1 © 2001 Bank for International Settlements BIS-BRI-BIZ Bank for International Settlements Banque des Règlements Internationaux Banca dei Regolamenti Internazionali Bank für Internationalen Zahlungsausgleich Creating “e-finance friendly” regulatory and institutional framework Setsuya Sato Bank for International Settlements The UNCTAD Expert Meeting on finance and e-finance for SMEs 24 October 2001, Palais des Nations, Geneva
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E-finance: recent developments and policy implicationsBIS-BRI-BIZ
Bank for International Settlements Banque des Règlements
Internationaux Banca dei Regolamenti Internazionali Bank für
Internationalen Zahlungsausgleich
Creating “e-finance friendly” regulatory and institutional framework
Setsuya Sato
The UNCTAD Expert Meeting on finance and e-finance for SMEs
24 October 2001, Palais des Nations, Geneva
© 2001 Bank for International Settlements
Structure of presentation
Key risks
Implications for banks
Public trust
(1) disintermediation
lower start-up/operating costs lower barrier to entry intensify competition and increase (a threat of) disintermediation
impact more significant in sectors that rely on high-cost network of agents for distribution
entering is easy, staying is difficult
– economies of scale
(2) blurring barriers
internet de-coupled manufacturing of financial products from distribution banks can retail products they do not produce blur boundaries between banks/brokers/insurers
increasing consumer demand for personalised money management services push banks to offer products that cross financial boundaries
technology (mobile internet, digital TV) adds complexity to design and delivery of “hybrid financial services”
© 2001 Bank for International Settlements
(3) public trust
pure internet banks not very successful because of insufficient public trust
– brand marketing and customer acquisition disproportionately expensive
– even promising demographics (young, educated, wealthy, IT savvy) don’t switch to tech firms for financial products
– a “brand premium” is the best protector of established banks
“clicks-versus-bricks” “clicks-and-mortar” (multi-channel distribution) has the advantage
– pure internet banks opened physical branches (“relationship enhancers”) or acquired ATM networks
© 2001 Bank for International Settlements
(4) entry of non-banks
the need for public trust does not necessarily favour existing banks
– non-banks with customer trust and name recognition also command confidence (Sony, Volks Wagen, GE)
greater reliance on untested and sophisticated technology implies greater need for “name”
– new form of conglomerate of financial and non-financial companies
– entry of telecom companies (IT skills, extensive customer base) is the most serious threat to banks
supervisory challenges
– validity of licensing rules (fit and proper, business plans, etc)? meaning of consolidated supervision?
© 2001 Bank for International Settlements
(5) financial consolidation
internet speeds up financial consolidation, both cross-border and cross-sector
– high fixed costs + low operating costs economies of scale
– larger client list enables the provision of more diversified and profitable services
– name recognition favours big players
e-banking facilitates cross-border expansion at minimum cost
– centralized resources (staff, computing resources) for foreign e-banking can be switched between countries
– easier to retrench quickly from a virtual offering than a branch-based one
© 2001 Bank for International Settlements
(6) new business models
“aggregators” allow customers to group all financial transactions on one site (one-stop shopping); threats to banks
– lose direct links/delivery channel to reach customers
– banks may be held responsible for mishandling of confidential customer data by the aggregator
banks respond by capitalizing on brand names and public trust
– certification, digital signatures, secure communication services
even-handedness in treating financial and non-financial firms
– supervisors usually reluctant to allow banks to expand into non-financial commercial business
© 2001 Bank for International Settlements
Implications for financial markets
Liquidity
effects
Continuity
e-trading and market liquidity
tighter pricing (lower bid-ask spreads) by decreasing transaction costs improved liquidity? or, less liquidity?
lower barriers to entry encourage proliferation of new trading systems (ECNs), none of which is individually particularly liquid markets become more fragmented?
e-trading reduces bid-ask spreads and the profitability of active market-making dealers scale back this activity shallower markets with prices adjusting more abruptly to changes in expectations? (more likely in periods of market stress, exacerbate turbulence)
© 2001 Bank for International Settlements
Key risks
(1) business misjudgement
risk during periods of rapid technical change
e-finance firms accept high initial costs in the hope of long-term profits
– difficult to validate this strategy due to the absence of short-term profit test with little near-term revenue
– mistakes evident from volatility of high-tech stocks and failure of many high-profile ventures
banks can make big mistakes in their e-finance strategies
– bank management needs to be more IT-knowledgeable than in the past
© 2001 Bank for International Settlements
(1) misjudgement (contd.)
two conflicting considerations in IT investment decisions
(1) technology constantly changing prospective returns on new technology undermined by still newer technology need for discounting future returns heavily
(2) “network effects” “first mover” advantage adopt latest technology without fully assessing costs and benefits
© 2001 Bank for International Settlements
(2) complex operational risks
outsourcing core technologies and processing operations oversight of service providers becomes difficult (how far? by what mechanisms?)
