BankMobile co-founders Jay Sidhu and Luvleen Sidhu discuss their business model and describe how fintech is disrupting the financial sector.

Technology is disrupting the banking industry in several ways. For instance, customers today interact with their banks via mobile devices more often than they visit a bank branch. Jay Sidhu, chairman and CEO of Customers Bank and BankMobile, believes that within five years mobile banking will become the norm.

It was this conviction that inspired Sidhu to set up BankMobile, a mobile-first bank, as a division of Customers Bank in January 2015. His daughter Luvleen Sidhu, who was working as a management consultant at Booz & Co. in the financial services practice, came on board as co-founder of BankMobile. She is now president and chief strategy officer. BankMobile currently has some 1.8 million customers. The Sidhus believe that over the next five to seven years, this number could go up to five million.

In a conversation with Knowledge at Wharton, Jay and Luvleen Sidhu discuss the future of banking, their goals for BankMobile, and why they are selling it to Flagship Community Bank. The spin-off and merger is scheduled to close in mid-2018. “I’ve been in the banking business for 45 years. This is the most exciting time. There is an opportunity to use a new means to show exponential growth,” says Jay Sidhu.

An edited transcript of the conversation follows.

Knowledge at Wharton: You launched BankMobile, which you call a completely digital bank, in January 2015. What was the opportunity that you saw?

Jay Sidhu: Banking is about attracting customers and making them feel good about their relationship with the bank so that they become customers for life. Traditionally, banks have used their branches to acquire customers. We noticed that customers were visiting bank branches less and less. We had to find a new way to attract them. We created a task force, which Luvleen headed, and told them: “If you couldn’t open a single bank branch, how would you acquire customers? How would you engage with customers so that they say, this is a great experience? How could you make them customers for life?” We felt that if we didn’t disrupt ourselves, then somebody else would.

Luvleen Sidhu: On an average, people walk into a bank branch once or twice a year. But they interact with their bank on mobile devices 20 to 30 times a month. From a business model perspective, bank branches are acquiring only 52 net checking accounts a year per branch. That is not an exponentially growing customer acquisition vehicle. We started thinking how we could create a sustainable, low cost, high volume customer acquisition strategy. That’s how we developed BankMobile.

Knowledge at Wharton: How does the mobile banking market in the U.S. compare to other parts of the world? A lot of the action seems to be in places like Africa and Asia.

Luvleen: Yes, it has been a lot slower in the U.S. This is partly because of the regulatory environment. It’s very difficult for fintech players or non-banks to enter into the banking space here. The reason is to protect the consumer. But it creates a lot of entry barriers for innovators in this space.

Jay: The U.S. banking system is built upon giving access to people in a local way. Regulators believe that if you permit digital banking it will be available primarily in populated centers and that the remote areas, the middle part of the country, will not have access to it. I think that is a total fallacy. My prediction is that within five years, the U.S. will be a leader in digital banking globally.

Knowledge at Wharton: How will that leadership be established?

Jay: It will be established because the U.S. is the innovation center of the world. There is a lot of innovation taking place in the fintech area, but it’s the bank charters, and it’s a partnership that is being debated. Regulators are preventing banks from engaging with fintech companies because they believe that fintech is not good for the consumers. There is no question that you need good regulation, there is no question you need good consumer protection, but why should one have to walk into a bank branch to open an account? For credit cards, you don’t need to go to a bank, but you need to do it for a checking account. BankMobile has changed that whole process. It is opening almost as many checking accounts as Bank of America does through its 4,000 plus branches across the nation. I think there will be more BankMobiles coming up, and it will become a very common way of doing banking in the United States.

Knowledge at Wharton: One of the advantages that fintechs seem to have over traditional banks is their ability to engage with millennials. How can banks engage more actively with millennials in terms of customer acquisition?

Luvleen: This may be a false perception. Some fintechs are doing really well — for instance, SoFi and Robinhood have done a great job of acquiring customers — but these are just a handful. There are thousands of fintech companies out there and one of their main struggles is customer acquisition. They are resorting to old school forms of marketing like direct marketing, where customer acquisition costs are $500-$1,000 or more, which is extremely high and not sustainable. That is why we’re seeing consolidation of fintechs. They are either shutting down or partnering with banks to create a sustainable customer acquisition strategy. While it seems like fintechs are doing a great job in terms of customer acquisition because they have a great user interface and are paying attention to customer experience, in reality banks are much better at customer acquisition because of the stickiness of the direct deposit checking account relationship.

