1.

1 Executive Summary

“E-banking”- The execution of financial services via internet, reducing cost and
increase in convenience for the customer to access the transaction. e- Banking is
an umbrella term for the process by which a customer may perform banking
transactions electronically without visiting a brick-and-mortar institution. The
following terms all refer to one form or another of electronic banking: personal
computer (PC) banking, Internet banking, virtual banking, online banking, home
banking, remote electronic banking, and phone banking. PC banking and Internet
or online banking are the most frequently used designations. It should be noted,
however, that the terms used to describe the various types of electronic banking are
often use.

The ever increasing speed of internet enabled phones & personal assistant,
made the transformation of banking application to mobile devices, this creative a
new subset of electronic banking i.e. mobile banking. In 1999 & 2000 mobile
banking as an established channels, still seems to be a distant prospect.

The internet is revolutionizing the way the financial industry conducts

business online, has created new players who offer personalize services through the
web portals. This increase to find new ways and increase customer loyalty to add
the value to this product and services.

Banks also enables customers lifestyle needs by changing and increasing

preference for speed and convenience are eroding the traditional affinity between
customer and branch offices as a new technology disinter mediates traditional
channels, delivering the value proposition hinges on owing or earning the customer

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Interface and bringing the customer a complete solution which satisfies their needs.
Smart card is a new trend which provides the opportunity to build an incremental
revenue stream by providing an ideal platform for extended application and
services. Banks are well positioned to play central role unit in future M-commerce
market. Banks have strong relationships with corporate and business customers and
a wide experience in providing them with corporate banking services. Bank
provides a multimedia of small and large retailers with acquiring functionality in
credit card transactions. Customers have trusted relationships with banks and a
lower propensity to switch banking providers.

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2.1 INTRODUCTION

Traditional banks offer many services to their customers, including accepting

customer money deposits, providing various banking services to customers, and
making loans to individuals and companies. Compared with traditional channels of
offering banking services through physical branches, e-banking uses the Internet to
deliver traditional banking services to their customers, such as opening accounts,
transferring funds, and electronic bill payment.

E-banking can be offered in two main ways. First, an existing bank with physical
offices can also establish an online site and offer e-banking services to its
customers in addition to the regular channel. For example, Citibank is a leader in e-
banking, offering walk-in, face-to-face banking at its branches throughout many
parts of the world as well as e-banking services through the World Wide Web.
Citibank customers can access their bank accounts through the Internet, and in
addition to the core e-banking services such as account balance inquiry, funds
transfer, and electronic bill payment, Citibank also provides premium services
including financial calculators, online stock quotes, brokerage services, and
insurance.

E-banking from banks like Citibank complements those banks' physical presence.
Generally, e-banking is provided without extra cost to customers. Customers are
attracted by the convenience of e-banking through the Internet, and in turn, banks
can operate more efficiently when customers perform transactions by themselves
rather than going to a branch and dealing with a branch representative.

E-banking services are delivered to customers through the Internet and the web
using Hypertext Markup Language (HTML). In order to use e-banking services,
customers need Internet access and web browser software. Multimedia information
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In HTML format from online banks can be displayed in web browsers. The heart of
the e-banking application is the computer system, which includes web servers,
database management systems, and web application programs that can generate
dynamic HTML pages.

One of the main concerns of e-banking is security. Without great confidence in

security, customers are unwilling to use a public network, such as the Internet, to
view their financial information online and conduct financial transactions. Some of
the security threats include invasion of individuals' privacy and theft of confidential
information. Banks with e-banking service offer several methods to ensure a high
level of security: (1) identification and authentication, (2) encryption, and (3)
firewalls. First, the identification of an online bank takes the form of a known
Uniform Resource Locator (URL) or Internet address, while a customer is
generally identified by his or her login ID and password to ensure only
authenticated customers can access their accounts. Second, messages between
customers and online banks are all encrypted so that a hacker cannot view the
message even if the message is intercepted over the Internet. The particular
encryption standard adopted by most browsers is called Secure Socket Layer
(SSL). It is built in the web browser program and users do not have to take any
extra steps to set up the program. Third, banks have built firewalls, which are
software or hardware barriers between the corporate network and the external
Internet, to protect the servers and bank databases from outside intruders. For
example, Wells Fargo Bank connected to the Internet only after it had installed a
firewall and made sure the firewall was sufficiently impenetrable.

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On October 1, 2000, the electronic signatures bill took effect, recognizing
documents signed online as legal. Some banks plan to begin us in electronic checks
as soon as they can work out various security measures. g

The range of e-banking services is likely to increase in the future. Some banks plan
to introduce electronic money and electronic checks. Electronic money can be
stored in computers or smart cards and consumers can use the electronic money to
purchase small value items over the Internet. Electronic checks will look similar to
paper checks, but they can be sent from buyers to sellers over the Internet,
electronically endorsed by the seller, and forwarded to the seller's bank for
electronic collection from the buyer's bank. Further, banks seek to offer their
customers more products and services such as insurance, mortgage.

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3.1 PRE E-BANKING SCENARIO IN INDIA

Traditional Banking
Traditionally the relationship between the bank and its customers has been on a
one-to-one level via the branch network. This was put into operation with clearing
and decision-making responsibilities concentrated at the individual branch level.
The head office had responsibility for the overall clearing network, the size of the
branch network and the training of staff in the branch network. The bank monitored
the organization’s performance and set the decision-making parameters, but the
information available to both branch staff and their customers was limited to one
geographical location.

Traditional Banking Structure (Diag.1)

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On IT Adoption
The Indian banking sector woke up to the world of technology in early 1990s. The
banking sector in India has been dominated by the public sector banks, who hold
between them more than 80% of the total asset base. New private sector banks and
foreign banks have tended to concentrate their efforts more on the top 23 centres,
which house the cream of the country's urban customers. These banks have taken
the lead in technology adoption and have succeeded in building up a substantial
base of technology savvy, high-end customers.

Making an observation about the adoption of technology by the banks,

P.C. Narayan, vice-president (IT and retail banking) of Global Trust Bank Ltd,
says, "The rate of adoption of IT by foreign and private sector banks in the country
has been significant over the last five years. This can be attributed largely to
intense competition as well as the Internet phenomenon worldwide. A number of
banks in the public sector have also accelerated the pace of IT deployment, largely
because of the competitive pressure brought upon them by private sector banks and
foreign banks."

Though in the beginning the employees resisted computerization (especially in

nationalized banks), the management finally succeeded in convincing its
employees about the benefits and need for adoption of technology. Says
P. Seshadri Rao, a financial consultant based in Hyderabad, "The basic reason for
getting the nod for computerization was the competition from private banks. Once
the gates were opened to the private sector to operate banks, they started with a
bang, thereby forcing nationalized banks to reconsider their way of doing
business."

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A SBI official in Delhi echoes the same sentiments: "Needless to say, competition
from foreign banks was one of the motivating factors for us to switch to computers.
But housekeeping scored over everything else. Maintaining books and regular tasks
like computing interest at the end of the calendar year was tedious. The quantum of
database was so huge that computerization was the only way out. Banks would
have certainly started downing their shutters had banking software not taken over
the reins."

In sharp contrast, most of private banks like GTB, HDFC and ICICI started their
operations with the use of technology. And with these new banks wooing the
customers by offering what was till then an unknown phenomenon-customer
service-the nationalized banks were forced to take remedial steps. "The compulsion
for private banks to adopt a very high level of IT was driven by their desire to
contain their operating cost at the lowest levels and at the same time be able to
offer a wide variety of products and services in the quickest possible time,"
observes Narayan.

