Six Segments of Simplified Banking System

1. A customer gives the bank an instruction or requests a service.
2. The bank receives and if necessary verifies the instruction or request and initiates some kind of action.
3. The transaction is processed in the appropriate bank department.
4. The customer’s account and the bank’s books are changed to reflect the transaction or some other record is created or updated.
5. The fact of completion of transaction is communicated to relevant bank departments.
6. The customer is told that the transaction is complete.

Transformed four stages by technology

1. Back office automation: - It occurs when the core record keeping function moves from paper to computer. Customer can’t see this work. (Segment 3 & 4)

2. Front office automation: - When bank staff can initiate transactions and make follow-up inquiries, electronically that is through a computerized link with the core processing function, automated stage. Customers meet bank staff at this stage.

3. Bring Customer on line: - When the customer can communicate directly with the core processing function, partly or wholly bypassing the second and fifth segments of business system and front office.

4. Integrated System          : - When all the piecemeal automation which happened in the preceding stages is integrated into fully electronic business system, which can provide detailed information and analysis to both bank and its customers.

Back office automation

The ‘ back office’ automation mainframe computer technology of the 1960s enabled customer accounts to be maintained and updated centrally, eliminating branch ledgers and the work associated with them. This mainframe was in bank’s central clearing department, with direct input from reader – sorter machines like MICR technology to generate accounting entries automatically.

1. To customers it was invisible and had virtually no impact on the way they did business with their branch.
2. To competitor it had no fundamental impact on competition. All the large banks adopted similar mainframes and batch processing system.

Front office automation

• During 1970, it became possible to transmit data cost effectively between input/output terminals and mainframes. This gave branch staff the ability to access current accounts on line, initially for balance inquiry and to access the accounts of customers at other branches.
• To implement it, banks had to build or acquire access to proprietary data networks, because Post office networks were technically limited and expensive.
• It improves service to customers by speeding up information and increasing their control over their accounts.
• Yet its economic and competitive effects are limited.
• Accessing an account directly through a terminal is more efficient than looking up state information in a ledger or computer printout but banks still need staff.
• Terminal eliminates need for a flow of paper but someone still has to enter the data.
• It increases efficiency but does not reduce staff greatly.

Online Service

• All six segments are handled electronically at this stage.
• Customers have direct access to their accounts in the core processing and accounting function for example through a push button telephone banking account or through an ATM.
• Once customers can initiate their own inquiries electronically, the second and fifth parts of the business system become obsolete. If all customers of a product line use direct electronically access, the staff previously involved in these functions are no longer needed or can be transferred to value added functions.
• Telephone banking is unlikely to make bank branches redundant in the near future.
• Customers feel they are getting better services when they can process their own transactions or enquiries; they enjoy the sense of control over their accounts.
• ATM is a hybrid; part direct access to the bank’s core systems, but also requiring the dispersal and collection of paper (for example to process deposits) which continues to be labor- intensive. Another hybrid is telephone banking using service centers open for 24 hours a day, but manned rather than electronic. Automated telephone banking also make users independent of the branch and of banking hours, opening the door to world wide, 24 hours banking.

Bringing customers on line

Bringing customers on line transfers control of the business system from the bank to the customer. Banks lose power because the technology is now in the hands of the customers. When customers exercise closer control over their accounts, a bank’s ability to make free use of customer’s deposit money quickly evaporates, often with devastating consequences for the profitability of a line of business. While this is especially true of wholesale business, the more sophisticated retail customer can also use this service to practice good cash management.

A more subtle disadvantage of bringing customers online is that the branch loses direct face-to-face contact with the customer. As a line of business becomes highly automated, with high capacity and high fixed costs, competitors seek t fill the capacity they have already paid for and price wars loom. This also allows in new competitors, since technology is usually modular and non-proprietary. The profits of all providers may then evaporate.

Integrated System

Final stage is to link not necessarily physically but at least virtually, all the incompatible and fragmented hardware and software accumulated over the years in the first three stages, to provide a complete picture of a customer’s relationship with the bank. There is a general belief that this information is of great competitive value. However it is still over the horizon for most banks and for most lines of business. And its economic and competitive consequences can be as dire as those of online system automation.

Integrated system means one of two things. A more or less total ‘ retrofit’ of existing automation around a coherent architecture of compatible hardware and software standards, or the installation of a whole banking system designed from the start to produce customer and management information, to limit maintenance, and to permit expansion. Either approach represents a very costly and very difficult endeavor.

