same time at E-Trade’s offices. Framke won’t specify how many customers have opted to use the security tokens, but says E-Trade is pleased with the adoption. “If people feel secure, they tend to keep more money with us,” he says. E-Trade did not provide data to back up this claim, but Internet performance monitoring company Keynote Systems says that in its most recent survey of prospective customers of online brokerages, E-Trade was ranked as a top performer in privacy and security.

Keep Moving

While E-Trade’s success reflects an increasing acceptance of online banking, traditional banks and their branches aren’t going away yet, or maybe ever. Some customers prefer talking with a real person face-to-face when making important financial decisions. Dotcom banks such as Wingspan failed because the majority of customers aren’t yet willing to make the leap to doing everything online. Still other customers are concerned that their financial information may not remain secure from hackers or phishing attacks. These factors present a challenge to E-Trade.

In acknowledgement of the advantages that brick-and-mortar banks still have, E-Trade has opened 20 financial centers and plans to add up to 15 more. The company doesn’t want to turn itself into a brick-and-mortar bank, but rather to offer some face-to-face advice to regular online customers at the sites, which will be located in areas where most customers are located, says Framke.

Going forward, E-Trade will have to keep its eye on its competitors—both online and traditional banks—in order to stay ahead. The online brokerages “are telling us [banking is] extremely competitive and they need to use their websites to draw people in,” says Lance Jones, an analyst at Keynote Systems. Looking ahead, Framke acknowledges that the competition is likely to remain stiff. “The challenge remains deploying technology that is easy to use yet produces meaningful results for the customer and the company,” he says. Framke also has his eye on new Internet technologies such as application composites, or mashups, which are applications created by combining multiple services.

And even though E-Trade is beefing up its physical presence, the company knows it will remain an online leader only if it can continue to come up with tools, such as the Intelligent Cash Optimizer and QuickTransfer, that are effective, easy to use and ahead of the pack. Says Framke: “We have to be ahead of the technology curve as new Web services technologies emerge, and use them in a way that is unique to us.”