Commenting on the reasons for public sector banks being laggards in the adoption
of technology, State Bank of Mysore managing director Sitarama Murty says: "The
private banks started with a clean slate. They hired technology savvy people. On
the other hand, public sector banks didn't have those advantages. We need to
follow the public sector bank's rules and regulation while hiring people. We can't
appoint computer professional in the top management directly."

Computerization of all branches, especially in semi-urban and rural areas, is still a

far cry for public sector banks. "This calls for huge investments and retraining of
staff. I think these factors are inhibiting most of the banks to take technology to
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rural areas. But since IT is becoming an integral and inevitable part of the banking
system, rural banks' computerization should also happen very soon," comments a
senior official with Andhra Bank. Explains P.K. Seshadrinathan, CTO of SSI
Technologies: "The key obstacles to introduction of IT are non-integration or non-
networking of branches, and a lack of corporate network. Computerization has
been introduced but each branch acts as an island. And, of course, cultural/social
issues continue to pose problems. Overcoming these obstacles, therefore, would be
the biggest challenge by itself."

However, the nationalized banks have taken to computerization in the right earnest.
Today most of them have their own in-house IT department which not only takes
care of deployment and implementation issues but is also into developing specific
and customized applications for the bank. From SBI to Canara Bank, everyone is
expanding its IT division and making huge investments to develop the division as a
profit centre by itself. According to an SBI official, "It makes more sense to have
our own division which understands our needs and comes out with a solution. It is
not just cost-effective but also useful for a bank to have a separate division that
takes care of IT in totality."

Transactions like transfer of funds, making payments, checking of account balance,

ordering cheques, etc,. This also eliminates the customer of the need to visit the
bank’s branch.

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THE INTERNET – A DISTRIBUTION CHANNEL

Distribution channels are physical capacities to build up customer contacts in a

systematic way in order to inform, counsel and sell products and services. The
Internet is a so-called electronic distribution channel. Combined with self-service
terminals and telecommunication equipment electronic distribution channels are
technical channels within the class of media distribution channels. Another
example for a media distribution channel is direct mail.

Today, media distribution channels are an important way of distributing

information and managing standard transactions. Counseling is mostly done in
branch offices or by field workers. Together, personal and media distribution
channels are called internal distribution channels. On the other side there are
external distribution channels like salesman or franchising partners. The following
figure visualizes this classification.
Distribution Channels of Financial Institutions (Diag. 2)

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Areas of Use of the Internet in Financial Institutions
Generally we may distinguish four classes of Internet use in financial institutions:
 Information presentation
 Information presentation together with two way (asynchronous)
communication (e.g. email to request further information)
 Interaction with user (e.g. execution of programs with individual customer
data)
 Transaction banking (e.g. electronic payments)

Information may be provided in connection with one or two way communication.

One-way communication means that the institution uses the Internet only as a
presentation medium for its products and services. The simplest way to use two-
way communication is to allow users to send electronic mails to the server in order
to ask for further information or make suggestions with respect to the Internet site.

Interaction with customers requires quick information exchange. Information

provided by the user controls the information offered by the server. If the customer
is identified and authenticated connecting to operative systems of the financial
institution may be possible. Then, often very little information has to be provided
by the customer since data stored in the databases of the financial institution may
be used.

Presentation of product information may be used to initiate new contacts.

Implemented product models permit the construction of optimal insurance or
financing contracts by using simpler components. Using mathematical models the
customer may analyze his portfolios. To do so, he may use simulation techniques,
what-if-analysis and other similar techniques.

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Most Internet presentations by financial institutions fall into one of these three
categories (actually most of them are within the first two groups). If actual
contracting is desired transaction management is necessary.

There are a large number of different financial transactions, like e.g. customer
payments, securities transactions applications for loans or insurance acquisitions,
funds transfer, etc.

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 4.1 SERVICES OF E-BANKS

Internet banks offer a variety of features and perks, rushing to lure online
customers. The race is on to increase market share and create customer loyalty with
features that make online banking friendlier, more useful, and less expensive. E-
Banking lures customers with ‘convenience’.

The three broad facilities that e-banking offers are:

Convenience - Complete your banking at your convenience, in the comfort of your
home or at any place you can access the Net.
No more Qs - There are no queues at an online bank.
24/7 service - Bank online 24 hours a day, 7 days a week and 52 weeks a year.

Below is a detailed review of features found in e-banking around the world.

 Online applications
Consumers can begin their banking relationship with an online application. No
need to waste time driving to a local branch to begin a banking relationship.
Consumers can fill out and submit electronically all necessary information needed
to open a checking, savings account or even a fixed deposit. When the application
is submitted, the bank will mail you a signature card for its records and request you
to mail or wire your initial funds. Some firms like American Express and
CompuBank enable customers applying for an account to fund their new account
electronically via a credit card or cheque from another banking institution. There
are some firms such as Wingspan and USA [Link] that enable customers
to digitally sign their applications.

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 Account Access
Internet banking customers now have the ability to view their accounts online,
including checking, savings, loans and credit cards. No need to wait for your
monthly statements or wait in queue for the next available customer service
representative. Account access enables customers to view most recent activity on
accounts, including cleared checks, deposits, ATM transactions and balances as of
previous days activities. Customers no longer have to hold on to the cleared
checks, since their bank will store them for them online.

 Account transfers
Internet banking customers have the ability to transfer funds to and from their
accounts online. With a simple online form, customers can move money from a
checking account to a savings account and vice versa within the safety and
convenience of their home –- without having to visit the ATM. Funds transferred
online are updated in less than three hours. In addition, customers can set up
recurring transfers to accounts. A recurring transfer will take place on the customer
specified date, with a specified amount.

 Bill Payment
Online bill payment enables customers to pay anyone, friends or family, as well as
a pay their bills electronically. As an add on feature to Internet banking, bill
payment enables customers to send paper checks to anyone or an electronic check
to any institution that accepts electronic bill payments. To use bill payment,
customers are required to set up their payees online. Customers then have the
ability to set up recurring, automatic payments to a specific biller on a specified
day or just a one-time payment. Arrange payments three to five days, before the

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 due date, to ensure timely delivery. It is important to note that not all banks provide
bill payment as a free feature.

 Benefits at participating online merchants

The banks partner with online merchants to offer discounts when a purchase is
made with the card.

 24/7 customer service

Although it is easy to yield to the temptation of allowing the Internet to replace
expensive branch personnel and overhead, many banks have found that an
customer service staff ready at any hour is well worth the expense. This can be
especially true as customers transition to online banking and need help learning the
features. Offering telephone and email contacts is a basic level of service. Offering
live chat assistance is the exceptional level.

 Access to old transactions

Choices made in designing the Internet interface may include how much history
will be available online. Some banks have chosen to show only 30-45 days, while
others offer a history of six months or a year.

 Categorize transactions and produce reports

Functionality is king as online banking customers using these features enjoy a Web
interface that delivers the utility of a money management software application.

 Export your banking data :

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 Most banks offering the management interface also allow easy downloading of
financial information into files that can be imported into Microsoft Money and
Intuit's Quicken.

 Interactive guides & tools to help selection of proper product

Although online, interactive guides through a bank's products, adds complexity to
the programming it also serves the bank by assisting potential customers in
choosing new products or services. Interactive Tools to design a savings plan,
choose a mortgage, obtain online insurance quotes all tied to applications These
tools help remove some of the mystery involved in so many account options and
costs.

