The euphoria that surrounded pure Internet banks when they first burst on the scene in the mid-1990s is dissipating fast. Many virtual organizations are discovering that the Internet is not a panacea for financial services, but rather a wedge of the pie they must serve to their customers -at least while they wait for the Net generation to grow up. In fact, Web-only institutions have captured only 1% to 2% of the roughly 19 million regular online banking customer market.

Last month, BTN reported on New York-based Citigroup Inc.'s decision to collapse Citi f/i, its Internet-only bank, and Direct Access, its online banking program, into a single service that will deliver service through a mix of electronic and physical channels. Other major institutions, such as Bank of America Corp., Charlotte, NC, and Wells Fargo & Co., San Francisco, chose from the beginning not to offer a standalone Internet service, pursuing instead what has come to be known as a "clicks and bricks" strategy.

Even some veteran Web players once pledged to all-electronic delivery are scrambling to build a physical infrastructure for their online banking programs.

E*Trade Group Inc., the Menlo Park, CA-based online brokerage, in March purchased 8,500 ATM machines from Card Capture Service Inc., the largest independent ATM network in the United States. The move was made to provide a sales and distribution platform for Telebank, the Internet-only bank

E*Trade acquired in January. The institution now goes under the name E*Trade Bank and is based in Arlington, VA. E*Trade Bank also plans to open financial services kiosks in select stores of Target Corp., the Minneapolis-based retail giant with 900 stores across the U.S. Target customers will be able to conduct brokerage and banking transactions in the store, use an E*Trade-branded ATM, and speak with an on-site E*Trade representative.

"To be more successful at capturing core relationships, you have to be where the customers are and give them access to your products," says Russell Keene, analyst for Keefe, Bruyette & Woods Inc., a financial services consulting firm in New York. "E*Trade's gotten on the ground, where people are." He adds that the alliance with Target will greatly expand E*Trade's already successful branding efforts.

Not surprisingly, you'll get a different spin from the likes of D. R. Grimes, vice chairman and chief executive officer of Alpharetta, GA-based NetB nk Inc., which has $1.5 billion in assets. He speaks with characteristic bravado about the future of his bank and of the pure-play sector as a whole. "NetB nk's been profitable for nine consecutive quarters," he says. "From the beginning, our intention was to be a general purpose bank operating on the Internet, take the cost savings that we achieved, and give a portion of that back to our customers."

One thing that's certain is that the advent of 24/7 banking has fundamentally altered the financial service industry. However, much of the hype has revolved around the technology itself, rather than its capabilities to support and enhance business processes.

Ignoring the hoopla, banks like BofA look at the Web as simply another access channel for customers. "Bank of America has never approached the Internet as a standalone channel. It's a new way to deliver our products and services, but the digital technology behind the Internet has much broader implications," says a BofA spokesperson. She says the bank has no plans to develop an Internet-only offering.

With big banks building their electronic capabilities to complement their brick-and-mortar presence, the pressure is on Internet-only banks to improve the level and scope of their services. "This environment is going to get a whole lot more competitive," says Kim Hemmes from his office in Grand Rapids, MI. Hemmes is principal in charge of financial services consulting at Crowe, Chizek and Co. LLP, a consulting and accounting firm. "The key for online banks is going to be to create a virtual experience that's equal to or better than the traditional bank. They haven't come close to doing that yet."

According to Forrester Research Inc., out of 54 million U.S. households with Internet access, 11 million use online financial services. By 2004, the Cambridge, MA, research firm predicts, 47% of online households will engage in financial online services. From the beginning, these types of hearty projections gave banks a good reason to jump on the Internet bandwagon.

On October 18, 1995, Security First Network Bank, based in Atlanta, opened the first all-Internet bank. Royal Bank Financial Group of Canada, a $273 billion-asset institution, purchased it in 1998, and Security First is now a $341 million-asset online bank.

Richard Crone, vice president and general manager of CyberCash Inc., a provider of payment services and software based in Reston, VA, worked as a consultant during the launch of Security First. He says the organization initially did well because of its approach to the Internet and effective customer service.

"Security First wasn't trying to reengineer a current process to handle the Internet," he says. "They worked from the call center out, whereas banks today putting in home banking are going from the Internet back into the call center. And their telephone and email support was fantastic."

This contrasts with electronic customer support across the board, according to Hemmes. His research indicates that more than 50% of the emails that customers send are going virtually unanswered. "The customer service level has been atrocious," Hemmes says.

