Chapter 3 1

CHAPTER 3

TECHNOLOGY IN BANKING:E-MONEY, E-BANKING,

AND E-COMMERCE

Chapter 3 2

LEARNING OBJECTIVES To understand …

1. Bank technology in term of e-money, e-banking, and e-commerce

2. How e-commerce affects the set-of-contracts theory of the firm and the similarities between banks and communications firms

3. E-banking as the delivery system based on electronic funds transfer (EFT)

Chapter 3 3

LEARNING OBJECTIVES (continued) To understand …

4. The components of EFT as ACHs, ATMs, and POSs

5. Home banking was a bust in the late 20th century but that Internet banking and e-commerce will take off in the early 21st century

Chapter 3 4

CHAPTER THEME This chapter focuses on the

information-processing and e-delivery aspects of banking from a technological perspective. Innovations related to information technology (the I in TRICK) have paved the way for e-money, e-banking, and e-commerce. EFTS and Internet banking are the delivery vehicles of the 21st century.

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ARE BANKS DINOSARUS?

Yes

No

Maybe

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Banks Are Dinosaurs

“Technology in the Workplace” Study Criteria Has the industry made use of technological

advances in a timely manner? Did it participate in or encourage the development

of new technologies? Has the industry improved its competitive standing,

efficiency, or profitability?

Banking’s Grade = C-

Chapter 3 7

Technological Innovations:

E-Money

E-Banking

E-Commerce

Electronic Funds Transfer Systems

BANKS ARE NOT DINOSAURS

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E-COMMERCE AND THE SET OF CONTRACTS THEORY OF THE FIRM

See Figure 3-1 (p. 67) Theory from Jensen and Meckling

(1976) Basic idea is to think about the

various groups that have claims on the firm’s assets/cash flow

Narrow view suggests only two claimants: Owners and creditors

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SET-OF-CONTRACTS THEORY(continued) Broader view has many claimants

including employees, tax collectors, society, suppliers, customers, and regulators.

Advances in technology permit information flows between and among these parties/claimants to be more timely and efficient

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Business-to-Customers (B2C)

Business-to-Business (B2B)

Business-to-Employees (B2E)

To which we can add,

Banks-to-Regulators (B2R)

THREE IMPORTANT WEB CONCEPTS

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Transparency -- permits debt and equity holders to receive information on a more timely basis

Risk Exposure - eases managers ability to sell and buy risk management

Customers -- enhances banks’ abilities to communicate, inform, and attract

Kapital Adequacy -- reduces agency costs associated with bank and securities regulations

INFORMATION TECHNOLOGY AND TRICK

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E-commerce uses IT to enhance communications and transactions among mangers and stakeholders

Claimant Shareholders Creditors Supplier/distributor Customers Employees Regulators/IRS Society

Example E-voting E-reports E-orders E-orders E-mail E-filings E-info

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CONCRETE(animals, hides, trinkets, gold)

to

ETHEREAL(electronic impulses)

THE EVOLUTION OF MONEY

Chapter 3 14

CHECKS Check Volume

Check Imaging

Electronic-Check Presentment

Electronic-Check Conversion

Chapter 3 15

CARDSTYPES

Credit Cards Debit Cards Smart Cards or Chip Cards

WAYS TO BE USED Face-to-Face or card present Mail order / telephone order (MOTO) Internet

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E-BANKING: PAYMENTS SYSTEMS

Automated Clearinghouses (ACHs, see Figure 3-2, p. 73)

Automated Teller Machines (ATMs, see Figure 3-4, p. 80)

Point-of-Sale Terminals Internet Banking

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PAY CARDS AND THE UNDERBANKED A pay card looks like a credit card,

acts like a debit card, and permits customers to receive electronic payments, but it is not tied to a conventional bank account

Pay cards are marketed through employers that offer direct deposit and to parents for teens

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WIRE-TRANSFER SYSTEMS

CHARACTERISTICS: High-dollar value of average transfers Real-time settlement A widely distributed network of users

SYSTEMS: Fedwire (see Figure 3-3, p. 77) CHIPS (Clearing House Interbank Payment

System) SWIFT (Society of World Interbank Financial

Telecommunications)

