Some claim that ATMs, not the internet, were the first "virtual banks" and that a move to facilitate their use would result in significant cost savings for the banking industry. Yet, after implementing incentives to avoid the use of an internal human teller, banks realized that the lack of face-to-face interactions actually limited profit-generating opportunities such as the cross-selling of bank services (Liao, 1999). Like ATMs, internet banking (e-banking) presented similar challenges, especially for those still considering the initial investment.
When the opportunity first presented itself, banks were faced with the challenge of estimating the demand for this option. Some firms decided to delay their final decision until the demand was more fully observed, thereby allowing themselves to "tailor the magnitude of their investment to suit the realized state of demand." (Courchane, 2002) The challenge was either to delay their investment and run the risk of being relegated to the follower status or to invest before their competition and face the risk of investing too heavily in an uncertain option. Timing then became the biggest issue.
A variety of studies demonstrated that the amount of investment is not related to the degree of better business performance and competitive advantage. "The financial sector has been prolific in its adoption of new technologies and according to estimates by the year 2005 consumers will have electronic service options for 90% of all financial products and services." (Stamoulis, 2002)
The three major quantitative indicators to assess the e-banking channel are cost reduction, profitability and risk:
Cost
This refers to the reduction in labor and property costs. The increased customer use of a channel that replaces the traditional bank teller's role can be easily be determined by measuring the number of saved labor hours. E-banking limits the need of individual branches to operate under extended hours, thereby decreasing their operating costs. The property cost is "derived from the leasing price attached to a branch or through the application of depreciation methods on the acquisition cost." In addition, e-banking can save banks operating costs by reducing the inefficiencies associated with paper transactions. A study done by Booz, Allen and Hamilton revealed that a teller transaction costs $1.07, a phone transaction costs $0.54, an ATM transaction costs $0.27 and an internet transaction costs $0.04 (Stanco, 2000)
Profitability
Profitability can be measured not only by the increased revenues generated by directly charging the customers but also by examining any reductions in operating costs (as shown above) that may result from the use of this channel. E-banking offers the potential to increase profits via expanding the time window in which transactions can be executed. Furthermore, it provides the opportunity for cross-promotional selling of other bank services (Stanco, 2000)
Risk
Risks associated with an electronic channel must be identified: customer mistakes, fraud, security breaches, etc. Guidelines must be created to determine the amounts to be allocated to limit these risks. Finally, those risks must be translated into costs that must be borne by the bank in case the preventive measures fail.
Other financial indicators to be used include sales growth rate, percentage revenue from new products/services offered via the channel, and cash to cash cycle.
Despite the anticipated benefits of e-banking, the number of bank branches has not decreased and the typical internet-only operation is struggling for profitability. Some of the larger banks are integrating their internet-only subsidiaries back into their traditional brick-and-mortar bank, and many internet-only banks are establishing their own physical branches (DeYoung, 2001).
Banks are reluctant to eliminate e-banking and those that do not offer e-banking services are still moving forward with plans to offer such services. The strategy is to create barriers to exit for the customer: banks hope to tie their customers to their own website. In doing so, the likelihood that a customer will move to another financial institution is significantly diminished (Pyun, 2002). Wells Fargo has found their retention rate to be better when a customer has online banking (Fung, 2001).
Profits have been significantly lower at internet-only banks as compared to traditional banks. As many as 30% of internet banks report that their website and related internet operations are unprofitable (Pyun, 2002). A number of factors contributed to these lagging profits. The cost of technology at the internet-only banks more than offsets the savings on physical overhead. In addition, "non-interest income and deposit funding were relatively lower" at the internet-only banks: a suggestion that this channel may be poor in developing customer relationships and capitalizing on cross-selling opportunities (DeYoung, 2001).
According to Jeff Kopchik, a FDIC senior policy analyst, if banks are to see any significant return on their e-banking investments, a trusted, universal framework and web banking certification program must be developed (Radcliff,1999).
Cost of Development
Internet banking has significantly reduced the barriers to entry, paving the way for a number of new entrants. Booz, Allen and Hamilton estimate that the cost to set up a traditional brick-and-mortar bank is between $25 and $30 million while the cost to set up an internet-only bank is only $6 million. Despite the fact that most internet banks are struggling to achieve profits, banks and non-bank financial institutions view the channel as an irresistible means of attracting and maintain customers (Pyun, 2002).
