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FRAMINGHAM, Mass. – Credit unions and others who wrote off Internet banks as only a passing fancy may want to think again. “Much of the financial services industry has pronounced Internet banking only `dot-gone.’ But we find that contrary to widely held opinions, Internet-only banks not only continue to exist but have managed to prosper,” says Richard Bell, an analyst with Financial Insights, an IDC research and advisory firm based in the Boston area. Rather than being a failure, Bell says, there are in fact as many, if not more, Internet-banks now than at the height of the Internet frenzy in 1999. Eventually, they may very well pose a significant threat to traditional credit unions and banks as consumers become more accustomed to doing business online. And a new kind of Internet-only bank – banking arms of insurance, investment and credit card companies – may pose a whole new competitive challenge, Bell says. “We believe that the outlook for this kind of Internet-only bank is strong,” he says, “and will inevitably grow stronger both as Internet banking becomes increasingly accepted and as consumers age and inevitably begin to depend more on their relationships with their insurance and investment providers. “This latter scenario is the financial battlefield of tomorrow as members of the baby boom generation move into their 60s.” Internet-only banks lost some of their luster amidst the demise of such notable entrants as BankOne’s high-profile Wingspan initiative, but they haven’t gone away, Bell says in his new report, “Internet-Only Banks 2004: Not Dot Gone.” Just defining what an Internet bank is can be problematic. Using an elaborate set of criteria, Bell winnowed his list to 32, 14 of which are retail banks doing business primarily on the Internet. The rest are associated with another entity, such as card, insurance, investment or other financial services company, with a bank attached. The largest is Merrill Lynch, with assets of almost $67 billion, with card-issuer MBNA America close behind at nearly $58 billion. Discover Card, Etrade Financial, ING Direct and American Express followed, but the list also includes State Farm Insurance at $7 billion all the way through NetBank at $4.5 billion to giantbank.com at $214 million. That Merrill Lynch leads this list helps illustrate how non-traditional “banks” can succeed with the most desirable clients. They leverage off high-value investment and insurance relationships, adding traditional banking services and offering these consumers a “one-stop” solution for their financial services needs, Bell says. “These captive Internet-only banks have an important physical advantage as well, they can easily get the money through the parent, which acts as a distribution channel,” the Financial Insights analyst observes. But are they really banks? It’s a matter of definition. And does it really matter? They provide the kinds of services people traditionally have gotten from credit unions and banks, and that makes them competitors who are slowly gaining traction in the retail banking world. Therefore, traditional financial institutions need to keep building their Internet presence and integrating it and the other ways they serve consumers, Bell advises. “For the majority of consumers, the Internet is just another delivery channel, and its role will gradually evolve over time to be the primary channel for most,” he says. “Banks must prepare for that change both with their Internet presence and by supporting changes to their other delivery channels.” Internet-only banks now are a permanent fixture, and their slow growth probably will increase going forward, Bell says. “Eventually, we believe that Internet-only banks will pose a significant challenge to traditional banks,” he concludes. -

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