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IWhy E-banking?

There are not many inventions that have changed the businessof banking as quickly as the e-banking revolution. Worldover banks are reorienting their business strategies to-wards new opportunities offered by e-banking. E-banking hasenabled banks to scale borders, change strategic behaviour andthus bring about new possibilities.

E-banking has moved real banking behaviour closer to neo-classical economic theories of market functioning. Due to theabsolute transparency of the market, clients (both business aswell as retail) can compare the services of various banks moreeasily. For instance, on the internet, competitors are only oneclick away. If clients are not happy with the products, prices orservices offered by a particular bank, they are able to changetheir banking partner much more easily than in the physical orreal bank-client relationship. From the banks point of view, useof the internet has significantly reduced the physical costs ofbanking operations.

As discussed by Turner (2001), progress in information tech-nology has slashed the costs of processing information, whilethe internet has facilitated its transmission, thus facilitating changein the very essence of the banking business. Around the world,electronic banking services, whether delivered online or throughother mechanisms, have spread quickly in recent years. It mustbe noted that the impact of e-banking is not limited to industrialand advanced emerging economies. Even in countries withunderdeveloped banking systems, E-banking has offered manynew business opportunities.

IIWhat Is E-banking?

In simple words, e-banking implies provision of banking productsand services through electronic delivery channels. Electronicbanking has been around for quite some time in the form ofautomatic teller machines (ATMs) and telephone transactions.In more recent times, it has been transformed by the the internet a new delivery channel that has facilitated banking transactionsfor both customers and banks. For customers, the internet offersfaster access, is more convenient and available around the clock

irrespective of the customers location. For banks, it is a muchmore efficient and cost- saving channel (see Table 1 which givescost comparisons for various delivery channels within US andIndia).

IIIInternational Trends in E-banking

Though data on internet banking are scarce, and differencesin definitions make cross-country comparisons difficult, a pre-liminary analysis by Nsouli and Schaechter from InternationalMonetary Fund (IMF) shows that internet banking is particularlywidespread in Austria, Korea, the Scandinavian countries,Singapore, Spain, and Switzerland, where more than 75 per centof all banks offer such services [Nsouli and Schaechter 2002].

The Scandinavian countries have the largest number of internetusers, with up to one-third of bank customers in Finland andSweden taking advantage of e-banking.

In the US, Internet banking is still concentrated in the largestbanks. While most US consumers have accounts with banks thatoffer internet services, only about 6 per cent of them use theseservices.

As of today, most banks have combined the new electronicdelivery channels with traditional brick and mortar branches, buta few that have emerged offer their products and services onlythrough electronic distribution channels. These virtual or internetonly banks do not have a branch network but might have aphysical presence, for example, an administrative office or non-branch facilities like ATMs. The US has about 30 virtual banks;Asia has two, launched in 2000 and 2001; and the European

E-banking: Challengesand Opportunities

E-banking has the potential to transform the banking business as it significantly lowerstransaction and delivery costs. This paper discusses some of the problems developing countries,

which have a low penetration of information and telecommunication technology, face inrealising the advantages of e-banking initiatives. Major concerns such as the digital divide

between the rich and poor, the different operational environments for public and private sectorbanks, problems of security and authentication, management and regulation; and inadequate

financing of small and medium scale enterprises (SMEs) are highlighted.RUPA REGE NITSURE

Table 1: Relative Costs of Banking TransactionsUnited States1 India2

Physical branch 100 100Postal .. 40Telephone 50 18ATM 27 18PC dial-up 8 naInternet 1 12

Notes: (1) Simple average of three studies by (a) US Department of Commerce;(b) Booz, Allen and Hamilton; and (c) Goldman Sachs and BostonConsulting Group(2) Figures taken from ICICI Bank.

Source: Bank of International Settlements.

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Union has several, either as separately licensed entities or assubsidiaries or branches of brick and mortar banks.

