The 'Network Effect' Persists Even in the Age of Electronic Banking

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Sep 24, 2023
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The 'Network Effect' Persists Even in the Age of Electronic Banking
In the world of banking, the concept of the network effect is still very much relevant, even in the age of electronic banking. The network effect refers to the phenomenon where large branch networks capture a disproportionate share of market deposits. This means that as a financial institution adds more branches, the average deposit size per branch increases. Each new branch not only benefits from the existing branches in the market but also provides a lift to them.
Historically, financial institutions have pursued concentrated deployment strategies to leverage the network effect. Instead of spreading their branches across multiple markets, they focus on having a larger presence in a single market. This strategy has proven to be effective, with studies showing significant positive correlations between network size and average branch size.
In recent years, however, some interesting trends have emerged. Firstly, smaller banks operating in a single market have realized that the network effect holds not only at the metropolitan area level but also at the corridor level. Instead of scattering branches across an entire metro area, these banks are now focusing on building cohesive networks in one or two corridors while ceding others entirely. This strategy has resulted in increased per-branch deposits.
Additionally, the financial crisis of 2008 had a significant impact on the banking industry. While larger banks bore the brunt of the industry's reputational damage, some consumers opted to migrate to smaller banks. These consumers were rewarding fiscal responsibility over location convenience, resulting in smaller banks boosting their ranking on measures like deposits per branch.
It's important to note that the strength of the network effect varies across markets. Markets with strong legacies of thrifts and mutual savings banks, for example, tend to show lower correlations. Institutions in this sector of the industry lean more towards rate-based, branch-light operating models.
In conclusion, the network effect continues to play a significant role in the banking industry, even in the age of electronic banking. Larger branch networks have proven to be more efficient in terms of balances per branch. However, smaller banks can still leverage the network effect by focusing on building cohesive networks in specific corridors. It's important for banks to understand the dynamics of the network effect in their respective markets and tailor their strategies accordingly.
Actionable advice:
- 1. For smaller banks operating in a single market, focus on building a cohesive network in one or two corridors rather than scattering branches across the entire metro area. This will increase per-branch deposits.
- 2. Consider the strength of the network effect in your market. Markets with strong legacies of thrifts and mutual savings banks may show lower correlations. Take this into account when developing your branch network strategy.
- 3. Emphasize fiscal responsibility and customer trust. In the aftermath of the financial crisis, some consumers migrated to smaller banks that demonstrated fiscal responsibility. Build and maintain a strong reputation for financial stability to attract customers who value these qualities.
In the ever-evolving landscape of banking, understanding and leveraging the network effect can give financial institutions a competitive edge. By strategically deploying branches and focusing on customer needs, banks can increase their market share and drive growth in the age of electronic banking.
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