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FEDWIRE

Funds Transfer ServiceReal-time gross settlement system

Custodial and Transfer Services1.Safekeeping Function

2.Transfer-and-Settlement Function

Chapter 3 20

CHIPS and SWIFT

CHIPS Clearing House Interbank Payment System

SWIFT Society of World Interbank Financial

Telecommunications

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MONEY LAUNDERERS AND TERRORIST FINANCING Box 3-3 (p. 79) describes how money

launderers use wire transfers Following 11 September 2001 great

attention has been drawn to how terrorists use financial systems and underground (cash) transactions to circumvent detection

When a paper trail exists, authorities “freeze assets” to impede funding

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E-BANKING: ATMs Pay the Teller $3 or See the ATM ATMs: The Numbers Game

1980 < 20,000 ATMs 2000 >200,000 ATMs During the 1990s, ATMs grew at a rate of 10%

per year ATM Networks: HONOR, PLUS, MAC, STAR, NYCE,

MOST, & CIRRUS

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POINT OF SALE SYSTEMS 53,000 in the early 1990s versus

2,000,000 in 2000

Why? Payment habits are slow to change and

customers prefer credit cards with a “grace period” or checks with “float” to debit cards

Merchants have gone with technologies more focused on electronic cash registers and inventory control rather that EFT

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INTERNET BANKING

The Internet is like a 20-foot tidal wave coming, and we are in kayaks. It’s been coming across the Pacific for thousands of miles and gaining momentum, and it’s going to lift you and drop you. We’re just a step away from the point when every computer is connected to every other computer, at least, in the U.S., Japan, and Europe. It affects everybody -- the computer industry, telecommunications, the media, chipmakers, and the software world. Some are more aware of this than others.

--Andy Grove, CEO of Intel (1996)

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ELECTRONIC DATA INTERCHANGE (EDI)

EDI refers to the process of exchanging information electronically (e.g., invoices, purchase orders, and remittances)

Why? Speed the flow of dollars and data

Omnibus Consolidated Rescission and Appropriations Act of 1996 (requires federal agencies to convert to EFT)

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OUTSOURCING

Do We Perform Computer Operations In House or Contract with a Third Party?

Outsourcing varies inversely with bank size as only 21% of banks with assets over $10 billion prefer to outsource compared to 40% for banks with total assets under $500 million

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TECHNOLOGY AND THE FUTURE OF COMMUNITY BANKS

Factors Contributing to the Decline of Community Banks

Failure to address the financial needs of baby boomers Burdensome regulations that create an “unlevel playing field”

favoring nonbank competitors Inability to afford the high cost technology necessary to compete Financial innovations such as securitization and the development

of secondary markets that are transforming banking into a “pure commodity business”

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PRODUCT AND SERVICE TRENDS IN BANKING Internet banking and bill-paying services Cash-management services Debit and chip (smart) cards Upgraded branch-delivery and loan

systems Imaging technology More efficient data storage (and greater

concern about security (backup systems) in the aftermath of 11 September 2001)

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TECHNOLOGY AND THE FUTURE OF COMMUNITY BANKS

How can Community Banks Compete? Invest in Niches

Leverage Their Core-Systems Vendors

Make Small Size and Advantage

Utilize Application Service Providers

Build Internal Integration Skills

Don’t be Penny Wise but Pound Foolish

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FINANCIAL-MANAGEMENT IMPLICATIONS OF E-BANKING View in terms of the ROE model: ROE = PM x AU x EM = ROA x EM Greater efficiency => higher PM and

higher ROA and ROE, ceteris paribus Revenue (sales) enhancement (e.g.,

through cross-selling) => higher AU and higher ROA and ROE, ceteris paribus

Lower EM through more efficient use of equity capital => higher ROE

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BANKS AS COMMUNICATIONS FIRMS They are similar in that they both:

1. Establish networking relationships through which they

2. Collect, store, process and transmit information for themselves and the customers’ accounts

Not a two-way street: It is easier for communications firms to enter financial-services businesses than the other way around

Chapter 3 32

CHAPTER SUMMARY Bill Gates predicts that online

banking (“virtual branches”) will become the primary vehicle for delivering financial products and services

E-money, e-banking, and e-commerce provide the platforms for Gates’ prediction to come true