IT Investment cycle

The incentive to initiate IT investments is often provided by the market; a current of potential player sees an opportunity to get ahead of its competitors or to prevent them getting ahead, and based on simple investment – return criteria decides to proceed with automation. As technology provides increased productivity and enables additional value to be provided to the customer, competitors are likely to follow a similar pattern of investment in order to stay in market. As a result of these investments, competitors realize that they have a larger fixed cost base to cover and significant spare capacity, and their propensity to lower their price increases. A price war is then not very far away.

Players who believe they can outlast a price competition have an incentive to initiate it, so that they capture the share of weaker players and then return to their high margins.

Competitive intensity is not likely to decrease until the industry has been through a consolidation process and has seen its profitability eroded sufficiently to make any further price reductions unaffordable to all competitors. Margins can then increase again, but so can investment in technology to gain competitive advantage. The cycle starts again.

Above description helps in understanding drivers of technology investment and its economic results, it does not always explain what is observed in the market – there seems to be a delay between investments and adverse profit impact.

There are several factors external to the cycle that affects its progress. These are accelerators and decelerators.

Accelerators

Deregulation enables market activities that were previously constrained and thus creates new markets that require additonal investment to be served. This can also kick-start an IT investment cycle, although the expansion of the market reduces the competitive pressures in the short to medium term.

Advances in technologies can also accelerate the process by making possible competitive activity that was previously impossible. The benefits of targeted marketing for example have been understood for some time, but computing and data warehousing technology was not sufficiently powerful to make it possible and economic until recently. The same is true of product developments like derivative instruments or linked accounts. Once these activities or products are made possible, investments in such a technology is likely to become a prerequisite for competing successfully.

Decelerators

Until new technology cycle takes off, the slowing power of current technology, which has reached at high level of system intensity, is limited to short or medium term.
• Constraint on reduction of labor as a result of social government policy.
• Regulation or restrictive practices that protect incumbents from competition.

Customer inertia is much more relevant in consumer markets. Consumer has less access to information on the options available to them than do company employees whose job it is to procure banking services. Also consumers often feel a sense of loyalty to provider brand that has served them satisfactory for a long period of time, frequently like school. Inertia like other factors can only be decelerator and can not stop the process altogether. Inertia can be reinforced by bank whether in form of switching barriers e.g. inefficient process of changing standing orders, or in the form of brand power and marketing muscle. The effects of inertia are unlikely to be sustainable in the long term.

Final decelerating factor is innovation itself. This is probably the most important factor to understand because banks can influence it directly. Innovation when generating new products or product features rather than process improvements can add value to a bank’s customer thus enabling a premium to be charged for products and services and limiting the effects of competitive price initiatives. Major challenge for banks in this case is how to use innovation to prevent their competitive positions from being eroded by the IT investment cycle?

Mastering the dynamics of Innovation: - Research by James Utterback

Innovation begins with radical product changes that after a pried of uncertainty and continue development at product and process level, crystallize into a dominant design. Once that dominant design has been established innovation become predominantly focused on process rather than product, and results in highly structured organizations that an extract maximum efficiencies from the improved process.

Highly structured organizations that succeed in process innovation period generally fail to do so in product discontinuities. Leaders in mature industries create major barriers to change by excessively focusing on efficiency within dominant formats, whilst attackers usually begin with alternative technologies that lead to new formats and innovations. As a results leaders in mature industries are vulnerable because they fail to recognize threats posed by new technologies and to adapt quickly enough once the threat becomes obvious. Leaders according to Utterback have successfully defended themselves in two instance : Where the innovation did not expand the market and was limited to process; and where the individual firm developed independent structures that were both adaptive to change and became themselves attackers. Impact of the decelerators on the technology investment cycle, the rapid switch of market power from defenders to attackers may be less marked in financial service. Following are the factors contributing dominant design, if we follow adjusted concepts.

• Technical Innovations MICR encoding of cheques, magnetic stripe on plastic cards, ATM
• Account concepts are made possible by computer code, e.g. tiered interest rate accounts, automatically linked accounts, dual purpose accounts, pre-approved loans.
• Infrastructures e.g. London Clearing House, Switch EFTPOS ( Ele. Funds transfer at point of sale), BACS, CHAPS
• Service concepts Cash management workstation, automated statement reconciliation.

To conclusion, challenge is to exploit the decelerators and not to rely on them. Reinforce decelerators, exploit innovation, push process improvement and first of all identify current position in the industry evolution process.

TECHNOLOGY MANAGEMENT FRAME WORK

Banks need to categorize cost according to framework for improvement in the business. This framework is called technology management framework. Any business system for producing goods or service can be described in terms of 3 functions.