Jay: It’s also interesting that while BankMobile is a bank for millennials, about 25% of our customers are older than 35 years of age. There is a perception that non-millennials do not want to get engaged using digital means. But I think while the age group 35 to 55 may be less receptive, above age 55 is more receptive because they don’t want to be left behind. Millennials consider it to be a pain to deal with brick and mortar, especially when they can get a better product at a lower price, and it’s more convenient, through digital means.

“On an average, people walk into a bank branch once or twice a year. But they interact with their bank on mobile devices 20 to 30 times a month.”–Luvleen Sidhu

Knowledge at Wharton: Jay, you were previously the CEO of Sovereign Bank, which was later taken over by Santander Bank. As you enter this new world of digital and mobile banking, are there things you had to learn or unlearn?

Jay: The basic business of banking hasn’t changed, which is acquiring customers, engaging with them, and considering customers for life as your model for the business. What is it that customers look for? They look for ways to make more money, save more money, get more money and get some help on managing the money. It’s basic stuff. In the bank branches, it’s a lot tougher to do this because there’s no consistency. Some bank branches cost millions of dollars.

When I was running Sovereign Bank, we were looking to acquire customers through bank branches. Now we are saying, “No bank branches.” So how do we acquire customers? We have developed partnerships. You look at any disruptor, they usually go from business to business to consumer (B2B2C). You look at Uber, you look at Airbnb — they are all doing that. Why are banks not doing that was a question that we kept asking. We got an answer, and it’s working.

Knowledge at Wharton: Luvleen, could you talk about some of these partnerships that Jay mentioned? How do partnerships fit into the way in which BankMobile has been growing?

Luvleen: We call it our leverage growth strategy. In essence, can we have one distribution partner give us access to potentially millions of customers? The way we have done this is through virtual digital banks in 800 campuses across the country. We have contracts with 800 campuses. We provide proprietary technology and regulatory oversight for any payments that they need to send between the school and the students. On an average, we save these colleges about a quarter of a million dollars every year for services. In return, the students get to choose if they want the money that they receive from the school to be transferred to an existing bank account, or if they want to open a BankMobile checking account. This has been a great way for us to open about 300,000 to 400,000 new checking accounts each year, which makes us the number one or close to the number one checking account acquirer in the nation.

Knowledge at Wharton: You have grown to around 1.8 million customers in the past three years. Was this your primary growth strategy?

“There are thousands of fintech companies out there and one of their main struggles is customer acquisition.”–Luvleen Sidhu

Luvleen: Currently, we dominate the student banking market. Our 1.8 million customers have an average age of 27, and primarily they are students. We are able to serve these customers when they’re looking for a bank account. Also, there’s a knowledge gap about credit, how to use money, and money management. There’s an opportunity for us to play in that space as well.

Knowledge at Wharton: Most large banks have a banking app and are adding digital services. How can a mobile-first bank like BankMobile differentiate its offerings from the digital offerings of legacy banks?

Jay: The large banks are still totally focused on attracting customers through bank branches. They have hundreds and thousands of bank branches and they are hoping that the customer doesn’t stop going to these branches. They are making their branches slicker, open for longer hours, have glass around it, they stand outside and have invite people, have video screens inside. But everybody has a video screen in their pocket. Why would they want to talk to you in a bank branch?

The large banks need to disrupt themselves. The reason they are not disrupting themselves is because of their infrastructure. And, they are making money by keeping customers misinformed. I’ll be specific. Today, the interest rates are such that consumers should be getting at least 1% on their savings accounts. Some large banks pay only .05% interest. And they are proud of this. Imagine a business that says we are proud that we charge the highest prices, but we give them an app to get it. Well, we have found a way to attract customers and pay them a competitive price. That is true engagement. This is why banks are either going to have to change themselves, or they will have to face a gradual death.

Luvleen: They are realizing this and a shift is taking place, but at a snail’s pace. JPMorgan Chase recently launched Finn, and Wells Fargo launched Greenhouse [both are mobile banking apps]. They are trying to create these branded apps with cool names and powered by JPMorgan/Wells Fargo so they have their reputation and credibility behind them. They are trying to use this as a customer acquisition strategy the way that we created BankMobile. But we launched BankMobile three years ago and they’re piloting these ideas now.

Jay: I think within five years you will see at least 50% to 75% reduction in the number of bank branches. These banks will wake up. They have the resources to wake up and they will be fine. Like the Bank of America and the JPMorgan Chases of the world. But Luvleen is right, they are moving at a snail’s pace. Bank of America closed 20% of its branches last year.