 Loan status and credit card account information

Bank customers are familiar with reviewing their checking account information,
but many banks are adding the ability to look at one's loan status and credit card
information as well. Access to as many accounts held at the bank seems to be the
goal.

 View digital copies of checks

This, again, is removing a down side to online banking. It makes images of checks
available as replacement for sending out cancelled checks or sheets of printed
check images.

 Online forms for ordering checks, stop payment,etc.

Convenience is popular and if a customer visits his or her online account frequently
it only makes sense to allow the ability to reorder checks or perform certain other
commands through the same interface.
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These features and many others help customers save time, simplify their lives and
provide greater value than conventional banking.

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5.1 MEDIUMS OF E-BANKING

 PC Banking –

The forerunner to Internet banking has been around since the late 1980's and is still
widely used today. Individual banks provide software which is loaded on to an
SME's office computer. The SME can then access their bank account via a modem
and telephone link to the bank. Access is not necessarily via the Internet.

 Digital TV Banking-

Using the standard digital reception equipment (set top box and remote control),
users can access their bank account. Abbey National and HSBC services are
available via Digital TV providers. One of its main selling points is that no
account details are transmitted via the World Wide Web;

 Text Phone Banking –

HSBC have introduced this service to allow customers with text phones to check
their balance, pay bills and transfer money.

 Corporate e-Banking

corporate e-banking is a comprehensive, corporate and small business banking

solution providing a single unified view of corporate banking relationships across
asset and liability products, limits, trade finance and cash management. It is

designed to support multiple channels including the Internet and mobile, and can
be interfaced with disparate host systems and third-party applications.

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 SMS-banking

The Short Message Service (SMS) is a GSM service to exchange text messages up
to 140 byte (or 160 characters of 7 bit). The transmission of mobile-originated
short messages is carried out by the short message service center (SMSC) of the
particular network operator. The SMSC is receiving the message from the mobile
device and routing it to the destination device. For generating mobile-terminated
short messages, it is possible that a company or a special service provider runs an
own SMSC. Thus, a bank could generate SMS from bank data like account balance
or account movements and send it to the mobile device of the customer. This
technique is used at SMS-banking: The customer sends an SMS with a request to
the bank, and gets the desired data as an answer.

The customer has to include a PIN for authorization in every SMS he sends to his
bank. Alike the WAP banking, one should pay special attention on the security of
the location of the SMSC. The operation of SMSC is offered as a service by many
service providers. The usage of such a service is out of question for banks, because
of the high sensitive character of the transmitted data. For this reason it is
mandatory for banks to run their own SMS-Gateway and secure it from
unauthorized access. The main problem with this kind of transmission is the
missing encryption of the data during the on-the air transmission between the
service center and the mobile phone. An encryption of pure text-SMS is not
possible (unless an application on the mobile device would be able to decrypt the
information). So the data is transmitted unencrypted. Because of this missing
encryption, banks

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 ATM (Automatic Teller Machine)

An ATM is basically a machine that can deliver cash to the customers on demand
after authentication. An ATM does the basic function of a bank’s branch, i.e.,
delivering money on demand. Hence setting of newer branches is not required
thereby significantly lowering infrastructure costs. These machines also hold the
keys to future operational efficiency.

 Internet banking:

It is sometimes called online banking, is an outgrowth of PC banking. Internet

banking uses the Internet as the delivery channel by which to conduct banking
activity, for example, transferring funds, paying bills, viewing checking and
savings account balances, paying mortgages, and purchasing financial instruments
and certificates of deposit. An Internet banking customer accesses his or her
accounts from a browser— software that runs Internet banking programs resident
on the bank’s World Wide Web server, not on the user’s PC. NetBanker defines a “
true Internet bank” as one that provides account balances and some transactional
capabilities to retail customers over the World Wide Web. Internet banks are also
known as virtual, cyber, net, interactive, or web banks.
This is basically the banking industry's attempt to jump on the "e-business" band
wagon. E-banking is a term that attempts to broadly describe today's alternate
delivery channels. Different banks - and vendors - will describe this differently.

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Rather than spending too much time on the term, I'd suggest you open a dialogue
with your customers about the types of services they are interested in, and begin to
prioritize your investment in these new services. Ideas would include image
delivery via Internet, Internet Commercial cash management, and on-line bill pay.

Internet Banking in India

The Internet banking is changing the banking industry and is having the major
effects on banking relationships. Even the Morgan Stanley Dean Witter Internet
research emphasized that Web is more important for retail financial services than
for many other industries. Internet banking involves use of Internet for delivery of
banking products & services. It falls into four main categories, from Level
1 - minimum functionality sites that offer only access to deposit account data - to
Level 4 sites - highly sophisticated offerings enabling integrated sales of additional
products and access to other financial services- such as investment and insurance.

DRIVERS OF CHANGE

Advantages previously held by large financial institutions have shrunk

considerably. The Internet has leveled the playing field and afforded open access to
customers in the global marketplace. Internet banking is a cost-effective delivery
channel for financial institutions. Consumers are embracing the many benefits of
Internet banking. Access to one's accounts at anytime and from any location via the
World Wide Web is a convenience unknown a short time [Link] six primary
drivers of Internet banking includes, in order of primacy are:

 Improve customer access

 Facilitate the offering of more services
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 Increase customer loyalty
 Attract new customers
 Provide services offered by competitors
 Reduce customer attrition

The banking industry in India is facing unprecedented competition from non-

traditional banking institutions, which now offer banking and financial
services over the Internet. The deregulation of the banking industry coupled
with the emergence of new technologies, are enabling new competitors to
enter the financial services market quickly and efficiently.

Advantages of Internet Bank

 Opening & closing of accounts

 Make the payments of merchandise transaction through Debit & Credit
cards.
 It gives reliefs to their customer from carrying heavy cash.
 Enables prompt & speedy operation to clients.
 It saves lot of time to their customers &convenient to access.

Disadvantages of Internet Banking

 Customer may have to face risky transaction & fraud.

 Failure of power supply cause to break down of system.
 Loss of heavy income at times of settlement of higher magnitude.
 Cost involved in training staff may not be profitable specially in times of
attrition.
 Development of an attitude of lethargy.
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 Mobile Banking: No wires, No worries, New Customers

Mobile communication devices are revolutionizing banking transactions over

wireless network and the Internet. To attract and retain customers, bank need to
exchange their full range of services across a wide range of Mobile, wireless
devices without having an impact on their current infrastructure and the delivery
channels it currently supports. Wireless Networks, Mobile Gateways, Wireless
Application Protocol (WAP) & Wireless Markup Language (WML) all play an
important role in bringing mobile banking strategy to the market.

In addition to established traditional channels, including branch banking and ATM

banking, most major banks in today market now offers e-banking as an extension
to their existing array of services & conveniences of wired consumers &
businesses, the next phase in the revolution is wireless-mobile-banking that is
available anytime anywhere from ‘always-on’ mobile devices like mobile phones
and personal digital assistant (PDA). With the proliferation & cost effectiveness of
mobile delivery channel, banks have a built-in delivery mechanism that can offer
services & 24×7 access regardless of where the customer happens to be. Unlike
PC-Based e-banking, m-banking provides banks with the unprecedented
opportunity to reach their customers in an unrestricted environment. The big
benefits for banks? Higher customer satisfaction & loyalty, no transaction-based
fee revenue, lower cost of ownership and integrated customer relationship
management channel.

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 6.1 ONLINE PAYMENT SYSTEMS

What is a Payment System?

