Analytical Wealth

Net Bank, an online only institution with $2.5 billion in deposits and the nation’s oldest online bank was shut down by the FDIC today; the ING DIRECT purchased $1.5 billion of the bank's deposits for a premium of approximately 1%, with the FDIC retaining $1.1 billion for larger disposition.

(From the Atlanta Journal Constitution) “After months of trying to keep itself afloat, Alpharetta-based NetBank was shut down by federal regulators Friday to become Georgia's largest failed bank ever. Meanwhile, its parent company filed for bankruptcy protection...

… The Federal Deposit Insurance Corp. was named receiver by the Office of Thrift Supervision, the bank's primary regulator. The FDIC is retaining $1.1 billion in assets for later disposition…

… "NetBank sustained significant losses in 2006 primarily due to early payment defaults on loans sold, weak underwriting, poor documentation, a lack of proper controls, and failed business strategies," the OTS wrote in news release issued Friday.

"As a result, the OTS executed a formal enforcement action with NetBank in 2006 directing the institution to correct its operating deficiencies and enhance its capital position. While the institution continued to operate in excess of minimum capital standards, the actions taken to address these problems were unsuccessful and it became clear that high operating expenses combined with continuing losses were jeopardizing the institution's viability."

The Net Bank story isn’t really about the viability of online only institutions (that aren’t subsidiaries of larger traditional banks like ING DIRECT), but about the problems nearly all banks are facing these days: accelerating debt losses, the mortgage crisis, subprime and bad decisions. However, even though the reason for Net Bank’s failure is so “2007 credit crisis”, reading about the Net Bank failure took me back to the late 90s, when the new online only banking start-ups were supposed to change the way America banked and put the old economy banks out to pasture.

When Net Bank first hit the scene back during the tech boom, they, along with a few other internet only institutions were supposed to be the future of banking. Instead, Telebank was bought by E-Trade, Next Card (an internet only credit card company), went into FDIC receivership and X.com more or less folded its operations and became part of Pay Pal. There were other online banking companies, but those were the most notable (to my memory), Next Bank now joins the list of standalone online banking companies that either failed or were bought out.

Many traditional banks opened up “online only banks” in order to get in on the “online banking trend”, however, most of those online banks were folded back into the traditional banking operations of the parent company. The usual “failure scenario” was that the bank wasn’t able to attract enough customers and people were frustrated over not being able to use the local branches to make deposits, get account assistances, etc. In many cases, customers who opened their accounts at the local branch could use the internet to manage their accounts, but people who went through the online branch couldn’t use the local branch, in other words, the online only customers received less service than the traditional customers. How can an online only bank that’s a subsidiary of your local bank survive under those circumstances? The lack of integration between online and offline, was the downfall of many brick and mortar bank’s initial forays online.

In one notable example, Bank One opened an internet only bank called Wingspan, but later folded those accounts back into Bank One after failing to attract enough customers. A common complaint was that customers couldn’t use their local Bank One branches to make deposits or withdrawals and people were generally afraid of banking online, so they just opened accounts with Bank One locally and use Bank One’s online service if they wanted to manage their accounts online. Citibank experienced similar issues during this time.

What many online institutions realized and the traditional banks quickly figured out, was that being online (in of itself) didn’t mean much to the average banking customer. Instead, customers wanted more convenience, better products and services and the internet was just an easy way to manage your account and pay your bills. The internet was only valuable if it provided you with the ability to better deliver banking services to customers.

If you look at the banking landscape today, people who use online only institutions are doing so in order to receive a pure “banking benefit” they can’t get from a brick and mortar bank, whether its higher interest rates on deposits, free bill pay, etc. However, those competitive advantages remain fleeting because the traditional banks can always offer the same service, but give you the benefit of local access to your money as well. I currently use an online only bank (via my Broker), due to its higher interest rates and a best in class (in my opinion) bill pay service. However, if my local bank which already pays an identical interest rate on money market deposits, matched the interest rate I get from my checking account, why would I stay online?

In the history of business, the “Internet Banking Revolution” is rather interesting, because in many ways it played out exactly the way the early players thought it would, as predicted, most people did in fact turn to banking online. However, the early players didn’t achieve the predicted level of success, for the simple reason that there was nothing stopping the traditional banks from putting up their own web sites. In the end, a Bank is a Bank and victory came down to simply offering the best banking services, not being online first.

No matter the bank’s categorization, the key to attracting customers will always be the type and quality of services offered.

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