1. Core technology
2. Production
3. Market – led product design.

1. Core Technology

It is a collection of technologies and tools, not specific to the business or the industry, which are necessary to carry out the work of producing the final product. In banking they largely consist of computers and the systems software needed to run them. This is vendor driven like IBM, BT and Oracle. It is the part of work to outsource. Decisions involved in selection and maintenance are highly capable and flexible.

2. Production

In banking, production means daily financial transactions that any bank handles.

3. Market – led product design.

Today banks are in effort to integrate solutions with customers on line. PC Banking, Home Banking and Online banking are few examples where banks have entered to be integrated with customers.

Conclusion of Technology management framework

In some industry, core technology leads market policies and segmentation and vice versa.  In case of today’s banking scenario, core technology helps easy financial transactions between customers and bank. ICICI has been favorite private bank because of core technologies, it has applied in Indian market. Even BankAway’s  application reduced its overall expenditure. In banking case, what leads traditional banking  to Internet banking ? There are so many banks who follow traditional system for transaction and maintain paper works in large amount. So it is possible for new generation banks to take away market share of these traditional banks.

Business Improvement Technology Evaluation

Technology management framework concludes what are the advantages a particular unit may have of technology against investment it does for. BITE framework discusses where most banks want to be after following growth after business improvement and integration.

Core Banking System: Does it need change?

Legacy system is not integrated core system. Today 60 – 70 % of a bank’s IT budget goes towards maintenance of old legacy system. David Slider of Alltel Corebanking Solutions notes : “ The real issue is that by deferring this investment, banks are taking a large, unstated risk over the most important piece of the technology infrastructure within the bank. The risk is fact that the systems that exists are legacy, the programming languages old, the OS inefficient and the people with system knowledge are retiring.

Market Watch

1. Gunit Chanda :- CEO ( IDBI , India) “ The existing technology was simply not good enough for running a scalable corporate bank, and was certainly insufficient to support retail banking”. Indian bank system realized business strategy that technology should support corporate banking across India and to eventually include retail banking.

2. Herb Phillips : - Director, NCB Jamaica “ The main driver to change was the need to be more customer focused and to centralize core banking system and data centers. Core banking system was developed from a product driven approach instead of customer approach.”  Decision: - “ To replace 50 odd branches infrastructure with project estimated cost of $ 50 m.”

3. Mr.Fernandes ( Infosys , Europe) : “Banking has changed dramatically, and is likely to continue to change. Flexibility of the solution is key.” A good core banking solution should be able to support the customization need of different needs of different banking environments without eliminating the benefits of having a vendor system.”

4. Mr. Gentle Deloitte Consulting: - The people part of core banking system transformation is critical to the success of bank. A single vendor rarely implements large projects so the vendor’s ability to work with different technology and business partner is necessary.

Source : - The Banker Jan.2003.

International experience

U.S.A.

In the USA, the number of thrift institutions and commercial banks with transactional web-sites is 1275 or 12% of all banks and thrifts. Approximately 78% of all commercial banks with more than $5 billion in assets, 43% of banks with $500 million to $5 billion in assets, and 10% of banks under $ 500 million in assets have transactional web-sites. Of the 1275-thrifts/commercial banks offering transactional Internet banking, 7 could be considered ‘virtual banks’. 10 traditional banks have established Internet branches or divisions that operate under a unique brand name. Several new business process and technological advances such as Electronic Bill Presentment and Payment (EBPP), handheld access devices such as Personal Digital Assistants (PDAs), Internet Telephone and Wireless Communication channels and phones are emerging in the US market. A few banks have become Internet Service Providers (ISPs), and banks may become Internet portal sites and online service providers in the near future. Reliance on third party vendors is a common feature of electronic banking ventures of all sizes and degrees of sophistication in the US. Currently, payments made over the Internet are almost exclusively conducted through existing payment instruments and networks. For retail e-commerce in the US, most payments made over the Internet are currently completed with credit cards and are cleared and settled through existing credit card clearing and settlement systems. Efforts are under way to make it easier to use debit cards, cheques and the Automated Clearing House (ACH) to make payments over the Internet. Versions of e-money, smart cards, e-cheques and other innovations are being experimented with to support retail payments over the Internet.