In developing economies, however, the spread of e-bankingis much limited. Globally speaking, internet usage only startsto take off once the average purchasing power of citizens exceedsUS $ 10,000, although of course this is also affected by thedistribution of income. But there are some emerging economies,which have higher internet usage than their incomes wouldsuggest such as Korea. An important factor that affects usageis the cost of connecting to the internet, which varies widely.This highlights the critical importance of an efficient telecom-munications industry in developing economies. Table 2 belowgives an idea about Indias relative position in the penetrationof information and telecommunications technology vis-a-vis otherdeveloped and emerging economies. As revealed in Table 2,usage of personal computers (PCs) or the internet or total ex-penditure on IT and Telecom as a per cent of GDP in Indiais abysmally low in comparative terms.

IVIndian Scene

To cope with the pressures of growing competition, Indiancommercial banks have adopted several initiatives and e-bankingis one of them. The competition has been especially tough forthe public sector banks (PSBs), as the newly established privatesector and foreign banks have already sharpened their competi-tive edge. Some of the proactive PSBs have been striving hardto make their structures flexible enough to accommodate

technological changes. Adoption of technology has facilitatedalternative channels for delivery within the PSBs, and, in turn,put pressure on them to restrict or limit the branch network andemploy a better skilled workforce. E-banking, facilitated by thetechnological revolution, has strongly impacted strategic busi-ness considerations for Indian banks (including the PSBs) bycutting down costs of delivery and transaction massively.

In India, currently, there are two types of customers one whois a multi-channel user and the other who still relies on the branchas the anchor channel. The primary challenge for banks is toprovide consistent service to customers irrespective of the kindof channel they use. The channels broadly cover the primarychannels of branch (i e, teller, platform, ATM), phone (i e, callcentre, interactive voice response unit), and internet channel(i e, personal computer, browser, wireless) banking. Banks inIndia have been working towards a vision that includes trans-formed branches, enhanced telephone services, and leading-edgeinternet banking functions that provide a consistently positivemulti-channel experience for customers. Even for PSBs, theongoing and future investments in technology are massive. Atpresent, the cumulative amount earmarked by 10 major PSBsadd up to a hefty Rs 2,200 crore plus (Table 3). It is expectedthat the provision of financial services through a versatile tech-nology platform will enable these banks to acquire more cus-tomers, cut costs, and improve service delivery. Though manypositive signs are already visible in India, including ahigher acceptance of technology by banks and customers, itis a reality that most projects have not yet been deployed on alarge scale.

VChallenges in E-banking for

Developing CountriesBased on best practices in developed countries, United Nations

Conference on Trade and Development (UNCTAD) report hasidentified four challenges that developing countries, in general,are expected to overcome to achieve the advantages that e-banking initiatives can bring about [UNCTAD 2002]:(1) The ability to adopt global technology to local requirements:An adequate level of infrastructure and human capacity buildingare required before developing countries can adopt the globaltechnology for their local requirements. For example, the reviewof the migration plan of Society for Worldwide Interbank FinancialTelecommunications (SWIFT) to the internet shows that to datefull migration has not occurred in many developing countriesdue to the lack of adequate infrastructure, working capital, andrequired technical expertise. Broadly accepted e-payment systemsare another such example. Many corporates and consumers insome developing countries either do not trust or do not have accessto the necessary infrastructure to be able to process e-payments.(2) The ability to strengthen public support for e-finance: His-torically, most e-finance initiatives in developing countries havebeen the result of cooperative efforts between the private andpublic sectors. For example, Singapores successful TradeNetsystem was a government-sponsored project. If the public sectordoes not have the necessary means to implement the projectsit is essential that cooperative efforts between public and privatesectors, along with the multilateral agencies like the World Bank,be developed to facilitate public support for e-finance relatedinitiatives.

Table 2: Penetration of Information and CommunicationsTechnology

Country Personal Computers Internet Users Information and(Per 1000 Persons) (in Thousands) Communications

2001 2001 Technology Exp(Per Cent of GDP)

2001

Austria 335.4 2,600 7.2Australia 515.8 7,200 10.7China 19.0 33,700 5.7Hong Kong 386.6 2,601 8.7France 337.0 15,653 9.1Germany 382.2 30,800 7.9India 5.8 7,000 3.9Japan 348.8 55,930 9.6Korea, Rep 256.5 24,380 7.4Singapore 508.3 1,500 9.9Switzerland 540.2 2,223 10.2United Kingdom 366.2 24,000 9.7United States 625.0 142,823 7.9

Source: World Development Indicators, World Bank, April 2003.