Knowledge at Wharton: What will the bank branch of the future look like?

Jay: The branch of the future will not be on the most expensive street corner. It could be on the fifteenth floor. I’ll give you an example. Customers Bank has a branch at 101 Park Avenue in New York. It’s on the eleventh floor. It has $1.8 billion in deposits. That by itself is in the top 50 banks in the country in size, and it’s on the eleventh floor of a building. That is so much more efficient than little branches all over the place in the streets of Philadelphia.

Knowledge at Wharton: Why are you spinning off BankMobile and merging it with Flagship Community Bank?

“I think within five years you will see at least 50% to75% reduction in the number of bank branches.”–Jay Sidhu

Luvleen: We have a regulatory arbitrage because 70% of our non-interest income is from interchange revenue, i.e. when someone swipes their debit or credit card. In our case, we are looking only at debit card payments. Being a bank under $10 billion in assets, which is what Customers Bank, our parent company was when we started our partnership, we could leverage this interchange revenue. Under the Dodd Frank [Act], as part of the Durbin Amendment banks that are over $10 billion in assets make about four or five times less in interchange revenue. To protect our growth and our future opportunity it makes sense for BankMobile to be part of a banking institution that is under $10 billion in assets.

Jay: At Customers Bank, we don’t like to charge fees. We like to have tremendous engagement. In the technology model, you’ve got to have a very low-cost operation. The only way that we make money right now is when customers swipe their cards. We are making about $45 million a year just with customers swiping their cards. If we don’t spin off BankMobile, that $45 million will go down to about $30 million and $15 million will have to be recovered by charging fees, which is not a part of our model. We believe there is a lot of room for growth in partnership banking. We’ve announced that we will be partnering with a top retail institution.

We expect that within two to three years our customer acquisitions will go from 300,000-400,000 to perhaps a million checking accounts a year. That is more than what Bank of America is doing. It won’t be possible for us to do this if BankMobile was part of Customers Bank.

Knowledge at Wharton: How important is financial inclusion for you as a goal for banks?

Luvleen: Part of the reason we launched BankMobile is because there are millions of Americans who are locked out of the banking system. This is because they don’t trust the banking system, or they can’t afford the monthly fees or the minimum balance requirements. The big banks charge Americans $33 billion a year in overdraft fees. That doesn’t build trust. We wanted to provide a banking experience that is affordable and can serve low to middle income Americans, individuals who are underbanked or unbanked. So, we created a very affordable banking product. We also have a strong educational component. We have curriculums that help people understand the psychology of money and money management so that they can understand the components of credit.

“The branch of the future will not be on the most expensive street corner. It could be on the fifteenth floor.”–Jay Sidhu

Jay: Around 20% of Americans are spending more than 15% of their income to have access to financial services. We believe the ones who can least afford it should spend nothing. We have a duty to help those who are underserved become more financially literate and less dependent upon the society.

Knowledge at Wharton: Where do you hope to go with BankMobile over the next couple of years?

Luvleen: We want to become the number one acquirer of checking accounts. It’s not just about high volume and getting as many customers as we can. It’s about the social mission we talked about. There are 65 million Americans that are unbanked and underbanked. There is an opportunity to serve these customers and provide them with the financial foundation they need to reach their dreams. It’s about creating customers for life, adding value to their banking experience all the way from convenience to actual products and services. We hope that in the process of serving our customers, we also impact the lives of our employees in positive ways. For our shareholders, we hope to grow BankMobile to a profitable endeavor over the next three to five years.

Jay: I think we are doing good and at the same time doing well. These opportunities exist because of technology. I’ve been in the banking business for 45 years. This is the most exciting time. There is an opportunity to use a new means to show exponential growth. It is no longer about 10% growth. American businesses have been cutting costs or finding ways to have slight increase in revenues. The street thinks if you get 10% increase you are a growth company. It is going to realize that with technology 20% sustainable growth is possible. But that’s only possible if you have a disruptive model. The future of banking, in my opinion, is going to be based upon doing few things really well. It will be niche banking. Business banking will remain, at least in the foreseeable future, as a human contact. But consumer banking is going through a disruptive change. We believe that we have found a way to continue to attract customers. That is the key. You cannot get engagement unless you attract them. We think it’s possible for BankMobile to have three million to five million checking account customers within a five to seven-year period. When I was running Sovereign, it was the 20th largest bank in the nation and we had 1.2 million checking account customers. So, we are talking about three times bigger than Sovereign in consumer banking within a 10-year period. That’s exponential growth.