Banking industry provides financial services to the customers such as accepting deposits granting loans/advances providing facilities for transfer of funds, giving financial guarantees, providing foreign exchange facilities,. etc. All these services are information-based services with cash operations forming the only physical process. The banks therefore process huge data in their normal operations to generate inforiilati6n to support. their functions. The information requited by banks need to be accurate and precise, secured and confidential, free from integrity errors and reliable and also ready available. As IT assures these features for data processing, the advent of information technology has changed way in which the data is processed. Therefore, almost all services provided by banks are influenced by' information technology -opening pew opportunities as well as posing new threats before the banking industry. We shall attempt understanding this impact from basic functions of banking to the concept of money monetary policies of central bank.
IMPACT ON TRANSACTION PROCESSING IN THE BANK
Handling volume of transactions was first priority of the banks.. The IT was therefore first used for transaction processing which required lot of manual records of transactions to be kept , cheques to be processed, interests to be calculated and funds to be transferred . The first stage of computerization involved transaction processing and maintaining accurate accounts of all the transactions. The first IT applications in banking, therefore, were ledger posting machines to post the transactions. The clearing of cheques issued by bank's customers for settlement is another transaction intensive operation in Banking. Traditionally, it was done by manual sorting and exchanging of cheques among the bankers. The automation of this work was another priority application of IT in banking sector. The introduction of MICR (Magnetic Ink Character Recognition) cheque clearing for cheque sorting and settlement was introduced in 1950s, The MICR cheque processing was done for clearing house operations, and involved computers, magnetic encoders as. Wel1 as electromechanical read et sorters. These applications were recorded off line and processed in batch mode wherein the. transactions were entered after they were done at the counter. The phase started in 1950 and has been the first activity to be taken up for computerisation. It continues to be an important application with banks increasingly resorting to have data centres and data warehouses to store their data and even cross border processing of their transactions to reduce the cost.
RETAIL BANKING & ON-LINE SERVICE.
After successful using IT for transaction processing arid accounting, the focus shifted to improving customer service to its retail customers for their cash transactions. The focus was on instantaneous processing of transactions, giving quick credit and quick delivery of customers funds using on-line computer systems. These systems also improved the speed of transaction processing and built essential banking controls and checks in the computer systems. There were four generations of on line systems as under : a) 1965 -1970 : The focus during this time was on line balance checking and updation of balances with tellers at the counter accessing centralised computers. b) 1970 -1980 : During this phase the banks developed applications for on-line specialized transactions like foreign exchange and stock market transactions. During this time Distributed Data Processing was introduced with data residing at different computers at different locations so that customers could access their funds even from different locations. c) 1980-90 : automation was done at the branch level with local processing and the banks had thousands of on line terminals. The transactions were also stored in Data centers having Distributed Databases and these databases were interconnected to each other using communication lines. The computer networks connected both local and long distances spread computers in the banks. Decision support systems were developed during this period. d) 1990 onwards: This is the current phase during which the banks have developed networks which spread across the globe and also have provided computer based access to bank's customers for their transactions. During this period, the banks have developed expert systems for quicker decision making and IT has become a strategic consideration in the planning process. The retail banking segment comprising all types of depositors and borrowers of the bank were targeted for better service in terms of quicker cash delivery or transfer of funds, faster sanctions of credit lines, improved reporting to customers for their transactions and accounting balances, etc. The IT applications' in clearing houses have made it possible to execute bulk payments of corporate houses like interest or dividend payments. In developed countries, regular government payments such as salary, pension or social security benefits are made through clearing houses without need for any paper instruments. This service known as 'Electronic Credit Clearing', credits the accounts of banks, which in turn credit to their customers. At the same time, routine collection services like electricity bills, telephone bills could be executed through Electronic Debit Clearing service. The banks in turn could reduce the cost of transaction processing for their retail banking uden to automation of routine and tedious activities like cheque handling, & clearing, execution of standing instructions. The speedy processing of customers' details and transactions as well as appraisal of credit needs led to quicker credit sanctions. Further, the banks could also improve the supervision of their loan assets by analyzing the transactions in their customers account with the help of computers.
