Internet only banks are making a comeback, for the first time since the late 90’s.

BY SUSAN HARRIGAN Newsday Staff Writer Just as new bank branches seem to be popping up on every street corner in metropolitan New York, a countertrend is gathering strength. Internet-only banks, which first made their debut in the 1990s but fizzled for lack of consumer interest, are making a comeback.

The number of U.S. households with an account at a Web-only bank — defined as one that primarily delivers its products online — has grown more than tenfold during the past six years, from 350,000 to about 4 million, according to Jim Bruene, publisher of the newsletter Online Banking Report. Such “virtual” banks, which don’t rely on physical offices, now are operated by about 40 financial services companies and hold about $80 billion in deposits, or 1.3 percent of total U.S. deposits, he says.

Source: A worldwide web of online banks – Newsday.com

First key and obvious point is the lower cost base of Internet banks.

Because they cost less to operate, online banks can offer higher interest rates than their brick-and-mortar counterparts, making them an ideal tool to gather deposits through savings and money market accounts. “Really, the success [of the Web-only banks] is in attracting people who have high balances in savings or checking accounts, and want to move them for higher rates,” Bruene said.

The other distinctive aspect of the new breed, is niche focus, both on customers, and with specific products.

Flushing Financial will use its Web operation to gather deposits at first, but in the future it plans to offer other types of online-only products, such as checking accounts and home-equity loans.

…

Westbury-based New York Community Bancorp, which has 166 branches, including 69 on Long Island, opened a Web-only operation early last year under the name MyBanking Direct.com. The unit offers a certificate of deposit and a money market account.

These moves are alerting experts to predict a significant reduction in reliance on branches is coming.

Although online-banks’ share of the U.S. deposit-taking business still is tiny, their growing popularity is causing some experts to predict that the craze for building bank branches is about to end. Over the past 20 years, consolidation has cut the number of banks in the United States from about 18,000 to 9,000, but branches have doubled from 35,000 to about 70,000, according to Mark Fitzgibbon, a banking analyst for Sandler O’Neill & Partners.

The debate about branches or internet, has been binary. The real story, is more of an evolution, that was well captured in a recent paper from onlinebankingreport.com authored by Bruene.

Bruene, who recently authored a report titled “The Demise of the Branch,” said he expects to see the number of bank branches in the United States decline by 20 to 30 percent over the next two decades. In contrast to the late ’90s, when fewer consumers were comfortable using the Web, “everybody’s online” now, he said. “It opens up a new way to reach people cost-effectively that you couldn’t have five or 10 years ago.”

Bankers have long memories, and at the first mention of internet banking, still too easily recall the demise of the early movers, mbanx, Wingspan, and Citi.

During the Internet bubble of the 1990s, banks including Citibank and Chicago-based Bank One, now a part of JPMorgan Chase, introduced Web-only units but ended up folding them when they didn’t attract enough customers. George Tubin, a senior analyst at TowerGroup Inc., a Needham, Mass.-based consulting firm, said the effort was, simply, too early.

The catalyst that actually began in the 90’s but survived, is ING. Their model was classic by todays standards. Focus on the online only, and only deliver those products that can be effectively delivered that way. They were also innovative enough (in Candia) to work on the fringes of the then current regulations, and by accepting the signature on the account funding cheque from the competition, successfully outflanked the regulations that the old banks diligently adhered to.

ING Direct, a unit of Netherlands-based ING Groep that began operating in the United States in 2000, was the catalyst for a revival of stand-alone Internet banking in this country. Operating only four retail locations that it calls “cafés” and uses solely for marketing purposes, ING offers savings accounts and mortgages, and also plans to offer a checking account later this year. At year-end 2005, it had $40 billion in U.S. deposits, according to the Online Banking Report, making it the nation’s largest stand-alone Web bank.

Relevance to Bankwatch:

The opportunity for traditional banks is hindered by concerns about cannibalism of balances. However better to cannibalize yourself than have the competition do it.

tags: internet+banks, ING

A worldwide web of online banks

BY SUSAN HARRIGAN
Newsday Staff Writer

Just as new bank branches seem to be popping up on every street corner in metropolitan New York, a countertrend is gathering strength. Internet-only banks, which first made their debut in the 1990s but fizzled for lack of consumer interest, are making a comeback.

The number of U.S. households with an account at a Web-only bank — defined as one that primarily delivers its products online — has grown more than tenfold during the past six years, from 350,000 to about 4 million, according to Jim Bruene, publisher of the newsletter Online Banking Report. Such “virtual” banks, which don’t rely on physical offices, now are operated by about 40 financial services companies and hold about $80 billion in deposits, or 1.3 percent of total U.S. deposits, he says.

Because they cost less to operate, online banks can offer higher interest rates than their brick-and-mortar counterparts, making them an ideal tool to gather deposits through savings and money market accounts. “Really, the success [of the Web-only banks] is in attracting people who have high balances in savings or checking accounts, and want to move them for higher rates,” Bruene said.

One local competitor in the online-only banking business soon will be Lake Success-based Flushing Financial Corp., the holding company for Flushing Savings Bank, which has 12 branches, including one in New Hyde Park. Flushing Financial recently announced plans to launch a Web-only unit in late October or early November, using a separate brand name.

Flushing Financial will use its Web operation to gather deposits at first, but in the future it plans to offer other types of online-only products, such as checking accounts and home-equity loans.

With the new unit, the thrift company wants “to get in as early as possible on what looks to be a very major trend in our business,” John R. Buran, Flushing Financial’s chief executive, said in an interview. ” … The Internet business is going to be a growing business, and we need to be a part of it.”

Westbury-based New York Community Bancorp, which has 166 branches, including 69 on Long Island, opened a Web-only operation early last year under the name MyBanking Direct.com. The unit offers a certificate of deposit and a money market account.