Payment means the transfer of money. In its simplest form, a payment system is an
agreed upon way to transfer value between a buyer and a seller in a transaction.
When coupled with rules and procedures, the payment system provides an
infrastructure for transferring money from one entity in the economy to another.
Payment systems can be distinguished by the mechanisms used to transfer value in
an exchange of goods or services.

 Electronic Payment Systems

Electronic payment systems exist in a variety of forms, which can be divided into
two groups: wholesale payment systems and retail payment systems. Wholesale
payment systems exist for non-consumer transactions--transactions initiated among
and between banks, corporations, governments, and other financial service firms.

Retail electronic payment systems encompass those transactions involving

consumers. These transactions involve the use of such payment mechanisms as
credit cards, automated teller machines (ATMs), debit cards, point-of-sale (POS)
terminals, home banking, and telephone bill-paying services.

 Wholesale Payment Systems

Wholesale payment systems are also called Large Value Payment Systems. Large -
value funds transfer systems are usually distinguished from retail funds transfer
systems that handle a large volume of payments of relatively low value. The
average size of transfers through large value funds transfer systems is substantial
and the transfers are typically more time critical.
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 There are two types of wholesale payment systems – net settlement systems and
gross settlement systems. Large Value funds transfer systems can also be classified
according to the timing (and frequency) of settlement. Systems can in principle be
grouped into two types - designated time (or deferred) settlement systems and real-
time (or continuous) settlement systems, depending on whether they settle at pre -
specified points in time or on a continuous basis.

 Net Settlement Systems

In a net settlement system, the settlement of funds transfers occurs on a net basis
according to the rules and procedures of the system. A participating bank's net
position is calculated, on either a bilateral or a multilateral basis, as the sum of the
value of all the transfers it has received up to a particular point in time minus the
sum of the value of all the transfers it has sent. The net position at the settlement
time, which can be a net credit or debit position, is called the net settlement
position.

 Gross Settlement System

In a gross settlement system, on the other hand, the settlement of funds occurs on a
transaction by transaction basis, that is, without netting debits against credits.

 Designated Time Settlements

Designated time (or deferred) settlement system is one in which final settlement
occurs at one or more discrete, pre specified settlement times during the processing
day. Designated time settlement systems in which final settlement takes place only
once, at the end of the processing day, are called end of day settlement systems.
Currently, net settlement systems for large value transfers are typically end of day

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 Net settlement systems that settle the net settlement positions by means of transfers
of central bank money from net debtors to net creditors.

In some countries, there are systems in which the final settlement of transfers
occurs at the end of the processing day without netting the credit and debit
positions - on a transaction by transaction basis or on the basis of the aggregate
credit and aggregate debit position of each bank. Such systems are often called end
of day gross settlement systems.

 Real time Settlement Systems

A real time (or continuous) settlement system is defined as a system that can effect
final settlement on a continuous basis during the processing day.

 Retail Payment Systems

Retail payment systems are also called small value payment systems.
An important emerging mechanism for enabling small-value payment systems is
electronic money. Electronic money is a payment mechanism that is a direct
substitute for traditional cash; value is transferred electronically to pay for goods
and services at vending machines, retail establishments, over networks, or through
direct person-to-person exchanges.

Electronic money offers some features that make it an attractive alternative over
other payment mechanisms. Electronic money does not have to be designed to
faithfully emulate all the properties of paper cash. It can be implemented to
preclude some features of paper cash, such as complete anonymity, while including
other desirable attributes of paper cash, such as full divisibility, assignment of
limits and constraints, and links to the current owner.
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 The following are some types of electronic money available over the net
worldwide.

 First Virtual
The account is set up by phone using a traditional credit card number and a First
Virtual account number is issued. Clients provide their credit card numbers to First
Virtual over the phone or other non-Internet method, and are issued a personal
account number to make purchases over the Internet. This payment mechanism
allows the user to order goods online and then charges the user's credit card
company on behalf of the online merchant. The merchant reports the transaction
amount with the First Virtual account number. First Virtual then confirms the
purchase with the customer via email. No special software is required for either
purchaser or merchant.

 DigiCash
David Chaum, a mathematician and privacy expert, founded DigiCash. This
provider creates e-cash, proprietary electronic cash tokens, which are marketed as
being the equivalent of cash. An account is established at a DigiCash-licensed bank
with real money. Once established, the customer can withdraw e-cash that is stored
on the user computer's hard drive. Using proprietary software, e-cash can be spent
with an Internet merchant or with anyone else whose computer is set up to deal in
e-cash. Using public-key cryptography, the digital tokens are said to be secure and
can be registered and verified by the issuer without revealing to whom it was
originally issued. In effect, these digital cash transactions are capable of being as
anonymous as cash. No transaction confirmations are necessary, meaning the
merchant can immediately ship the product.

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 CyberCash
This payment mechanism consists of a downloadable software package using
public-key encryption that is designed to assure the security of credit card
transactions over the Internet. The system protects the customer's authentication
data. An account is set up and acts as an Internet front end to any existing credit
card that is designated. When a purchase is made, proprietary software is used that
sends the purchase and account information in encrypted form to the account
provider. The provider in turn sends the information to the appropriate financial
organization for processing.

 NetCash
This concept is similar to e-cash, except that it does not require any special
software to use. NetCash is transmitted across the Internet using an encryption
scheme known as PGP (pretty good privacy). To get NetCash, a party must send a
check or money order to the company's headquarters. The company returns
electronic coupons via e-mail.

 NetChex
This payment mechanism is similar to CyberCash for checking accounts.

 Millicent
The Millicent method is developed by Digital Equipment Corporation (DEC) to
manage small and smallest payments (e.g. payment for getting information from
the Internet about news and stock quotations or payment for small programs like
Java-applets)

28
 The customer buys a broker scrip with a defined value by using his credit card or
by debiting a suitable bank or broker account. Such scrip is like a telephone card.
At the time of purchase the customer exchanges parts of the scrip into a dealer's
scrip. This scrip is then send to the dealer. The dealer collects all scrips and
exchanges them into "real" money.

 Electronic Checking Accounts

Several organizations and coalitions of organizations have been trying to create
ways of using existing checking accounts over the Internet. In most of those
efforts, the consumer uses his or her checking account with a bank or service and
then draws down those funds using special electronic checks and digital signatures.
Generally, those programs are not as close to a major commercial introduction as
are those based on credit cards or electronic scrip. Many observers feel that
electronic checks, despite a slow start, could become a widely used method for
making payments.

 Credit Cards
The credit card is usually a four-party card which involves two banks in each
transaction, the cardholder's bank (the issuer of the card) and the retailer's bank.
The retailer hands over the credit card slips to its own bank for payment, less a
discount, typically about 2-3%. The retailer's bank then passes the slips on to a
clearing system. The clearing system presents each slip for payment to the bank
that issued the card on which it was written. The issuing bank collects from the
cardholder. All of these exchanges are now done by wire.

29
 Debit Cards
With a debit card, the payment comes right out of your checking account. The card
is issued by the entity that holds your money on deposit, probably a bank, but
possibly a money market fund. When you present your card, money is transferred
from your account to the merchants account that day.

