All the breathlessness, expectation, and zealotry about Internet-only banks seems to have amounted to one resounding conclusion: People like branches.

A year or two ago every expert and analyst around was telling bankers at traditional institutions that unless they got religion about the Internet, they would soon lose their flocks to nonbank companies with greater faith.

Many bankers heeded the call and quickly set up online divisions. Some, like Citigroup Inc. and Bank One Corp., went one step further by establishing quasi-independent Internet banks. By last year it was a point of orthodoxy for bankers to believe in the power of the Internet as a delivery channel.

While 2000 may have been the year that a record number of bankers and entrepreneurs set up branchless Internet banking operations, it also stood out as the year when more people began espousing the once-heretical notion that Internet banking will never be very popular. Survey after survey confirmed that people like branches whether or not they rely heavily on them, and the Internet-only entities picked up paltry numbers of customers.

Indeed, pure-play Internet banks grabbed only 2% of the new online customers last year, and traditional banks — which expanded and improved their online offerings — got the rest, according to a recent survey by the consulting firm Cap Gemini Ernst & Young of 125 financial institutions around the world.

James Scurlock, senior manager at the firm’s financial services practice in Boston, said he believes Internet banks have tapped as much customer growth as they ever will.

News of a weakening among Internet-only banks is continuing into 2001. First Internet Bank of Indiana announced Wednesday that it would lay off four of its 20 employees. Last month the bank announced that is had experienced its most rapid growth yet.

Also on Wednesday, NetBank, a $1.7 billion-asset Internet-only bank in Atlanta, said it had introduced a redesigned Web site and hired an outside consulting firm to audit and test its site and its customer care program.

“Our surveys have shown that the fastest growing customer online is the one-stop shopper who wants everything in a single source — they look to traditional brick-and-mortar banks,” said Paul Jamieson, senior analyst for banking and payment services at Gomez Advisors in Lincoln, Mass.

Only 12% of U.S. banking customers have online accounts, according to Ray Graber, senior analyst of e-banking at TowerGroup of Needham, Mass.

“If these numbers are correct, then you have missed the majority of the population,” Mr. Scurlock said. “They do not have their needs met by pure-plays. The challenge here is in the right mix of channels.”

Nancy Bush, an equity analyst at Prudential Securities, said in a telephone interview Wednesday that she had reached the once-heterodox opinion that “the Internet is not a huge threat” to banks.

“Certainly, banks cannot ignore the long-term demographic implications of the Internet,” given the reality that younger people are more comfortable banking there than others, Ms. Bush said. “But it has been proven pretty definitively that, as a free-standing distribution network, there is not a lot of attraction.”

Mr. Jamieson cited Citigroup Inc. as a leading example of what a brick-and-mortar institution can do with Internet banking.

In October, Citigroup launched a site that gave consumers a choice of several online channels, including Direct Access (the Internet version of the bank’s decades-old online banking software) and Citi f/i (the bank’s attempt at a stand-alone Internet bank).

By combining these offerings, “they created a super platform of services and products well beyond anything out there,” Mr. Jamieson said. “They haven’t even integrated everything yet. As they do, you will get a super sweep of services. When a traditional bank looks at the Internet as a real channel, you get what Citi is rapidly becoming.”

Just a short time ago Citigroup, like many other banking companies, clearly took the threat of Internet-only institutions seriously. In 1999 the company opened Citi f/i, which operated separately from the institution’s traditional branch network.

“We didn’t know how strong it was,” said Mark Parsells, chief operating officer of Citibank Online. “We wanted to be playing in that space.”

Citi f/i’s poor results convinced the company to end its foray into Internet-only banking and re-integrate Citi f/i into the traditional bank.

Bank One Corp. went through the same gymnastics with its Internet-only effort,

Even some banks that started out with an Internet-based business model broke down and added physical branches last year. Among those were E-Trade Bank, Salem Five Cents Savings Bank, First-E Group PLC of Dublin, and VirtualBank.

Other Net banks remained true to the idea of providing low-cost services exclusively through the Internet, but found themselves in the position of having to justify their actions.

D.R. Grimes, chief executive officer of NetBank, has consistently been one of the cheerleaders for pure-plays like his. He argues that the 2% of customers Internet banks attracted last year is a hefty number and will continue to grow.

But this year traditional banks clearly are emboldened by the mixed results achieved by the highly touted dot-com banks.

Mr. Parsells said Citi’s experiment with Citi f/i taught the company that having a robust set of applications and informative content on the Web was more important to consumers than whether a bank offered services exclusively over the Internet.

“We found that what people most liked about Citi f/i was our robust content,” which included information on mortgages, education loans, market research, news, and calculators, he said.

Another lesson learned was about brand value online. Citi f/i was not available to users of Direct Access. Bank executives thought that fact would draw new users to the Internet-only operation. “People liked those offerings, but they didn’t know that Citi f/i was from Citibank,” Mr. Parsells said. “We found that the name Citibank pulled higher recognition.”

Mr. Parsells said Citi’s foray into Internet-only banking ultimately has bolstered his confidence about Direct Access, the more traditional offering that combines Internet, telephone, automated teller machines, and branch access.

The price-conscious customer who likes Internet banking is not necessarily the type that Citi wants, he said. “Price-based customers are only looking for the best deal. You will never be able to keep those customers or make money off of them. It is much more important to our customers to have top products and key services, like account aggregation, that improve their lives.”

