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May
2003 / No. 23 |
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Banking |
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Challenges of the
E-Banking Revolution
E-banking is an opportunity for
countries with underdeveloped financial systems to leapfrog developmental
stages |
E-banking (electronic banking) is the
wave of the future. It provides enormous benefits to consumers –in terms of
the ease and cost of transactions– and banks –in terms of new business
opportunities. However, it also poses new challenges for country authorities
in regulating and supervising the financial system and in designing and
implementing macroeconomic policies.
E-banking has been around for some time
in the form of automatic teller machines (ATMs) and telephone transactions.
More recently, it has been transformed by the Internet. This newest channel
for banking services is the focus of this report.
With e-banking access is fast,
convenient, and available around the clock, whatever the customer’s location.
Plus, services are provided more efficiently and at substantially lower costs.
Comparing bank services and products is made easier and therefore competition
is increased, allowing banks to penetrate new markets. It is even an
opportunity for countries with underdeveloped financial systems to leapfrog
developmental stages.
The flip side to this technological boom
in e-banking is the exacerbation of some of the risks inherent in traditional
banking, particularly governance, legal, operational, and reputational.
Trends in E-banking:
E-banking is rapidly gaining
ground; with more and more banks operating websites through which customers
are able not only to inquire about account balances and interest and exchange
rates but also to conduct a range of transactions. To date, most banks have
combined the new electronic delivery channels with traditional "brick banks"
creating "brick and click banks". However, a small number of banks offer their
products and services predominantly, or only, through electronic distribution
channels. These "virtual" or "internet-only" banks do not have a branch
network but might have a physical presence, for example, an administrative
office or non-branch facilities like kiosks or ATMs.
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Most banks have combined the new
electronic delivery channels with traditional "brick banks" creating
"brick and click banks". |
New Challenges for Regulators:
This changing financial landscape
brings with it new challenges for bank management and regulatory and
supervisory authorities. These stem from increased cross border transactions
due to drastically lower costs, greater ease of banking activities, and
reliance on technology to provide necessary security measures.
Regulatory risk:
Because the Internet allows services to be provided from anywhere in the
world, there is a danger that banks will try to avoid regulation and
supervision. Regulators must require even banks that provide their services
from a remote location through the Internet to be licensed. Licensing would be
particularly appropriate where supervision is weak and cooperation between a
virtual bank and the home supervisor is not adequate. However, determining
when a bank’s electronic services trigger the need for a license can be
difficult, but indicators showing where banking services originate and where
they are provided can help.
Legal risk:
E-banking carries heightened legal risks for banks. Banks can potentially
expand the geographical scope of their services faster through e-banking than
through traditional banks. In some cases, they may not be fully versed in a
jurisdiction’s local laws and regulations before they begin to offer services
there, either with or (where one is not required) without a license. When a
license is not required, a virtual bank –lacking contact with the host country
supervisor– may find it even more difficult to stay abreast of regulatory
changes. As a consequence, virtual banks could unknowingly violate laws and
regulations and expose themselves to losses through lawsuits or crimes that
are not prosecuted because of jurisdictional disputes. Moreover, e-banking
greatly facilitates the age-old crime of money laundering because of the
anonymity it affords. Once a customer opens an account, it is impossible for
banks to identify whether the nominal account holder is conducting a
transaction or even where the transaction is taking place. To combat money
laundering, many countries have issued specific guidelines on identifying
customers.
Operational risk:
The reliance on new technology to provide services makes security and system
availability the central operational risks of e-banking. Security threats can
come from inside or outside the system, so banking regulators and supervisors
must ensure that banks have appropriate practices in place to guarantee the
confidentiality of data and as well as the integrity of the system. Bank’s
security practices should be regularly tested and reviewed by outside experts
to analyze network vulnerabilities and recovery preparedness.
