Banks are heaving their in-house broker-dealer operations. During the past year, four banks phased out their units and outsourced the business to third-party broker-dealers, according to management consulting firm Kehrer Saltzman & Associates.

That leaves only 40 banks that have their own brokerage units, a mere 2% of the 1,809 banks that offer investment services.

Banks are bowing to technology, compliance and other cost pressures and shifting their businesses to large third-party broker-dealers that have the economies of scale to run the businesses more cost effectively, Kenneth Kehrer, a principal of Kehrer Saltzman, explained in a telephone interview. Banks are also concerned about risk management and view outsourcing as a way “of shifting some of the risk of being in that business to someone else,” Saltzman said.

Five Star Bank, the nation’s smallest bank to have had its own broker-dealer, was one of the four banks that decided to partner with a third-party marketing firm—or TPM—last year.  The Warsaw, N.Y.-based commercial bank partnered with LPL Financial because it realized that its investment services program needed to be bigger, something it couldn’t achieve on its own. “The investment program was never going to be very large to be able to afford to be a broker-dealer, and so they decided they would partner up with an organization that had that capability,” Saltzman said.

The other three banks to outsource their investment services businesses last year were FirstMerit Bank, The Bank of Tampa, and BancorpSouth, which partnered with Infinex Financial Group. Both FirstMerit Bank and The Bank of Tampa chose LPL Financial as their TPM. The partnering came on the heels of Regions Bank’s outsourcing of its brokerage services business to Cetera Financial Institutions in 2012.

Indeed, only the largest banks have the scale to run their own brokerage units. According to Kehrer Saltzman’s research, the 40 institutions that have their own broker-dealer account for 79% of all bank consumer deposits. “So most bank customers experience a bank’s investment services offering as a bank-branded BD,” Kehrer noted. 

Bank broker-dealers need to have at least $10 million in annual revenue to capture most of the benefits of owning a broker dealer. More than $20 million would be even better.  “Once you’ve over $20 million, it’s pretty clear that financially you’re better off with your own broker-dealer,” said Kehrer. 

Outsourcing, however, has its drawbacks. Bank executives worry that new guidelines from the Office of the Comptroller of the Currency for more intensive due diligence of third-party broker-dealers will take some of the shine off of outsourcing.

“The OCC is saying that just because you’ve outsourced something to a vendor doesn’t mean you don’t have the responsibility to be managing it and maintaining the risk,” Kehrer said.

Outsourcing also dilutes the brands that bank brokerages invested a great deal of money to build.  In addition, executives fear that outsourcing would lead to a loss of control of the client experience.

Still, the trend is toward outsourcing.  “Other banks are in discussions with the TPMs about outsourcing,” said Kehrer. “Cost pressures, the need to provide better client-facing and advisor-facing technology, and regulatory pressure all continue to intensify.”

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