Make no mistake, the bread and butter of small banks in Kentucky has always been the personalized service they offer above and beyond that of their giant out-of-state and national competitors.

But regional banks are increasingly feeling the pressure to offer Internet banking services to attract new customers. And as more and more of the state’s smaller banks come online – often at a sizeable initial profit loss – they are discovering they can offer Internet services just as effectively as larger banks.

Ask Dennis T. Dorton, president and CEO of Citizens National Bank in Paintsville. Dorton calls online banking “a great equalizer.” His bank, which has 14,000 customers and $350 million in assets, has signed up more than 700 customers for Internet banking since it launched the service a little over a year ago.

“Offering online access and bill payment to customers can help maintain a smaller bank’s partnership with customers, helping to keep them from moving to a larger bank,” Dorton said. “Large banks may have a price advantage over us on some products, but we have every bell and whistle on our online site that any large bank has.”

That online equality is likely to take on greater importance in coming years as younger customers open accounts and fuel an even greater shift to online banking. On a typical day, 13 million Americans do their banking on the Internet, according to a recent national survey by the Pew Internet and American Life Project. The study found their ranks have grown by 58 percent in just the past two years. With 53 million Americans (44 percent of Internet users and one-quarter of all adults) now using online banking, the virtual alternative to visiting a bricks and mortar branch bank has become the fastest-growing major use of the Internet, the study found.

Online banking is also among the fastest-growing business segments in the banking industry. Since the first online banking portal was launched by California’s Wells Fargo Bank in 1995, the number of online banking customers grew by tenfold from 1996 to 2003, according to TowerGroup Research, a Massachusetts firm that conducts industry research with the American Banking Association. TowerGroup projects that 42.5 million households – close to 37 percent of all U.S. households – will be registered to bank online by 2007.

The most recent study of online banking’s rapid rise – the Pew survey – notes that the spread of online banking coincides with the expanding availability of high-speed broadband connections and the increasing savvy of Internet users. Nearly two-thirds of computer users who have broadband Internet access at home have tried online banking, versus about one-third of those with slower-speed dial-up connections.

Coupled with growing ranks of Generation Xers banking online – the study found 28 to 39 year olds are in some cases twice as likely to try Internet banking as older Americans – broadband access could well continue fueling the sector’s growth.

That will be especially important to small and large banks alike in Kentucky if Gov. Ernie Fletcher’s broadband initiative begins to show results in coming years. The program aims to deregulate the state’s broadband industry and bring access to rural counties in Kentucky.

Making online banking pay
For many banks across Kentucky, growth in the Internet banking customer base couldn’t come too soon. Even larger banks are finding that while online customers demand fewer services and tend to be more profitable than offline customers, Internet services must be free to remain very attractive.

Central Bank and Trust Company, a large and growing Kentucky regional bank based in Lexington with 110,000 customers and $1.3 billion in assets, is one of many banks that have recently dropped a monthly service fee of several dollars for online customers who pay bills automatically or on command. Luther Deaton, chairman and president, says about 23 percent of Central Bank’s consumer customers now use its CentralNET site. With the elimination of the service fee for bill payment, Deaton says he expects the number of online banking customers to double over the next 18 months. About 15 percent of online customers now use bill payment, and even faster growth is expected there, he said.

“We believe that online banking will continue to grow and may reach a saturation point of around 50 percent penetration,” Deaton said. “Most people still prefer to establish relationships in person, with a banker who knows them and understands their needs. Once that has occurred, convenience drives how they transact business, and there is no question that online banking gives the consumer many advantages that save time and travel.”

Dorton, of Paintsville’s Citizens National, says the banking industry has had to come to grips with how to price online banking. “Free is the only way online banking will be accepted and successful.” While many customers want the convenience of online banking and bill paying, most are not willing to pay a monthly surcharge for it.

The good news for small banks, Dorton says, is that the availability of online banking software and site services from third-party vendors and contractors has lowered the costs of offering online banking.

With startup costs at nearly a $50,000 minimum for launching an online banking system, many small and even mid-sized banks concede that in most cases, the costs of offering online banking far exceed the actual savings in the cost of serving online customers. “The expenses outweigh the savings at this point,” Dorton said. “But as the number of online customers grows, we can see that the savings that will generate ultimately will make money. We’re still trying to find that number.”

 

The Online Banking Generation Gap Perhaps the most significant of the Pew study results is the emergence of an underlying trend that will probably drive continued strong growth of online banking: The rise of Gen X Internet users, those between the ages of 28 and 39. Some 60 percent of Gen X Internet users have tried online banking, compared with 38 percent of those between the ages of 18-27, the so-called Gen Y, and 25 percent of those with Internet connections over the age of 60. A greater percentage of men (49 percent) than women (39 percent) have tried online banking, compared with a roughly equal percentage reported in a similar Pew survey conducted in 2002. The latest Pew survey found that online banking, like other online activities, is more common among the affluent and college-educated who live in urban areas. The survey noted, however, “There has been an across-the-board increase in online banking that has brought more of those who are working class, those who don’t have college degrees, and those in rural areas into the online banking population.” According to Susannah Fox, associate director of the Pew Internet Project, “the rise in online banking likely flows from two major trends. The first is that as Internet users gain more experience online, they are more likely to perform activities that involve money, such as making online purchases and travel reservations, and participating in online auctions. The other trend is that banks themselves have discovered the virtues of online banking and are more aggressively offering it as an option to customers, Fox said. “Various studies have found that online banking customers are more profitable than offline customers – they make fewer customer service calls and are less likely to switch banks. That means many banks are improving their online services and offering them free of charge to customers.” —Taylor Moore

Part of that cost is driven by the constantly evolving demands of protecting online information. Maintaining complex security systems can be particularly expensive for smaller banks, costing tens of thousands of dollars a year to maintain. But so far, the threat of cyber crime hasn’t seemed to slow the growth of online financial services.

“I know people who never come into the bank,” said Rodney Mitchell, COO of Lexington-based Paramount Bank, which focuses heavily on its Internet banking services. “Customers feel that the convenience overrides the threat of fraud or identity theft. Eventually, online banking will be the rule. That security is costly is just something banks have to live with if they want to serve their customers.”

Deaton said Central Bank’s “heavy investment in technology and start-up expenses” have made reaching a cost break-even point a future goal. “That eventually will happen as more and more customers choose to bank online,” he said. “The cost of an online transaction will decline as more people find it attractive.” Deaton sees encouraging growth in Internet banking. Last year, electronic transactions overtook written checks as the payment method of choice in America, and the number of electronic transactions is growing by 15 to 20 percent a year.

Increasingly, small banks are coming to view online banking as just another mandatory cost of doing business, said Jim Bailey, president and CEO of Farmer’s Bank of Jessamine County, which has 4,000 customers and assets of $91 million. “Online banking is not a luxury any more. It’s necessary for retaining and attracting customers.” Farmer’s Bank signed up 275 customers for online access in the first five weeks since it launched its online banking site in January. “We recognized that our individual and small business customers like the convenience of online banking. For us, it’s just like another branch of the bank. It would be more costly for us not to offer it than it is to offer it.”

For a list of Bank Holding Companies Domiciled in Kentucky, click here.

For a list of Kentucky Banks in order of total deposits, click here.


Taylor Moore is a staff writer for The Lane Report
editorial@lanereport.com