Table 3: PSBs Investment Plans in IT DevelopmentBank Investment (Rs Crore) Period (Years)Bank of Baroda 400 5Bank of India 100 2003-04Bank of Maharashtra 150 3Canara Bank 100 2003-04Indian Bank 120 2003-04Oriental Bank of Commerce 280 5Punjab National Bank 300 2003State Bank of India 500 2003-04UCO Bank 200 naUnited Bank of India 150 2

Source: The Financial Express, October 17, 2003.

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(3) The ability to create a necessary level of regulatory and insti-tutional frameworks: The lack of regulatory frameworks, trust,security and privacy standards, high trade barriers, customer andinvestor protections impede progress in implementing e-bankinginitiatives on a larger scale in many developing countries.(4) The ability to mainstream small and medium scale enterprises(SMEs) towards e-banking: The availability of and access to qualitydata and banking information is required for SMEs in developingcountries to move towards e-banking. Similarly, on-line creditinformation will enhance SMEs ability to secure financing.

VIE-banking in India: Major Concerns

First, in India, there is a risk of the emergence of a digitaldivide as the poor are excluded from the use of the internet andso from the financial system. Empirical evidence shows thatricher countries possess higher concentrations of internet users(higher than income concentration) in comparison with poorercountries [Hawkins 2002]. In India (where the poverty ratio isstill adverse at 26.1 per cent of total population), it is likely thatwealthier people will rapidly migrate to e-banking platformsleaving the poor to bear the cost of the physical infrastructureof branches in the form of transaction fees or non-competitiveinterest rates on their deposits.

Second, even today, the operational environment for public,private and foreign banks in the Indian financial system is quitedifferent.

A handful of foreign banks operating in India first offered e-banking services to their customers such as ATMs, computerisedmonthly statements, secure online operations, etc. The newgeneration of private sector banks (who did have developmentalobligations similar to their counterparts in the public sector) didnot possess a legacy of manual practices and, hence, were ableto adopt easily modern banking practices with state-of-the-art-operations. However, challenges before the public sector banksare plenty and of a different kind. While, they have to handlevolumes which are mind boggling, there are also issues of legacy,old habits and political pressures. Systems of accounting, controland delegation were set up decades ago and adoption of tech-nology in terms of real time banking and its compatibility withall phases of banking is not yet adequately perceived. Further-more, the security risk involved in computerisation is directlyrelated to the size of the network. For PSBs, the major problemsare in the form of security risks, network downtime, scarcity oftrained personnel, expensive system upgrades and recurring costsgiven the massive scale of their current operations.

A research study by Errol DSouza (2002) on the comparativeperformance of public and private sector banks in the decadeof the 1990s shows that though the turnover/employee ratio rosein PSBs, the turnover per employee in private and foreign banksdoubled relative to the ratio for PSBs. Also, this is not due tothe presence of a large rural and semi-urban concentration ofbank branches amongst PSBs but rather due to technologicalupgradation in the private and foreign banks. Private and foreignbanks have changed the structure of their employment towards ahigher skilled workforce by increasing the recruitment of officersand reducing clerical and subordinate staff. The combination ofhigher technology and higher skills have posted a higher turnoverfor these banks as they have been able to provide better customersupport and have managed their assets well.

Third, confidentiality, integrity and authentication are veryimportant features of the banking sector and were very success-fully managed the world over in pre-internet times. Communi-cation across an open and thus insecure channel such as theinternet might not be the best base for bank-client relations astrust might partially be lost [Grethen 2001]. Though at differentlevels in the computerisation spectrum, both public and privatebanks in India have realised the importance of Public KeyInfrastructure (PKI) solutions. PKI is expected to guarantee therequired level of trust and to provide for the security needs ofall e-communities in terms of confidentiality, integrity, non-repudiation services, etc. However, the size of the initiative isgoing to vary significantly between public and private banks. Forprivate banks, security considerations are an important value-added and risk reduction utility for their online and real timetransactions. But for public sector banks, computerisation is thefirst agenda a massive exercise given their very large branchnetworks and security is the second priority. But this endangersthe position of public sector banks in the immediate period asbreaches of security and disruptions in the systems availabilitycan damage a banks reputation. The more a bank relies onelectronic delivery channels, the greater the potential forreputational risks.

