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					                                  Banking and IT
                                   John Ure
             Director of the Telecommunications Research Project
                           University of Hong Kong
            Banking and Financial Services iin Shanghai Workshop
                               18th March 1996

The Evolution of Banking and Financial Information Technology
1. The first applications of the computer age within banking were the use of mainframes,
and later minicomputers, to process data such as customer accounts, bank inventories,
personnel records, and accounting packages - which ultimately evolved into spreadsheets.
Although 70% of banking applications expenditure in the US remain mainframe based,
this reflects an old embedded base. Client/server systems expenditure are the fastest
growing at 29% p.a.

2. The idea of direct customer services was less clear, but the first ATM (Automatic
Teller Machine) came into commercial use in 1968. By 1995 in Europe over 100,000
were in use. In Hong Kong there are two networks, the Hong Kong Bank system which
had around 800 ATMs in September 1994 (Business Asia Survey) and the Jetco network
linking the other clearing banks with about 1,150 ATMs.

These are ‘private’ or corporate wide-area networks run over leased circuits. If we denote
these networks as ‘C’ for corporate we can describe the ATM system as:
                                           C-C
that is transactions, such as EFT (Electronic Funds Transfer) or communications take
place just within the corporate WAN.

3. The next step in providing direct customer services came logically in the extended use
of debit and credit cards in the shops of merchants through EPOS (Electronic Point of
Sale) technology. In Hong Kong there are over 5,000 terminals, an increasing number of
them handheld wireless applications. The authentication and direct debit functions of
EPOS use the PSTN (Public Switched Telephone Network) to connect into the corporate
networks of banks and credit card companies. If we denote the PSTN as ‘P’ then we can
describe the interconnection of merchant system to the corporate system as:
                                           C-P-C
4. The latest step is the introduction of smartcard technology. Here, for example, money
can be downloaded from the ATM into the card, and then transferred by smartphone
across the PSTN to another person’s smartcard and finally transferred to a merchant or
into another bank account. A description of this process would be as follows:
                                           C-P-P-C
5. We do not have time here to develop this model further, although it would interesting
to see how it enters the general model of the circulation of commodity money and capital.
What we can point out is that the opportunities for entry into this extended system of
transactions opens up the logical possibility of new financial service providers offering
specialist services at different points in the chain, especially where the chains cross (nodal
points) and the need for specialist carrier networks and for specialist network
management. We could begin to model this as follows:
                                               C-C
                                            C-P-P-C
                                            C-P-P-C
                                               C-C

The Shape of Things To Come
1. Two diametrically opposed views have been put forward concerning the future shape
of the banking business. Everyone agrees that information technology will change its
shape. Deloitte Touche Tohmatsu International The Future of Retail Banking argues that
because branch banking is so expensive and telephone banking so cheap by comparison -
around 40% per customer cheaper - retail banks will cut the number of branches by 50%
by the year 2000. In contrast, Dominic Casserley, director, McKinsey & Co. (HK)has
argued that technology will be used to maximize revenues rather than to minimize costs,
and foresees direct banking services as complementary to rather than as a substitutes for
branches. Support for this view may come from past experience. Technology freed up
bank labour, but to extend personal customer services - such as direct enquiries,
processing loan requests, etc - rather than cut staffing costs.

2, An alternative analysis is to consider the economics of the banking market.
The DTT study found that profitability of small and large banks in the UK was similar.
This was explained by the fact that while economies of scale exist in some operations, a
large branch network is very expensive to maintain.
Some activities, such as cheque clearing and credit card and debit card authentication and
settlements, are most efficiently handled in volume and at national level. Other activities,
such as personal banking services and correspondence, either require individual attention
by a professional bank manager or are labour intense and are better handled at the local
branch level.

Electronic banking, such as telephone banking, is typically half the cost per customer to
the bank than branch service, and also has marketing advantages. Hence it will
proliferate. The shape of banking in the future will involve direct banking in the form of
telephone banking, personal and commercial banking and financial management using
home or office PC, kiosk banking where the public can access a telephone line, a PC, a
fax machine, a smartphone all in one location to carry out their transactions.

