Banking on the web
Companies struggle with an onslaught of deposits from Internet accounts
For most of its history, Emigrant Savings Bank kept things simple. It was a local bank serving local customers, seldom reaching much past New York City's borders to grab new deposits. But last October, when the family-owned institution took over an old bank building in Ossining, N.Y., the idea wasn't to turn the town's art-deco centerpiece into another traditional branch. Instead, most of the employees and much of the new real estate would be used to service tens of thousands of new clients who had never set foot in any of Emigrant's 36 branches but were already plowing millions of dollars in deposits into the bank.
Attracted by Emigrant's offer of some of the highest interest rates in the country, these customers--about 260,000 by last count--were pumping money into new savings accounts that could only be accessed over the Internet. And this was a flood, with about $7 billion coming in since the bank started offering the accounts in January 2005.
Cash flow. That money and those customers needed a home, says Emigrant's chairman, Howard Milstein, adding that in just a year and a half EmigrantDirect had taken in more deposits than its brick-and-mortar counterpart had accumulated in 155 years. "This is the 'next idea' for banking," he says.
Internet banks such as NetBank have been around for more than a decade, but brick-and-mortar banks in search of deposits have increasingly joined the fray. Nearly all banks have greatly improved their online services. Many have pushed to increase their number of branches as well. But with more and more customers searching out higher rates of return for their parked cash, banks that might have shunned the idea of Internet-only savings accounts a few years ago are now lining up to offer them.
Capital One, HSBC, Countrywide Financial, Washington Mutual, and Citibank are among the big names now offering high-yield savings accounts for Internet clients, moves that have quickly bolstered their deposits--sometimes at the cost of more established players. ING Direct, the online subsidiary of the Dutch financial conglomerate ING and the 26th-largest bank in the country, is one now feeling the heat. Its share of new customer applications dropped to 33 percent from 63 percent during 2005, according to an April survey by the research firm comScore Networks.
The heightened competition has made consumers more aware of high-yield offerings, and so they have been pouring money into such assets. Richard Brown, the chief economist of the Federal Deposit Insurance Corp., notes that the amount of money being put in interest-bearing accounts has been rising rapidly, registering a 19.6 percent year-over-year growth rate as of March 31, nearly double that experienced by all deposits over the same time frame. And online rates have been among the most attractive, with some Internet-only savings accounts promising rates above 5 percent on deposits, compared with less than 1 percent at a brick-and-mortar bank.
Emigrant's Milstein says that he would have had to open 350 branches to bring in the amount of money Emigrant accumulated through its online operation. "That's the power of the Internet," he says. "It is a much more powerful way of raising deposits than traditional banking."
While fewer than 3 percent of retail bank deposits are now in high-rate Internet-only accounts and fewer than 2 percent of bank customers have made the switch to Internet-only banking, Jim McCormick, CEO of First Manhattan Consulting Group, says that the market has reached about $90 billion and that deposits have been growing 40 to 50 percent a year since 2002.
Many analysts and bank officers say the market will most likely continue to rise, as customers become more at ease with online banking. With people using the Internet to keep track of and pay bills from their regular bank accounts, online banking has grown substantially over the past five or so years, with the Pew Internet and American Life Project finding that 43 percent of Internet users (or about 63 million Americans) were banking online last year compared with only 17 percent in 2000. The number of users was even greater for those with annual incomes of $75,000 or more.
"The Internet has been huge for banking," says Andrew Collins, a banking analyst with Piper Jaffray, noting that online banking has become an important retention vehicle. "It's hard to switch banks when you have all your accounts already set up online," he says.
But few banks are placing all their bets online. After a period of consolidation and branch closings, banks are building again. Well-run branches can bring in a lot of new business. Recent research suggests that branches also increase customers' use of a bank's Internet banking products, with most customers learning about them through advertisements in their local branch.
Seeking value. "The branch is still king in terms of originating business and originating accounts," says McCormick of First Manhattan. "If I was running a bank and was achieving average or below-average growth in deposits, the first thing I would worry about is how to improve the value proposition being offered in my branches. "McCormick adds that the Internet-only banking segment will remain "dominated by financial institutions that do not have the wherewithal to raise lower-cost deposits through an effectively run branch system."
There are definite pitfalls to competing in the Internet-only banking space. ING Direct and others have seen their margins squeezed as banks try to one-up each other on rates. And there is always a risk that banks will cannibalize their customer base. Banks don't want customers who currently stash their money in no-interest checking accounts suddenly moving it to high-interest savings accounts.
But some customers invariably switch. Citibank CEO Charles Prince said in a call with analysts last month that his company's recently launched Internet-only offering, Citibank Direct, had raised over $4.7 billion in deposits and that about "two thirds of that amount was new money to Citi." But implicit in that comment was that one third of the funds had been cannibalized from lower-yielding, and from a bank's perspective, less expensive, accounts already at the bank.
The second problem many banks are now facing is what to do with all the new money. Milstein says Emigrant has originated loans on only about $2.5 billion of the nearly $7 billion taken in by his Internet arm, with the rest sitting in low-yielding short-term investments.
The bank saw its deposits increase from $6.1 billion to more than $10.6 billion in the 12 months from March 2005 but saw its net loans on those deposits increase by less than 12 percent. Meanwhile, its cost of funding those deposits increased, lowering the bank's return on equity for shareholders from 23.69 percent to 13.7 percent.
Milstein isn't the only one being squeezed. Owing to the rising interest rate environment, many banks are finding it difficult to lend their deposits for a rate that covers either the cost of the deposit or the risk of the loan.
"The banks that have usefully generated deposits are having a difficult time putting the money to work in a flat yield curve environment and in a much cooler borrowing environment," says Greg McBride, senior financial analyst with Bankrate.com. "Putting the money to work--that in a nutshell is an issue confronting the entire banking industry. But if you are going to pay 5.5 percent on a CD, this environment is a lot tougher to make that work."
This story appears in the August 14, 2006 print edition of U.S. News & World Report.