 Stored Value Card Scheme or Smart Cards

Smart card technology represents a real change in how and where information is
processed. The smart card is a credit card-sized payment mechanism with an
integrated circuit chip embedded within the card. The embedded chip enables the
card to contain significant amounts of data including prepaid stored value. The
embedded chip can also hold programs that interact with data either contained on
the chip or external to the chip. These programs can be permanent and
unchangeable or can be modified when the card is connected to a network. Data
can be stored, updated, and retrieved both when the card is issued and throughout
its life. However, because of the embedded chip, the smart card operates as a stand
alone payment mechanism--in effect, a direct substitute for cash--without requiring
online network connections. This stored value can be accessed and altered by
terminals at a merchant's establishment or at remote locations. A consumer with a
smart card can go to a bank or ATM and have the card loaded with a certain
amount of value. The consumer can then proceed to make purchases, up to the
amount of stored value, in the same manner as if currency were being used. At
each terminal, the device reads the smart card to determine that there is sufficient
value available and deducts the amount of the transaction. When the card's value
has been exhausted, the consumer can return to the bank or ATM to replenish the
value.

30
 The strength of this scheme is that it avoids the need to identify the user and access
the user's bank account or credit card in order to verify funds availability because
the only funds available are those that are on the card. This eliminates the problem
of retailers who are reluctant to accept payment by check due to concerns about
funds availability.

 Mondex
Mondex is owned by Master Card and National Westminster Bank of London and
is being tested in several countries. Mondex uses a smart card to store electronic
cash that can be used to pay for goods and services in the same way as cash but
with some key benefits over traditional cash.

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7.1 BENEFITS OF E-BANKING

Consumers are embracing the many benefits of Internet banking.

The following are a few advantages that e-banking gives to customers:

• Consumers can use their computers and a telephone modem to dial in from
home or any site where they have access to a computer.

• The services are available seven days a week, 24 hours a day.

• Transactions are executed and confirmed quickly, although not

instantaneously. Processing time is comparable to that of an ATM
transaction.

• In general, the customer will find lower fees and higher interest rates for
deposits due to the reduced cost of operating online and not needing
numerous physical bank branches.

• And the range of transactions available is fairly broad. Customers can do

everything from simply checking on an account balance to applying for a
mortgage.

• The interface is very user-friendly and often intuitive. Additionally, business

customers will most likely use the Internet for more than cash management,
and they will be accustomed to a similar "look and feel" among all
applications that they use.

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BENEFITS TO THE BANK

Why should a bank ‘bank online’? Advantages previously held by large financial
institutions have shrunk considerably. The Internet has leveled the playing field
and afforded open access to customers in the global marketplace. Internet banking
is a cost-effective delivery channel for financial institutions.

The bank has an opportunity to generate revenue, decrease operational and

transactional costs, increase productivity, and attract new customers.

Ability to increase Revenue

Financially, the bank can benefit a great deal from providing their customers with
an online banking service. The bank has the ability to increase revenue by
generating user and transaction fees for the use of a bill payment product and has
the option of charging an account access fee for the use of the online system.
Online banking provides an excellent promotional opportunity to generate revenue
by helping the bank to cross-sell products such as credit cards, loans, certificate of
deposits, and other financial services.

Save Money
In addition to making money, the bank can save money with an Internet banking
system. Online banking can actually decrease operating costs by reducing the daily
reproduction and distribution of paper-drawn transactions and delivering and
processing statements for accounts, credit cards, and bills. Performing transactions
via the Internet also provides cost savings, as indicated by a study done by Booz,
Allen & Hamilton that shows a transaction over the phone costs $.54, at an ATM it

33
costs $.27 and via the Internet the cost is $.01. Using the Internet to perform
transactions greatly reduces the cost to the bank.

Improves Productivity
Internet banking improves productivity as well. Bank representatives are able to
process data more quickly and efficiently; track account activity with automated
reports, help customers achieve daily tasks via the Internet, and reduce time spent
handling service problems. There can be a dramatic reduction in the number of
customer service calls, as some banks that are providing this service has proven.

Marketing & Competitive Tool

Internet banking also offers the bank an exceptional marketing and competitive
tool. Large banks such as Nations Bank and Wells Fargo, in the United States, have
already capitalized on the Internet as a mechanism to attract new customers. The
majority of people using the Internet are middle to high income and polls indicate
that 50% of the people online are either in professional or managerial positions.
These people are also the ones who want to have the convenience of online
banking for home or business use. This is an excellent opportunity for the
community bank to keep their hometown customers from looking to national
institutions for an online product.

Innumerable services are available via the Internet today. Internet banking provides
a higher level of convenience that both commercial and retail customers desire to
have. With this service, the bank not only has the opportunity to manage their
business better, but can also help their customers achieve a much more efficient
process of managing their finances.

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8.1 DISADVANTAGES OF E-BANKING

The most obvious disadvantage is: Technophobes need not apply i.e. if you are still
not comfortable using a computer, e-banking is not for you.

The other disadvantages are:

 Investment of time upfront can be formidable. The data entry is necessary before

the numbers can be massaged and money managed successfully. Online bill
payment is an example of an effort that requires setting up which leads to
ultimate convenience.

 Switching software or banks can mean re-entry of data, although Internet-based

systems are less impacted by this. But competition seems to be minimizing this
problem. The personal finance management software Microsoft Money enables
users of competing software to import data easily.

 Like anything that deals with the transfer of large amounts of money, security is

a major factor of Online Banking. It is taken very seriously during Online

Banking procedures.

With a system as complex as Online Banking, some errors are inevitable. i.e.: An
interrupted online session; late arrival of payments etc. A mistake made by either
the user or the bank in question, can affect both, causing problems. For Example:
An 'Infinity' (ICICI’s Online Banking Brand name) customer from Bangalore (who
did not want to be named) paid his cell phone bill through the bank, only to receive
35
another bill the following month, with late fees. The amount had been debited from
his account but not passed on to the cellular operator.

 When dealing with computers, there is always the concern of the system

crashing, viruses entering the system or a power cut. These are larger problems
and are not as easily solved. In all three cases, many people would be affected,
information may be lost and a back-up plan would have to be initiated.

 Need an account with an Internet Service Provider (ISP)

36
9.1 CHALLENGES FOR INDIAN E-BANKS

The challenges that Indian banks are facing are:

1. How to manage multiple distribution channels?
Internet banking is bound to become the most important channel in next few years.
Even the traditional banking would move towards Internet technology with open
standards and low cost. Although all traditional channels would not die down in a
day and success would depend on how the banks generate synergy in these two
vastly different channels. The services provided in all types of distribution channels
must be in tandem with each other and must be in synergy.

2. How to address the issue of internationalization i.e. how to take in and make e-
banking an integral part of one's attitudes or beliefs?
The real challenge for Internet banking is to penetrate the customer base of banks.
According to IDBI Bank’s head (e-commerce and new product initiatives) J
Venkataramanan, the maximum usage of Internet banking is for accessing account
balances and making bill payments. For most customers, there's nothing more
reassuring than watching their cheques getting credit on a paper ledger. Then, there
is the question of how real is real time. For instance, while you can requisition for,
say, a new set of cheques any time of the day, the request will get processed only
during the banking hours.

Perhaps, the biggest of all concerns for e-banking customers is the security issue.
People still aren't comfortable having information about their life's hard-earned
money saved on a server they don't know about. A physical pass-book is still
preferred. While e-bankers use multiple firewalls, filtering routers, 128-bit

37
encryption and digital certification for safe and confidential transactions, there are
still chances of a snafu.

Another problem is that an on-line service that merely mimics an off-line one
doesn't give customers an adequate inducement to move a significant portion of
their banking on-line. As a result, most customers tend to treat on-line banking as
no more than an extra channel to check their balances and transaction histories, and
they continue to do the rest of their business at the ATM or the teller window. A
vicious cycle ensues.

Also, there is no more security and customer loyalty. With Internet, the gateway to
low cost international expansion around, tackling the virtual competition would be
a key. Competition is just a ‘click’ away. Customers would be loyal as long as the
rates offered are competitive.

