Online banking — at least to some degree — has become the norm for many simple bank transactions. And that's not a bad thing — the easier it is for consumers to check their accounts, pay their bills and move money from one account to the other, the more likely they are to actually do these things and maintain a more organized financial life. However, it's important to consider that just because online banking is a good addition to the world of consumer banking, doesn't necessarily mean that direct internet banks are a substitute for their brick-and-mortar peers in all cases.
Here we'll take a look at what internet banks have to offer — and where they may fall short.
The Evolution of Online Banking
As commercialization of the internet evolved in the early 1990s, traditional brick-and-mortar banks began to investigate ways of delivering limited online services to reduce operating costs. The success of these early efforts led many banks to expand their internet presence with improved websites that featured the ability to open new accounts, download forms and process loan applications.
The next stage of development was the arrival of internet-only banks that offered online banking and other financial services without a network of branch offices. These so-called "virtual" or "direct" banks were able to pass savings in labor and overhead costs on to their customers by offering higher interest rates on deposit accounts, lower loan costs and reduced service fees.
The first fully-functional direct bank insured by the FDIC was the Security First Network Bank. Based in Atlanta, it began operations on October 18, 1995. While it was not very profitable before it was bought out three years later, it proved the feasibility of the virtual bank concept.
(To learn more about the FDIC, see The History of the FDIC.)
The Benefits of Online Banking
Online banking has plenty of perks. These include:
Direct banks are open for business anywhere there is an internet connection. Other than times when technical maintenance is being done, they are open 24 hours a day, 365 days a year. If internet service is not available, customer service is normally provided around the clock via telephone. Real-time account balances and information are available at the touch of a few buttons. This makes banking faster, easier, more efficient and even more effective because consumers are able to always stay on top of their account balances.
Updating and maintaining a direct account is also easier. It takes only minutes to change your mailing address, order additional checks and check for current interest rates.
The lack of significant infrastructure and overhead costs allow direct banks to pay higher interest rates on savings and charge lower mortgage and loan rates. Some offer high-yield checking accounts, high-yield CDs and no-penalty CDs for early withdrawal. Some accounts can be opened with no minimum deposits and carry no minimum balance or service fees.
(To learn how to choose a bank that won't charge you unnecessary fees, check out Choose to Beat the Banks.)
Direct banks typically have more robust online services that offer a comprehensive set of features that may not be found on the websites of traditional banks. These include functional budgeting and forecasting tools, financial planning capabilities, investment analysis tools, loan calculators and equity trading platforms. They also offer free online bill paying, online tax forms and tax preparation.
Online banking now includes mobile capabilities. New applications are continually being created to expand and improve this capability on smartphones and other mobile devices.
Accounts can be automatically funded from a traditional bank account via electronic transfer. Most direct banks offer unlimited transfers at no cost, including those destined for outside financial institutions. They will also accept direct deposits and withdrawals that you authorize, such as payroll deposits and automatic bill payment.
Ease of Use
Online accounts are easy to set up and require no more information than a traditional bank account. Many offer the option of inputting your data online or downloading the forms and mailing them in. If you run into a problem, you have the option of calling or emailing the bank directly. One advantage of using online checks is that the payee's information is retained, which eliminates having to re-enter information on subsequent checks to the same payee.
Online banking is also environmentally friendly. Electronic transmissions require no paper, reduce vehicle traffic and are virtually pollution-free. They also eliminate the need for buildings and office equipment.
The Drawbacks of Direct Banking
Banking exclusively online also has its share of drawbacks and inconveniences. These include:
A traditional bank provides the opportunity to develop a personal relationship with that bank. Getting to know the people at your local branch can be an advantage when you need a loan or a special service that is not normally offered to the public. A bank manager usually has some discretion in changing the terms of your account if your personal circumstances change. They can help you solve problems such as reversing an undeserved fee or service charge.
Your banker will also get to know you and your unique needs. If you have a business account, this personal relationship may help if you need capital to expand. It's easier to get the bank's support if there is someone who understands your business and can vouch for your operating plan.
Sometimes a face-to-face meeting is required to complete complex transactions and address complicated problems. A traditional bank can host meetings and call in experts to solve a specific issue. In addition, international transactions may be more difficult (or impossible) with some direct banks.
If you regularly deposit cash, a traditional bank with a drive-through window may be more practical and efficient. Another potential drawback is that most direct banks do not have their own ATM machines. Unless an internet bank has a network alliance with another bank, you will be charged for your ATM use.
(For related reading on ATMs, see 5 ATM Scams That Can Break the Bank.)
Services Not Offered
Some direct banks may not offer all the comprehensive financial services, such as insurance and brokerage accounts, that traditional banks offer. Traditional banks sometimes offer special services to loyal customers, such as preferred rates and investment advice at no extra charge.
In addition, routine services such as notarization and bank signature guarantee are not available online. These services are required for many financial and legal transactions.
Direct banks are subject to the same laws and regulations as traditional banks, and accounts are protected by the FDIC. Sophisticated encryption software is designed to protect your account information, but no system is perfect. Accounts may be subject to phishing, hacker attacks, malware and other unauthorized activity. However, one advantage of online banking is that you are likely to find a security breach more quickly, because your account balance is so accessible.
Most banks now make scanned copies of cleared checks available online, which helps to avoid and identify check fraud. It enables verification that all checks are signed by you and that dollar amounts have not been changed. The timely discovery of discrepancies can be reported and investigated immediately.
Identity theft is a significant concern, but some online banks take this risk more seriously than others. Before opening an online account, thoroughly investigate the bank's security policies and protections to ensure they meet your expectations.
The Bottom Line
The rise of internet banks has increased the competition for your banking business. While both online and brick-and-mortar banks offer unique benefits and drawbacks, it may not be wise to do your banking exclusively with either option. Although it's not possible for everyone, the best play may be to split your banking between both in-store and online services and enjoy the conveniences and savings of internet banks while maintaining the customer service and personal relationships a physical branch can provide.
(For related reading, also check out Online Banks: Lower Costs and Little Sacrifice.)