Citigroup has moved away from classifying customers who sign up for online banking as “converted” customers, Mr. Parsells said. This would indicate that the company has accepted a retail banking approach that treats all channels equally. “We still consider an online banking customer a branch customer,” he said.

Another argument against the Internet banking faithful is that financial institutions still are not experiencing the savings they had expected online services to produce. In 1997 banking companies predicted they would save 6% of costs through online banking, but they only saved 2%, according to the Cap Gemini Ernst & Young study.

The banking companies now predict they will save 8% of costs this year from Internet banking, down from an original prediction of 13%.

“Banks are spending more than they anticipated,” Mr. Scurlock said. “Originally, people thought it was all about putting up Web pages, but these pages need to be connected to the mainframes. You need to link it to the bank technology where customer data exists.”

Mr. Parsells said he agreed that the lowered expectations are accurate. “The initial view in the marketplace was that you would have substantial cost savings when customers go online,” he said. “But they still call you, and they still go into branches.”

The outlook is not all bad, however. “People are leaning to getting more comfortable online,” Mr. Parsells said. “We have seen that once customers are with us for over a six-month period, the number of calls do start to go down.”

As customers feel more at ease banking online, they tend to sign up for more accounts and take advantage of such offerings as checking, savings, investment accounts, mortgages, and education loans, Mr. Parsells said. “People put more money in us. The data shows that with the additional money that customers have deposited, the costs are in our favor. Revenue has gone up.”

Jeanine Brown, head of interactive banking at Bank of America Corp., said online banking has fostered longer customer relationships with the company. “Online bill payment customers stay with us longer and buy more products,” she said. “That is extra revenue retention.”

As customers get more comfortable using the Internet for banking, they do more transactions there, and the company saves money, she said. “You can point to where customers are applying for products online. The application process is saving money.”

Ms. Brown said she sees room for both pure-plays and brick-and-mortar institutions. “I wouldn’t rule out the capability of a pure-play,” she said. “It will have a niche. I think there will be room for both.”

Mr. Parsells was harsher in his analysis of pure-plays. “It’s not hard to have 150% growth when you are dealing with small numbers,” he said. “Look at the pure-plays and their total number of customers, and compare that to traditional brick-and-mortar numbers.”

Certainly, the future of the Internet-only institution is an issue to watch this year. Mr. Scurlock said he believes the next growth spurt for pure-plays will lie in creating strategic partnerships with firms that can provide physical channels, such as automated teller machines, supermarkets, and kiosks. Internet-only banks should focus on those types of alliances, not on advertising and marketing, he said.

Mr. Scurlock also criticized pure-plays for a recent trend of partnering with retail stores that have nothing to do with banking. When customers make a deposit, they want to know the background of the employees working there, he said. “From the customers we have spoken to, they are not comfortable giving their money to a minimum wage employee. I mean, would you go and give your money to an untrained, unbonded employee?”

Mr. Grimes said he is confident NetBank, one of the few consistently profitable Internet-based banks, will grow this year, though that growth may slow. NetBank’s customer base increased 142% last year, he said. “I expect it to taper off to a range of 25 to 50% over the next few years.”

Every customer who signs up to bank at a brick-and-mortar institution can click to NetBank and immediately get better rates, Mr. Grimes said. Customers “will eventually come to us,” he said. “I want more people to bank online.”

One thing working in Internet banks’ favor is the trend of the mergers between brick-and-mortar banks, he said. “A lot of people have come to us after their bank was bought out.”

NetBank’s latest strategy is to narrow its target market to customers who already are comfortable using the Internet, rather than trying to teach people how to use it.

“There are enough people using the Internet that we are able to grow 30% as fast as a traditional bank,” he said. In the past “I don’t think we focused enough on gathering customers from the Internet. A lot of people we had to teach to use the Internet, and we learned from that.”

Mr. Jamieson said NetBank has proven that an Internet-only strategy can work. NetBank has been acquiring customers at a rate at which it can make a profit, and it has avoided the usual dot-com approach of overspending to attract customers and offer aggressive rates, he said.

“I commend their senior management for having a very focused, disciplined approach,” Mr. Jamieson said. “A lot of ‘Net banks have not done that. They are struggling with building a brand.”

But despite NetBank’s success, “an Internet-only bank will never challenge the traditional bank institution that we have come to know,” Mr. Jamieson said. “They have a limited amount of resources that they can offer.”

Gomez research indicates that 96% of online banking customers have adopted the online offering of their existing banks. “There is very little brand awareness with pure-plays,” Mr. Jamieson said. The only pure-plays that consumers could readily name were Wingspan and, to a lesser extent, NetBank, he said.

Mr. Scurlock said the advertising and marketing efforts of pure-plays often prompts customers who saw the ads to go to their brick-and-mortar institutions to ask for the advertised service.

Mr. Jamieson said that because there is no compelling reason to go to a new bank for an online service, consumers have chosen to take online solutions from their existing bank.

Consumers like the idea of having options in terms of access, he said. “If their PC blows up, they have other options to access their banking services, more than a pure-play would have. No one wants to visit a branch today, but they need the knowledge that they can if they have to.”

Christopher T. Kelley, an analyst at Morgan Keegan & Co. in Memphis, said that Internet-only banks are trying to establish brands, and that is never easy. “The market doesn’t reward you for your stated strategy,” he said. “They want to see your results. The market will react favorably when they start to show some profitability."

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