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Online savings accounts duke it out
ING Direct faces new competition as brick-and-mortar banks woo online savings customers.
August 9, 2005: 1:35 PM EDT
By Shaheen Pasha, CNN/Money staff writer

NEW YORK (CNN/Money) - Let the battle begin.

With money market returns averaging a paltry 0.69 percent, savvy consumers are looking for higher yield saving accounts. And that's creating opportunity for those interested in entering the world of online savings accounts.

Online banking is hardly new territory. Recent studies have indicated that more and more consumers are turning to the Internet to meet their banking needs. A report by Javelin Strategy & Research indicated that online banking was particularly popular with users between the ages of 18-24.

But pioneers like ING Direct, a unit ofING Groep NV (Research), have taken online banking one step further, providing returns significantly higher than the average money market rates provided by brick-and-mortar institutions. Currently ING Direct consumers can open an account for as little as $1 and earn a 3.15 percent return.

What's the trick? Without the expense of maintaining brick-and-mortar branches, ING Direct is able to provide a higher rate without eating into its profits.

It's a strategy that has generated more competition in recent years.

"There's a game of one-upmanship in terms of who's offering the best yields," said Greg McBride, senior financial analyst at personal finance site "Every household needs a liquid savings account in a place where you can keep up with inflation and the Internet is certainly a powerful platform to market to customers in a cost-effective way."

Enter the competition

EmigrantDirect, the online branch of New York-based Emigrant Savings Bank, is trying to beat ING at its own game, offering a 3.5 percent savings yield.

The strategy has gained the bank over 100,000 new customers since its launch in mid-2004, with an average deposit of over $30,000, said John Hart, vice chairman of Emigrant Savings Bank. And it's given the company access to markets outside of the New York metropolitan area.

"The overwhelming majority of new deposits are not from the local area," Hart said. "It's been a cost-effective way of reaching a new marketplace."

That's also a perk for UK-based HSBC (Research), which offers consumers a high-yield online savings arm with a yield of 3.25 percent.

But competitors have to be careful that in the battle to provide the highest possible yield, they don't wind up attracting the wrong kind of customer, said Catherine Graeber, principle analyst for financial services at Forrester Research.

"It's not going to be easy to emulate ING Direct's strategy," Graeber said. "Copycats are attracting rate-sensitive customers and the people they're connecting with are day savers."

She said, like the day traders in the 1990s, day savers are those that hunt the net for the highest possible yield, deposit funds to earn more on their cash and then move the money rapidly to another investment.

She said that ING Direct tends to attract "systematic savers" that have an average savings balance of $10,000 to $13,000. These savers park their money for the long term.

Part of the attraction is the company's customer service, she said, as well as its relatively easy site navigation. EmigrantDirect has faced criticism that opening an account can be a bit of a hassle due to security questions users must answer.

Graeber added that competitors need to move beyond luring consumers with the promise of high yields and branch out into ancillary products. Competitors will also have to manage their cost structure to avoid damaging their margins with aggressively high rates.

EmigrantDirect's Hart was confident in the company's strength, saying that the parent bank, Emigrant Savings, has a safe credit culture, lower operating expenses than other larger banks, and high investment returns. He added that the Internet allows the company to expand geographically without the cost of opening up brick-and-mortar branches.

A bad move for big banks?

But Graeber was cautious on big banks offering high-yield online savings accounts, saying the high rate attraction may not translate into sustainable success. She said that online accounts with ties to a bank's physical branches don't benefit from the lower costs associated with a pure online entity such as ING Direct.

Citigroup (Research), for instance, is piloting the E-Savings account, an online account with a yield of 3.25 percent, to consumers that already have a checking account with Citibank. The banking giant is offering the savings account in a few test markets.

"We're testing this only in certain markets and we'll evaluate the outcome," a Citigroup spokesman said.

While there is certainly interest among consumers for high-yield online savings accounts, don't expect the branch network to fade away anytime soon, said Bruce Cundiff, research analyst at Javelin Strategy and Research.

Cundiff said consumers are still interested in using automatic teller machines, writing checks and interacting with the teller behind the window.

"They may take it to the next level in terms of increasing the depth of relationship they have with account holders," he said. "But this will still be a secondary banking relationship for consumers."


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