3. Increasingly, electronic commerce will take over from cash transactions and paper-
based contract signing. This is a major challenge for banks, but it could also be a major
threat. Non-banking institutions - ie. those which do not have authorization to issue new
money - already have the potential to create e-cash or electronic money and create
extended credit. For example, merchants issue Loyalty Cards which provide credit to their
customers. The rise of Internet combined with the smartcard and an international
telephone circuit offers the scope for e-money and credit creation beyond the control of
nation states, far less within the control of banks.

4. To become competitive in the global market banks will have to develop rapidly their
capabilities in electronic money matters and electronic commerce. But they have
opportunities. The first is they have, or are building out, their own highly reliable
networks. Without wishing to do so, they are becoming quasi-telecommunications
companies. The second, is they can provide a high level of professional support for
customer services, which perhaps remains their key advantage, but only if they develop it
before new entrants attract customers away.

Making It All Work
1. This brings me to the final issue: how can banks develop their customer services to the
point where customer loyalty is strong and where customer switching costs are high? As
banks lose their monopoly - either by de-regulation or as a consequence of technology -
how can they remain the dominant players? And how can a city like Shanghai regain its
competitive advantage as a world banking and financial centre?

2. Building the infrastructure is obviously the first critical step, but two questions follow:
(a) does it all work together? are the networks well integrated within banks, between
banks, between banks and customers? (b) who can use these networks? for example, can
foreign banks utilize these networks, and will they be able to use them to access
customers when the rules and regulations of China permit foreign banks to compete for
renminbi deposit taking? This is a question to be asked of foreign banks as well as the
Shanghai authorities, because Shanghai’s goal of achieving world status as a banking and
financial centre can be helped by foreign banks explaining their needs and requirements
in terms of telecoms facilities and data communications available, and in terms of what
they are permitted to do with those facilities and what services they can offer over them.

3. Some idea of what needs to be done to make it all work can be got from looking at the
experience of other successful places. Expenditure patterns provides a clue. In the US the
fastest growing category of expenditure on IT is on network services, with a compound
annual growth rate or CAGR of 19%. This is followed by outsourcing at CAGR 18%.
The largest market by year 2000 is forecast to be software applications ($68 billion)
followed by professional services ($48 billion). Manufacturing, banking and finance are
the leading sectors, spending $43 billion and $33 billion respectively by the year 2000.
(INPUT forecast)

Current Bank IT Spending:
              Retail Banking = 55% -
                      (a) consumer & branch automation = $1 billion, but only 7% p.a.
                      (b) Call center automation services have a growth rate of 26% p.a.
              Wholesale = 25%-
                      (a) $315 million, growing at 10% p.a.
              Admin & Support in both = 20%
By year 2000 it is forecast that banking applications expenditure will reach $800
million p.a.

The fastest growth area however is outsourcing of systems and project
installation and data communications and management. Systens integration
is a key component of outsourcing business.

Appendix
3 Types of Systems Integration 3
(a) Solutions support: the systems integrator provides delivery of service
and may take responsibility for selecting, buying and installing
equipment.This is the fastest growing area, especially as banks merge and
grow in size, in business scope and geographical location.
(b) Team project support: the systems integrator has responsibility for
project implementation, but this is only one part of an overall system. As
banks extend the scope of their business and IT networks they are tending to
cut down on the total number of systems integrators they use on service
contracts to avoid too many problems of project co-ordination - integrating
the integrators!
(c) Individual development support: where banks want a specialist to advise
and assist them. The most popular type ($451 million in 1995) This is the
slowest growth at around 7% p.a.
Another way of looking at it:
1. Staff supplement approach: hiring individuals or assigning
responsibilities to staff for short durations, leaving the implementation of
systems to the bank. The advantage to the bank is the low cost involved in
switching between staff for different expertise and services, and the ease of
cutting back on expenditure (by ending the contract or reassigning staff
responsibilities) when required. Spending in 1995 totalled $695 million and
was growing at 6% p.a.
2. Project based approach: where the service provider/systems integrator
assumes responsibility, working under contract for periods of months to
several years. This occurs where work is usually of critical importance to an
entire LOB (line of business) or department within the bank. Switching
costs are higher if the bank wants to change service providers, but an
integrated system approach is assured. Spending in 1995 totalled $878
million and was growing at 13% p.a.
3. Ongoing services approach: this is typically a long-term relationship, say
10-15-20 years. The service provider-bank relationship becomes a working
partnership, but the switching costs to the bank are high.This approach is
more popular. Spending in 1995 totalled $1.4 billion and was growing at
12% p.a.
Article by Diogo Teixeira, The A
mercan Banker, 1996

