The Rise of Cyber Branches in Banking

The development of new banking technology continues to change the industry. In a recent Regional Economist article, Senior Economist Andrew Meyer explored a potential measurement problem that online banking has brought about.

Online banking is becoming more common. Meyer cited a recent survey conducted by the Conference of State Bank Supervisors (CSBS), which found that 91.5% of community banks offered mobile banking, 82.6% of community banks offered electronic bill payment, and 78.9% offered remote deposit capture.

The rise of online banking has led to the development of online-only branches, or “cyber” branches, for gathering deposits nationwide. Though cyber branches are less common than other technological developments, banks are using them to gather deposits, the author noted. 

Difference between a Cyber Branch and a Traditional Branch

An important difference between a cyber branch and a traditional brick-and-mortar branch is the area of service, Meyer noted. A traditional branch typically serves customers only in its designated market, or the metropolitan area or county where it is set up. A cyber branch is not limited to one market and can serve customers across the entire nation.

“When the bank reports those deposits at a branch level, the market with a cyber branch gets credit for deposits that clearly come from outside of the market,” he wrote.

Along with their ability to reach more markets, another advantage of cyber branches is their lower overhead, which can benefit the customers, employees and owners, he pointed out.

Cyber Deposits Are Growing

According to FDIC data, in 2019, cyber branches made up 0.22% of all branches. Although smaller in number than traditional branches, cyber branches were larger than average and accounted for 3.18% of total deposits, the author noted.

Some results in the CSBS survey indicate that the number of cyber branches will likely increase in the future. While 2.2% of community banks claimed an online-only division, an additional 2.2% were actively planning to start one and another 15.2% had discussed creating one.

“Thus, we can expect the amount of cyber deposits to rise in future years, given the continuing increase in use of technology in banking,” he wrote.

Measuring Market Concentration

The Department of Justice uses the Herfindahl-Hirschman Index (HHI) to measure market concentration and identify mergers as potentially anticompetitive. The HHI is calculated by summing the squares of banks’ shares of deposits in a given market. An HHI of zero would indicate a perfectly competitive market, while an HHI of 10,000 (100²) would indicate a monopoly, Meyer explained.

A market with an HHI above 1,800 is highly concentrated and is determined to be uncompetitive to highly uncompetitive; a merger that raises an HHI by 200 points or more and push the HHI into this range generally requires regulators to undertake additional analysis before the merger is approved. A market with an HHI between 1,000 and 1,800 is considered moderately concentrated, and a market with an HHI of 1,000 or less is considered unconcentrated, the author explained.

Meyer also noted that rural markets tend to be much more concentrated than urban markets.

Cyber Branches Distort Measurements

Cyber deposits can have a nontrivial impact on the measured level of concentration in banking markets, the author pointed out. While cyber branches do not represent a large proportion of deposits on the nationwide level, in certain markets, the proportion can be large.

Meyer honed in on one market as an example: In 2019, 60% of the deposits credited to the Hardy County, W.Va., market came from two cyber branches.

“In a market like this one, analysts should investigate how many of those deposits are actually local before computing any market concentration ratios,” he wrote.

Data for this analysis are not easily accessible, so regulators may have to make assumptions that could increase or decrease the measured levels of concentration and distort the picture of competitiveness in individual markets, he explained.

Rather than calling for a change, Meyer warned about a potential measurement problem that could mislead analysts in both directions.

“As the cost of technology decreases, the measurement problems associated with cyber deposits are likely to get worse, not better,” he concluded.

Additional Resources

• Regional Economist: How Cyber Deposits Affect Perceived Competition in Banking Markets
• On the Economy: Faster Payments, More Disruptions
• On the Economy: Will Digital Wallets Replace Cash?