complex arrangements between a financial institution and a chain of service providers (main contractors with multiple sub-contractors) is not fully aware of
concentration of service providers amplify the problem if several banks use the same system
© 2001 Bank for International Settlements
(3) legal/regulatory uncertainty
– physical or legal?
definition of home and host supervisors, clarification of division of responsibilities
– licensing in the “targeted” host country?
common standards across countries desirable to avoid e-finance firms moving headquarters to laxer supervisory regimes
– similar considerations apply to different sectors
– risk of “regulatory arbitrage” must be kept in mind
© 2001 Bank for International Settlements
(4) systemic risk
many institutions use similar software programs could be hit simultaneously
no computer systems “hacker-proof”; failure of internet service provider pose major disruption
– so far incidents relatively minor and contained
greater numbers of new and different firms
– difficult to monitor links between various actors and assess risks
barriers between financial/non-financial firms become more blurred
– sources of possible systemic threat harder to identify
other?
Official sector agenda
Co-ordination problems
Market and operational integrity
– greater importance of unregulated entities outside the reach of supervisor
prudential concerns about individual institutions/markets need to be supplemented by systemic risk-focused perspectives
– market dynamics, industry structure, etc.
too few reliable data on e-finance itself
– piecemeal market statistics, based on different definitions and assumptions, including optimistic biases
– need for a clearer conceptual framework to pose relevant questions
© 2001 Bank for International Settlements
(2) co-ordination problems
since bank become less “special”, be aware of linkages between banks/insurance/securities
– greater need for consultation and coordination between regulators across sectors
since depositors less familiar with e-banks, deposits can be withdrawn faster
– e-banks may be more susceptible to runs than traditional banks
– cyberspace may leave far less time for crisis management and resolution
© 2001 Bank for International Settlements
(3) a flexible regulatory approach
does not mean absence of regulations
– licensing rules (for banks, investment advisers, etc) will remain crucial in maintaining high standards in the financial system and building public confidence
public sector’s dilemma
(1) public sector cannot predict future shape of financial industry should not stifle trial-and-error process of innovation
(2) a danger of new unregulated developments going too far, too quickly more difficult to impose prudent guidelines
© 2001 Bank for International Settlements
(3) regulatory approach (contd.)
US supervisors are strong advocates of on-site systematic inspection of unregulated service providers
old regulatory mind-set no longer appropriate
– need for guidance, not rules
– need for more emphasis on operational and reputational risks
– use of advanced technology for more effective monitoring
© 2001 Bank for International Settlements
(4) prudential buffers
are e-banks inherently riskier?
– arguable, but some aspects of e-banks deserve much more careful examination
generally offer higher interest rates to attract deposits, can be rapidly transferred to another bank
vulnerable to operational breakdowns and security breaches by “hackers”
credit assessment at a distance less well-understood
need for additional prudential buffers?
– in some jurisdictions, e-banks cannot be established except through conversion of existing local banks (Singapore, Hong Kong)
– some countries require a physical presence within their national jurisdiction, but difficult to enforce
© 2001 Bank for International Settlements
(5) market/operational integrity
secure and orderly operation of banking and financial systems at all times crucial to allow customers to do financial transactions online
– “virtually closed“ network supported by robust technology to ensure security (eg cryptography, digital signature)
– reliable clearing and settlement infrastructure that meet CPSS Core Principles
– STP to support efficient and robust back-office
– disclosure for listing and licensing for investment advisers
© 2001 Bank for International Settlements
Conclusions
assessing and dealing with potential risks is the key challenge to central bankers and supervisors worldwide
not only is reliable data on the current situation hard to find, its growth extremely hard to predict
even once the trends are identified, hard to distinguish between familiar issues in new guise and totally new challenges
hard to isolate the contribution of internet separately from complementary innovations and long-term industry trends
© 2001 Bank for International Settlements
Conclusions (contd.)
regular and deep exchange of information between central banks, supervisors and market players all the more important (Basel-based Committees, FSF)
periodic reappraisal of global e-finance landscape and main policy issues vital
the private sector to play a full part
© 2001 Bank for International Settlements
Thank you.
Products
1 Technical costs (marketing costs are included under “brand name”)
2 May take the form of ATMs
Source: Authors’ assessment, Claessens et al (2000).