“This year is the year that Internet banking has kind of taken hold,” Joseph Ficalora, chief executive of New York Community, said. ” … It’s a tool we feel we should have.”

Less ‘mortar’ foreseen

Although online-banks’ share of the U.S. deposit-taking business still is tiny, their growing popularity is causing some experts to predict that the craze for building bank branches is about to end. Over the past 20 years, consolidation has cut the number of banks in the United States from about 18,000 to 9,000, but branches have doubled from 35,000 to about 70,000, according to Mark Fitzgibbon, a banking analyst for Sandler O’Neill & Partners.

“I think that trend will radically slow and may reverse course in years ahead,” Fitzgibbon said. “The biggest thing they do is gather deposits. You don’t need a huge branch system to make business loans and things like that.”

Moreover, although their recent success has been founded on savings products, some online-only banks have begun offering other services, such as checking accounts and loans, making it possible for customers to do even more or all of their banking via the Web. Other banks plan to do the same.

Bruene, who recently authored a report titled “The Demise of the Branch,” said he expects to see the number of bank branches in the United States decline by 20 to 30 percent over the next two decades. In contrast to the late ’90s, when fewer consumers were comfortable using the Web, “everybody’s online” now, he said. “It opens up a new way to reach people cost-effectively that you couldn’t have five or 10 years ago.”

During the Internet bubble of the 1990s, banks including Citibank and Chicago-based Bank One, now a part of JPMorgan Chase, introduced Web-only units but ended up folding them when they didn’t attract enough customers. George Tubin, a senior analyst at TowerGroup Inc., a Needham, Mass.-based consulting firm, said the effort was, simply, too early.

Back then, fewer Americans were using the Internet, and a lot of them had dial-up connections instead of faster broadband, Tubin said. By contrast, he said, an estimated 75 percent of all U.S. households are online today, and half of all households have broadband. Moreover, Tubin said, about one-third of all households do some routine transactions with their traditional banks online, such as transferring money and paying bills, making people more receptive to the idea of a completely Web-based operation.

“Consumer adoption of online financial services is much more mainstream and mature now,” said Madhavi Mantha, a senior banking analyst with Celent, a Boston-based financial research and consulting firm. “That is probably the single largest factor that’s made the difference between earlier initiatives and the current situation when it comes to banking.”

Dutch spark

ING Direct, a unit of Netherlands-based ING Groep that began operating in the United States in 2000, was the catalyst for a revival of stand-alone Internet banking in this country. Operating only four retail locations that it calls “cafés” and uses solely for marketing purposes, ING offers savings accounts and mortgages, and also plans to offer a checking account later this year. At year-end 2005, it had $40 billion in U.S. deposits, according to the Online Banking Report, making it the nation’s largest stand-alone Web bank.

Inspired by ING’s success, a number of other Web-only banking operations have sprung up, including some operated by Emigrant Savings Bank of New York, Citibank and HSBC’s U.S. unit as separate channels for attracting customers. Citibank, which says its new Citibank Direct unit has attracted about $7 billion in deposits since its launch March 29, will begin offering home equity and other loans later this year. It plans to offer online-only investment products in 2007.

Banks’ profits depend heavily on the difference between what they pay for deposits and what they can charge to lend that money out or make by investing it elsewhere. Even though Web-only banks offer higher interest rates than those available to traditional branch customers, those rates still can be lower than what it would cost to raise money from other sources, experts said. Greg McBride, a senior financial analyst at Bankrate.com, which surveys rates, said that the average interest on traditional banks’ money market or savings accounts is below 1 percent, while a number of online-only banks offer accounts that pay more than 5 percent.

Online-only banking is a “pretty cost-effective way of gathering deposits,” said Matthew Kelley, a banking analyst with Sterne Agee and Leach who follows both Flushing Financial and New York Community Bancorp. But he called it a “low-value business” in the sense that, unlike branch customers who are likely to build relationships and stay with a bank, Web-only customers tend to be “very volatile,” moving their money wherever they can find the highest interest.

Robert Warasila, 65, of Patchogue, a physics teacher at Suffolk County Community College, moved some of his retirement savings to a money market fund at ING Direct several years ago, attracted by the relatively high rates. But within the past six months, he shifted most of it to what he said is a similar, but higher-yielding, fund at HSBC’s Web-only unit. The move was “simply because of the interest rates,” Warasila said.

Mark Ulrich of Hicksville regularly monitors rates at a number of Web-only banks and also is considering switching from ING to earn more interest. “When the difference was one quarter or one half of a percent, I didn’t mind,” said Ulrich, a 22-year-old graduate student at St. John’s University.

Kate Fitzgibbon, a spokeswoman for ING Direct, said the bank “prides itself on its competitive annual yields.” She said people who wish to switch to a higher-rate online bank should “read the fine print carefully” in their account agreements to make sure there aren’t hidden costs, such as transaction fees.

Banks offering savings products through their online-only units need to be careful not to “cannibalize,” or siphon off, their existing depositors, Kelley, the bank analyst, said. That’s one reason Flushing Financial will use a different name for its online-only unit, according to Buran, that company’s chief executive.

Another reason is that the thrift hopes to attract deposits from other parts of the country where interest rates are not so competitive, and “we really don’t have name recognition” in those areas, said Maria Grasso, Flushing Financial’s chief operating officer. The new unit’s name hasn’t been announced.

Ficalora of New York Community Bank said that institution’s separate Web operation was named MyBankingDirect .com simply so it would appeal to customers who are comfortable with the Internet.

“It’s basically a targeted product for that [Internet user] market,” he said. “We wanted a name that would fit … the audience it serves.”Copyright 2006 Newsday Inc.