At the same time, banks would have to manage different product portfolios, at
different yet competitive prices to different corporates across the world. The issue
of offering services in multiple geographies / customers – due to increased global
access and competition may ask for new virtual alliances between small local
banks and the global players.

3. How to address the emergence of value-focused specialist competitors that are

competing for specific value components currently dominated by banks and now
are increasingly gaining access to the bank’s customers?
The real trouble is that Internet Bank doesn’t really need to be a bank. It can
Even be a group of innovative persons with no bank branch at all, just working
Through alliances and leading the field because of their superior capabilities
38
Through focus and innovation advantage.

The entry of multiple non financial institutions and other non-traditional players
would just fasten this whole process. E.g. Times Bank and IDBI Bank.

39
10.1 STRATEGY FOR INDIAN BANKS

Internet banking would drive us into an age of creative destruction due to non-
physical exchange, complete transparency giving rise to perfectly electronic market
place and customer supremacy. The question to be asked right now is "What the
Indian Banks should do"?

Most banks today are pursuing what might be described as a ‘fortress’ strategy,
defending themselves against new entrants while waiting for more clarity in the
online world. The fortress strategy has the benefit of relying on traditional sources
of advantage; it plays to the strengths of current legacy banks. The risk, of course,
is that these sources of advantage may not be enough to keep out new entrants that
rely on a totally different business model.

Banks must today at least hedge by experimenting with the web business model.
But it calls for profound organizational changes if it is to be executed successfully.
It needs the banks to fundamentally re-assess their opportunities for adding value
and hence re-define their roles in the new paradigm.

Banks must first determine what kind of web to target. Customer webs focus on
maximizing a bank’s share of wallet of a target customer segment while Market
webs seek to aggregate a critical mass of buyers and sellers within one transaction
category.

Within any web that it might target, there are a number of possible roles a bank
could play. Web shapers are the one or two companies that own a shaping
platform, take initiative to mobilize other companies around it, and define a set of
40
standard practices or policies to coordinate participant’s activities. Banks that
choose not to be Web shaper would be adapters and would need to define a clear
niche that will help them differentiate themselves from other participants. Some
adapters may become influencers, working closely with shapers to ensure the
overall success of their web.

Indian banks still have a few important lessons in customer service that they would
do well to pay heed to.

 Customer Relationship
Banks and other financial institutions cannot go completely virtual - they need
physical branches after all. This is probably one area where Internet banking in
India scores over the 'stand alone' Internet banks of the West. Several Internet
banks like E-trade have acquired ATM networks like Card Capture Services to
offer consumers a way to deposit and access their money through ATMs.

Physical branches help forge a 'relationship' with the customer that a virtual bank
cannot. Although most online consumers utilise account tracking, bill pay and e-
shopping, they would prefer direct, personal contact with their banker when
shopping for financial products.

 Personalisation
Banking solutions become truly personalised when they are able to respond to the
changing customer needs, and this is possible using strong data mining and target
marketing capabilities.

41
For example, software that might tell you which credit card balance to pay off first,
or alert you in advance when your cheque will bounce. This level of
personalisation is still lacking in the banking solutions offered by Indian banks.

 Integration
Another important aspect is integrating customer service interfaces and channels,
so that the customer deals with a single channel that caters to diverse needs such as
kiosks, ATMs, Web TV, mobile phones, pagers, and branch counters. Banks have
to get their acts together. If the SmartCards, and the Online Banking, and the
ATM's, and the Branches don't work together, there's no real benefit in having the
electronic tools.

Customers shouldn't have to go to one site to just pay their utility bill and phone
bill and then have to go offline to pay their cable and credit card bills. They should
be able to check the value of their investment portfolio, updated daily, in their
personal balance sheet, include all their other assets and other personal finance.

Banks must learn to aggregate their customers' different on-line financial-services

relationships. The purpose of aggregation is not to engage in blatant cross-selling
or to achieve "100 percent share of wallet" but rather to develop a picture of the
consumer's entire balance sheet. Any institution that gains such a view can provide
superior convenience and advice.

Banks need to be 'one-stop shops' for an entire range of personal finance products-
from loans and insurance to mutual funds and even tax-saving instruments. This is
being done by 'account aggregators' such as Yodlee, Corillian, eBalance and
VerticalOne that let you log in to one Web site, enter your username and password,
42
and track information as diverse as bank and credit-card balances, value of
investments, and frequent-flier miles from several sites, each of which has its own
username and password.

 Innovation
Today's value-added product could easily be tomorrow's commodity. That is why
banks would need to depend more on product innovation, expanding the range of
their products and service offerings. Apart from just online accounts, e-banks
would need to tailor specific products for the Internet, like online bill presentment
or credit cards with instant online approval. Many Internet banks like Egg have
taken the lead in offering innovative products like Egg card - a credit card that
features an introductory zero-percent interest rate.

 Migrate old customers and go after new ones

In building an on-line business, a bank's off-line customer base is a huge asset, for
it will be harder for competitors to pick off the bank's current customers than for
the banks to get them on-line. But to do so, banks must make one-time offers and
then constantly provide incentives such as free services (for example, bill payment
and on-line trades) for increased balances.

Banks must also move swiftly to acquire new on-line customers. Most of the early
attempts to do so, carried out in partnership with Internet portals, have flopped-
largely because the banks failed to offer any differentiation in pricing or any other
very compelling lure. Yet here, too, banks have an advantage. Despite significant
increases in revenue from on-line relationships, credit card companies and
brokerage firms have spent so much money building their on-line customer base
that some would question whether they will ever profit from these efforts. Most
43
banks already have a powerful retail distribution network that should allow them
both to migrate their customers and to acquire new ones at much lower cost.

Banks will have to reinvent their role and the way they deliver value-leveraging
new technology as well as their existing assets-to remain their customers' financial
institution of choice.

44
11.1 WHERE IS E-BANKING IN INDIA HEADED?

There will be a large-scale shift to online banking in the next decade as banks go
the extra mile in technology developments to keep up with the competition It is
believed the low transaction cost will make banking on the Net irresistible, but also
that this will require institutions to carefully consider and plan customer relations
programs.

It is believed that everything will be determined by content and context, and where
execution will be key. From a customer and service provider perspective, this is
where the world is moving-it is going to be real-time, on-line, personalisation for
both marketing and the service experience. If existing banks don't want to
disappear, it is this challenge that they need to embrace in order to win and survive.

Internet usage is expected to grow with cheaper bandwidth cost. The Department
of Telecommunications (DoT) is moving fast to make available additional
bandwidth, with the result that Internet access will become much faster in the
future. This is expected to give a fillip to Internet banking in India.

The setting up of a Credit Information Bureau for collecting and sharing credit
information on borrowers of lending institutions online would give a fillip to
electronic banking. The recommendations of the Vasudevan Committee on
Technological Up gradation of Banks in India have also been circulated to banks
for implementation. In this background, banks are moving in for technological up
gradation on a large scale. Internet banking is expected to get a boost from such
developments. Other major developments will be:

45
Inter Bank Fund Transfers
Today, e-banking operations mainly consist of providing information viz.
requesting check books, statements, fund transfer, even online share trading (with
reference to a particular branch) but the next two or three years are likely to see a
huge change in the entire banking value chain. It would be possible to process any
inquiry or transaction online without any reference to the branch at any time rather
like 'anywhere banking' - a service already being offered by HDFC, ICICI and
Citibank.