There is a matrix of legislation and regulations within the US that specifically codifies the use of and rights associated with the Internet and e-commerce in general, and electronic banking and Internet banking activities in particular. Federal and state laws, regulations, and court decisions, and self-regulation among industries groups provide the legal and operational framework for Internet commerce and banking in the USA. The international model laws promulgated by the United Nations Commission on International Trade Law (UNCITRAL) provide the guidance to the member nations on the necessity for revising existing legal structures to accommodate electronic transactions. Some important laws of general application to commercial activity over the Internet within the US are the Uniform Commercial Code (UCC), the Uniform Electronic Transaction Act (UETA) (which provides that electronic documents and contracts should not be disqualified as legal documents particularly because of their electronic form), various state laws and regulations on digital signatures and national encryption standards and export regulations. Many states already have digital signature and other legislation to enable e-commerce. State laws in this area differ but the trend is towards creating legislation, which is technology neutral. The E-sign Act, a new US law that took effect on October 1, 2000, validates contracts concluded by electronic signatures and equates them to those signed with ink on paper. Under the Act, electronic signatures using touch-tones (on a telephone), retinal scans and voice recognition are also acceptable ways of entering into agreements. The E-sign Act takes a technological neutral approach and does not favor the use of any particular technology to validate an electronic document. The Act however does not address issues relating to which US state’s laws would govern an online transaction and which state’s code would have jurisdiction over a dispute.

The Gramm - Leach – Bliley (GLB) Act has substantially eased restrictions on the ability of banks to provide other financial services. It has established new rules for the protection of consumer financial information. The Inter-agency Statement on Electronic Financial Services and Consumer Compliance (July 1998) addresses consumer protection laws and describe how they can be met in the context of electronic delivery. In addition, the Federal Reserve Board has issued a request for comment on revised proposals that would permit electronic delivery of federally mandated disclosures under the five consumer protection regulations of the FRB (Regulations B, DD, E, M & Z).

The Interpretive Ruling of the Office of the Comptroller of Currency (OCC) authorizes a national bank to ‘perform, provide or deliver through electronic means and facilities any activity, functions, product or service that it is otherwise authorized to perform, provide or deliver’. The concerns of the Federal Reserve are limited to ensuring that Internet banking and other electronic banking services are implemented with proper attention to security, the safety and soundness of the bank, and the protection of the banks’ customers. Currently, all banks, whether they are ‘Internet only’ or traditional banks must apply for a charter according to existing guidelines. The five federal agencies - Federal Deposit Insurance Corporation (FDIC), Federal Reserve System (FRS), Office of the Comptroller of Currency (OCC), Office of Thrift Supervision (OTS) and the National Credit Union Association (NCUA) supervise more than 20,000 institutions. In addition, each state has a supervisory agency for the banks that it charters. Most financial institutions in the US face no prerequisite conditions or notification requirements for an existing banking institution to begin electronic banking activities. For these banks, supervisors gather information on electronic banking during routine annual examination. Newly chartered Internet banks are subject to the standard chartering procedures. For thrift institutions, however, OTS has instituted a 30-day advance notification requirement for thrift institutions that plan to establish a transactional web site. A few State banking departments have instituted a similar notification requirement for transactional Internet banking web sites.Supervisory policy, licensing, legal requirements and consumer protection are generally similar for electronic banking and traditional banking activities. Internet banks are also subject to the same rules, regulations and policy statement as traditional banks.

However, in response to the risks posed by electronic banking, federal banking agencies have begun to issue supervisory guidelines and examination procedures for examiners who review and inspect electronic banking applications. Although specialized banking procedures are used in some areas of Internet banking activities, the existing information technology examination framework that addresses access controls, information security, business recovery and other risk areas generally continues to be applicable. To assist supervisors in monitoring the expansion of Internet banking, state chartered and national banks have been required since June 1999 to report their websites’ ‘Uniform Resource Locators’ (URL) in the Quarterly Reports of Financial Condition that are submitted to supervisors. In addition, examiners review the potential for reputational risk associated with web-site information or activities, the potential impact of various Internet strategies on an institution’s financial condition, and the need to monitor and manage outsourcing relationships. To address these risks, the OCC is developing specific guidance for establishing ‘Internet only’ banks within the US. The Banking Industry Technology Secretariat recently announced the formation of a security lab to test and validate the security of software and hardware used by banking organizations. If a bank is relying on a third party provider, it is accepted that it should be able to understand the provided information security programme to effectively evaluate the security system’s ability to protect bank and customer data. Examination of service providers’ operations, where necessary, is conducted by one or more Federal banking agencies pursuant to the Bank Services Company Act, solely to support supervision of banking organizations.

