Egg Internet bank

In response to a question in the comments of my previous post - in fact an ex-colleague of mine - I thought it might be interesting to review the situation at Egg, the UK-based online bank.

Egg is one of those institutions that started on the premise that customers would prefer to have low cost banking services in exchange for Internet only access to their money. The interesting question, now we are several years on from the founding of Egg, is whether this is a strategy that has actually bourne fruit.

Now, firstly, Egg is a fully owned subsidiary of Prudential, as of the beginning of this year, and they have delisted from the London Stock Exchange. That means that any analysis has to be on the basis of whatever proxy information they disclose. Here are the interims from the most recent Prudential report:

Net interest income at June 2006 was up 12% to 163 million pounds from 2005. Obviously a good sign. There was a drop in non-interest income of 32%, but this was largely due to product mix decisions rather than any reduction in business activity. There was also an increase in the cost to income ratio of 1.7%, for reasons not disclosed. But most important of all, the bad debts write off increased a massive 42% compared to the same period, for a charge of 166 million pounds.

Looking at the numbers, the loss at Egg is the result of all those bad loans.

Now, the question in my mind is whether the write off is a result of a market wide dynamic, or if it is something specific to Egg.

This data from the Scotsman is informative on this point. Barclays have increased their bad debt provision by 42%. Lloyds TSB has gone up by 19% and HBOS 17%. Alliance and Leister - 50%. So a 42% rise at Egg is hardly out of order, even if it is at the high end.

But in the case of all these other institutions, profits are still being made even in the face of writedowns. Why? Because all the other institutions have a scale and diversity that enable them to absorb their bad debts. Egg doesn't. Egg is lucky it has Prudential to bail it out, I suppose, even if Prudential is trying to bail out of Egg.

Back to the original question asked, and the subtext behind it: can an Internet-only bank work? My view is there is nothing in the present loss making of Egg that suggests it can't. Seems everyone is losing on bad loans at the moment, and it appears that's happening regardless of the channel mix of the bank.

Update: The super-prolific Colin over at BankWatch has already posted his views on the question addressed in this post here.