Interbank fund transfers between different banks are a feature that is not offered by
any of the e-banking services in India. "At present, we have no plans to offer third-
party transfer outside the bank. Globally, this is not allowed due to security
reasons. Also, the other banks also have to allow transfer/debit of funds into/out of
their NetBanking system. According to HDFC, the RBI needs to set up a
clearinghouse to route these transfers, and thus enable such transactions.

M-Banking
Today, with mobile being the 'in-thing', banks are not far behind to position
themselves for this new medium to ring in customers and convenience. Most of
them are talking about helping people access information of their accounts and
even do transactions while on the move-calling this M-banking (mobile banking).

Almost all major banks have SMS-enabled mobile banking. The use of WAP-based
applications for Internet banking is an increasing trend especially in the Asia
Pacific region, though it doesn't seem likely that it will catch on in India given the
miniscule populace of WAP-enabled phone users.

46
"We have plans to offer WAP-enabled FedNet soon" says Nair of Federal Bank.
"WAP-enabled banking will become popular and affordable to a larger number of
users if the cost of the devices drops and airtime tariff come down."

Account Aggregation
A new wave called 'Account Aggregation' is slowly sweeping through the online
banking/brokerage industry. Account aggregation -- or account consolidation --
provides consumers with the ability to access the information about all of their
financial transactions sourced from different web sites, at a single web site.

Now you can obtain updates of all of your investments (from banks, mutual funds,
online brokers), and liabilities (car loans, credit card loans, bank loans) at a single
point. That way you don't need to remember multiple login IDs, and passwords,
and also don't need to consolidate this information yourself. Further, at the same
site you shall be able to get 'payment due' reminders, online payment services and
even query your transactions to find, say how much you spent on entertainment last
year. They could also provide you with e-mail, book your airline tickets and more.

True Relationship Banking

The future will provide the bank with the ability to allow account access and
control privileges at the customer level. This means that all accounts in a
relationship will be accessible via the Internet while only a subset of these accounts
will be viewable and accessible for a third party (such as son or daughter who is
away at school). It allows your tax consultant to view accounts in your relationship
pertinent to performing their service. And, business customers will see their entire
commercial relationship bank.

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Integration
Service Providers will integrate and market their offerings across different
channels. The strategic and executional battles of the future are going to be fought
for Channel Integration.

The beauty of integration is that one channel does not displace another. They feed
on each other to create incremental value for the customer, as well as the
institution. The incremental value comes from two distinct sources. Firstly, you
reduce inefficiencies. You don't send people junk mail because you know that they
are not likely to buy a particular product or service today. That results in net saving
for the economy. Secondly, you persuade people at the right time (the right time
from the customer's perspective, not from the service provider's perspective) to opt
for a tailor made offering. This too increases value. Actually, this has to do with the
Internet itself, and more to with the underlying technologies of the Internet which
allow incremental efficiency, and empowers the customer to make more
enlightened and timely choices.

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12.1 VARIOUS RISK IN E-BANKING

 Strategic Risk

On strategic risk E-banking is relatively new and, as a result, there can be a lack of
understanding among senior management about its potential and implications.
People with technological, but not banking, skills can end up driving the initiatives.
E-initiatives can spring up in an incoherent and piecemeal manner in firms. They
can be expensive and can fail to recoup their cost. Furthermore, they are often
positioned as loss leaders (to capture market share), but may not attract the types of
customers that banks want or expect and may have unexpected implications on
existing business lines.

Banks should respond to these risks by having a clear strategy driven from the top
and should ensure that this strategy takes account of the effects of e-banking,
wherever relevant. Such a strategy should be clearly disseminated across the
business, and supported by a clear business plan with an effective means of
monitoring performance against it.

Business risks

Business risks are also significant. Given the newness of e-banking, nobody knows
much about whether e-banking customers will have different characteristics from
the traditional banking customers. They may well have different characteristics –
eg I want it all and I want it now. This could render existing score card models
inappropriate, thus resulting in either higher rejection rates or inappropriate pricing
to cover the risk. Banks may not be able to assess credit quality at a distance as
effectively as they do in face to face circumstances. It could be more difficult to

49
assess the nature and quality of collateral offered at a distance, especially if it is
located in an area the bank is unfamiliar with (particularly if this is overseas).

Furthermore as it is difficult to predict customer volumes and the stickiness of e-

deposits (things which could lead either to rapid flows in or out of the bank) it
could be very difficult to manage liquidity.

Of course, these are old risks with which banks and supervisors have considerable
experience but they need to be watchful of old risks in new guises. In particular
risk models and even processes designed for traditional banking may not be
appropriate.

 Operations risk

Banks face three main types of operations risk:

• volume forecasts
• management information systems and
• Outsourcing.
Accurate volume forecasts have proved difficult - One of the key challenges
encountered by banks in the Internet environment is how to predict and manage the
volume of customers that they will obtain. Many banks going on-line have
significantly misjudged volumes. When a bank has inadequate systems to cope
with demand it may suffer reputational and financial damage, and even
compromises in security if extra systems that are inadequately configured or tested
are brought on-line to deal with the capacity problems.

As a way of addressing this risk, banks should:

50
 • undertake market research,
• adopt systems with adequate capacity and scalability,
• undertake proportionate advertising campaigns, and

• Ensure that they have adequate staff coverage and develop a suitable
business continuity plan.
In brief, this is a new area, nobody knows all the answers, and banks need to
exercise particular caution.

The second type of operations risk concerns management information systems.

Again this is not unique to E-banking. I have seen many banks venture into new
areas without having addressed management information issues. Banks may have
difficulties in obtaining adequate management information to monitor their e-
service, as it can be difficult to establish/configure new systems to ensure that
sufficient, meaningful and clear information is generated. Such information is
particularly important in a new field like e-banking. Banks are being encouraged
by the FSA to ensure that management have all the information that they require in
a format that they understand and that does not cloud the key information with
superfluous details.

Finally, a significant number of banks offering e-banking services outsource

related business functions, e.g. security, either for reasons of cost reduction or, as is
often the case in this field, because they do not have the relevant expertise in-
house. Outsourcing a significant function can create material risks by potentially
reducing a bank’s control over that function. Outsourcing is of course neither new
nor unmanageable but banks should be mindful of the FSA’s guidance on
outsourcing, which addresses these risks.

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 Security Risk

Security issues are a major source of concern for everyone both inside and outside
the banking industry. E-banking increases security risks, potentially exposing
hitherto isolated systems to open and risky environments. Both the FSA and banks
need to be proactive in monitoring and managing the security threat.

Security breaches essentially fall into three categories; breaches with serious
criminal intent (e.g. fraud, theft of commercially sensitive or financial
information), breaches by ‘casual hackers’ (e.g. defacement of web sites or ‘denial
of service’ - causing web sites to crash), and flaws in systems design and/or set up
leading to security breaches (e.g. genuine users seeing / being able to transact on
other users’ accounts). All of these threats have potentially serious financial, legal
and reputational implications.

Many banks are finding that their systems are being probed for weaknesses
hundreds of times a day but damage/losses arising from security breaches have so
far tended to be minor. However some banks could develop more sensitive "burglar
alarms", so that they are better aware of the nature and frequency of unsuccessful
attempts to break into their system.

