The Electronic Marketplace

Banks, finance companies, and other suppliers of financial services to consumers face some daunting strategic decisions in entering and adjusting to the growth of e-commerce. John Wenninger has addressed these issues in the most recent issue of Current Issues published by the Federal Reserve Bank of New York. How banks adjust to electronic commerce will have important implications for banks and their competitors.

Banks are responding to the electronic marketplace in at least two ways. On the one hand, new banks have emerged that operate exclusively on the Internet. Unencumbered by brick-and-mortar branches, these banks can offer lower rates on loan and credit cards and higher yields on savings accounts than traditional banks. Their competitive pressure on credit card rates is increased by online information services, such as Cardtrak.com, which provides extensive listings of credit card rates and sources. While the online approach sounds good in theory, in practice the results currently are less satisfactory. A 1999 survey by McKinsey of customers of Internet banks found that a third of the nine million consumers who had signed up had left, with many vowing never to return. The article in Money also noted that among the remaining customers, "less than half say they are completely satisfied, while 24% claim to be completely unsatisfied."

On the other hand, many banks have already established transactional web sites to deliver banking services, such as those developed to take and approve applications for credit cards. They have also formed networks linking ATM machines and are already exploring ways of tying those facilities to the Internet and to bank web sites. Some banks have formed online subsidiaries to compete with the online-only banks. These strategies capitalize on the competitive advantage of having a "brand name" known to prospective customers.

What are the risks that bankers face in adapting to the electronic marketplace? First, they may over-react or under-react to the competitive threats. If they build extensive networks to meet a challenge that withers away because of customer dissatisfaction, they will have both an expensive electronic network and brick-and-mortar branches. In contrast, if their response is too mild and too late, they could lose market share. In addition, there is a "technological risk." If a branch temporarily closes for some reason, no great harm is done. If an electronic network crashes, thousands of customers will be alienated and seek more reliable banking alternatives. Fortunately, many banks already have experience in managing electronic payments systems and controlling risk and fraud in their credit card operations.

Finally, the growth of the electronic marketplace is most threatening to small banks, who will find it particularly difficult to adjust to electronic banking. This is not a trivial problem. About 85 percent of all commercial banks in the United States have assets below $300 million.