Bogged down by branch costs, banks' prospects for profiting from on- line banking are getting dimmer and dimmer, according to various analysts and research studies.

Branch networks-once a bank's crown jewels-could become a huge liability. Combined with downward pressure on on-line banking fees and an insufficient number of on-line users, branches are helping to take the steam out of on-line banking plans.

"The business model for on-line banking is practically nil," said James Marks, electronic commerce analyst at Deutsche Bank Securities.

He cited incremental costs beyond expensive branch networks as a major culprit, as well as the fact that any new fee banks would be able to wrest from on-line billing services is likely to go into the coffers of providers such as Checkfree Corp.

"Banks are going to have to come to terms with this," Mr. Marks said. "They will still have a very valuable (branch) franchise for a very long time." But during the next five to 10 years, he said, "they are going to be increasingly pinched"

There are no easy answers, especially as nonbank competitors weigh in with offerings that do not include the built-in costs of broad branch networks.

The situation is akin to the threat Barnes & Noble faces from, said William Randle, senior vice president of Huntington Bancshares.

The Internet bookseller gained the market's attention and a share of business by deep price discounting. Barnes & Noble's response was defensive, and the banking industry will wind up emulating it, Mr. Randle said. The bookstore developed its own Internet offering, adding a delivery channel-and costs-beyond its stores.

"I do not think they would have done it on their own volition," Mr. Randle said. "This is a demand-driven movement to a new way of doing business."

Like Barnes & Noble, banks need to balance the value of their branches against the potential of a new, cheaper way of doing business.

"Banks are going to have to figure out how to make this into a positive opportunity rather than just a defensive reaction," Mr. Marks said. "At this point, however, it will become a necessity just for defensive reasons alone."

Mr. Randle agreed: "It really is a survival issue."

And banks are spending to survive.

They will invest $851 million on Internet and PC banking systems by 2002, or 15% of their retail technology spending, according to a December report by GartnerGroup Mentis Financial Services of Durham, N.C. This would imply a 35% annual growth rate, the fastest-growing retail expenditure.

Mr. Randle predicted that Web-based banking will become ubiquitous by 2004, with 40% to 50% of the population using the Internet as their primary access to bank accounts.

Despite banks' investments and expectations of use, Tower Group, a Needham, Mass., research firm, has concluded that home banking is not profitable for traditional banks in the near term. It estimates an average per-customer loss to banks of $6 per month.

"If you are a large bank offering home banking, you have got a loss leader," said Richard Bell, senior analyst at Tower Group. New Internet distribution methods will not make expensive branches go away, he said.

But he said he sees hope for eventual on-line profits, once banks develop business opportunities such as electronic bill presentment and payment.

Mr. Marks said he expects competitors like Telebanc Financial Corp. and Netbank Inc., which don't operate networks of high-cost branches, to stir banks from their "on-line lethargy."

Also looming are nonbank competitors like Charles Schwab & Co. Within six months, the San Francisco-based discount brokerage firm plans to offer all customers an account called Access.

Access will rattle banks, Mr. Marks predicted. It is to offer competitive checking, debit card, credit card, and electronic bill payment and presentment services. Its introduction will be backed by an extensive marketing campaign aimed at persuading consumers to give up their bank accounts.

"We believe consumers will prove amenable to the idea of using a brokerage account as their bill paying account, simply because the rates are so much better," Mr. Marks said. "We expect a tremendous response from the industry.

"Banks will wake up one day very shortly and realize that there is no more waiting," he said. "The barbarians are finally at their gates."

Mr. Marks recommended a fresh approach to retail banking, singling out direct banking efforts like Citigroup's e-Citi and Bank of Montreal's Mbanx.

Mbanx, carved out of Bank of Montreal in 1996, is a stand-alone business, separated operationally and financially from its parent. Providing full banking services via the Internet, telephone, and mail, it is not obliged to support its parent's extensive branch network.

It attracted 100,000 customers within a year of its opening and now has 167,000.

Denny Allen, MBanx senior manager of public affairs, admitted that the unit's success comes at the expense of its parent. "But we knew that if we did not provide this service to our customers, somebody else would come along, and we would lose them completely," she said.

Mbanx carries a $13 monthly charge that can be whittled away, depending on how much business a customer does with it. "Depending on the extent of the relationship, a consumer can actually get paid by Mbanx," Ms. Allen said.

Royal Bank of Canada is also shunning branches. Though it has 1,500 branches supporting its retail strategy in Canada, it does not plan to use branches to expand into the United States.

"We won't buy anything in the U.S. in terms of a traditional bank," said David Moorcroft, a Royal Bank spokesman. "We're investing in the next way of how people will do banking."

Toward this end, it bought the Internet-based Security First Network Bank for $6 million last August.

Initially, the Internet service has mostly attracted Royal's Canadian customers who spend the winter months in the U.S. Sun Belt. But the bank anticipates attracting users from the growing U.S. on-line banking population.

Spending billions to buy an established retail bank would not give Royal Bank a "significant differentiation," Mr. Moorcroft said. "We're going to build a business base in the U.S. electronically."

Mitchell Caplan, president and CEO of Arlington, Va.-based Telebanc, wouldn't take a branch if it were free. "Even if you gave it to us, we would still have all the costs associated with running it," he said.

Customers of the $2.3 billion-asset thrift can reach his bank only by telephone, mail, or the Internet.

Mr. Caplan thinks branches have value but said they do not compare with the value created by competitive pricing, convenience, and high-quality customer service. With no branch overhead, Telebanc's costs are 50% less than those of similar-sized institutions. It boasts higher savings rates, limited bank fees, and interest bearing checking accounts.

"If we started spending the money to build branch infrastructures, we would be at a competitive disadvantage," Mr. Caplan said.

As more consumers turn to electronic alternatives like Mbanx, physical branches will become underused, predicted Huntington Bancshares' Mr. Randle. Banks will need to develop new uses for them, such as sales of insurance or brokerage products.

"The banks with the biggest inventory of physical distribution, in my judgment, are at the greatest risk," Mr. Randle said.

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