After bursting on the scene at the height of the dot.com frenzy, virtual banks are struggling to maintain deposit levels as customer inertia and an assault on online banking from the high street banks hinders their progress.
Last week Prudential-owned Egg, the UK’s first Internet bank announced pre-tax losses of &£155.3m for 2000, up from &£149.7m in 1999. The bank insists it is on target to break even by the end of this year, despite having cut rates on some of its accounts.
Egg has recently launched an online unit trust supermarket and is planning one for mortgages as well in an attempt to entice account holders to buy other financial service products online.
The strategy is common with purely Internet players, which attract customers with higher interest rates than the high street banks offer. Once signed up the online banks aim to recoup the cost of the high rates by cross-selling other financial products such as mortgages, loans and credit cards. But analysts say this strategy is unsustainable and bound to result in consolidation or market fall-out.
Dan McAuley, product development manager for Durlacher’s investment site, Nothing_Ventured.com, says: “Internet banks such as Egg, Cahoot and Smile have very high rates of interest to attract deposits, but they lose money by doing so. It is a high risk strategy which is economically unsustainable over time.”
McAuley adds that high street banks have been trying to sell other financial products to customers for years without notable success . Cross-selling for offline banks stands at about 1.5 products per customer.
So far, there is scant evidence that Egg customers visiting the site move on to buy something else – the number of products sold, or cross-sold, to each customer stands at 1.29.
“I don’t see why online banks should succeed where offline institutions have failed,” says McAuley. “Customers do not put all their eggs in one basket. It doesn’t follow that because you have a current account in one bank you will take out life insurance with them.”
Egg says it plans to spend between &£40m and &£50m on marketing and advertising this year but refuses to say how much is to be put behind the cross-selling of products.
Egg chief executive Paul Gratton says: “Cross-buying within our core customer base has been encouraging, with some 97,000 products being cross-bought during the last quarter alone. We believe this is an area ripe for development over the coming year.”
The bank says it will continue to invest heavily in advertising (it spent &£17m last year) and has recently launched its first TV campaign for a standalone product – an ISA account.
Bob Head, chief executive of Smile, the standalone online bank from the Co-operative Bank, thinks the Internet banks’ loss-making strategy to attract customers and build loyalty will pay off in the long run.
While some of the products, such as the zero per cent personal loan from Abbey National’s Cahoot which was dropped last year, are unsustainable in the long term, Head says any business looking to acquire customers expects to lose money.
He adds: “Once customers realise they are being ripped off by the big banks and start switching accounts, rates of interest will come down to a more realistic and sustainable level.”
Egg leads the race for customers among the purely online banks. Egg has 1.3 million account holders, Abbey National’s Cahoot has 107,000, Smile and Dublin-based First-e both have about 200,000 customers and Halifax’s Intelligent Finance (IF) 163,000.
The UK’s Internet banks face renewed competition from traditional banks, which are threatening to steal their thunder with a range of products that blend online and branch banking.
The so-called big four – HSBC, Barclays, Lloyds TSB and NatWest – hold 80 per cent share of the UK current account market – and they are aiming for the same dominance in the online banking market.
Barclays is a bricks-and-mortar bank with an online presence launched in June 1998. It has 1.5 million customers. Lloyds has 1.04 million customers and NatWest 500,000. Even HSBC, which didn’t introduce Internet banking services until the middle of last year, has 310,000 customers.
One of biggest hurdles online banks must overcome is customer inertia to switching from established banks which offer both online and offline services to purely online providers.
Although 55 per cent of UK Internet users have used some form of online banking, only four per cent have their main account with an online brand according to research by Netsurvey.
Head believes that Internet banks will eventually win the race against old stalwarts like Lloyds and NatWest. “At the moment only about seven per cent of those who bank online switch providers.” he says. “Once they become comfortable with the Internet as a medium they will start to realise that the high street banks which only offer half a per cent interest on their current account are ripping them off and that is when they will start switching accounts.”
Security concerns is another obstacle to e-banking take-up. Smile spends the bulk of its seven-figure marketing budget on guerrilla type campaigns to educate consumers about online banking and alleviate security concerns.
But analysts say the key to unlocking the UK’s online potential lies in the integration of Internet services with offline channels, and offering third-party products and services. Branchless banks need to get “physical”, not necessarily by establishing branches, but through partnerships with other companies or organisations which do have a physical presence. For example, Egg recently announced plans to set up kiosks offering basic banking facilities in Boots outlets.
Forrester UK associate analyst Charlotte Hamilton says a more attractive model would be to use the space for broader financial advice to customers.
“If you can get customers to use self-service channels for basic banking services, then provide face-to-face advisory services for broader financ
ial products, use of the Internet will start to become a more attractive proposition,” she says.
IF has also recognised that providing an offline presence through a call centre and offering customers the opportunity to make transactions at Halifax branches offers them reassurance.
Old habits are hard to break and the online banks face an uphill battle in persuading UK consumers, who are still more likely to get divorced than switch bank accounts, to trust them with their money.