Academic journal article Academy of Banking Studies Journal

Internet Banking: Gold Mine or Money Pit?

Academic journal article Academy of Banking Studies Journal

Internet Banking: Gold Mine or Money Pit?

Article excerpt

ABSTRACT

This paper explores the impact that implementing internet banking has on a bank's profits, costs and revenues. A production function approach utilizing maximum likelihood estimation procedures is used. We find that internet banking improves bank profits, and that the extent of this impact depends on the number of customers the bank succeeds in getting to adopt it. At lower levels of consumer adoption, profit gains are driven by increased revenues. These revenue improvements, however, taper off until profits are largely unaffected by further consumer adoption. Finally, at a sufficiently high level of consumer adoption, lower costs drive increased profits.

INTRODUCTION

Firms in myriad industries spend millions, even billions, of dollars on Information Technology (IT). In 2001, IT spending topped $527 billion in the US (CIO Magazine, November 8, 2002.) and $1.2 trillion worldwide (CIO Magazine, April 12, 2002). The banking industry, for example, invests heavily in IT--increasing investment from 6% of revenues in 2000 to 6.5% in 2001 (Parton, C. & J. Glaser, 2002). However, many bank CEOs are unsure of IT's impact (Vrechopoulos, A., & G. Siomkos, 2002), while others claim that these investments lead to increased services but decreased profits (Ross, J. & P. Weill, 2002). A specific technology--Internet Banking (IB)--has been heralded as both a competitive advantage and a competitive necessity (Dynamicnet, 2001; Vrechopoulos, A., & G. Siomkos, 2002; Retail Banking Research, Ltd., 1996). Accordingly, banks spent 15% of their IT dollars on internet banking in 2002 (Olazabal, N, 2003). Yet, many banks question its profitability (Hoffmann, K, 2003, March). In fact, half of all U.S. banks have no plans to offer internet banking (Orr, B, 2001), with the most common reason given being an unclear return on investment (Parton, C. & J. Glaser, 2002).

This paper utilizes firm level data gleaned from public and proprietary sources to take a detailed econometric look at the profit implications to banks of implementing internet banking. Three questions concerning internet banking are addressed. 1) Does offering IB improve bank profits and are these improvements derived from lower costs and/or increased revenues? 2) Does bank management influence the value of IB through either the decision to be an early-mover or by its ability to get its customers to adopt IB? 3) Does the value of IB change over time?

We find that internet banking does improve bank profits, and that the extent of this impact depends on the number of customers the banks succeeds in getting to adopt it. At lower levels of consumer adoption profit gains are driven by increased revenues and not by lower costs. These revenue improvements, however, diminish as additional consumers adopt until profits are largely unaffected. Then, after a sufficiently high level of consumer adoption is reached, lower costs do indeed drive increased profits. That is, IB can generate both revenue and cost advantages for those banks that implement it. We also find no evidence of an early-mover advantage, nor do we see that the impact of IB has softened over time.

The paper proceeds as follows. We begin with a discussion of how internet banking provides value to both a bank and its customers. This discussion produces four hypotheses for investigation. Next, the regression models needed to address our research questions are developed. The data then are described and our empirical findings presented. We conclude with a summary that highlights managerial and academic implications.

VALUE OF INTERNET BANKING

Internet banking is defined as a transaction-oriented system that enables a bank's customers to engage in online banking activities. IB enhances a bank's offerings by providing its customers with 24/7 access to many of its services. The services available through IB can vary but typically include informational account access (view balances and past transactions), funds transfers among accounts at the providing institution, bill payment, bill presentment, and loan application and approval (including credit cards, mortgages and other personal loans). …

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