Fourth, e-banking has created many new challenges forbank management and regulatory and supervisory authorities.They originate not just from increased potential for cross-border transactions but also for domestic transactions basedon technology applications which raise many security relatedissues [Hawkins 2002]. The Basel Committee on BankingSupervisions Electronic Banking Group (EBG) (2001) hasdefined risk management principles for electronic banking.They primarily focus on how to extend, adapt, and tailor theexisting risk-management framework to the electronicbanking setting. It is necessary to know whether the effortsundertaken by the RBI are sufficient to ensure a reasonable levelof security.

Fifth, there are some serious implications of internationale-banking. It is a common argument that low transaction costspotentially make it much easier to conduct cross-border bankingelectronically. For many banks, cross-border operations offer anopportunity to reap economies of scale. But cross-border financealso needs a higher degree of cross-border supervision. Suchcooperation may need to extend to similar supervisory rules anddisclosure requirements (for efficiency and to avoid regulatoryarbitrage) and some harmonising of legal, accounting and taxa-tion arrangements. The real question here is whether India at thepresent juncture is adequately prepared to face the consequencesof cross border e-banking?

Sixth, there is no commercial bank in India, which has exclu-sively specialised in the small business segment. SMEs in Indiahave generic problems like the inability to provide quality data,to exhibit formal systems and practices and the lack of asset cover.This has created unwillingness in banks to undertake large-scalelending to SMEs. Legal and regulatory compliance has also beeninadequate. Traditional drawbacks like asymmetric and non-transparent data and low capital bases continue to characterisetheir balance sheets. The problem is further compounded dueto the preponderance of a large cash economy in this segment.There are many challenges involved in a web-based relationshipmodel for SMEs within India given the current state of regulation[Sushant Kumar 2001].

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VIIState of E-banking Regulations in India

At present, there are three major statutes or guidelines gov-erning e-finance operations within India, notably, The Informa-tion Technology Act, 2000; The Information Technology (Cer-tifying Authorities) Rules 2000; and Central Bank (Reserve Bankof India (RBI)) guidelines on Internet Banking in India.

The RBI guidelines have defined the operational frameworkon internet banking with a focus on security issues. Though theRBI has mandated that the commonly used PKI technologystandard should be followed, no compulsory timeframe has beenset for the same so far. However, the guidelines detail theorganisational, operational, and supervisory structures that bankswill have to implement while offering internet banking. The ITAct 2000 and the IT Rules for Certifying Authorities lay downthe framework for appointment of digital certifying authorities,acceptance of digital signatures, etc, which would enable theorderly development of cyber business [Sushant Kumar 2001].However, there is a feeling that the Act has not given enoughpower to safeguard E-banking from frauds and complexities.With many sites getting hacked and content being changed, itis felt that the IT Act should have given more powers to dealwith the complexities of the virtual world.

VIIIExploiting E-banking in India

for Strategic AdvantageNobody would deny that electronic banking is the wave of the

future. Though the practice of e-banking in India is quitelimited, there is a huge potential for it given its impact on thecost and efficiency of financial intermediation. As suggested byClaessens, Glaessner and Klingebiel (2001), developing coun-tries in general have an advantage as they can learn from theexperience of advanced economies. It may even be possible forthem to leapfrog straight to the most advanced technologies. Theycan put in place appropriate policies (especially regarding se-curity aspects) before e-banking becomes widespread rather thanreacting to it at the time of implementation. In this section, anattempt is made to see how India can exploit the ongoing e-banking wave to reap maximum possible benefits without in-curring any major risks.

