WASHINGTON - Robert Cannon, president of Momentum Cash Systems, thought his company could change the face of financial services by turning its automated teller machine network into the backbone of an Internet bank.
But more than 18 months later, the Federal Deposit Insurance Corp. still has not approved Momentum's request for coverage. Mr. Cannon said the Houston company will probably have to submit a revised business plan soon, which would start the clock all over again, and that he doubts whether it is worth his trouble.
"The opportunities still exist in the marketplace," he said, "but the cost in terms of capital requirements is rising, and the cost in terms of regulatory oversight is also rising. The landscape has changed."
Momentum's experience is a cautionary tale for would-be Internet bankers. Regulators said in interviews that they intentionally take more time to approve charters and deposit insurance for Web-only banks because they are new and untested. Observers said regulators are raising the bar in light of the rash of dot-com failures.
"Speed is not the driving force or goal here. It is making sure that we have a viable bank," said Julie L. Williams, chief counsel of the Office of the Comptroller of the Currency.
Ms. Williams said Internet banks are required to hold more capital than regular ones, and that regulators are giving online banks' business plans closer inspection to see if they are counting on emergency capital from the market. "The markets don't seem to be as accommodating these days as they used to be," she said. If a bank is relying on help from Wall Street, "it may be that the bank needs to have additional capital."
Delays and added regulatory demands can be deadly for entrepreneurs. Indeed, while Momentum has been trying to get deposit insurance, companies including E-Trade and American Express have launched their own Internet banks.
Analysts said regulators are trying to walk a fine line between promoting innovation and protecting the economy.
"They have to make decisions about the development of an unprecedented new market and a revolutionary new way of delivering financial services," said Thomas P. Vartanian, chairman of the financial institutional and electronic commerce practice at the Washington law firm Fried Frank Harris Shriver & Jacobsen. "It is very hard to balance the instincts of the marketplace with concepts of safety and soundness. They are standing in the middle of the revolution, trying to make sense of it."
Ms. Williams said regulators' biggest challenge is a lack of precedent.
"When we look at an application for a new charter for a community bank, we've seen those types of institutions for over a hundred years," she said. "When we look at an application for an Internet-only bank, we are facing a proposal that has a large element of something that is unproven."
For example, a traditional small bank knows its core deposits will come from the community where it is based. When regulators review plans, they can determine whether the business model has worked in similar areas before, and what kind of business the bank will generate in that area.
For Internet banks, all bets are off.
"It is a hard business model," said John Douglas, a former FDIC general counsel who is now a partner at the Atlanta law firm Alston & Bird. "You have no logical customer base, and you're competing with other institutions, not just other Internet banks but banks like Bank One, Wells Fargo, and Bank of America, that are equally convenient. In order to attract deposits, you have to offer attractive rates. Loans are hard to generate over the Internet, and you are constantly having to spend on technology."
Mr. Douglas said that these conditions cause regulators to worry about the risk of failure.
Internet bank entrepreneurs had said the absence of branches and offices would reduce expenses, savings that could be passed along to customers. But "the model hasn't borne that out, because there are other costs including research for where the Internet traffic is going, and technology fees for having to keep current," said John Lane, associate director of the division of supervision for the FDIC. "We had an early flurry of Internet banks with a handful approved, but now that everyone has looked at the model, and realized there was a problem with it, there haven't been as many coming into the pipeline."
Twenty-one Internet banks are now operating, with only a few more on the way. The OCC said it is reviewing three new applications, and the Office of Thrift Supervision has none pending.
Approval periods are hard to peg, but an OCC spokesman said that its typical review for brick-and-mortar national banks takes less than four months. However, a review of agency records showed that of the six Internet banks granted conditional or full approval by the agency, five took more than seven months.
Mr. Lane said that the FDIC normally approves deposit insurance requests within four months. But for most of the 11 new Internet banks (the 10 others purchased existing banks), the application process took more than double that. One institution's application approval took nearly 16 months.
Another reason regulators require Web banks to have more capital is the greater likelihood that they will fail to draw many customers or will run into other difficulties.
"We want those banks to have a little more staying power so that if they have to shift to the exit strategy, there is that nest egg," Mr. Lane said. "If they are not successful, they are going to need the extra capital to carry them through their change in strategy."
Jennifer Dickerson, director of risk management at the OTS, said the eight Internet thrifts that it supervises hold an average of 10.4% capital, against a 7.9% average for the for thrift industry as a whole.
Momentum and the FDIC have both written letters to congressional representatives about their difficulties, Momentum complaining that the FDIC keeps demanding more information and the agency countering that the Internet bank has caused delays by continually retooling its plans.
Mr. Cannon said he understands that regulators need extra time and want more of a capital cushion, but he suggested that they may be asking too much.
"The question is, How hard are we going to press forward with this plan?" he said. "How much capital is it going to take to satisfy the regulators? Are we prepared to put up that amount? Frankly, I don't have the answers at this point."