The Federal Financial Institutions Examination Council (FFIEC) introduced the Information Systems (IS) rating system to be used by federal and state regulators to assess uniformly financial and service provider risks introduced by information technology and to identify those institutions and service providers requiring special supervisor attention. The FFIEC has recently renamed the system as Uniform Rating System for IT (URSIT), which has enhanced the audit function. The importance of risk management procedure has been reinforced under the revised system. Some characteristics of e-money products such as their relative lack of physical bulk, their potential anonymity and the possibility of effecting fast and remote transfers make them more susceptible than traditional systems to money laundering activities. The OCC guidelines lay down an effective ‘know your customer’ policy. Federal financial institutions, regulators, Society for Worldwide Interbank Financial Telecommunications (SWIFT) and Clearing House Interbank Payment System (CHIPS) have issued statements encouraging participants to include information on originators and beneficiaries.

U.K.

Most banks in U.K. are offering transactional services through a wider range of channels including Wireless Application Protocol (WAP), mobile phone and T.V. A number of non-banks have approached the Financial Services Authority (FSA) about charters for virtual banks or ‘clicks and mortar’ operations. There is a move towards banks establishing portals. The Financial Services Authority (FSA) is neutral on regulations of electronic banks. The current legislation, viz. the Banking Act 1987 and the Building Societies Act, provides it with the necessary powers and the current range of supervisory tools. A new legislation, the Financial Services and Market Bill, offers a significant addition in the form of an objective requiring the FSA to promote public understanding of the financial system. There is, therefore, no special regime for electronic banks. A draft Electronic Banking Guidance for supervisors has, however, been developed. A guide to Bank Policy has also been published by the FSA which is technology neutral, but specifically covers outsourcing and fraud. The FSA also maintains bilateral discussions with other national supervisors and monitors developments in the European Union (EU) including discussions by the Banking Advisory Committee and Group de Contract. New legislation on money laundering has been proposed and both the British Bankers Association and the FSA have issued guidance papers in this regard. The FSA is actively involved in the Basle Committee e-banking group which has identified authorization, prudential standards, transparency, privacy, money laundering and cross border provision as issues where there is need for further work. The FSA has also been supporting the efforts of the G7 Financial Stability Forum, which is exploring common standards for financial market, which is particularly relevant to the Internet, which reaches across all borders.

The Financial Services and Markets Bill will replace current powers under the 1987 Banking Act giving the FSA statutory authority for consumer protection and promotion of consumer awareness. Consumer compliance is required to be ensured via desk based and on site supervision. The FSA has an Authorization and Enforcement Division, which sees if web sites referred to them are in violation of U.K. laws. The FSA has issued guidelines on advertising in U.K. by banks for deposits, investments and other securities, which apply to Internet banking also. The guidelines include an Appendix on Internet banking. The FSA’s supervisory policy and powers in relation to breaches in the advertising code (viz. invitation by any authorized person to take a deposit within U.K., fraudulent inducements to make a deposit, illegal use of banking names and descriptions, etc.) are the same for Internet banking as they are for conventional banking. The FSA does not regard a bank authorized overseas, which is targeting potential depositors in its home market or in third countries as falling within U.K. regulatory requirements solely by reason of its web site being accessible to Internet users within the U.K., as the advertisements are not aimed at potential U.K. depositors.

Scandinavia

Swedish and Finnish markets lead the world in terms of Internet penetration and the range and quality of their online services. Merita Nordbanken (MRB) (now Nordic Bank Holding, a merger between Finland’s Merita and Nordbanker of Sweden) leads in “log-ins per month” with 1.2 million Internet customers, and its penetration rate in Finland (around 45%) is among the highest in the world for a bank of ‘brick and mortar’ origin. Standinaviska Easkilda Banken (SEB) was Sweden’s first Internet bank, having gone on-line in December 1996. It has 1,000 corporate clients for its Trading Station – an Internet based trading mechanism for forex dealing, stock-index futures and Swedish treasury bills and government bonds. Swedbank, is another large-sized Internet bank. Almost all of the approximately 150 banks operating in Norway had established “net banks”. In Denmark, the Internet banking service of Den Danske offers funds transfers, bill payments, etc.

The basic on-line activity is paying bills. Swedbank was the first bank in the world to introduce Electronic Bill Presentment and Payment (EBPP) and now handles 2 million bill payment a month. E-shopping is another major Internet banking service. MNB has an on-line “mall” of, more than 900 shops, which accepts its “Solo” payment system. Swedbank has a similar system called “Direct”. Besides using advanced encryption technology, the Scandenavian banks have adopted a basic but effective system known as “challenge response logic”, which involves a list of code numbers sent to every online client and used in sequence, in combination with their password or PIN. This gives each transaction a unique code, and has so far proved safe. Some banks use even more sophisticated versions of the same technique. It is not a common practice to use third party vendors for services.

