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In the beginning, online banks had a simple strategy: With the money they saved by not owning expensive, marble-clad branches, they could offer high-interest, low-fee bank accounts that would bring customers flocking to their virtual doors. But things haven't worked out that way. Five years after the first Internet bank launched its Web site, online banks have failed to capture more than a sliver of the banking business. Meanwhile, their customers are demanding many of the conveniences associated with traditional banks -- creating an added expense that Internet banks hadn't worked into their business plans. These unexpected pressures have started to take a toll. Online banks are rolling back or abandoning the generous offers they once dangled in

front of potential customers. BankDirect (www.bankdirect.com) and WingspanBank.com (http://findarticles.com) are raising fees and cutting interest paid on deposits. Meanwhile, other online banks have been bailing out of the business altogether. In November, a company called X.com Corp. decided to phase out its Internet-banking operations to focus on its person-to-person payment service, PayPal (www.x.com). Also last year, financial-services giant Citigroup Inc. pulled the plug on citi f/i, its Internet-only banking subsidiary. Many other Web banks will soon be forced to become more tightfisted or even shut down, analysts and industry executives say. It's a development that mirrors the painful lessons of the e-commerce sector, as online retailers discovered that free shipping and below-cost pricing aren't so compatible with profits. WingspanBank.com, for example, will be raising its monthly service fee on Jan. 18 to $10 on checking accounts with average balances of less than $1,500, up from $7.50 on accounts with a balance under $1,000. Interest rates will also change at WingspanBank. For customers with balances of $10,000 or more, interest rates will drop to 4%, down from 4.59%. Rates will also drop to 2% from 3.14% on accounts between $2,500 and $10,000. The fee increases by WingspanBank, one of the most prominent players in the business and the subsidiary of a deep-pocketed old-line bank, illustrates the difficulties its rivals might be facing. The fee increases come two days after a similar but more drastic move by BankDirect. BankDirect customers with less than $2,500 in their checking accounts will now be assessed a new $15 monthly account-maintenance fee and see their 3.25% interest payments drop to zero. Rose Hultgren, executive vice president of BankDirect, a division of Texas Capital Bank with about 30,000 online customers, says her company couldn't continue to absorb losses each month on its low-balance checking accounts and remain viable. "Raising fees is everyone's least favorite thing to do," Ms. Hultgren says. "But we believe that we won't be the last ones to do it." Online banks have faced a tough challenge making inroads into the retail banking business. Many consumers have avoided these banks because they lack branch networks and don't have tellers. Jim Bruene, editor of the Online Banking Report (www.onlinebankingreport.com), a Web site that tracks the Internet banking industry, estimates that the total of all deposits held by stand-alone Internet banks is less than $10 billion. That's less than 1% of the $4.02 trillion in overall bank deposits. The generous terms offered by online banks can be a drain on profits because they contribute to lower-than-average net interest margins. (Net interest margin is the difference between the rates that banks pay depositors and the yield they get on customers' assets.) NetBank (netbank.com), for instance, had a net interest margin of 2.41% in the third quarter of 2000, compared with an industry average of 4.57% for banks of comparable size. NetBank Chief Executive Officer D.R. Grimes defends his company's strategy, arguing that NetBank chose to increase its marketing budget in the recent three quarters to fuel customer acquisition. As a result, he says, the number of NetBank's customer accounts has nearly doubled in the last year to 133,000, with a dollar value of $909 million. "We are a profitable bank and we will continue to be profitable," Mr. Grimes said. "We don't consider low fees and higher rates as something we're going to offer for a short time. They are fundamental to our business." Greg McBride, a financial analyst at BankRate, says it is "notable" to see WingspanBank and BankDirect both raising their fees this month. "There certainly have been questions about the viability of some of these online institutions," Mr. McBride says. "Namely, how are they going to make money?" Some online banks are showing signs of health, however. E*Trade Bank (www.etradebank.com), acquired by Internet brokerage firm E*Trade Group Inc. in January 2000, reported earlier this week that it added $1 billion in accounts during the recent quarter, bringing its total customer deposits to $5.7 billion. Cross-promotion appears to be the key to E*Trade Bank's recent growth: The company says that 60% of the new accounts in the recent quarter were opened by customers of its brokerage arm. In general, online banks still offer better deals than their brick-and-mortar counterparts. An October survey by BankRate.com Inc. (www.bankrate.com) found that the average annual percentage yield on an interest-bearing checking account at an Internet banks was 3.85%, more than three times the 1.17% yield which was the average at traditional banks and thrifts. Of the 20 checking accounts rated by BankRate as most favorable to consumers, 19 were Internet banks. Paul Van Dyke, a senior analyst at Jupiter Research, a unit of New York-based Jupiter Media Metrix, says he eventually expects to see the favorable pricing at Internet banks disappear completely. "In the long-term, there won't be any price advantage," he says. "You won't be able to get a better rate by going online than by standing in a teller line." Instead, Mr. Van Dyke says, online banking will be just a convenient counterpart to traditional banks.

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