To Assure Consumers They're Real, Virtual Banks Are Getting Physical

By EDMUND SANDERS

Aug. 6, 2000 12 AM PT

TIMES STAFF WRITER

Two years ago, Internet-only banks vowed to swim circles around traditional financial institutions, which the virtual crowd predicted would sink under the weight of old-fashioned branches and costly infrastructure.

Today, it is the branchless banks that are barely treading water.

Despite offering substantially higher rates on deposits, budding Net-based banks as a group have scraped together little more than one-tenth of 1% of the nation’s bank deposits.

Now, in an effort to draw more customers, many Net banks are turning to a surprising source for growth: bricks and mortar.

National InterBank, an Irvine-based Net bank, inked a deal last month that allows its customers to use Mail Boxes Etc. locations to make deposits. In spring, Arlington, Va.-based E-Trade Bank, the No. 1 Net-based bank, paid $82 million for the nation’s second-largest automated-teller-machine network. And the parent of the nation’s oldest Net bank, Atlanta-based Security First Network Bank, bought a mortgage company so its customers can use the lender’s 150 offices.

Internet bank start-ups are learning what traditional banks have known for years: People still like branches.

Though customers may embrace new technologies such as online banking, most don’t want to give up all the old ways of doing business. That’s why ATMs and call centers failed to put branches out to pasture, even though banks had hoped they would.

Lack of face-to-face interaction and the inability to make deposits at a branch are still the two biggest reasons more consumers aren’t logging on to Web-based banks, according to a survey by consulting firm McKinsey & Co.

“The bottom line is that when people have a problem, they still want to be able to walk into a branch, throw their paperwork at a person and say, ‘Here, fix it,’ ” said Eric Rothmann, banking analyst at brokerage First Security Van Kasper in San Francisco.

So five years after the first online bank was born, the combined customers of the more than two dozen Net banks still don’t total even half the online customers at Wells Fargo. Bank of America signs up more online accounts in two months than E-Trade Bank has attracted in two years. And Wilmington, Del.-based WingspanBank.com, the Net-only spinoff of Bank One, has 95,000 customers, while its bricks-and-mortar parent boasts nearly seven times as many online users.

“There’s been no Amazon.com of banking,” said Jim Bruene, editor of Online Banking Report in Seattle. “No one has lived up to the rhetoric of a couple of years ago, and no one’s been able to unseat the powers that be, or even to cause much nervousness.”

Stymied by the competitors they once viewed as dinosaurs, the Net banks now are aiming to compete by getting physical.

“We are trying to create more touch points for our customers, “ said J. Randall Waterfield, co-chairman of National InterBank, which is moving toward a “clicks-and-mortar” strategy.

The bank’s deal with Mail Boxes Etc. will overcome one of the biggest complaints of Net bank customers: the inability to deposit paper checks. Currently, most branchless banks require customers to use regular mail, something the tech-savvy set is loath to do.

Now, National InterBank’s 8,000 account holders can visit one of the 3,400 Mail Boxes Etc. offices, where checks will be over-nighted at no charge.

Meanwhile, E-Trade Bank’s deal with Card Capture Services Inc. gives it nearly 9,000 ATMs nationwide. The agreement will enable E-Trade Bank’s 225,000 customers to use the machines for deposits and other transactions by the end of the year.

E-Trade Bank, owned by online brokerage E-Trade Group Inc., also plans to open 200-square-foot financial kiosks in Target stores and a single branch in New York.

“We view this as another marketing vehicle, a place where people can learn more about E-Trade Bank,” said Mitchell Caplan, chief banking officer at E-Trade Group.

Analysts say Net banks are finding they must add a physical presence--even if it’s a token one--to overcome consumers’ anxieties about entrusting their money to “dot-com” financial institutions.

Tangible locations not only provide convenience for customers, but they also send a marketing message of stability and permanence, analysts say.

“You have to give customers a visceral sense that you still exist after they turn their computer off,” said Chris Musto, online banking analyst at financial research firm Gomez Advisors.

The fact that most Net-only banks are still losing money doesn’t help matters. Though start-up banks commonly lose money in their early years, it’s nevertheless unsettling to consumers, analysts say.

A person might not mind if a dot-com bookseller is unprofitable, but no one likes to see his or her bank bleeding cash.

“People don’t always want to entrust their money to the newest kid on the block,” Bruene said.

The trend toward physical outlets, however, raises a new dilemma for Net banks: If they buy ATMs, create financial kiosks or open branches, can they still be considered virtual banks?

E-Trade Bank’s Caplan insists the answer is yes. In fact, the bank still bills itself a “pure-play” Internet bank. To Caplan, ATMs don’t count as bricks and mortar. Neither, apparently, do the Target kiosks, which won’t be staffed, or the new New York branch, which he prefers to call a “concept store.”