In Sweden, no formal guidance has been given to examiners by the Sverigesbank on e-banking. General guidelines apply equally to Internet banking activities. Contractual regularization between customers and the bank is a concern for regulators and is being looked into by the authorities.The role of the Bank of Finland (Suomen Parkki) has been, as part of general oversight of financial markets in Finland, mainly to monitor the ongoing development of Internet banking without active participation. Numerous issues concerning Internet banking have, however, been examined by the Bank of Finland.

All Internet banking operating from a Norwegian platform are subject to all regular banking regulations, just as any other bank. As part of the standard regulation, there is also a specific regulation on the banks’ use of IT. This regulation dates from 1992 when Internet banking was not the main issue, but it covers all IT systems, including Internet banking. The regulation secures that banks’ purchase, development, use and phase out of IT systems is conducted in a safe and controlled manner. An Act relating to Payment systems defines payment systems as those which are based on standardized terms for transfer of funds from or between customer accounts in banks/financial undertakings when the transfer is based on use of payment cards, numeric codes or any other form of independent user identification. Internet banking is covered by this regulation. The Banking, Insurance and Securities Commission may order for implementation of measures to remedy the situation if there is a violation of provisions.

In addition to their national laws, countries in Europe are also expected to implement European Union (EU) directives. In 1995, the EU passed a Europe-wide Data Protection Directive aimed at granting individuals greater protection from abuses of their personal information. It also passed the Telecommunications Directive that prescribes special protection in relation to telephones, digital TVs, mobile communications, etc. Every EU country is to have a privacy commissioner to enforce the regulations as they apply within the EU. The EU directive on electronic signature is also required to be implemented in national laws.

Australia

Internet Banking in Australia is offered in two forms: web-based and through the provision of proprietary software. Initial web-based products have focused on personal banking whereas the provision of proprietary software has been targeted at the business/corporate sector. Most Australian-owned banks and some foreign subsidiaries of banks have transactional or interactive web-sites. Online banking services range from FIs’ websites providing information on financial products to enabling account management and financial transactions. Customer services offered online include account monitoring (electronic statements, real-time account balances), account management (bill payments, funds transfers, applying for products on-line) and financial transactions (securities trading, foreign currency transactions). Electronic Bill Presentment and Payment (EBPP) is at an early stage.

Features offered in proprietary software products (enabling business and corporation customers to connect to the financial institutions (via dial-up/leased line/extranet) include account reporting, improved reconciliation, direct payments, payroll functionality and funds transfer between accounts held at their own or other banks. Apart from closed payment systems (involving a single payment-provider), Internet banking and e-commerce transactions in Australia are conducted using long-standing payment instruments and are cleared and settled through existing clearing and settlement system. Banks rely on third party vendors or are involved with outside providers for a range of products and services including e-banking. Generally, there are no ‘virtual’ banks licensed to operate in Australia.

The Electronic Transactions Act, 1999 provides certainty about the legal status of electronic transactions and allows for Australians to use the Internet to provide Commonwealth Departments and agencies with documents which have the same legal status as traditional paperwork. The Australian Securities and Investments Commission (ASIC) is the Australian regulator with responsibility for consumer aspects of banking, insurance and superannuation and as such, it is responsible for developing policy on consumer protection issues relating to the Internet and e-commerce. ASIC currently has a draft proposal to expand the existing Electronic Funds Transfer Code of. Conduct (a voluntary code that deals with transactions initiated using a card and a PIN) to cover all forms of consumer technologies, including stored value cards and other new electronic payment products. Australia’s anti-money laundering regulator is the Australian Transaction Reports and Analysis Centre (AUSTRAC).

Responsibility for prudential supervisory matters lies with the Australian Prudential Regulation Authority (APRA). APRA does not have any Internet specific legislation, regulations or policy, and banks are expected to comply with the established legislation and prudential standards. APRA’s approach to the supervision of e-commerce activities, like the products and services themselves, is at an early stage and is still evolving. APRA’s approach is to visit institutions to discuss their Internet banking initiatives. However, APRA is undertaking a survey of e-commerce activities of all regulated financial institutions. The growing reliance on third party or outside providers of e-banking is an area on which APRA is increasingly focusing.

New Zealand

Major banks offer Internet banking service to customers, operate as a division of the bank rather than as a separate legal entity.Reserve Bank of New Zealand applies the same approach to the regulation of both Internet banking activities and traditional banking activities. There are however, banking supervision regulations that apply only to Internet banking. Supervision is based on public disclosure of information rather than application of detailed prudential rules. These disclosure rules apply to Internet banking activity also.

