What's it all about?" is a common reaction to the euphoria that surrounds the Internet. "My customers don't care what happens on the Internet" is a

frequent follow-up.

"The checkless society is an idea whose time will never come" typically provides the final exclamation point.

The attitude reflected, of course, is that banking remains a high- touch business of interpersonal dynamics that electronic products cannot easily and effectively accommodate.

True enough. But the future banking world will probably be harder to divide into black-and-white, all-or-nothing propositions.

The history of financial intermediation has been a constant blending of tradition and technology that moves customers from one level of financial sophistication to the next. In each transition, though many old products and services remain, more sophisticated and convenient ones displace them at the margin. And as each transition occurs, nontraditional providers offering better products at cheaper costs capture an increasing share of the market.

Money market and mutual funds, mortgage banks, diversified financial services companies, investment banks, and brokerage firms have all taken slices of the deposit, mortgage, credit card, commercial lending, and retirement savings markets.

Moreover, they have done so without having to accept the responsibilities and costs of being regulated as depository institutions. (They would point out, of course, that they don't have the advantages provided by federal deposit insurance.)

In a seminal investor guide, analyst James Marks at CS First Boston describes the trend as disaggregation of financial services, products, and processes into value-added components that specialty firms can handle better - firms that achieve higher return for owners and investors.

Mr. Marks pointed out that 20 years ago thrifts originated 53% of single-family mortgages and held 53% of mortgage loans outstanding, while today they originate 18% and hold roughly 14%.

There is every reason to believe that this trend will continue, and that the traditional customer base of regulated financial institutions will continue to shrink. Indeed, the share of consumer assets placed with regulated financial institutions has declined from 34% to 17% since 1980. Straight-lining this defection rate suggests that the bank customer will be an extinct species by 2005.

The development of the Internet as a commercial market is about access to customers and the evolution and control of the payment system.

Nonbanks and diversified companies have wanted to control banks, break down Glass-Steagall Act restrictions, and acquire savings institutions for some time. Their goals were to create a package of financial products that would better approximate the "relationship" advantages banks and thrifts have enjoyed, and to gain access to the payment system.

Indeed, the provisions in Rep. Jim Leach's bill on financial modernization in 1995, which would have authorized the chartering by nonbanks of wholesale financial institutions, known as "woofies," were devised largely to provide payment-system access to those who did not have it and clearly wanted it.

If the world is moving toward a new form of commerce in cyberspace, it is clear why access to the payment system would be so valuable.

International Data Corp. estimates 44 million households own computers, 30 million of them have modems, and 14 million have some type of on-line access. Though such estimates vary from source to source, there seems to be agreement that on-line access - both business and personal - is growing exponentially. Most agree that the number of World Wide Web users has doubled each of the last few years.

Internet commerce through electronic money can change the flow of money and value, alter the collection and settlement process, and render today's costly payments infrastructure obsolete. The stakes are high, and the potential profits from rewiring the flow of money are staggering.

Two key questions are whether banks can control the payment system as efficiently as others can, and how government should react to nonbanks' entering the inner sanctum of that system.

To compete cost-effectively, banks need to be operationally and legally capable of developing, acquiring, and joint-venturing technology. In that regard, Congress and bank regulators should continue to authorize banks and holding companies to establish, acquire, and partner with technology-driven subsidiaries and affiliates.

Constraints that do not apply to unregulated businesses are likely to hinder banks' competitiveness.

As to the role of nonbanks: Governments want strong, stable financial markets that consumers trust, and electronic commerce is no reason to repeat errors of the past by retesting proven formulas for financial disaster.

Governments cannot and will not tolerate the wholesale proliferation of electronic money and the creation of alternative payment systems revolving around entrepreneurs with little financial standing and credibility.

Domestic and international entities convincingly argue that electronic money and payments should be routed through the banking system in the short term. Documented frauds with telephone and stored value cards have called the security of smart cards and electronic money into question.

The government's task will be to balance technology with concern for the soundness of financial markets.

Today's typical consumers are not banging down their banks' doors for Internet or interactive banking products. But that will change as new generations of electronically proficient students enter the work force.

Furthermore, the Internet could capture a significant flow of commerce if it became more like television and began to capture the entertainment flavor of video games.

Another factor to consider is that the 30 million recipients of federal assistance or governmental subsidies will be introduced to electronic payments no later than Jan. 1, 1999, by virtue of the passage of the Debt Collection Improvement Act of 1996.

Similarly, welfare legislation enacted this year directs states to deliver food stamps electronically by 2002. Federal and state governments are distributing or planning to distribute various forms of benefits and assistance through smart cards, electronic transfers, and other technological means, to lower the costs borne by taxpayers. This will expose still more of the population to new technology.

To be sure, predictions of the demise of the paper check have been premature, even though the technology for a "checkless society" has long existed. But that such predictions have not come true does not mean that they will not.

Growth in U.S. check volume is slowing, and the business is regarded as mature. To reduce the labor-intensive costs of check processing and comply with laws and regulations on presentment, funds availability, and settlement, banks have been experimenting with ways to transmit check data electronically and with truncating transfers of the checks themselves.

Combining all these factors with the growth of the Internet and its capacity to generate commercial activity suggests that some aspects of the payment system will be altered. Naturally, the question again arises as to who will be allowed to make those alterations, and to what degree.

Even if near-term predictions of Internet commerce are 70% hype (a number that seems large, given the strides of the last two years), the remaining 30% may be the foundation of a massive market for new products.

An increasing number of banks are coming to this conclusion. The number with Web sites has ballooned, according to CS First Boston, from about 50 in early 1995 to more than 500. About 30 of those banks have transactional capabilities.

Can banks afford to ignore Internet commerce? Can they afford to relinquish control of the payment system?

Those that stay on the sidelines, waiting to buy, rent, or borrow whatever technology develops later, may be entirely excluded from electronic commerce.

If your company had reinvented and perhaps patented the payment system, would you sell it? Or would you keep and operate it? The answer would probably turn on how you could make the most money over the long term.

Thus the battle lines for the payment system are clearly drawn, though the outcome is far from decided.

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