As regards the problem of a possible digital divide, there isa lot one can learn from the experiences of other developingcountries to include the poor within the net of e-banking. Forinstance, some countries have adopted policies to encourage thespread of mobile phone networks into poorer rural areas. Claessens,Glaessner and Klingebiel (2001) have cited examples like, licenceobligations to serve rural communities (as in Mexico and thePhilippines); subsidies through rural telecom development funds(as in the case of Chile, Peru); variations of build-operate-transferarrangements (as in Thailand) and low-interest loans. They havealso described an experiment undertaken in South Africa, wherepost offices in remote parts of the country provided financialservices including bill payments through terminals where illiterateusers were identified biometrically (i e, using fingerprints). In EastAfrica, the internet has been effectively used to make micro-loansto small entrepreneurs. These and many such innovative effortswould help India tide over the emerging problem of a digital divide.

As regards PSBs within India, one certainly sees a paradigmshift in their behaviour triggered by the heightened competition.

There has been a strong realisation that technology is not justan enabler but a driver of business [Kohli 2003]. At least the firstphase of technology adoption has been more or less completedwithin PSBs, and involved large-scale computerisation of branchesand operations for better operational efficiencies. There has beensome reorientation of staff in terms of newer skills, though ata lower level. There is also an awareness that such large-scalecomputerisation is not going to help in other operational areaslike back-office functions, management information systems (MIS),fraud prevention, marketing and higher value-added business. Asstated earlier, security concerns are an important factor for manyinternet users in India who are shying away from the PSBs.

PSBs can try to change this situation by creating a positive workculture and gaining the confidence and support of all the employeesfor organisational goals. What matters for success is leadershipand not ownership, whether for private or public entity. As sug-gested by a Bureau of Indian Standards (BIS) paper on RiskManagement Principles for E-banking, a banks board of directorsand senior management should review and approve the key aspectsof the security control process, which should include measuresto authenticate the identity and authorisation of customers, promotenonrepudiation of transactions, protect data integrity, and ensuresegregation of duties within e-banking systems, databases andapplications. Top leaders in PSBs should ensure that their staffmembers have the relevant technological expertise to assesspotential changes in risks, which may necessitate significantinvestment in staff training and in hardware/software. The generaltendency of PSBs is to contract out operations to service pro-viders. But this makes them vulnerable to problems with theseservice providers. Also, in the process of adoption of new techno-logy, a due role has to be played by experts in the banking field,who have better insights about the banks functions and operationsas compared to technocrats in order to avoid the havoc createdby inefficient applications of technology. As an article in theEconomist observed, few things have promised so much anddelivered so little as customer (or client) relationship management(CRM) software. In implementing CRM, insiders reckon that fourout of five such projects fail to deliver the goods. But that hasnot stopped banks and other financial institutions from pilinglayers of CRM software on top of one another [Economist 2003].The PSBs in India, at the present juncture, can learn lessons notjust from international experience but also from mistakes madeby domestic private sector banks in this regard and avoid wastage.

So far as the regulatory or legal framework is concerned, theIT Bill in India has served the purpose of bringing in structure,legal validity and authenticity for transacting online. Its passagecould be seen as an indication of the governments inclinationtowards promoting e-commerce and e-governance while ensur-ing accountability. However, there should be a proper inclusionof IT issues and their accompanying operational risks in RBIssafety and soundness evaluations. In addition to aspects likeprivacy and security, the regulator should also examine the banksbusiness plan for e-banking in greater detail, especially if bankshave outsourced critical functions to the third party.

To avoid potential risks involved in cross border e-banking,India can make a gradual beginning. For instance, as suggestedby Mathew and Nitsure (2002), to begin with, Indian banks shouldseek benefits in the export of remote processing services for whichthey have developed comparative advantage in recent years. Theseinclude financial data processing services, back-office operations,share transfers, processing of insurance claims, travel booking,customer call centres and any other customer services.

