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Tuesday, 20 February, 2001, 14:21 GMT
The tough world of online banking
Barclays online banking screenshot (slightly altered for better view)
Doesn't my online bank just look like my old one?
by BBC News Online's Tim Weber

UK bank customers have rarely had it so good.

Courted by a raft of new banks, they are being lured with discounted mortgages, high interest rates and a promise of 24 hours a day, seven days a week service.

This is a very crowded market place... and a great time for consumers

Bob Head, Smile chief executive
But there are a few catches.

For one, the more spectacular rates are available only on the internet.

For another, some banks are picky, choosing only rich customers with a good credit history.

The biggest worry, though, is for investors in the new ventures: Can all the internet and telephone banks ever make a profit?

Great offer, shame about the name

To most people, the new banks are only remarkable for their 'hip' brand names like Cahoot, IF, Smile, Egg, Evolve and First-e.

It's going to be tough to make a profit

Tim Sawyer, Cahoot
Their customers, though, value highly competitive interest rates and promises of innovative money management.

The good deals are possible because the new banks have done away with traditional branches.

Operating a telephone bank account is less than half as expensive as running a normal bank account.

Online customers are even cheaper, costing less than one tenth of normal branch customers.

For customers this results in better deals. Investors, meanwhile, are promised that the banks can still deliver a profit.

Welcome to the real world

Cahoot screen shot
Account management at the click of a button
But Andrei Ilyin, a banking analyst with Nomura International, warns that this strategy works "only in theory - if customers are acting rationally and show no inertia".

In the real world, the big flow of customers has yet to materialise.

People, fearing the hassle, are reluctant to switch accounts.

The little things irk: Who wants to pay postage for mailing in a cheque, when it can be dropped off at a local branch on the way to work?

What about the call charges to service centres and for internet access?

And there are bigger worries, says Nomura's Andrei Ilyin.

The uptake of internet banking is happening big time

Bob Head, Smile chief executive
Online banks have been beset by technical problems and security scares.

The money spinners of the banking world - sophisticated products like life insurance - just don't sell well on the internet or on the phone.

And some customers simply want to have the option to go to a branch and talk to a human being.

A leap of faith

Online banks like industry pioneer Egg point to surveys that suggest people's attitudes to electronic banking will change during the next five years.

But Nomura's Andrei Ilyin says it "takes a little faith to believe in those forecasts".

A niche market?

No doubt, the sector is growing. Two years ago there were 1.4m online accounts. Now there are about 5 million.

But that is less than 5% of all accounts held by UK banks.

And traditional banks are convinced that it could stay that way.

Egg advert for Egg credit card
Banking is a serious business: The credit card of market leader Egg is very successful
Lloyds TSB, one of Britain's largest banks, says that internet banking will remain a "niche product" for the foreseeable future.

The most successful way to service customers, the bank believes, is a multi-channel retail strategy, where traditional branch services are complemented by banking on the internet, telephone and mobile phone, and interactive television.

Barclays, for example, claims to be the biggest online bank as many of its customers now manage their traditional accounts online.

Not surprisingly, online bankers detect a different trend.

Bob Head, the chief executive of Smile, the Co-operative Bank's online venture, says that "half of all internet users now look on the web for financial stuff".

He predicts they will soon try out new ways of banking.

"The uptake of internet banking is happening big time," says Mr Head, and adds: "Once customers realise how they've been taken for a ride by their old banks, they will switch to new providers".

Smile screenshot
Online banks hope their customers will help them with their marketing
One secret to online success is not to be an internet-only bank. Smile, for example, offers its customers both internet and telephone banking.

Egg recently dumped extra charges for customers who insisted on talking to real people. Intelligent Finance first launched its telephone business before offering business over the internet.

And, says Mr Head, customers don't insist on meeting their bank manager anymore. "They are now comfortable to discuss financial matters on the phone".

'It's gonna be tough'

But as long as the masses stay offline, there are just too many banks for too few customers.

In such a crowded marketplace "it's going to be tough to make a profit", says Tim Sawyer, director of marketing at Cahoot, an internet bank backed by Abbey National.

Running an online bank may be cheap, but the start-up costs are huge.

It is costly to establish a brand

Tim Sawyer, Cahoot
The technology and the call centre may be expensive but the true costs - and real success - come with brand building.

Lloyds TSB, for example, has shelved plans to roll out its Evolvebank in the UK, and instead teamed up with Centrica, using that firm's well-established Goldfish credit card brand to create a online and phone bank.

That is certainly cheaper than creating an online bank from scratch.

Other newcomers, meanwhile, watch with envy the name recognition achieved by Egg who was one of the industry's "first movers".

They have to rely on expensive advertising campaigns and hope for success through word-of-mouth.

To make profit, the banks have to address three issues, says Cahoot's Tim Sawyer: "Can you establish a brand personality? Can you achieve cost efficiency? Can you achieve a high level of cross-selling?"

Cross-selling is the magic word.

Online banks are luring customers with good deals on savings accounts or mortgages. But to make real profit, they have to persuade customers to buy additional products with higher margins as well.

Once again, Egg is the pioneer with its "supermarkets" for investment funds, insurances and tax-free Individual Savings Accounts.

Egg says its "cross-selling ratio" is going up. Intelligent Finance reports that more than 65% of its customers are buying at least two financial products.

Waiting for a profit

But all that is not enough yet to turn in a profit - at a time when High Street banks are making billions.

Egg now has 1.35m customers, and hopes to become profitable by the end of this year - an optimistic prediction says Nomura's Andrei Ilyin.

We don't have an example yet of a successful internet bank, that can outdo a traditional bank

Andrei Ilyin, Nomura
Cahoot says it has attracted about 123,000 accounts, and keeps adding 5,000 every week. Profitability could be achieved at the end of 2003, while the parent company hopes to get a return on its investment in 2006, according to Mr Sawyer.

Smile's chief executive Bob Head dodges questions about profitability targets, but says his customer acquisition is ahead of plans.

The big banks, meanwhile, are busy rolling out or improving their own online banking operations.

Waiting on the sidelines, and itching to move, are the real giants of the business, European and American banks eager to break into the lucrative UK market.

That leaves investors with the knowledge that there is just no "example yet of a successful internet bank, that can outdo a traditional bank", says Nomura's Andrei Ilyin.

For now, online banking is a niche market with too many players.

It may soon be a "chunky niche", says Mr Ilyin, but it will be a niche nonetheless.

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