Security First may have excelled early on, but it changed its strategy when Royal Bank purchased Prism Financial Corp., a Chicago mortgage company, so that Security First could take advantage of Prism's branches and sales force.

"We are developing a strategy now to leverage the Prism locations," says Ashif Ratanshi, chief executive officer of Security First. "As Royal Bank makes more acquisitions, we will leverage any and all opportunities with physical locations."

Ratanshi also says that Security First will remain primarily an online bank and will continue to build a more self-directed, personalized service for customers. It will take advantage of opportunities to grow physically, but invest no money in brick and mortar.

"We will not go out and build a traditional bank," he says. "In ten years, we will be an Internet bank, as we are today. We will have alliances and relationships with a number of affiliates that Royal Bank decides to purchase. We will continue to do what we do."

Security First does have two physical locations of its own in key market areas-one in Largo for Florida's snowbirds, and one in Atlanta, the bank's hub. The site has recently undergone an overhaul to increase functionality and ease of use for customers.

Grimes admits that NetB nk often struggles to maintain good customer service but says the problem is a result of the company's rapid growth. And he doesn't see any reason to doubt that the future holds more big growth. "When you grow by 300% a year, you have to work to make sure that you handle the customer relationship," Grimes says. "But I'd rather figure out how to grow well than figure out how to get smaller."

Poor precedent in Wingspan

In 1995, Crone led the development of an online banking program for Home Savings of America, a subsidiary of H.F. Ahmanson & Co. Home Savings and its parent company that has since been purchased by Washington Mutual Inc. He provides an example of the bank's attitude at the time.

"The chairman of Home Savings said on my first day, 'Your job is to figure out how to use this home banking stuff to drive more traffic into our branches.' Even at the time, it sounded completely incongruous with the purpose of home banking."

Since then, bankers have realized that decreasing branch traffic may be a more sensible goal. The cost benefits of self-service make sense and have given rise to a slew of Internet-only services.

Perhaps the most notable to date has been, which Bank One Corp., a $270 billion-asset institution headquartered in Chicago, launched in mid-1999. It chose to keep Wingspan separate from its own Internet banking program at to avoid alienating its own customers with incentives only for online account holders. Wingspan had a reported 175,000 accounts at the end of the second quarter, compared with 100,000 at year-end 1999. It has about 95,000 customers.

As has been documented, of course, Wingspan has been a disappointment, with some estimates putting its total number of funded accounts at a meager 15,000. In the throes of a major cost-cutting initiative, Bank One now plans to combine Wingspan with its own Internet banking site,, which will save an estimated $30 million a year. The changes are only on the back end and should not be obvious to customers, says Kevin Waters, senior vice president of marketing for Wingspan. The two brands will remain separate.

But when asked whether Wingspan will remain Internet-only, he hints that Wingspan is shortly to make a major announcement about a brick initiative.

Virtual banks have many advantages, for both customers and the organizations. Tech-savvy customers receive great incentives to bank with Internet-only entities, no fees or minimum balances, in addition to great interest rates. The Web banks of course maintain low overhead and can gather sophisticated targeted marketing data through Internet technology. The question remains whether they can do it without any brick and mortar, whether they need a little, or a lot.

Some experts believe that consumers simply aren't ready to cut their ties to the physical world, particularly in banking. Trust is paramount, and the Internet is too new and unstable to inspire consumer confidence when it comes to their money.

"People like to open their bank account in front of a person," says Jennifer Schmidt, an analyst for Meridian Technology Corp., a vendor of enterprise networking software in Chesterfield, MO. "Online is great for looking at balance inquiries and things like that, but there are things people aren't ready to do all online."

"How do you establish trust if you're an Internet-only?" adds Sam Callard of Cyber Dialogue, an Internet customer relationship management firm in New York. "That's at the heart of the issue."

From a practical perspective, the two most prevalent issues are access to cash and deposit functions. Online banks typically don't own their own ATM machines, making these critical banking requirements a challenge. Crone, on the other hand, sees the glass as half full. "That's the beauty of an Internet bank. It's a free rider to the ATM network and postal service," says Crone. "It does incur a toll, but that's just the price of doing business." He also notes that the global infrastructure for online banks to reach customers is already established, with more than 165,000 ATMs in the U.S., and nearly 300,000 worldwide.

All the online banks discussed here charge no fees for ATM usage, but of course the ATM owners may charge customers hefty fees. Are people willing to pay two dollars to withdraw forty? Some online banks, like Wingspan, offer rebate programs. It repays its customers up to five dollars a month in ATM fees. Customers can also receive a check in the mail at no charge. Ironically, they'd probably end up cashing it at a local bank.