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As regards SME financing, some private sector banks in Indiaare aggressively developing web-based relationship bankingmodels, which are customer driven [Sushant Kumar 2001]. Theirfocus is on giving the SME customer what is wanted and in theform in which it is wanted. They are using e-channels to offerprocesses or relationship benefits and not just as channel pointsolutions to maximise value for customers. It is strongly felt thatafter acquiring the necessary technical capabilities, PSBs arebetter situated to provide value maximising services to SMEsgiven their comparatively larger sizes and extensive branchnetworks, which has given them a unique advantage of a closerelationship with their business clients and a good knowledgeof their needs, requirements and cash positions. They are in amuch better position to select the right clients and to offer themright products or services at the right time. Thus, e-financing toSMEs offers another growth channel to PSBs, which is un-matched by most private players.

IXConclusion

The e-banking revolution has fundamentally changed thebusiness of banking by scaling borders and bringing about newopportunities. In India also, it has strongly impacted the strategicbusiness considerations for banks (including the PSBs) by sig-nificantly cutting down costs of delivery and transactions.

It must be noted, however, that while e-banking provides manybenefits to customers and banks, it also aggravates traditionalbanking risks. Compared to developed countries, developingcountries face many impediments that affect the successfulimplementation of e-banking initiatives.

In this paper, we have identified some such impediments inthe Indian context and have suggested ways to overcome themin order to move forward with the wave of e-banking successfully.

In India there is a major risk of the emergence of a digital divideas the poor are excluded from the internet and so from thefinancial system. Even today, the operational environment forpublic, private and foreign banks in the Indian financial systemis quite different. Though there has been higher acceptance oftechnology by public sector banks, they are at a different levelin the computerisation spectrum as compared to private andforeign banks. This has endangered their position in the immediateperiod due to the lack of adequate systems for customer andinvestor protection. PSBs are more susceptible to breaches ofsecurity and to disruptions in the systems availability and henceto reputational risk. E-banking in India has also created manynew challenges for bank management and regulatory authorities,which originate from increased potential for cross border trans-actions and lack of adequate cross border supervision. Given theimportance of the SMEs in India, there is a strongly felt needto mainstream this segment towards e-banking. But currentlythere is no commercial bank in India that has exclusively specialisedin this segment and SMEs in India continue to have genericproblems like inadequate quality data, asset covers, etc.

However, there are ways to overcome these obstacles andexploit trends in e-banking to derive the desired benefits. Asregards the problem of a digital divide, there is a rich internationalexperience from which India can learn many lessons and includethe poor within the net of e-banking. As regards the PSB situation,they can rapidly change their work environment by attractingyoung specialists in critical functional domains and by cre-ating a positive work culture that has all employees supporting

organisational goals. For the security issues involved in e-bank-ing, risk management principles recommended by the BIS shouldbe implemented by PSBs on an urgent basis. Their board ofdirectors and senior management should regularly review andapprove key aspects of the security control process. The topmanagement should ensure that their staff members have therelevant technological expertise to assess potential changes inrisks. For this, they should accord a high priority to investmentin staff training and technological infrastructure. As far as possible,PSBs should avoid contracting out operations to service provid-ers, which makes them vulnerable to problems of these serviceproviders. In the process of adoption of new technology, a majorrole has to be played by the internal banking experts who arenot necessarily the technocrats. As regards the problem of se-lection of appropriate technology, PSBs in India can learn lessonsnot just from international experience but also from the mistakesmade by domestic private players so as to avoid wastage.

In the regulatory arena, in addition to aspects like privacy andsecurity, the regulator should also examine banks business planfor e-banking more closely, especially if banks have outsourcedcritical functions to a third party.

To avoid the risks involved in cross-border e-banking, Indiacan make a gradual beginning, first by seeking benefits in theexport of remote processing services in which it has a strongcomparative advantage.

In the case of SME-financing, it is strongly felt that afteracquiring the necessary technical capabilities, PSBs are bettersituated to provide value propositions to SMEs given theircomparatively extensive branching networks, close relationshipwith business clients and a good knowledge of their needs,requirements and cash positions. This actually offers them anothergrowth channel unmatched by most private players.

Address for correspondence:chief.economist@bankofbaroda.com

[The views expressed in this article are the authors personal views and donot necessarily reflect the views of the organisation to which she belongs.]

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EPW