City wakes up to Net threat to old banks

WHEN ONE of Bank of Scotland's advisers recently asked Peter Burt, the bank's chief executive, which of his competitors he was afraid of, his response was characteristically blunt. "No one, at least not any of the existing banks. What really worries me is that someone will set up an Internet-only bank. However successful we are at keeping down costs, there is no way we can compete with that."

WHEN ONE of Bank of Scotland's advisers recently asked Peter Burt, the bank's chief executive, which of his competitors he was afraid of, his response was characteristically blunt. "No one, at least not any of the existing banks. What really worries me is that someone will set up an Internet-only bank. However successful we are at keeping down costs, there is no way we can compete with that."

In America, where Internet banking is well established, it is estimated that the cost of processing a transaction over the Internet is just 13 cents compared with 29 cents for an automatic teller machine, 65 cents by phone, and a staggering $1.70 to handle a transaction at a conventional bank branch.

It is these kind of statistics that have the chief executives of existing bricks and mortar banks quaking in their Church's brogues.

Yesterday Smile, the stand-alone Internet bank created by Cooperative Bank went live, offering what it claims to be the best savings and borrowing rates available on any current account anywhere in the country.

Mervyn Pedelty, the Coop Bank's chief executive, has been delighted with the response. "We believe we have a success on our hands," he said yesterday.

When Coop Bank revealed its plans less than a month ago it had clearly caught others in the sector completely on the hop. Within days of Coop going public, Halifax revealed its own plan to launch an £850m Internet bank, provisionally called greenfield.co, headed by Jim Spowart, the former Direct Line executive who set up Standard Life Bank.

The announcement was clearly premature. At the time, the venture had no name, no premises or staff, although Mr Spowart is aiming to be online next spring. Other similar start-ups are even further behind.

Strictly speaking Coop and Halifax are by no means alone, or necessarily the first, in the e-banking field. Barclays, which has launched its own Internet service provider, claimed in August to be Britain's biggest Internet bank, while most of the big UK banks are already offering or are close to offering Internet access to existing banking customers.

But unlike Barclays and NatWest which are adding Internet capability to existing products to satisfy their existing customer base, Smile and Greenfield are seeking to exploit the Internet to to go for growth, winning customers they would not otherwise be able to get.

As James Crosby, Halifax's chief executive, explained: "There are a lot of people who have rejected Halifax in the past. We hope that this will make them look at us again."

Potentially, the Internet is the great leveller that allows Smile access to the same customer base as a Barclays or NatWest bank, without having to spend the time and money replicating the branch networks.

The question is whether the public is ready to desert conventional banks for Smile and the legions of imitators that are about to launch. For the City, the realisation that the Internet has dramatically altered the terms of trade is only starting to sink in. Investors have piled into shares of conventional bricks and mortar banks on the assumption that they are valuable properties which are about to be fought over.

But if all you need to grab a share of the financial services market is a well-designed website and a catchy logo, many are starting to wonder if paying a hefty takeover premium to buy NatWest is destroying rather than creating shareholder value. The success of Egg, Prudential's stand-alone direct banking operation, has also led many in the industry to question the value of financial services brands.

As Sir Peter Davis, Prudential's chief executive, is fond of repeating: "If you can acquire a deposit base the size of the Yorkshire Building Society in 18 months, what is the point of going out and buying a bank?"

Bill Gates, the founder of Microsoft, argues that it won't be shareholders who benefit from the lowering of cost that the Internet brings but consumers.

Rob Thomas, banks analyst at SBC Warburg, agrees. The new entrants, he says, will take customers away from traditional banks for sure. But the real impact will be to force established players to cut their charges to stay in the game.

He adds: "The margins will be squeezed. The total quantum of profit is lower. When you look at this technology it hasn't any positives for the industry as a whole. In the face of lower costs, the industry will be seeking to protect its profits. But it is difficult to see how it can."