NetB nk does not offer a rebate program. It is a member of the Cirrus and Honor networks, and gives its customers debit cards. It has a "free ATM locator" on its site to help customers find ATMs that will not charge them a fee for cash.

"There is no issue getting to cash. It's a non-issue. Our customers have access to cash literally all over the world. They get a debit card and ATM card," says Grimes, putting an end to the matter.

But when customers want cash exceeding the ATM limit, say $2,000 for a trip, the online bank customer has a problem. Grimes says that NetB nk will send out a cashier's check overnight at no fee, yet that still creates a delay for the customer.

In addition to getting cash, depositing money can be an issue at branchless banks. Deposits must be mailed to the institution, creating a lag in account funding, particularly with customers using automatic withdrawal programs. Direct deposit has been a central goal for online banks. "Customers need to be able to get payroll checks deposited directly. It's a critical stickiness issue," Hemmes says.

According to NetB nk, 40% of its checking accounts use direct deposit. Grimes says the bank takes in about 2,000 mailed deposits per day. NetB nk's customers receive postage-paid envelopes, with deposits posted the day they're received, a bank spokesperson says.

The BofA spokesperson says that may not be sufficient. "You can do a great deal on the Internet. But people still need to make deposits and having to mail your deposit and having that lag is a definite challenge."

Canadian Imperial Bank of Commerce, a Toronto-based $267 billion-asset bank, and its subsidiary, CIBC National Bank, are addressing all of these issues by mixing its clicks with bricks. It has established in conjunction with Winn Dixie Stores Inc., based in Jacksonville, FL, one of the largest grocery store chains in the U.S. The duo will offer Internet banking supplemented by in-store pavilions.

Like the all-Internet variety, will offer no-fee banking and maintain a nominal physical presence. There will be pavilions in Winn Dixie stores, each staffed with one bank representative. Customers receive free groceries upon opening an account. Pavilions serve as deposit- gathering locations, in addition to providing customers with the reassurance of a physical presence. But the key to profitability will be customers adopting self-service.

"The idea is for customers not to need the personal service again, but rather, go through the Internet," says Joe Heim, spokesperson for CIBC. "Fulfillment online is the goal."

Canadian Imperial has some experience in this area. It offers the same type of financial service through Safeway, branded as Safeway Select Bank, and Loblaw Companies Ltd. in Canada under the brand President's Choice Financial Services. Why does CIBC bother with a skeleton branch network when what it wants is online adoption? "Because customers want to be reassured that there's something behind it," Heim says.

Even the most evangelical online bankers concede there are weaknesses to the pure Internet model. "We need to make it easier for people to get money in there on the first day," says Grimes, referring to the relatively cumbersome process of opening an online account.

Though the interface to set up accounts is high-tech, the back end remains paper-intensive. Banks still needed to receive written signatures and to provide paper disclosures to customers. That may all change with the Millennium Digital Commerce Act (S.761) signed into law in June by President Clinton. This act legalizes the use of electronic signatures online and replaces some requirements for paper-based documentation relating to financial services.

In addition to the logistical drawbacks of e-banking, there is also the issue of how consumers perceive technology. For most people, the Web is still new, and they remain wary of it. A physical infrastructure may offer an intangible benefit, along with a practical one. If a bank customer's computer breaks down, it is reassuring for him to know he still has access to his accounts through another venue.

The big question of what business model will work best may not be answered for a few years. Technology, legislation, and consumer expectations all need to evolve further before that can happen. To Grimes, there's no question.

"Nobody would logically want to pay $10 per month to earn less interest than they can online," he says.

Nevertheless, the online banks have a long way to go before they can proclaim victory over brick. "The online bank is certainly going to have a challenge. They are very much going to have to be a niche player. It's pretty easy to accumulate deposits these days, but it's very difficult to figure out what the viable, long-term profit model is going to be," Hemmes says.

Callard agrees and believes there will be a tremendous amount of consolidation of all-online banks during the next couple of years. He also sees no immediate solution for the difficulty of originating loans online. Moreover, loans are a huge investment for which people may always require personal contact.

Ratanshi of Security First disagrees. "Clients are going to get much more comfortable dealing with banks over the Internet," he says. "Loans and mortgages can be turned around so quickly, they will have no problem doing it online."

Lynn Koller is a business writer in Ormond Beach, FL. Web Banks

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