Singapore

The Monetary Authority of Singapore (MAS) has reviewed its current framework for licensing, and for prudential regulation and supervision of banks, to ensure its relevance in the light of developments in Internet banking, either as an additional channel or in the form of a specialized division, or as stand-alone entities (Internet Only Banks), owned either by existing banks or by new players entering the banking industry. The existing policy of MAS already allows all banks licensed in Singapore to use the Internet to provide banking services. MAS is subjecting Internet banking, including IOBs, to the same prudential standards as traditional banking. It will be granting new licences to banking groups incorporated in Singapore to set up bank subsidiaries if they wish to pursue new business models and give them flexibility to decide whether to engage in Internet banking through a subsidiary or within the bank (where no additional licence is required). MAS also will be admitting branches of foreign incorporated IOBs within the existing framework of admission of foreign banks.

As certain types of risk are accentuated in Internet banking, a risk – based supervisory approach, tailored to individual banks’ circumstances and strategies, is considered more appropriate by MAS than “one-size-fits-all” regulation. MAS requires public disclosures of such undertakings, as part of its requirement for all banks and enhance disclosure of their risk management systems. It is issuing a consultative document on Internet banking security and technology risk management. In their risk management initiatives for Internet banking relating to security and technology related risks, banks should (a) implement appropriate workflow, authenticated process and control procedures surrounding physical and system access (b) develop, test, implement and maintain disaster recovery and business contingency plans (c) appoint an independent third party specialist to assess its security and operations (d) clearly communicate to customers their policies with reference to rights and responsibilities of the bank and customer, particularly issues arising from errors in security systems and related procedures. For liquidity risk, banks, especially IOBs, should establish robust liquidity contingency plans and appropriate Asset-Liability Management systems. As regards operational risk, banks should carefully manage outsourcing of operations, and maintain comprehensive audit trails of all such operations. As far as business risk is concerned, IOBs should maintain and continually update a detailed system of performance measurement. MAS encourages financial institutions and industry associations such as the Associations of Banks in Singapore (ABS) to play a proactive role in educating consumers on benefits and risks on new financial products and services offered by banks, including Internet banking services.

Hong Kong

There has been a spate of activity in Internet banking in Hong Kong. Two virtual banks are being planned. It is estimated that almost 15% of transactions are processed on the Internet. During the first quarter of 2000, seven banks have begun Internet.30 services. Banks are participating in strategic alliances for e-commerce ventures and are forming alliances for Internet banking services delivered through Jetco (a bank consortium operating an ATM network in Hong Kong).

A few banks have launched transactional mobile phone banking earlier for retail customers. The Hong Kong Monetary Authority (HKMA) requires that banks must discuss their business plans and risk management measures before launching a transactional website. HKMA has the right to carry out inspections of security controls and obtain reports from the home supervisor, external auditors or experts commissioned to produce reports. HKMA is developing specific guidance on information security with the guiding principle that security should be “fit for purpose”. HKMA requires that risks in Internet banking system should be properly controlled.

 The onus of maintaining adequate systems of control including those in respect of Internet banking ultimately lies with the institution itself. Under the Seventh Schedule to the Banking ordinance, one of the authorization criteria is the requirement to maintain adequate accounting system and adequate systems control. Banks should continue to acquire state-of-the art technologies and to keep pace with developments in security measures.

The HKMA’s supervisory approach is to hold discussions with individual institutions who wish to embark on Internet banking to allow them to demonstrate how they have properly addressed the security systems before starting to provide such services, particularly in respect of the following – (i) encryption by industry proven techniques of data accessible by outsiders, (ii) preventive measures for unauthorized access to the bank’s internal computer systems, (iii) set of comprehensive security policies and procedures, (iv) reporting to HKMA all security incidents and adequacy of security measures on a timely basis. At present, it has not been considered necessary to codify security objectives and requirements into a guideline. The general security objectives for institutions intending to offer Internet banking services should have been considered and addressed by such institutions.

HKMA has issued guidelines on ‘Authorization of Virtual Banks’ under Section 16(10) of the Banking Ordinance under which (i) the HKMA will not object to the establishment of virtual banks in Hong Kong provided they can satisfy the same prudential criteria that apply to conventional banks, (ii) a virtual bank which wishes to carry on banking business in Hong Kong must maintain a physical presence in Hong Kong; (iii) a virtual bank must maintain a level of security which is appropriate to the type of business which it intends to carry out. A copy of report on security of computer hardware, systems, procedures, controls etc. from a qualified independent expert should be provided to the HKMA at the time of application, (iv) a virtual bank must put in place appropriate policies, procedures and controls to meet the risks involved in the business; (v) the virtual bank must set out clearly in the terms and conditions for its service what are the rights and obligations of its customers (vi) Outsourcing by virtual banks to a third party service provider is allowed, provided HKMA’s guidelines on outsourcing are complied with. There are principles applicable to locally incorporated virtual banks and those applicable to overseas-incorporated virtual banks.

