E-Banking: Status, Trends, Challenges and Policy Issues

E-Banking:
Status, Trends, Challenges and Policy Issues



November 2003














MU Yibin
Financial Economist
The World Bank



Paper presented at CBRC Seminar
The Development and Supervision of E-banking
Shanghai, Nov. 24-26, 2003



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E-Banking:
Status, Trends, Challenges and Policy Implications

1.
Introduction....................................................................................................................... 1
2.
Status ................................................................................................................................. 1
2.1.
Definition.................................................................................................................. 1
2.2.
Fundamental characteristics ...................................................................................... 2
2.3.
Levels/Scope of e-banking business ......................................................................... 2
2.4.
Current development situations (in industrial countries) ......................................... 2
2.5.
Status in developing countries .................................................................................. 3
3.
Prospects--Impact of E-banking on traditional banking ................................................... 3
3.1.
The early conventional wisdom: ............................................................................... 3
3.2.
In reality, e-banking develops fast, but not damaging as conventional wisdom
projected................................................................................................................................ 3
3.3.
Prevailing vision ....................................................................................................... 4
3.4.
Case-study--experience from the two most successful cases ................................... 4
3.5.
Prospects ................................................................................................................... 5
4.
Trend: The major application of e-banking—SME finance ............................................. 5
4.1.
Obstacles to SME’s access to finance....................................................................... 5
4.1.1.
from banks’ perspective .................................................................................... 5
4.1.2.
from SME’s perspective .................................................................................... 6
4.2.
New Technology, New Hope for SME Finance ....................................................... 6
4.2.1.
From bank’s side, new technology (e-banking) makes SME finance
economically possible ....................................................................................................... 6
4.2.2.
From SMEs’ perspective................................................................................... 7
4.2.3.
From the government’s perspective .................................................................. 7
5.
Challenges and policy implications .................................................................................. 8
5.1.
Cross-border e-banking activities and its policy implications .................................. 8
5.1.1.
definition........................................................................................................... 8
5.1.2.
Two scenarios ................................................................................................... 8
5.1.3.
Raised many challenges and questions for banking regulatory authorities (both
home and host).................................................................................................................. 8
5.1.4.
Its policy implications ....................................................................................... 9
5.2.
From the society’s perspective................................................................................ 10
5.2.1.
Challenges ....................................................................................................... 10
5.2.2.
Policy implications .......................................................................................... 10
5.3.
From bank’s perspectives........................................................................................ 10
5.3.1.
Risk management challenges.......................................................................... 10
5.3.2.
Policy implications/recommendations ............................................................ 12
5.4.
From the authorities’ perspective (banking supervisor, central bank, related
government depts.).............................................................................................................. 13
5.4.1.
Challenges from e-banking ............................................................................. 13
5.4.2.
Policy implications/recommendations ............................................................ 13
6.
Some concluding thoughts .............................................................................................. 15
Reference ................................................................................................................................ 16


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E-banking:
Status, Trends, Challenges and Policy Implications



1. Introduction

In addition to introduction (section I) and conclusion (section VI), the paper includes four
sections. Section II addresses the definition and current situation of e-banking. Then, section
III addresses the impact of e-banking on banking business. After that, section IV addresses
the major application of e-banking. That is also the bottom line whether e-banking can be
viable in a country. Section V addresses the new challenges e-banking has brought and
policy implications from the perspectives of society, banks, and regulatory authority as well
as government.

2. Status
2.1. Definition
• The Internet includes all related web-enabling technologies and open
telecommunication networks ranging from direct dial- up, the public World Wide
Web, cable, and virtual private networks. (BIS-EBG, 2003)
• Internet banking (e-banking) is defined to include the provision of retail and small
value banking products and services through electronic channels as well as large
value electronic payments and other wholesale banking services delivered
electronically. (BIS-EBG, 2003)

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2.2. Fundamental characteristics

Comparison between the current round financial innovation (e-banking) and past
financial innovations


The current innovation (e-
Past financial innovations
banking)
Content
Delivery channel innovation--
Products and services, i.e.,
deliver banking business via
delivery, swap
internet.
Impact
Wider
Narrow