In the U.S., one-third of e-banking firms design and maintain their own sites while the remaining two-thirds outsource their needs. The initial cost of bringing in e-banking averages $50,000, with average maintenance costs of about $22,000. Estimates for community banks are significantly higher, requiring an initial cost of $100,000 to $200,000 and monthly upkeep costs of approximately $4 per account. This translates to annual maintenance costs of $2.5 to $5 million for community banks with 50,000 to 100,000 accounts (Pyun, 2002).
NetBank.com: The World's Largest Internet Bank
NetBank is a diversified financial services company. Its major operating subsidiaries provide internet banking, mortgage lending and leasing services. In order to enhance current and prospective customers' trust, NetBank has invested a lot in technology and security systems. At least three levels of security are used: firewalls, passwords and encryption. One additional level is the FDIC insurance of deposits up to $100,000 per depositor (NetBank.com).
Launched in 1996, NetBank shares its operational cost savings of its branchless business model with its customers: high interest rates and reduced- or no-fee banking services. NetBank finally achieved profitability in 1998, eight months after its IPO primarily due to the one-time gains on the early retirement of its debt (Bach, 2001). As of 31 December 2001, NetBank had approximately 245,000 accounts, $1.5 billion in deposits and $2.9 billion in assets. NetBank's earnings before interest and taxes totaled over $10 million (NetBank.com).
E*Trade E*Trade, an online discount brokerage firm, began E*TradeBank, an online bank with $13 billion in assets and total deposits exceeding $7.7 billion. Like NetBank, E*TradeBank offers banking, lending and brokerage services. Unlike its counterpart, however, it opened a traditional brick-and-mortar retail branch in New York City. A possible reason for this move is that E*Trade recognized the benefits of a traditional brick-and-mortar institution: "trust and confidence are the basis for client-relationship in banking" and that these institutions can augment internet banking (Pyun, 2002).
Even despite the current economic conditions, the E*Trade Group is making it primarily due to the success of E*TradeBank which brought in revenues of $38 million in net interest income and $24 million in mortgage origination fees and gains on sales of mortgages (Anonymous, 2002).
Security First
Security First (S1) was the world's first internet-only bank. The two major challenges Security First faced were the lack of brand recognition and physical presence. It was in need of a larger partner who could aggressively promote the bank. At the time it was purchased in $20 million deal by Royal Bank of Canada, Security First had more than 15,000 accounts and approximately $85 million in assets. In the three years prior to its purchase, Security First was not profitable (Stanco, 2001).
S1 is now the leading internet bank software provider. As of 31 December 2001, S1 had $372 million in assets and generated $278 million in revenues. After a loss of $1.1 billion in 2000, S1 only posted a net loss of $221 million in 2001.
Citibank.com
Citibank, a firm with 100 million customers, only had 300,000 use the internet for their transactions. Despite that fact, Citibank launched Citi Fli, a branchless retail bank offering banking, brokerage and financial services. Citi Fli customers will not have access to Citibank's branches (Stanco, 2001).
Additional Opportunities
The nature of e-banking coupled with the end-user risks has created opportunities for new products and services. An Internet Banking Protection Package (IBPP), underwritten by Progressive, is a liability policy and an enhanced version of an existing financial bond. Additional options include public relations expense, business interruption and cyber/network extortion coverage. This package includes but is not limited to losses from acts such as invasion of privacy, loss or damage to electronic data or unauthorized access to a customer account. The enhanced bond covers losses from theft of electronic data by hackers; damage or destruction to electronic data or computer programs; computer viruses and employee sabotage; and fraudulent fund transfers (Anonymous 2001).
The growth opportunity for the bank is in the rapidly expanding senior population. The challenge for banks is to educate these individuals about the benefits and conveniences of e-banking. One study revealed that 32% of seniors were "very confident" in conducting financial transactions on the internet while 25% said they were "somewhat confident" and 24% said they were "not at all confident." One internet bank is attempting just that. Bank of Internet USA designed their site with seniors in mind: it is very simple and advertises that seniors can insure their account for more than the FDIC's $100,000 (Quinn, 2001).
One of the less obvious opportunities banks are achieving by way of e-banking is that the previous geographic restrictions are being destroyed. The U.S. prohibits nationwide branch banking. The nature of the internet allows U.S. banks and non-financial institutions access to a much larger market. As a result, local banks no longer have the security garnered with such restrictions: competition has increased dramatically (Pyun, 2002).
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NetBank.com
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