Reputation risk:
Breaches in security and
disruptions in the system’s availability can damage a bank’s reputation. The
more a bank relies on electronic delivery channels, the greater the reputation
risk. If one e-bank encounters problems that cause customers to lose
confidence in electronic delivery channels as a whole or to view bank failures
as system-wide supervisory deficiencies, these problems can potentially affect
other providers of e-banking services. Reputation risks also stem from
customer misuses of security precautions or ignorance about the need for such
precautions. Security risks can be amplified and may result in a loss of
confidence in electronic delivery channels. The solution is consumer education
–a process in which regulators and supervisors can contribute.
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There are three key tools that
regulators need to focus on to address the new challenges posed by the
arrival of e-banking: adaptation, legalization and harmonization. |
Regulatory Tools:
There are three key tools that
regulators need to focus on to address the new challenges posed by the arrival
of e-banking:
Adaptation:
In light of how rapidly technology is changing and what the changes mean for
banking activities, keeping regulations up to date has been, and continues to
be, a far-reaching, time-consuming, and complex task. The bank’s board of
directors and senior management must review and approve the key aspects of the
security control process, which should include measures to authenticate the
identity and authorization of customers, promote non-repudiation of
transactions, protect data integrity, and ensure segregation of duties within
e-banking systems, databases, and applications. Regulators and supervisors
must also ensure that their staffs have the relevant technological expertise
to assess potential changes in risks, which may require significant investment
in training and hardware and software.
Legalization:
New methods for conducting transactions, new instruments, and new service
providers will require legal definition, recognition, and permission. For
example, it will be essential to define an electronic signature and give it
the same legal status as the handwritten signature.
Harmonization:
International harmonization of e-banking regulation must be a top priority.
This means intensifying cross-border cooperation between supervisors and
coordinating laws and regulatory practices internationally and domestically
across different regulatory agencies. Jurisdiction problems that arise from
"borderless" transactions are still in limbo. The task of international
harmonization and cooperation can be viewed as the most daunting in addressing
the challenges of e-banking.
The Macroeconomic Challenges:
As the advent of e-banking
quickly changes the financial landscape and increases the potential for quick
cross-border capital movements, macroeconomic policymakers face several
difficult questions:
If e-banking makes national boundaries
irrelevant by facilitating capital movement, what does this imply for
macroeconomic management?
How is monetary policy affected when,
for example, the use of electronic means makes it easier for banks to avoid
reserve requirements, or when business can be conducted in foreign currencies
as easily as in domestic currency?
When offshore banking and capital flight
are potentially only a few mouse clicks away, does a government have any
leeway for independent monetary or fiscal policy?
How will the choice of the exchange rate
regime be affected, and how will e-banking influence the targeted level of
international reserves of a central bank?
Can a government afford to make any
mistakes? Will the spread of e-banking impose harsh market discipline on
governments and businesses?
The answers to these questions fall into
two emerging strands of thought. First, the technological revolution could
result in a reassessment of households’ and firms’ decision of conducting
their financial operations purely through the central bank. Thus, the ability
of monetary policy to influence inflation and economic activity will be
threatened. Second, as e-banking expands financial transaction costs will
decline significantly, in effect reducing the "sand in the wheels" of the
financial sector machinery, making capital flow even easier, with a potential
erosion of the effectiveness of domestic monetary policy.
Conclusion:
While e-banking can provide a
number of benefits for customers and new business opportunities for banks, it
exacerbates traditional banking risks. Even though considerable work has been
done in some countries to adapt banking and supervision regulations,
continuous vigilance and revision –especially on the international level– will
be essential as the scope of e-banking increases. Moreover, the ease with
which capital can potentially be moved between banks and across borders
creates a greater sensitivity to economic policy management. To understand the
impact of e-banking on the conduct of economic policy, policymakers need a
solid analytical foundation. Without one, the markets will provide the answer,
possibly at a high economic cost. |
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CURRENT ISSUE |
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May 2003 / No. 23 |
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