Hingham Institution for Savings charges a $5 monthly fee to customers who use online bill payment.

As bank customers become more Internet-savvy, financial institutions increasingly are attempting to keep their online banking options sophisticated enough to meet growing consumer demand – and keep one step ahead of the competition. But staying on the cutting edge exacts a cost in budgets and personnel.

According to a recent study by Celent Communications, a research and consulting firm that focuses on the application of information technology in the global financial services industry, bill payments online will continue to increase and costs for providing the service will continue to rise.

In its study, “Consumer Bill Payments: A Market Overview,” Celent predicts that 29 percent of consumer bill payments in the United States will be paid over the Internet by 2007. That would represent a 13 percent increase from online payment activity in 2004. Celent predicts bill payment transactions made via bank Web sites will grow faster than those made directly at billers’ Web sites.

Danvers Savings Bank, which began offering online banking in September 1999, purchased an application for online banking and the staff runs it themselves.

Lisa Rose, senior vice president and chief information officer, said that allows the bank to have control over security and application performance.

Rose said there are a variety of ways a bank can offer Internet banking.

“The options of how you can offer online banking is very diverse,” Rose said.

Rose said banks can build an application on its own, which costs the least but often is demanding on internal resources, buy an application and run it for a medium cost or outsource the service and pay a third-party provider. Outsourcing, which often involves costs based on the number of bank accounts serviced, is the most expensive option but is less labor-intensive for banks.

“Any bank can offer online banking these days,” Rose said.

Approximately 21 percent of Danvers Savings customers utilize some form of online banking, Rose said.

According to Celent’s study, online bill payment will increase from 10 percent of total payment transactions in 2003 to 29 percent in 2007. The bill payment category in the study includes both payments made directly at a biller’s Web site and payments made through a bank to the biller.

At Slade’s Ferry Bank in Somerset, about 10 percent of the bank’s customers have used online banking in some capacity since the service was first offered in April.

At Salem Five Bank, some branch locations have 50 percent of the customer base using online banking, said Jay Spahr, senior vice president of electronic commerce at Salem Five.

Hingham Institution for Savings has about 1,000 customers, or 15 percent of its account holders, using online banking.

While most institutions say they are excited about customers using the Internet for their banking purposes, it is not a cheap endeavor.

“The expenses are not insignificant,” said Spahr.

‘Emerging’ Trends

Regulation compliance and security issues account for much of the costs incurred by banks. Spahr said costs overall for banks go down because online bill payment is more efficient than processing paper checks, but increased transaction volume often means increased costs to banks, whether the processing is handled in-house or by an outside service provider.

While technology often is expensive in the early stages, Rose said as more software vendors compete for banks’ business and as technology becomes more commonplace, costs go down.

“[Companies have] kept costs very reasonable,” Rose said.

Rose said although many of the community banks are offering online services similar to those of larger banks, fee structures may be very different and are being closely watched by consumers.

“The fee area is a big differentiator right now,” Rose said.

Danvers Savings charges a fee for online bill payments, but as more banks decide to absorb the costs and offer the service for free to woo customers, the bank is constantly reassessing its fee structure. Rose said the bank is considering offering an introductory free period for new online customers. The choice is one many community banks are wrestling with. She said if the bank does not charge fees, it foregoes any income potential from the growing market. But if the bank can attract and retain customers by curtailing fees for online bill payment, revenue is enhanced in other areas.

At Salem Five, most of the bank’s checking accounts include free bill pay and Internet banking, Spahr said.

Spahr said online services are an “emerging” sector and the bank is always looking to offer more options, but it remains costly to provide these services.

Deb Jackson, senior vice president and treasurer at Hingham Savings, said the bank charges a $5 fee per month to customers who use online bill payment. The first six months are free. Because the bank uses a third party to offer bill pay, Jackson said it is necessary to charge fees to recoup the bank’s costs.

The bank does not gain any revenue from offering Internet banking but does realize some savings because the bank does not process as much paper, Jackson said.

According to Celent, rising processing expenses will likely force banks to consider alternatives to the third-party infrastructure, including bringing all or part of the development, maintenance and security functions in-house.

Slade’s Ferry Bank does not charge fees to customers for online banking, according to Deb Grimes, vice president of alternative delivery services for the bank. The bank does incur costs for offering the service, but Grimes said it is still a cost-effective measure, reducing paperwork and keeping customers happy.

Because the customer is conducting a transaction on their own, it frees up time for bank employees to handle more challenging customer inquiries, Grimes said.

Another way Slade’s Ferry is saving time online, Grimes said, is by offering a secured e-mail site. That also costs the bank money to provide and maintain, but Grimes said the time-saving element is more important.

Because the e-mail site is secure, customers are instructed to include personal information, such as a social security or account number. If a bank does not have a secured site, customers may e-mail the bank, but are asked not to include personal information, which is furnished later, adding time and complexity to the inquiry or transaction.

“[Online banking] is much more cost-effective,” Grimes said.

She compares the implementation of online banking to the introduction of ATMs, which were costly to implement but eventually increased banking efficiency. Grimes said if bank branches and personnel had to conduct every transaction that can be conducted at an ATM, an institution’s overhead would be astounding.

Most banks expect online banking to increase in the future. Spahr said as more people realize online banking is more secure than receiving a bank statement in a mailbox, the amount of people going online will rise.

Spahr said Salem Five, which was the first bank in New England to offer online banking, is trying to move from being the early adopters of Internet banking to encouraging the general public to become comfortable using online banking.

Jackson said she was surprised to see the lack of acceptance for bill payment services by many consumers.

“We’ve historically seen slow growth [in that area],” said Jackson.

She said only about 20 percent of the 1,000 customers online at Hingham Savings actually use bill pay.

All of the bank executives agreed that online security is a major concern. Rose said the Danvers Savings invests a significant amount of money to secure its site.

Spahr said the Salem Five is constantly seeking new ways to secure its Web site and anticipates that online security will require attention and funding indefinitely.