The Internet's place in the banking industry
How the Internet will affect banking is one of the most intriguing questions in the ongoing evolution of the U.S. banking industry. Internet banking gives customers the ability to access virtually any type of banking service (the main exception for now being cash) in any place and at any time. If customers adopt this new way of banking in large numbers, banks may be able to shed much of their investment in expensive brick and mortar branches. But Internet banking remains a work in progress, and for many U.S. banks the initial Internet experience has been disappointing.
In this Chicago Fed Letter, I argue that the Internet is chiefly a new delivery channel-not a new product-and based on this argument, I propose a simple framework for analyzing the strategic interactions between physical branches, automated teller machines (ATMs), the Internet, and other bank delivery channels. For most banks, the future of the Internet lies in how well it can be integrated with more traditional delivery channels. But in the end, profitability will depend primarily on the quality of the products and services banks deliver to their customers, and not necessarily on how those products and services are delivered.
Changing delivery channels
The way that U.S. commercial banks deliver products and services to thei customers has changed substantially over the past decade (figure 1). Bank mergers-many of which combined two banks from different geographic markets-reduced the total number of banks by about one-third during the 1990s. But despite having fewer banks, the U.S. now has more banking "points of sale" than a decade ago. The number of branch locations has increased from about 60,000 to about 70,000, and the number of ATMs has skyrocketed. The typical bank now has a greater geographic reach, and covers those markets with a denser network of branches and ATMs.
More recently, banks have augmented their distribution networks with transactional websites, which allow customers to open accounts, apply for loans, check balances, transfer funds, and make and receive payments over the Internet. The number of banks with transactional websites is increasing rapidly-- from near zero just a few years ago, to 1,100 at year-end 1999, to an estimated 2,000 plus by the end of 2001. And the recent introduction of wireless Internet banking promises to further increase the convenience of Web-based banking.1
The Internet is also transforming traditional bank distribution channels. For example, the recent increase in ATMs includes the introduction of automated banking machines (ABMs). Often deployed at banking "kiosks," ABMs combine at a single location an ATM for getting cash and depositing checks, an Internet connection to the bank's website, and often a telephone for accessing customer service. Similarly, the increase in bank branches over the past decade includes the introduction of "mini-branches," in which Internet kiosks are placed sideby-side with teller windows.
New product or new package?
When a retailer like Eddie Bauer sells a pair of jeans, the point of sale might be a physical store, a telephone order, or an Internet purchase. Regardless, the customer's choice of a delivery channel does not affect the nature
of the product. This analysis can be applied to most banking services, regardless of whether the point of sale is a physical branch, an ATM or ABM, or the Web. With a few exceptions, a transactional Internet website is not a new financial product-rather, it is a new delivery channel for existing financial products.
In some ways, the introduction of the Internet banking channel parallels the introduction of ATMs several decades ago. ATMs did not introduce any new financial services, but they offered customers more convenient access to a limited array of existing financial services, primarily the safekeeping of …