the giants of the industry, institutions with the capital and the national focus to make the Internet a viable and important distribution channel. It is no wonder that these companies want to be associated with the Internet. With more than 54 million Americans using the Internet, it is growing at a rate that eclipses the rise of both radio and television. According to Forrester Research, revenue from e-commerce will increase from $1.3 billion in 1998 to $43 billion in 2003. This translates into $1 out of every $10 of trade. But what about community banks? What does the Internet mean to them? Is it a distribution channel to be explored or left to the big boys? A quick review of the undeniable potential of the Internet suggests that those who choose to ignore it will get hurt. At the same time, however, evidence also exists to show that anyone with the foresight to become involved with Internet banking, even the smallest of community banks, can find their businesses raised to unimagined heights. It is easy to see why the Internet is such an appealing distribution alternative. Internet banking offers customers unparalleled convenience and the ability to conduct transactions from the comfort of their home or office, 24 hours a day, seven days a week. At the same time, the absence of bricks and mortar and human interfaces significantly reduces the cost of providing certain standard banking services. The Internet also provides growth prospects far in excess of existing channels; it is estimated that 17 million households will utilize on-line banking by 2000. Despite the advantages, on-line banking faces many hurdles. E-banks have experienced challenges reminiscent of those that many banks encountered in developing a supermarket strategy. That is, some customers may be willing to open deposit accounts through these channels but are often less likely to apply for a loan. Industry sources estimate that only 8% of on-line customers utilize the Internet to find mortgage information. This failure to generate assets may be an Internet bank's greatest shortcoming. Some consumers, especially the elderly, desire a human element with their banking activities. They may perceive financial products as too risky or complex to select without the aid of an expert. Further, queasiness over transmitting personal information on loan applications over the Web is a drawback for many. Finally, many banks have found that success in the virtual world depends on combining above-market interest rates with value-added products and services. Despite present-day limitations, the competitive threat of Internet banks to major institutions and community banks cannot be ignored. As Internet users mature, they tend to have higher incidences of e-commerce and on-line financial activities. It is quite likely that familiarity and comfort with on-line banking will translate into the establishment of the Internet as a viable medium for banking transactions, comparable to consumer adoption of automated teller machines. Demographics also favor the growth of e-banking over time. The future wave of profitable bank customers is younger, with greater reliance on debit and credit cards for purchases. Real-time data and PC-based funds transfers, therefore, will have far more appeal than traditional bill payment. Furthermore, while banks have been slow to generate assets over the Internet so far, success in this area is likely to accelerate soon. According to Forrester Research, in five years, the combination of willing customers and maturing technologies will lead to on-line credit amounting to nearly 10% of all credit extended. Because of the promise of the Internet, many traditional banks are developing strategies that aim to complement their existing franchises. Industry surveys indicate that 34% of banks currently offer some form of on-line banking while 45% are actively developing it. Online Banking Report estimates that 750 to 1,000 U.S. banks will offer e-banking by the end of this year. Ernst & Young predicts that 57% of technological investments made by banks in 2001 will be directed toward the Internet, up from 24% in 1998 and 1% in 1996. For community banks, Internet banking opens a whole new form of competition. Not only are they competing with the superregional across the street, but also with banks hundreds of miles away. As a result, community banks should consider developing an interactive Web site - if not for offensive reasons, then for defensive ones. The technology required to create such an Internet capability is affordable and considerably less expensive than other delivery channels. One of the most successful and well-known on-line bank sites is that of Salem Five Cents Savings Bank, a 145-year-old, $1 billion-asset thrift in Massachusetts. Since it began its Internet service in 1995, it has opened more than 6,000 on-line accounts, which have generated roughly $87 million in deposits, or 10% of the company's total. Based on a survey by Gomez Advisors Inc., Salem's was the sixth-best Internet banking site in the country. Of traditional banks, only megabanks Wells Fargo and Citibank and superregional Huntington Bancshares fared better. In the near term, Internet banking will serve as just another channel for distribution of services and a means to retain certain customers. However, in the not-so-distant future, as demographics change and technology evolves, customer preferences to bank on-line will likely increase. As a result, community banks ought to consider what it might mean to be a community bank in the future. David P. Lazar and Charles K. Hull are managing director and vice president, respectively, of the financial institutions practice at Berwind Financial, a Philadelphia investment bank.

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