Rivals snicker at Caplan’s hairsplitting, but the debate involves more than mere semantics. The shift toward once-shunned bricks and mortar--or at a minimum toward steel and plastic--threatens the very business model Net banks have relied upon.

By avoiding branches and ATMs, Net banks can cut their non-interest expenses in half, compared with a traditional bank of the same size. Much of that savings is passed along to customers in the form of fee waivers and higher interest rates on deposits.

First Internet Bank of Indiana, for example, offers 5% interest on its checking account deposits, with no monthly fee and no minimum balance. Bank of America pays just 0.25%.

But what happens to that business model if Net banks start buying ATMs, which cost about $30,000 apiece, or branches, whose annual operating costs, according to Musto, start at about $100,000?

Caplan says E-Trade’s investments won’t cause the bank to raise prices for services. In fact, he says, the ATM network will enhance profitability by providing a new source of income from the fees the bank charges non-customers to use the machines.

“It’s not going to change our cost model,” Caplan said.

Rivals have doubts. Atlanta-based NetBank, with 110,000 accounts, has thus far resisted the temptation to invest in physical outlets.

“When an Internet-only bank expands into the physical realm, it significantly adds to expenses and impacts the economics of the business model,” said D.R. Grimes, chief executive of NetBank. “We looked at the same ATM network E-Trade bought. But none of the reasons were compelling enough.”

At the same time, Grimes isn’t ruling anything out. Though NetBank is one of the industry’s only profitable Net banks, its shares have plummeted 80% in the last 14 months, a sign of Wall Street’s skepticism about the pure virtual model.

Of course, Internet-related stocks in general have plunged from their highs last year or early this year, as investors have reconsidered just how much profit potential there is in the many start-ups seeking to profit from the virtual world.

Grimes recently said NetBank would consider forging a partnership with another financial institution, such as a foreign bank that has U.S. offices.

“I’m not saying we’ll never have branches,” Grimes said. “But right now, we have no plans to do anything physical.”

Times staff writer Edmund Sanders can be reached at edmund.sanders@latimes.com.

(BEGIN TEXT OF INFOBOX / INFOGRAPHIC)

The Pros and Cons of Internet-Based Banking

Advantages

* Interest on checking. Internet-based banks pay substantially higher interest on checking accounts. Net banks are offering nearly 5% on checking accounts, often with no minimum balance or monthly fee. Traditional banks pay less than 1%, if they pay anything at all. Based on a $10,000 average balance, the difference could save the account holder $400 a year.

* Higher CD rates. Net banks are offering some of the nation’s highest rates on federally insured certificates of deposit. Last week, E-Trade Bank and NetBank offered 7% on one-year CDs of at least $1,000, according to Bankrate.com. By contrast, Bank of America and Wells Fargo offered 5.73% and 5.5%, respectively.

* Lower fees. Net banks rarely charge monthly fees for checking accounts, bill-paying services or using another bank’s automated-teller machines.

* No minimum. Most Net banks don’t require customers to keep minimum account balances.

* High-tech. Though traditional banks are catching up, Net banks have tended to offer the most state-of-the-art technology, and the Web sites are typically easy to navigate.

* Special offers. To attract business, many Net banks are offering cash incentives to new customers or for referrals. Those who sign up through https://www.gomez.com can receive cash rebates of up to $75 at several Net banks. CompuBank offers $40 to a customer who refers a friend.

Disadvantages

* No branches. Forget about darting into a branch to work out a problem, pick up a new check register or get some traveler’s checks for your vacation.

* Harder to make deposits. You can have your paycheck direct-deposited, but that $20 birthday check from Aunt Tilly is going to have to be mailed to the bank. And if the guy who buys your used car pays you in cash, your mattress is going to feel a little lumpy for a while.

* ATM fees. Your Net bank won’t charge you to use another bank’s ATM, but that other bank probably will. Most Net banks reimburse customers for about four ATM visits a month. If you use ATMs more often than that, be prepared to shell out about $1.50 to $2 each time.

* Not for beginners. Net banks are geared toward the tech-savvy crowd, not Net newbies. If you’re still nervous about buying something online, you’re probably not ready for online banking.

* Less experience. Though most Net banks are insured by the Federal Deposit Insurance Corp., they are younger and smaller than their traditional rivals. Most are still unprofitable and are struggling to find their niche. That could mean changes in product offerings and pricing for customers.

For more information about Net banks,

go to https://www.gomez.com or https://www.onlinebankingreport.com.

(BEGIN TEXT OF INFOBOX / INFOGRAPHIC)

To E-Bank--or Not?

A growing number of banks are betting on the branchless model, but many consumers have reservations about doing business with Internet-only banks.

Number of Internet-based banks: 2000: 44*

*Including some banks not yet open

Common concerns about virtual banking

Why consumers won’t do business with a Net bank

(percentage of respondents citing each reason):

Inability to make physical deposits except by ATM: 66%

Lack of face-to-face involvement: 61%