2.3. Levels/Scope of e-banking business

• Basic information e-banking/web sites that just disseminate information on
banking products and services offered to bank customers and the general public;
• Simple transactional e-banking/web sites that allow bank customers to submit
applications for different services, make queries on their account balances, and
submit instructions to the bank, but do no permit any account transfers;
• Advanced transactional e-banking/web sites that allow bank customers to
electronically transfer funds to/from their accounts pay bills, and conduct other
banking transaction online.
• Usually, e-banking refers to types II and III.
2.4. Current development situations (in industrial countries)

• E-banking products and services are getting more and more advanced and
increasing in variety. From providing information at the early stage to providing
transactional activities.

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• Both volume and share in the total banking business are getting bigger and bigger
very fast (Graph, Europe)
• E-banking customer base is getting bigger quickly.

2.5. Status in developing countries
Developing countries are in catching up in e-banking:
• The average e-banking penetration for developing countries by the end of 1999 was
close to 5% (World Bank Survey, 2001).
• In Brazil, the number of e-banking users reached 8 million in 2000.
• In Mexico, the number of e-banking users reached 1.25 million in 2000.
• In India, over 50 banks are offering online banking services. ICICI Bank’s e-banking
is very impressing.
• E-banking in Korea, Thailand, Malaysia, and Singapore, Hong Kong and Taiwan
(China) is thriving.
• In Ghana and some other African countries, smart cards based on Visa Horizon
proximately technologies are getting started.


3. Prospects--Impact of E-banking on traditional banking
3.1. The early conventional wisdom:
• Internet banking would destroy the traditional banking business model and promote
the entry of newcomers from the outside of the banking industry.
• Developing countries could have the “opportunities to leapfrog” in the adoption of e-
finance on a large scale.
3.2. In reality, e-banking develops fast, but not damaging as conventional wisdom
projected.

• The notion of leapfrog has not worked in many developing countries due to various
impediments. This can be verified by UNCTAD report. “Some positive signs are

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already visible, including a high level of acceptance of technology by customers and
financial institutions….H(h)owever, most projects have not yet been deployed on a
large scale.” (UNCTAD 2002. It provides a comprehensive look at the status of e-
finance in developing countries. It covers arrange of areas related to e- finance
including e-banking, e-payments, e-trades, and e-credit information).
• Even in industrial countries, e-banking is still a complementary tools to traditional
banking. Lots of pure e-banking businesses have been forced out of market.
• Internet-only banks have been substantially less profitable. They generate lower
business volumes and any savings generated by lower physical overheads appear to
be offset by other types of non-interest expenditures, notably marketing to attract new
customers. (De Young 2001).
3.3. Prevailing vision
• The prevailing view today is that Internet banking can only succeed if it is thoroughly
integrated within the existing banking infrastructure, which should combine “click”
(e-banking) with “mortar” (physical branches) due to the importance of public trust in
banks, the value of an established brand name, and the desire of customers to do
something physically.
• According to this view, Internet is regarded simply as another distribution channel as
a complement to physical braches, phone banking and ATM networks. The
dominance of the so-called “click and mortar” model can be explained by its success
on the ground. Two good examples are Wells Fargo in the US and Nordea in
Scandinavia.
3.4. Case-study--experience from the two most successful cases
Two most successful examples:

• Wells Fargo (US), has actually the highest absolute number of online customers,
more than 3 million out of its total 24 million customers in 2001.
• Nordea (Scandinavia), has 2.3 million online customers, representing over 20% of its
total customer base. It has the highest share of online customers.

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They share the following common elements:

• Both are leaders in their traditional markets and thus can capitalize on a sizable
customer base.
• Furthermore, their customer base is technologically sophisticated. California and
Scandinavia have extremely high rates of Internet use.
• Both are technologically advanced and started early in Internet deployment. Wells
Fargo started e-banking business as early as in 1989.
• Both have tightly integrated Internet in their operations and their existing
infrastructure.
• Both have large number of SME customer base.

3.5. Prospects

Bottom line: the ability to mainstream SME and individuals into E-banking.


