The battle for online banking: Lessons from the consumer market

Businesses still leery of online financial services are anxiously watching how the battle for online consumer markets will play out. Here, we examine the issues that will reach past the consumer market and into the business marketplace.

Internet and brick-and-mortar banks are fiercely fighting for market share in the new consumer online banking arena. While businesses are not ready to go on the Net to do their banking, savvy CIOs are paying very close attention to this new service. Many senior level IT executives know that what shakes out in the online banking consumer market will influence how online banking will come to the enterprise.

A transitioning industry
While growing in popularity, online banking still has a way to go. According to a study by Gomez Advisors , an e-commerce advisory and research firm, the number of virtual banks is on the rise, and more than two-thirds of brick-and-mortar banks provide Web access to checking accounts with bill payment. Yet another survey by the McKinsey & Co. consulting firm reveals that only a small percentage of financial services revenue comes from online transactions, indicating this is an expensive endeavor for traditional banks who may be more interested in claiming market share than making profit.

Enter the virtual banks—financial institutions whose emphasis is on consumer interaction via the Internet. According to another McKinsey study, virtual-only banks are attracting few depositors, again indicating a possible play for uncharted territory.

The new consumer
While brick-and-mortar firms have the advantage of holding most of the assets, some experts believe that eventually these Main Street banking institutions will become petty-cash dispensers and that the consumers of the future will force this change.

“The people coming on the Net five years from now will be different from those on the Net now,” said Nina Das, spokesperson for Citigroup , a financial-services company. This change means that the industry will have to learn how to acquire new customers who will have completely different expectations about their relationship with their banks, she said.

For example, she pointed out the generational difference between herself and her son in their attitudes toward computers. Das, 42, believes her finances are secure only with the existence of a physical bank, even though she pays all her bills online. To her, a computer is a work tool. Her 16-year-old son, on the other hand, lives, plays, and works on the Internet, even using it as a major social outlet. The impact of this change on traditional feelings about financial institutions and trust is unknown, she said.

The lack of trust and the need for a physical banking presence are reasons virtual banks face an uphill battle, said Asheet Mehta, a partner at McKinsey & Co. Studies have shown that these “cyber” institutions are not widely accepted, he said. Bank of America, for example, has 1.2 million depositors to about 70,000 for Telebank, a virtual bank. In addition, studies have shown that almost all customers who have online banking have it through their existing, physical bank.

Where’s the drive-through?
David Becker, president of First Internet Bank of Indiana , a virtual bank, doesn’t agree. He believes that the time has come for virtual banks.

Getting consumers to put money in his bank “hasn’t been a tough play,” he said. In its first month, activated more than 200 accounts with deposits worth more than $1.2 million.

Becker attributes part of the success to a natural transition. He said 85 percent of consumer banking is already done without tellers, and, with consumers beginning to shop online, it’s been easy to get them to bank online. Because Internet transactions cost the bank only about a penny each, versus about $2 for a teller transaction at a physical bank and $1 for ATM transactions, he can offer depositors a higher interest rate. The higher rate has been particularly helpful in attracting the affluent depositors that make up his customer base, he said.

Deposits can be made via wire transfer, with automatic deposit, or through the mail, he said. In addition, the bank is affiliated with a network of ATMs, which allows customers to withdraw money.

Becker believes that, as the use of the Internet expands, his customer base will also expand. Access to the Internet is becoming more widely available through televisions and remote controls. And, unlike stock trading, which is limited to the more affluent, “virtually everyone does banking,” he said. He thinks 40 million people will do their banking online by the year 2003.

Dissatisfied consumers
The trend is definitely toward more consumers going online, said Mehta of McKinsey. McKinsey studies show that the first wave of those doing so included the most attractive customers; their average annual household income is $86,000. Average income of the second wave is $66,000. For those not online, average annual income is $47,000.

Another plus on the side of the cyber-bank is the growing dissatisfaction of consumers who use the Web sites of brick-and-mortar institutions. Product selection is poor compared with virtual bank sites; information is sparse, and the sites don’t always work, Mehta said.

To successfully compete, physical banks need to “get their act together” and emphasize sales on their Web sites. But, virtual banks are not the traditional banker’s main competition. Online brokerage firms, which are attracting customers at rapid rates, represent a greater threat, Mehta said.

For one thing, customers are used to seeing their brokers rarely, so remote trading is not much of a change. In addition, the discounts of online brokers over full-service ones are significant.

Mehta said brokerage firms will threaten banks’ core business because those with a strong online customer base will receive more of their customers’ money. A McKinsey survey showed that one-third of online brokerage customers would move money into the brokerage accounts if offered free checking and bill pay. Most of them also said they would take the money from their savings and checking accounts, leaving only a small amount in the bank for petty expenses.

Ready for the fight
No matter what the future brings, Citigroup believes a diversified strategy has positioned it well within the new banking industry. Through mergers and product development, Citigroup has planted itself in all worlds by offering brick-and-mortar banking with a direct access add-on for bill-paying, checking balances, and discount brokerage; a completely virtual bank; and full service brokerage through its merger with Salomon Smith Barney. One aspect of its strategy that Das believes is unique is the extension of the Citigroup brand throughout the Internet operations.

“We believe the value of the brand is even more important in the electronic space,” said Das. She said Citigroup’s diversified strategy gives customers the “ability to interact with us any way they want.” She’s unsure how the financial services industry will look in the future—whether virtual banks will grow, whether the brokerage industry will split into two parts, or whether all financial services, on and off line, will coexist in a big one-stop shop. But, what customers value most—“safety, security, and privacy”—will never change, she said. Now, and in the future, financial institutions that offer these three will come out winners.

Randi Hicks Rowe is a writer and communications consultant in Washington, DC.She specializes in business-to-business communications, including financial services and technology.

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