The Internet has become a major distribution channel for U.S. banks and thrifts. Nearly two thousand banks and thrifts have established transactional websites since 1997. Most of these websites are deployed by banks and thrifts alongside traditional brick and mortar branches in a “click and mortar” banking model. The core of this distribution strategy is to route repetitive, low-value-added transactions through the inexpensive, low-touch Internet channel, while routing low-volume, high-value-added transactions through expensive, high-touch brick and mortar branches. In contrast, only a handful of these websites are used as the sole delivery channel in a stand-alone, “Internet-only” banking model. The core of this distribution strategy is to leverage the savings from eliminating physical overhead into better prices and faster growth.

To date, most Internet-only banks and thrifts have struggled for profitability. Some independent Internet-only banks have responded to low profits by abandoning the pure Internet business model and adding physical branches, and some large banks have responded to poor performance at their “trade name” Internet-only units by integrating them back into the main bank. At mid-year 2001, only about two dozen U.S. banks and thrifts are operating as separately chartered virtual banks without any full service branches. (For convenience, the generic term “banks” will often be used in place of “banks and thrifts” for the remainder of the paper.)