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CHAPTER 3 TECHNOLOGY IN BANKING: E-MONEY, E-BANKING, AND E-COMMERCE LEARNING OBJECTIVES To understand … Bank technology in term of e-money, e-banking, and e-commerce How e-commerce affects the set-of-contracts theory of the firm and the similarities between banks and communications firms

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CHAPTER 3

TECHNOLOGY IN BANKING:

E-MONEY, E-BANKING,

AND E-COMMERCE


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LEARNING OBJECTIVES

  • To understand …

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

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

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


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LEARNING OBJECTIVES (continued)

  • To understand …

    • The components of EFT as ACHs, ATMs, and POSs

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


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CHAPTER THEME

  • This chapter focuses on the information-processing and e-delivery aspects of banking from a technological perspective.

  • Innovations related to information technology (the I in TRICK) have paved the way for e-money, e-banking, and e-commerce.

  • EFTS and Internet banking are the delivery vehicles of the 21st century.


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ARE BANKS DINOSARUS?

Yes

No

Maybe


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Banks Are Dinosaurs

“Technology in the Workplace” Study Criteria

  • Has the industry made use of technological advances in a timely manner?

  • Did it participate in or encourage the development of new technologies?

  • Has the industry improved its competitive standing, efficiency, or profitability?

    Banking’s Grade = C-


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BANKS ARE NOT DINOSAURS

Technological Innovations:

  • E-Money

  • E-Banking

  • E-Commerce

  • Electronic Funds Transfer Systems



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THE SET OF CONTRACTS THEORY OF THE FIRM

  • Theory from Jensen and Meckling (1976)

  • Basic idea is to think about the various groups that have claims on the firm’s assets/cash flow

  • Narrow view suggests only two claimants: Owners and creditors


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SET-OF-CONTRACTS THEORY(continued)

  • Broader view has many claimants including employees, tax collectors, society, suppliers, customers, and regulators.

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


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THREE IMPORTANT WEB CONCEPTS

  • Business-to-Customers (B2C)

  • Business-to-Business (B2B)

  • Business-to-Employees (B2E)

  • To which we can add,

    • Banks-to-Regulators (B2R)


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INFORMATION TECHNOLOGY AND TRICK

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

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

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

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


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ClaimantExample

Shareholders E-voting

Creditors E-reports

Supplier/distributor E-orders

Customers E-orders

Employees E-mail

Regulators/IRS E-filings

Society E-info

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


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THE EVOLUTION OF MONEY

CONCRETE

(animals, hides, trinkets, gold)

to

ETHEREAL

(electronic impulses)


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CHECKS

  • Check Volume

  • Check Imaging

  • Electronic-Check Presentment

  • Electronic-Check Conversion


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CARDS

TYPES

  • Credit Cards

  • Debit Cards

  • Smart Cards or Chip Cards

    WAYS TO BE USED

  • Face-to-Face or card present

  • Mail order / telephone order (MOTO)

  • Internet


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E-BANKING: PAYMENTS SYSTEMS

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

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

  • Point-of-Sale Terminals

  • Internet Banking


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PAY CARDS AND THE UNDERBANKED

  • A pay card

    • looks like a credit card,

    • acts like a debit card, and

    • permits customers to receive electronic payments,

      • but it is not tied to a conventional bank account

  • Pay cards are marketed through

    • employers that offer direct deposit and to

    • parents for teens


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WIRE-TRANSFER SYSTEMS

CHARACTERISTICS:

  • High-dollar value of average transfers

  • Real-time settlement

  • A widely distributed network of users

    SYSTEMS:

  • Fedwire (see Figure 3-3, p. 77)

  • CHIPS (Clearing House Interbank Payment System)

  • SWIFT (Society of World Interbank Financial Telecommunications)


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Funds Transfer Service

Real-time gross settlement system

Custodial and Transfer Services

1. Safekeeping Function

2. Transfer-and-Settlement Function

FEDWIRE


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CHIPS and SWIFT

CHIPS

Clearing House Interbank Payment System

  • 95% of money moving internationally

    SWIFT

    Society of World Interbank Financial

    Telecommunications

  • Primarily Messaging


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MONEY LAUNDERERS AND TERRORIST FINANCING

  • Box 3-3 (p. 79) describes how money launderers use wire transfers

    • Aggregate funds in bank account of legitimate

  • Following 11 September 2001 great attention has been drawn to how terrorists use financial systems and underground (cash) transactions to circumvent detection

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


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E-BANKING: ATMs

  • ATM or

    • Pay $3 to deal with a Teller

  • The Numbers Game

    • 1980 < 20,000 ATMs

    • 2000 >200,000 ATMs

    • During the 1990s, ATMs grew at a rate of 10% per year

  • ATM Networks:

    • HONOR, PLUS, MAC, STAR, NYCE, MOST, & CIRRUS


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POINT OF SALE SYSTEMS

  • 53,000 in the early 1990s versus 2,000,000 in 2000

  • Why were they so slow to grow?

    • Payment habits are slow to change and customers prefer credit cards with a “grace period” or checks with “float” to debit cards

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


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INTERNET BANKING

--Andy Grove, CEO of Intel

(1996)

  • The Internet is like a 20-foot tidal wave coming, and we are in kayaks.

  • It’s been coming across the Pacific for thousands of miles and gaining momentum, and it’s going to lift you and drop you.

  • We’re just a step away from the point when every computer is connected to every other computer, at least, in the U.S., Japan, and Europe.

  • It affects everybody -- the computer industry, telecommunications, the media, chipmakers, and the software world.

  • Some are more aware of this than others.


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ELECTRONIC DATA INTERCHANGE (EDI)

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

  • Why?

    • Speed the flow of dollars and data

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


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OUTSOURCING

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

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


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TECHNOLOGY AND THE FUTURE OF COMMUNITY BANKS

Factors Contributing to the Decline of Community Banks

  • Failure to address the financial needs of baby boomers

  • Burdensome regulations that create an “unlevel playing field” favoring nonbank competitors

  • Inability to afford the high cost technology necessary to compete

  • Financial innovations such as securitization and the development of secondary markets that are transforming banking into a “pure commodity business”


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PRODUCT AND SERVICE TRENDS IN BANKING

  • Internet banking and bill-paying services

  • Cash-management services

  • Debit and chip (smart) cards

  • Upgraded branch-delivery and loan systems

  • Imaging technology

  • More efficient data storage (and greater concern about security (backup systems) in the aftermath of 11 September 2001)


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TECHNOLOGY AND THE FUTURE OF COMMUNITY BANKS

How can Community Banks Compete?

  • Invest in Niches

  • Leverage Their Core-Systems Vendors

  • Make Small Size an Advantage

  • Utilize Application Service Providers

  • Build Internal Integration Skills

  • Don’t be Penny Wise but Pound Foolish


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FINANCIAL-MANAGEMENT IMPLICATIONS OF E-BANKING

View in terms of the ROE model:

  • ROE = PM x AU x EM = ROA x EM

  • Greater efficiency => higher PM and higher ROA and ROE, ceteris paribus (other things being equal)

  • Revenue (sales) enhancement (e.g., through cross-selling) => higher AU and higher ROA and ROE, ceteris paribus

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


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BANKS AS COMMUNICATIONS FIRMS

  • They are similar in that they both:

    • Establish networking relationships through which they

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

  • Not a two-way street:

    • It is easier for communications firms to enter financial-services businesses than the other way around


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CHAPTER SUMMARY

  • Bill Gates predicts that online banking (“virtual branches”) will become the primary vehicle for delivering financial products and services

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


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