Online Banks: Mixed Messages

If account acquisition is any indication, then customers are lukewarm about online-only banks. But that's not stopping new players from setting up online-only divisions.

NetBank, the largest purely online bank, has about 45,000 customers.

Wells Fargo, on the other hand, has managed to get more than 1 million banking customers to use its online service, but those customers still have access to Wells' branches.

Despite customer ambivalence, big traditional banks such as Citibank, a unit of Citigroup, and Bank One are starting their own online-only shops.

American Express launched its own online-only bank in July. In the end, analysts expect hybrid banks to be the winners, because customers want the security of knowing that, in a pinch, they can speak to a live person in a branch.

According to James Punishell of Forrester Research, "At the end of the day I don't believe a Net-only bank can survive."

GartnerGroup analyst Laura Starita doesn't think those sorts of comments will slow down traditional financial institutions.

During the next three years she expects 60 to 100 of them to launch direct banks - banks supported only by the telephone, Internet and automatic teller machines, without benefit of a branch structure. She thinks about a third of these will fail.

Others, such as Telebank, will become acquisition targets for Internet brokers.

Starita's explanation for customer apathy is simple: Internet banking is simply not that compelling.

"There's nothing you can do on the Internet today that you can't do through a call center," she says.

Instead, Internet-only banks push customer service and pricing. But the customer service is often lousy, as Punishell found out when he tried to open a Wingspan Bank account.

Customer service is so crummy, in fact, that an August survey by Cybercitizen Finance found that 3.1 million customers defected from online banking.

While the survey included both Net-only banks and traditional banks with online services, that's almost half of the 6.3 million who use the services.

The reasons? Online banking was too complicated or the level of customer service was unacceptable.

And it's not clear how much of a market there is for online-only banks. Goldman Sachs expects 20 percent of U.S. households to bank online by 2002, but doesn't say how many customers online-only banks will snare.

Even Citibank isn't forecasting a huge market for Citi f/I, an online bank with no connection to Citibank's Web-based direct banking. Mark Rodgers, a vice president at Citibank, says, "This is a very distinct market segment. It's not an enormous market. . . . We believe the market at this time is relatively modest, but we think it is going to be growing."

Unlike their brick-and-mortar competitors, online-only banks have no customers to poach. Wells Fargo has been singularly successful in moving its customers to the Internet.

But online-only banks, even with the Citi brand name behind them, are starting from scratch.

Lower overhead should allow online banks to compete on price. Citi f/I and Wingspan are both offering money market accounts paying 5 percent interest.

Since deposits to online banks often need to be mailed in, Wingspan offers customers overdraft protection of $2,000, with a five day grace period before fees kick in. But online-only banks are also faced with high marketing and technology costs.

Wingspan plans to spend $150 million to market its services. Royal Bank spent about $15 million upgrading the infrastructure for Security First Network Bank in the first six months after acquiring SFNB. Citi f/i and Wingspan Bank can afford to make some missteps, says Ian Rubin, an analyst at The Tower Group. "This industry is still so young, and they want to have a hand in it." Online-only divisions let them keep an eye on the industry and gauge customer acceptance.

Rubin guesses the business model for Citi f/i could change three or four times in the next two years, but Citi is infamous for keeping a hand in every pie: It also has investments in banking consortium Integrion and Microsoft-backed bill presentment start-up Transpoint.

Online-only banks do offer some advantages. They are one of the very few ways whereby even the largest regional banks can develop a national presence.

These banks risk confusing customers in their home region, but they start with a clean slate everywhere else. Citibank only has branches in five states, but it has an agreement to put cash machines in Blockbuster stores nationwide.

D.R. Grimes, chief executive at NetBank, doesn't expect his customers to take care of all of their financial services needs at his site.

He does expect to get their checking accounts, money market accounts and savings certificates. NetBank can't offer safe deposit boxes for jewelry, but he is looking at uncomplicated financial products that can easily be moved to the Web.

NetBank makes mortgage loans and will soon offer home equity loans. "We're a volume business," says Grimes. "We've got 65 employees and 45,000 customers. I can't spend an hour talking to a customer."

An online-only bank also gives banks an opportunity to tweak their business model. Banks traditionally design products and then go out and flog them to customers.

That's a far cry from the strategy that has made Dell Computers so successful on the Net: Let the customers design their own products and then deliver them painlessly. So Wingspan and Citi will try to position themselves as providers of a full range of financial services, not just banking, Starita says.

Wingspan already offers loans from E-Loan, while Citi is expected to start by offering insurance products from other carriers.

Proponents say an online-only bank can be more nimble than one that's tied to a large bank's systems and management. Citibank's Direct Access Web banking is tied to all of Citi's legacy processing systems, which means changes to the offering can be time-consuming.

Because Citi f/I is designed to run exclusively on the Web, Citi expects it will be much easier to improve it. Citi is getting help from Broadvision to personalize the site.

The big banks think they can beat the online-only players at their own game. Marketing comes first. Citi f/I and SNFB, through Royal Bank, are going to rely on target marketing, while Wingspan is just going to buy the branding.

Citi will start by using direct mail to target students in areas where the bank does not have branches.

SFNB is looking at cities that host a large population of vacationing Canadians, and will advertise through traditional print, radio and television outlets, says David Noble, the Royal Bank executive vice president in charge of SFNB.

Even if the big banks' online divisions turn out to be big flops, they'll have learned from experience.

In this regard, the Bank of Montreal's Mbanx is instructive.

Mbanx launched in October 1996 as an alternative to the Bank of Montreal's online service. Mbanx users had access to tellers, but they got their own telephone and Web-based customer service team.

Mbanx made a point of hiring people with a talent for customer service and then trained them to be bankers, whereas the Bank of Montreal had the opposite priorities for its customer service hiring.

While Mbanx didn't fully exploit the Bank of Montreal brand name, by keeping the "M" it didn't toss it out the window either.

Further, the bank figured it could use the Mbanx name, without translation, if it expanded overseas.

By early 1998, Mbanx was offering 6-second online loan approval. But it was also running two sets of online services in parallel: one for Mbanx, and one for its direct banking service. The two were mutually exclusive.

Direct banking customers were complaining when Mbanx customers got new Web-based services faster than they did.

By August 1999, the bank decided to merge the two services together. Outside competition helped push the changes, but Denny Allen, a senior manager at Mbanx, says the competition wasn't fiercest from other banks. Instead, customers compared the Mbanx site to that of leading Canadian e-commerce players, such as the bookstores Chapters and Indigo. "People were saying, 'We can do this on the Chapters site, why can't we do it on yours?'" Allen says. So maybe Citi f/I and Wingspan will soon be taking a page from Amazon.com.