What should I know about online-only banks?

Evaluating online-only banks

Initially, there are three things you should know about online-only banks.

• There are relatively few online bank choices in North America and Europe.
• “Online-only” is actually a misnomer, as online banking institutions usually also have sophisticated call centers to answer customer questions and make transactions.
• Some online-only banks are only “branchless” functions of larger traditional banks.

In theory, online banks should offer excellent choices of products and services since they don’t have many of the expenses of traditional brick and mortar financial institutions – including real estate, branch office personnel, and other costs of having a physical branch system. However, total online banking organizations have sometimes encountered problems that were originally unanticipated.

The lack of any neighborhood presence, ability for in-person relationships, and involvement in local causes and problem solving often accentuates the perception of a purely online bank as primarily a resource to make customers more money.

Banks and credit unions with long standing relationships and a branch system generate many low cost (to them) deposits in checking and traditional savings accounts. This low cost money allows them to offer reasonable loan rates and generate sufficient profit to continue to be successful.

Online banking organizations tend to generate much higher cost deposits from customers looking for better interest-bearing accounts. At the same time, they must remain competitive with their loan products and pricing or they won’t generate sufficient new loan volume to make sufficient income.

This combination often creates a “profit squeeze” not faced by most traditional banks and credit unions. You should evaluate the financial condition of online-only banks carefully to be sure they are financially sound.