Outsourcing and service contracts                 $969 million (<33%)
Systems Integration, applications and maintenance > $1 bn (>33%) 18% p.a

Key buying criteria (a) technical skills of hardware/software vendors, and
(b) track record/experience

As banks devote greater resources to planning IT systems prior to
implementation this expenditure, which constitutes 8% of total IT system
expenditure, is rising at 20% p.a. Services connected with systems
implementation constitute 49% of IT expenditure, and this grows at 15%
p.a, with expenditure on services for systems modification grows at only 8%
annually. Maintenance expenditures are growing very slowly.

Outsourcing      90% on mainframes and 10% on minicomputers;
spending on networking technologies is fastest such as data warehousing
(25% p.a.) document management (19% p.a.) and image processing (18%
p.a)

Systems Integration         3 types
(a) Solutions support: the systems integrator provides delivery of service
and may take responsibility for selecting, buying and installing
equipment.This is the fastest growing area, especially as banks merge and
grow in size, in business scope and geographical location.
(b) Team project support: the systems integrator has responsibility for
project implementation, but this is only one part of an overall system. As
banks extend the scope of their business and IT networks they are tending to
cut down on the total number of systems integrators they use on service
contracts to avoid too many problems of project co-ordination - integrating
the integrators!
(c) Individual development support: where banks want a specialist to advise
and assist them. The most popular type ($451 million in 1995) This is the
slowest growth at around 7% p.a.
Another way of looking at it:
1. Staff supplement approach: hiring individuals or assigning
responsibilities to staff for short durations, leaving the implementation of
systems to the bank. The advantage to the bank is the low cost involved in
switching between staff for different expertise and services, and the ease of
cutting back on expenditure (by ending the contract or reassigning staff
responsibilities) when required. Spending in 1995 totalled $695 million and
was growing at 6% p.a.
2. Project based approach: where the service provider/systems integrator
assumes responsibility, working under contract for periods of months to
several years. This occurs where work is usually of critical importance to an
entire LOB (line of business) or department within the bank. Switching
costs are higher if the bank wants to change service providers, but an
integrated system approach is assured. Spending in 1995 totalled $878
million and was growing at 13% p.a.
3. Ongoing services approach: this is typically a long-term relationship, say
10-15-20 years. The service provider-bank relationship becomes a working
partnership, but the switching costs to the bank are high.This approach is
more popular. Spending in 1995 totalled $1.4 billion and was growing at
12% p.a.




Smartcards
Europe vs USA - telco costs less in USA, therefore authentication costs less.
France has around 85% of all smartcards in use.
Smartcard Forum in USA has around 200 members




Worldwide Semiconductor Revenues in Smartcards
                     1994 = $45 million           2000 (E) = $1,065 million

Banking              45%                          38%
Mobile Phone         27%                          19%
Pay TV               22%                           6%
Pay phonecards        2%                           2%
ID Cards              2%                          14%
Transport             2%                           7%
Health                                             9%
Road Tolls                                         5%

[Electronic Business Today Dec. 1995]

Security Issues
1. Personal savings and consumption - cryptography/PIN numbers/electronic
2. Corporate and state commercial transactions - encryption techniques
3. Faking credits on smartcards = a loss to the banks
4. Stealing PINs and codes = a personal loss
5. Biometrics (finger print; voice-recognition; even eyeball measurements)

				
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