The most sensitive computer systems, such as those used for high value payments
or those storing highly confidential information, tend to be the most
comprehensively secured. One could therefore imply that the greater the potential
loss to a bank the less likely it is to occur, and in general this is the case. However,
while banks tend to have reasonable perimeter security, there is sometimes
insufficient segregation between internal systems and poor internal security. It may
be that someone could breach the lighter security around a low value system, e.g. a

52
bank’s retail web site, and gain entry to a high value system via the bank’s internal
network. We are encouraging banks to look at the firewalls between their different

Systems to ensure adequate damage limitation should an external breach occur. As

ever though, the greatest threat so far has been from the enemy within – ie your
own employees, contractors and so on.

It is easy to overemphasise the security risks in e-banking. It must be remembered

that the Internet could remove some errors introduced by manual processing (by

Increasing the degree of straight through processing from the customer through
banks’ systems). This reduces risks to the integrity of transaction data (although the
risk of customer’s incorrectly inputting data remains). As e-banking advances,
focusing general attention on security risks, there could be large security gains.

So what should banks be doing? Our view is that to deal with these emerging
threats effectively, financial institutions need as a minimum to have:

a strategic approach to information security, building best practice security controls

into systems and networks as they are developed

a proactive approach to information security, involving active testing of system

security controls (e.g. penetration testing), rapid response to new threats and
vulnerabilities and regular review of market place developments

Sufficient staff with information security expertise

Active use of system based security management and monitoring tools

Strong business information security controls

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These are the issues line supervisors will be raising with their banks as part of their
on-going supervision; or, for new applicants, will need to be given adequate
assurances about.

 Reputational risks

Finally, with regard to risks, I would mention reputational risk. This is

considerably heightened for banks using the Internet. For example the Internet
allows for the rapid dissemination of information which means that any incident,
either good or bad, is common knowledge within a short space of time. Internet
rumours can easily become self-fulfilling prophecies. The speed of the Internet
considerably cuts the optimal response times for both banks and regulators to any

Incident. Banks must ensure their crisis management, particularly PR, processes
are able to cope with Internet related incidents (whether they be real or hoaxes).

Any problems encountered by one firm in this new environment may affect the
business of another, as it may affect confidence in the Internet as a whole. There is
therefore a risk that one rogue e-bank could cause significant problems for all
banks providing services via the Internet. This is a new type of systemic risk and is
causing concern to e-banking providers. Overall, the Internet puts an emphasis on
reputational risks. Never before has the bank’s shop window (ie its site) been so
important.

One last reputational risk will be familiar to us all. That is whether the products
being sold over the net are being marketed in such a way that the bank will be
protected against future charges of mis-selling. As in the physical, so in the virtual
world. Banks need to be sure those customers’ rights and information needs are
adequately safeguarded and provided for.

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 COMPLIANCE AND LEGAL RISK

Compliance and legal issues arise out of the rapid growth in usage of e-banking
and the differences between electronic and paper-based processes. E-banking is a
new delivery channel where the laws and rules governing the electronic delivery of

Certain financial institution products or services may be ambiguous or still

evolving. Specific regulatory and legal challenges include:

Uncertainty over legal jurisdictions and which state’s or country’s laws govern a
specific e-banking transaction,
Delivery of credit and deposit-related disclosures/notices as required by law or
regulation,
Retention of required compliance documentation for on-line advertising,

applications, statements, disclosures and notices; and

Establishment of legally binding electronic agreements.

Laws and regulations governing consumer transactions require specific types of

disclosures, notices, or record keeping requirements. These requirements also apply
to e-banking, and federal banking agencies continue to update consumer laws and
regulations to reflect the impact of e-banking and on-line customer relationships.
Some of the legal requirements and regulatory guidance that frequently apply to e-
banking products and services include:

Solicitation, collection and reporting of government monitoring information on

applications and loans, as required by Equal Credit Opportunity Act (Regulation

and Home Mortgage Disclosure Act (Regulation C) regulations;

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 Advertising requirements, customer disclosures, or notices required by the Real
Estate Settlement Procedures Act (RESPA), Truth in Lending (Regulation Z),
and Truth In Savings (Regulation DD) and Fair Housing regulations;
Proper and conspicuous display of FDIC or NCUA insurance notices;

Conspicuous webpage disclosures indicating that certain types of investment,

brokerage, and insurance products offered have certain associated risks,
including not being insured by federal deposit insurance (FDIC or NCUA);
Customer identification programs and procedures, as well as record retention and
customer notification requirements, required by the Bank Secrecy Act;
Customer identification processes to determine whether transactions are
prohibited by the Office of Foreign Asset Control (OFAC) and, when necessary,
whether customers appear on any list of known or suspected terrorists or terrorist
organization provided by any government agency;

Delivery of privacy and opt-out notices by hand, by mail, or with customer

acknowledgement of electronic receipt;
Verification of customer identification, reporting, and record keeping
requirements of the Bank Secrecy Act (BSA), including requirements for filing a

suspicious activity report (SAR); and

Record retention requirements of the Equal Credit Opportunity Act (Regulation
B) and Fair Credit Reporting Act regulations.

Institutions that offer e-banking services, both informational and transactional,

assume a higher level of compliance risk because of the changing nature of the
technology, the speed at which errors can be replicated, and the frequency of
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regulatory changes to address e-banking issues. The potential for violations is
further heightened by the need to ensure consistency between paper and electronic
advertisements, disclosures, and notices. Additional information on compliance
requirements for e-banking can be found on the agencies’ websites and in
references contained in appendix C.

13.1 MITIGATION OF E-BANKING RISK

 Board and Management Oversight

Because the Board of Directors and senior management are responsible for
developing the institution's business strategy and establishing an effective
management oversight over risks, they are expected to take an explicit, informed
and documented strategic decision as to whether and how the bank is to provide e-
banking services. The initial decision should include the specific accountabilities,
policies and controls to address risks, including those arising in a cross-border
context. Effective management oversight is expected to encompass the review and
approval of the key aspects of the bank's security control process, such as the
development and maintenance of a security control infrastructure that properly
safeguards e-banking systems and data from both internal and external threats. It
also should include a comprehensive process for managing risks associated with
increased complexity of and increasing reliance on outsourcing relationships and
third-party dependencies to perform critical e-banking functions.

 Security Controls

While the Board of Directors has the responsibility for ensuring that appropriate
security control processes are in place for e-banking, the substance of these
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processes needs special management attention because of the enhanced security
challenges posed by e-banking. This should include establishing appropriate
authorisation privileges and authentication measures, logical and physical access
controls, adequate infrastructure security to maintain appropriate boundaries and
restrictions on both internal and external user activities and data integrity of
transactions, records and information. In addition, the existence of clear audit trails

For all e-banking transactions should be ensured and measures to preserve

confidentiality of key e-banking information should be appropriate with the
sensitivity of such information.

Although customer protection and privacy regulations vary from jurisdiction to

jurisdiction, banks generally have a clear responsibility to provide their customers
with a level of comfort regarding information disclosures, protection of customer
data and business availability that approaches the level they can expect when using
traditional banking distribution channels. To minimise legal and reputational risk
associated with e-banking activities conducted both domestically and cross-border,
banks should make adequate disclosure of information on their web sites and take
appropriate measures to ensure adherence to customer privacy requirements
applicable in the jurisdictions to which the bank is providing e-banking services.

 Legal and Reputational Risk Management

To protect banks against business, legal and reputation risk, e-banking services
must be delivered on a consistent and timely basis in accordance with high

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customer expectations for constant and rapid availability and potentially high
transaction demand. The bank must have the ability to deliver e-banking services to
all end-users and be able to maintain such availability in all circumstances.
Effective incident response mechanisms are also critical to minimise operational,
legal and reputational risks arising from unexpected events, including internal and
external attacks that may affect the provision of e-banking systems and services.

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