© 2001 Bank for International Settlements
Annex 2: Co-ordination problems
Annex 3: Market integrity
Annex 4: Account aggregator
Account aggregator (contd)
allow users to electronically access personal account information from a multitude of unrelated sources through a single user name and password
information can be gathered from Web sites without the site owners’ knowledge (“screen scraping”) privacy and security concerns
Web site owners (financial institutions) are unable to differentiate between the customer and the aggregator when either logs on if a loss/security breach occurs, there will be no audit trail
banks sued aggregators, but soon withdrew their suits banks decided to provide the service themselves; customers want this service from their bank (public trust issue)
fraud/money-
laundering
inter-relationships of various issues
1
2
ATMs
Creating “e-finance friendly” regulatory and institutional framework
Setsuya Sato
The UNCTAD Expert Meeting on finance and e-finance for SMEs
24 October 2001, Palais des Nations, Geneva
© 2001 Bank for International Settlements
Structure of presentation
Key risks
Implications for banks
Public trust
(1) disintermediation
lower start-up/operating costs lower barrier to entry intensify competition and increase (a threat of) disintermediation
impact more significant in sectors that rely on high-cost network of agents for distribution
entering is easy, staying is difficult
– economies of scale
(2) blurring barriers
internet de-coupled manufacturing of financial products from distribution banks can retail products they do not produce blur boundaries between banks/brokers/insurers
increasing consumer demand for personalised money management services push banks to offer products that cross financial boundaries
technology (mobile internet, digital TV) adds complexity to design and delivery of “hybrid financial services”
© 2001 Bank for International Settlements
(3) public trust
pure internet banks not very successful because of insufficient public trust
– brand marketing and customer acquisition disproportionately expensive
– even promising demographics (young, educated, wealthy, IT savvy) don’t switch to tech firms for financial products
– a “brand premium” is the best protector of established banks
“clicks-versus-bricks” “clicks-and-mortar” (multi-channel distribution) has the advantage
– pure internet banks opened physical branches (“relationship enhancers”) or acquired ATM networks
© 2001 Bank for International Settlements
(4) entry of non-banks
the need for public trust does not necessarily favour existing banks
– non-banks with customer trust and name recognition also command confidence (Sony, Volks Wagen, GE)
greater reliance on untested and sophisticated technology implies greater need for “name”
– new form of conglomerate of financial and non-financial companies
– entry of telecom companies (IT skills, extensive customer base) is the most serious threat to banks
supervisory challenges
– validity of licensing rules (fit and proper, business plans, etc)? meaning of consolidated supervision?
© 2001 Bank for International Settlements
(5) financial consolidation
internet speeds up financial consolidation, both cross-border and cross-sector
– high fixed costs + low operating costs economies of scale
– larger client list enables the provision of more diversified and profitable services
– name recognition favours big players
e-banking facilitates cross-border expansion at minimum cost
– centralized resources (staff, computing resources) for foreign e-banking can be switched between countries
– easier to retrench quickly from a virtual offering than a branch-based one
© 2001 Bank for International Settlements
(6) new business models
“aggregators” allow customers to group all financial transactions on one site (one-stop shopping); threats to banks
– lose direct links/delivery channel to reach customers
– banks may be held responsible for mishandling of confidential customer data by the aggregator
banks respond by capitalizing on brand names and public trust
– certification, digital signatures, secure communication services
even-handedness in treating financial and non-financial firms
– supervisors usually reluctant to allow banks to expand into non-financial commercial business
© 2001 Bank for International Settlements
Implications for financial markets
Liquidity
effects
Continuity
e-trading and market liquidity
tighter pricing (lower bid-ask spreads) by decreasing transaction costs improved liquidity? or, less liquidity?
lower barriers to entry encourage proliferation of new trading systems (ECNs), none of which is individually particularly liquid markets become more fragmented?
e-trading reduces bid-ask spreads and the profitability of active market-making dealers scale back this activity shallower markets with prices adjusting more abruptly to changes in expectations? (more likely in periods of market stress, exacerbate turbulence)
© 2001 Bank for International Settlements
Key risks
(1) business misjudgement
risk during periods of rapid technical change
e-finance firms accept high initial costs in the hope of long-term profits
– difficult to validate this strategy due to the absence of short-term profit test with little near-term revenue
– mistakes evident from volatility of high-tech stocks and failure of many high-profile ventures
banks can make big mistakes in their e-finance strategies
– bank management needs to be more IT-knowledgeable than in the past
© 2001 Bank for International Settlements
(1) misjudgement (contd.)
two conflicting considerations in IT investment decisions
(1) technology constantly changing prospective returns on new technology undermined by still newer technology need for discounting future returns heavily
(2) “network effects” “first mover” advantage adopt latest technology without fully assessing costs and benefits
© 2001 Bank for International Settlements
(2) complex operational risks
outsourcing core technologies and processing operations oversight of service providers becomes difficult (how far? by what mechanisms?)
complex arrangements between a financial institution and a chain of service providers (main contractors with multiple sub-contractors) is not fully aware of
concentration of service providers amplify the problem if several banks use the same system
© 2001 Bank for International Settlements
(3) legal/regulatory uncertainty
– physical or legal?