Consumer protection laws in Hong Kong do not apply specifically to e-banking but banks are expected to ensure that their e-services comply with the relevant laws. The Code of Banking Practice is being reviewed to incorporate safeguards for customers of e-banking. Advertising for taking deposits to a location outside Hong Kong is a violation unless disclosure requirements are met. Consideration is being given as to whether this is not too onerous in the context of the global nature of the Internet.

Recognising the relevance of Public Key Infrastructure (PKI) in Hong Kong to the development of Internet banking and other forms of e-commerce, the government of Hong Kong has invited the Hong Kong Postal Authority to serve as public Certificate Authority (CA) and to establish the necessary PKI infrastructure. There is no bar, however, on the private sector setting up CAs to serve the specific needs of individual networks. There should be cross-references and mutual recognition of digital signatures among CAs. The Government is also considering whether and, if so, how the legal framework should be strengthened to provide firm legal basis for electronic transactions (particularly for digital signatures to ensure non-repudiation of electronic messages and transactions).

Japan

Banks in Japan are increasingly focusing on e-banking transactions with customers. Internet banking is an important part of their strategy. While some banks provide services such as inquiry, settlement, purchase of financial products and loan application, others are looking at setting up finance portals with non-finance business corporations.Most banks use outside vendors in addition to in-house services. The current regulations of the Bank of Japan on physical presence of bank branches are undergoing modifications to take care of licensing of banks and their branches with no physical presence.

The Report of the Electronic Financial Services Study Group (EFSSG) has made recommendations regarding the supervision and regulation of electronic financial services. Financial institutions are required to take sufficient measures for risk management of service providers and the authorities are required to verify that such measures have been taken. Providing information about non-financial businesses on a bank web site is not a violation as long as it does not constitute a business itself. With respect to consumer protection it is felt that guidance and not regulations should encourage voluntary efforts of individual institutions in this area. Protection of private information, however, is becoming a burning issue in Japan both within and outside the field of e-banking. Japanese banks are currently requested to place disclosure publications in their offices (branches) by the law. However, ‘Internet Only banks’ are finding it difficult to satisfy this requirement. The Report of the EFSSG recommends that financial service providers that operate transactional website should practice online disclosure through electronic means at the same timing and of equivalent contents as paper based disclosure. They should also explain the risks and give customers a fair chance to ask queries.

The Government of Japan intends to introduce comprehensive Data Protection Legislation in the near future. There are no restrictions or requirements on the use of cryptography. The Ministry of International Trade and Industry (MITI)’s approval is required to report encryption technology.

Conclusion

World over, electronic banking is making rapid strides due to evolving communication technology. Penetration of Internet banking is increasing in most countries. Wireless Application Protocol (WAP) is an emerging service which banks worldwide are also.offering. The stiff competition in this area exposes banks to substantial risks. The need is being felt overseas that transparency and disclosure requirements should be met by the e-banking community. While existing regulations and legislations applicable to traditional banking are being extended to banks’ Internet banking and electronic banking services, it is recognized that Internet security, customer authentication and other issues such as technology outsourcing pose unique risks. Central Banks worldwide are addressing such issues with focused attention. Special legislations and regulations are being framed by the regulators and supervisors for proper management of the different types of risks posed by these services. The reliance on outsourcing is an area where overseas regulators and supervisors are focusing their attention, with banks having to regularly review and test business continuity, recovery and incidence response plans in order to maintain their reputation of trust. Consumer protection and data privacy are areas which assume great significance when banking transactions are carried over a medium as insecure as the Internet.

Many countries are looking at special consumer protection/data privacy legislation for an e-commerce environment. The presence of ‘virtual banks’ or ‘Internet only banks’ and the licensing requirements required for such entities are also areas which are being looked into by overseas authorities. There has also been co-operation among the regulators and supervisors to meet the challenges of ‘virtual’ cross border e-banking, particularly in the light of the possibility of increased money laundering activities through the medium of Internet. Internet banking is universally seen as a welcome development, and efforts are being made to put in place systems to manage and control the risks involved without restricting this service.

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