4. Trend: The major application of e-banking—SME finance

E-banking is used more and more for improving access to finance. Financial constraints for
SMEs have never been effectively solved and have been thought inevitable. This section will
cover the advantages of e-banking on this aspect.
4.1. Obstacles to SME’s access to finance
4.1.1. from banks’ perspective
• High costs and low profitability of SME loans because of the small loan size.
• High risks of SME loans due to lack of business track record, credit history, and
transparent information.
• Evaluating SME risk is “too labor-intensive” to be profitable.

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• Many banks lack strategies and skills to tackle impediments associated with SME
finance. In many developing countries, the staff of banks lack necessary skills to
appropriately assess credit risks of SMEs
4.1.2. from SME’s perspective
• Inappropriate products and services, which are rigidly supply-driven instead of
demand-driven. Commercial bank products are usually designed to meet the needs of
large corporations; few products and service are specifically tailored to the needs of
SMEs. SME sector is usually underserved.
• High interest rates. SMEs usually require much smaller loans than large enterprises.
banks, therefore, usually charge high margins to cover the costs.
• Cumbersome procedures.
• Over insistence on collaterals and guarantees. SMEs usually have low-level of fixed
assets and relatively high- level of working capital. Therefore, when lending to an
SME, a bank needs to assess the SME’s economic viability and future cash flows
instead of collaterals. However, in many developing countries, banks are still in the
very early stage of mastering sound lending policies and good credit practices. Their
lending appears to simply rely on collateral rather than cash- flow projections. banks’
lack of capacity of non-collateral credit assessment has caused them unable to provide
lending services to SMEs.
• Inflexible credit criteria—one size fits all.

4.2. New Technology, New Hope for SME Finance
4.2.1. From bank’s side, new technology (e-banking) makes SME finance
economically possible

(i) lower operational costs of banks
• Automated process
• Accelerated credit decisions
• Lowered minimum loan size to be profitable

(ii) potentially lower margins

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• Lower cost of entry
• Expanded financing reach
• Increased transparency

(iii) expand reach through self-service
• Lower transaction cost
• Make some corporate services economically feasible for SMEs
• Make anytime access to accounts and loan information possible
4.2.2. From SMEs’ perspective
E-banking business makes access to finance from banks attractive. SMEs have benefited
from the development of E- finance and gradually stepped out of the informal sector. In
particular, E- finance offers the following attractive benefits for SMEs:
• Ease of use
• Lower costs of financing
• Convenience
• Time savings
• Operational efficiency

4.2.3. From the government’s perspective

New technologies have provided the incentives/benefits for the government to improve SME
finance by
• Increasing employment.
• Contributing to poverty reduction.
• Contributing to economic development.
• Reducing the informal sector and cash economy1.


1 Lack of SME’s access to FIs is one of the major reasons why there are usually big informal economic sector
(cash economy) in many developing countries. Improved SME access to formal financial institutions is
expected to reduce the informal economic sector.


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5. Challenges and policy implications

5.1. Cross-border e-banking activities and its policy implications
5.1.1. definition
• Definition: Cross-border e-banking is defined as the provision of transactional on-line
banking products or service by a bank in one country to residents of another country.
(BIS, 2003)
• A note on the definition: A bank delivering its e-banking activities via its physical
branches/ subsidiaries in a host country does count into cross-border e-banking.
• A further note: banks can use the new delivery channel (e-banking) reach customers
in another country without as much reliance on physical presence and the significant
investment that it entails (example).
5.1.2. Two scenarios
• The in-out scenario—In-country institutions providing banking services to customers
outside the home country.
• The out-in scenario—institutions based outside the home country providing banking
services to parties within the home country.
5.1.3. Raised many challenges and questions for banking regulatory authorities (both
home and host)
• Who should take the supervision responsibility? Borderless nature of e-banking
increase the potential for jurisdictional ambiguities with respect to the supervisory
responsibilities of different national authorities. Such situations could lead to
insufficient supervision of cross-border e-banking activities.
• Does it need to be licensed?
• Banks that engage in cross-border e-banking may face increased legal risk.
Specifically, unless banks conduct adequate due diligence they run the risk of
potential non-compliance with different national laws and regulations, including

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