definition of home and host supervisors, clarification of division of responsibilities
– licensing in the “targeted” host country?
common standards across countries desirable to avoid e-finance firms moving headquarters to laxer supervisory regimes
– similar considerations apply to different sectors
– risk of “regulatory arbitrage” must be kept in mind
© 2001 Bank for International Settlements
(4) systemic risk
many institutions use similar software programs could be hit simultaneously
no computer systems “hacker-proof”; failure of internet service provider pose major disruption
– so far incidents relatively minor and contained
greater numbers of new and different firms
– difficult to monitor links between various actors and assess risks
barriers between financial/non-financial firms become more blurred
– sources of possible systemic threat harder to identify
other?
Official sector agenda
Co-ordination problems
Market and operational integrity
– greater importance of unregulated entities outside the reach of supervisor
prudential concerns about individual institutions/markets need to be supplemented by systemic risk-focused perspectives
– market dynamics, industry structure, etc.
too few reliable data on e-finance itself
– piecemeal market statistics, based on different definitions and assumptions, including optimistic biases
– need for a clearer conceptual framework to pose relevant questions
© 2001 Bank for International Settlements
(2) co-ordination problems
since bank become less “special”, be aware of linkages between banks/insurance/securities
– greater need for consultation and coordination between regulators across sectors
since depositors less familiar with e-banks, deposits can be withdrawn faster
– e-banks may be more susceptible to runs than traditional banks
– cyberspace may leave far less time for crisis management and resolution
© 2001 Bank for International Settlements
(3) a flexible regulatory approach
does not mean absence of regulations
– licensing rules (for banks, investment advisers, etc) will remain crucial in maintaining high standards in the financial system and building public confidence
public sector’s dilemma
(1) public sector cannot predict future shape of financial industry should not stifle trial-and-error process of innovation
(2) a danger of new unregulated developments going too far, too quickly more difficult to impose prudent guidelines
© 2001 Bank for International Settlements
(3) regulatory approach (contd.)
US supervisors are strong advocates of on-site systematic inspection of unregulated service providers
old regulatory mind-set no longer appropriate
– need for guidance, not rules
– need for more emphasis on operational and reputational risks
– use of advanced technology for more effective monitoring
© 2001 Bank for International Settlements
(4) prudential buffers
are e-banks inherently riskier?
– arguable, but some aspects of e-banks deserve much more careful examination
generally offer higher interest rates to attract deposits, can be rapidly transferred to another bank
vulnerable to operational breakdowns and security breaches by “hackers”
credit assessment at a distance less well-understood
need for additional prudential buffers?
– in some jurisdictions, e-banks cannot be established except through conversion of existing local banks (Singapore, Hong Kong)
– some countries require a physical presence within their national jurisdiction, but difficult to enforce
© 2001 Bank for International Settlements
(5) market/operational integrity
secure and orderly operation of banking and financial systems at all times crucial to allow customers to do financial transactions online
– “virtually closed“ network supported by robust technology to ensure security (eg cryptography, digital signature)
– reliable clearing and settlement infrastructure that meet CPSS Core Principles
– STP to support efficient and robust back-office
– disclosure for listing and licensing for investment advisers
© 2001 Bank for International Settlements
Conclusions
assessing and dealing with potential risks is the key challenge to central bankers and supervisors worldwide
not only is reliable data on the current situation hard to find, its growth extremely hard to predict
even once the trends are identified, hard to distinguish between familiar issues in new guise and totally new challenges
hard to isolate the contribution of internet separately from complementary innovations and long-term industry trends
© 2001 Bank for International Settlements
Conclusions (contd.)
regular and deep exchange of information between central banks, supervisors and market players all the more important (Basel-based Committees, FSF)
periodic reappraisal of global e-finance landscape and main policy issues vital
the private sector to play a full part
© 2001 Bank for International Settlements
Thank you.
Products
1 Technical costs (marketing costs are included under “brand name”)
2 May take the form of ATMs
Source: Authors’ assessment, Claessens et al (2000).
© 2001 Bank for International Settlements
Annex 2: Co-ordination problems
Annex 3: Market integrity
Annex 4: Account aggregator
Account aggregator (contd)
allow users to electronically access personal account information from a multitude of unrelated sources through a single user name and password
information can be gathered from Web sites without the site owners’ knowledge (“screen scraping”) privacy and security concerns
Web site owners (financial institutions) are unable to differentiate between the customer and the aggregator when either logs on if a loss/security breach occurs, there will be no audit trail
banks sued aggregators, but soon withdrew their suits banks decided to provide the service themselves; customers want this service from their bank (public trust issue)
fraud/money-
laundering
inter-relationships of various issues
1
2
ATMs
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