IMPACT OF IT ON FUND TRANSFER AND SETTLEMENT MECHANISM
Handling customers' receipts and payments are an important service provided by banks. However, the transfer or receipt of funds for banks customers involves intense data processing and record keeping. There were many innovations in this area which have brought revolutionary changes in the settlement mechanism by introduction of Electronic Fund Transfer (EFT) in the banking industry. The developments in this regard can be traced to two district phases. First Phase of EFT 1969 to 1984: During this period the banks introduced Automatic Teller-Machines (ATM) which were linked to banks central computers over leased line or telephone line. The ATMs identify the customer identity using magnetic coding on the cards supplied to. customer and the password in the form of Personal Identification Number (PIN) keyed in by the customer, check the balance in his account , dispense cash and update customers balance. There are other services rendered on ATMs apart from cash dispensing. The ATMs quickly became. popular as customers could access their funds at their convenience and banks could recover their cost of opening branches to service their customers. The introduction of credit cards and debit cards by banks began the era of plastic money wherein banks would effecting payments on behalf of their customers who would in turn pay the banks. The use of credit cards became widespread in USA and Europe. Although initially the credit cards were not linked to computer systems, gradually the cards were provided with hardware elements like magnetic stripes and memory chips for identification to the bank's computer systems. Whereas credit cards check the validity of cards and allows credit to its customer far settling the retail transactions, debit cards actually debit customers' account for value of transaction at the time of transaction. Another variation of cards is charged cards or smart cards which are magnetised or charged against payment and the payment is made through transfer of magnetic fields from one card to other card or machine. During this period, the banks developed private and co- operative interbank networks for secured financial messaging, such as Chemlink 'of Chemical bank. The co-operative society of European and American banks namely the Society for Worldwide Interbank Financial Telecommunication (SWIFT) was formed in 1973- for developing a secured and reliable network network for financial messages. The network was made operational in 1976. The banks in United States of America (USA) formed an automatic clearing house called Clearing House Inter bank Payment System(CHIPS)in 1970. During this phase. the U.S. Federal Reserve Bank established electronic settlement system called Fed wire for funds and securities settlement for institutions maintaining account with Federal Reserve Bank. EFT II 1985 onwards: During this current phase, the Danks, have introduced new services like Electronic Fund, Transfer at Point Of Sale (EFTPOS)".Electronic. Fund Transfer through Automated Teller Machine across the border, Electronic Data Interchange between different locations Using pre decided data formats, etc', The advent of internet banking has introduced new retail payment instruments like e-cash, digi-cash, etc, These initiatives are still in their initial stages. The second stage of SWIFT network was introduced in 1990 and many other private networks for trade settlement, securities transactions, funds transfer, etc. were also developed for banking industry, The CHAPS network (Clearing House Automated Payment System)in UK was developed on lines of CHIPS in USA.' Banks sponsored Automated Clearing Houses (ACH) have, become common in the U.S. and the European countries. A phenomenal growth in global foreign exchange transactions and cross border investment operations (discussed later in this chapter) which pose serious risks to the settlement systems all over then world. The central banks of the different countries have taken up net working projects for netting transactions for net settlement as well as having a Real Time Gross Settlement Systems (RTGS) wherein transactions would be settled as Versus Payment (DVP) systems using Electronic Payment Networks are considered as most essential item of agenda before the central banks to control settlement risk arising out of accelerating growth in domestic as well as cross border transactions in money market, foreign exchange and securities markets. Impact of using IT in ATMs, credit cards,-smart cards; EFTPOS, global ATM service have reduced the need for physical cash for the banks customers thereby attempting to ushering an area of cashless, anytime society. The innovations in retail payments are continued by the banking industry and also by non bank intermediaries like IT companies. WHOLESALE BANKING The IT enable quick distribution of information on any issue of interest to the bankers. This meant that the banks could gather information about the short term and long term funds available with them at branches and various other offices. The high value transactions at the corporate level among the different financial institutions is known as wholesale banking which is characterized by low volume but high value of funds transacted, ever changing nature of market and involvement of only the corporate participants like other banks, securities houses, financial institutions in the transactions. there are variety of instruments traded in wholesale banking. These institutional transactions and their settlement are also referred to as financial markets. Very good telecommunication system and analytical tools from basic infrastructure for timely decision making and speedy settlement of transactions of these transactions is the basic infrastructure needed for the development of financial markets. IT, by its very nature, provides for all these requirements. The versatility of IT solutions used for these operations decide the competitive edge of the bank in these operations. Further, as these are always high value transactions, the profitability of banks is decided by success or failure of banks in conducting these operations. some of the applications are discussed below: a) Maintenance of statutory reserves: As a statutory requirement, banks are required to maintain certain part of their deposits in approved securities and certain part as cash with themselves and central banks. The banks need .to take action well in time so that they do not keep excess funds idle in cash form or invest in low yielding investments to meet statutory obligations. The speedy and accurate information on deposits, advances and cash positions is different branches of banks is needed for taking such decisions for which Information Technology is used. b) Money market Operations The improved cash management makes it possible for banks to invest excess funds in short term money market instruments like interbank deposits, treasury bills, overnight deposits, commercial papers, bills of exchange, etc. alternatively, banks can also borrow from other banks on a short term basis to meet its liquidity requirements. Such operations need intense As the market started growing, more instruments and more sophisticated IT applications with better communication facilities are developed and continuously improved upon. c) Investment operations : Besides investing in the government. securities for statutory reserves directly, the banks can also invest their funds in other securities or stocks as part of their investments. There is also a secondary market in government and other securities wherein banks can purchase and sale securities as per their fund position. These investments are basically long term in nature and prices are subject to various parameters like.interest rate movement, liquidity in the market maturity period of the securities, risk perceptions about the securities, etc. The investment officers in banks need quick, reliable information of prices, yields and impact of changes in interest rates on securities for speedy decision making. Variety of hybrid instruments in securities like Repos', ' Reverse Repos', 'securities lending are developed which serve as bridge between long term and short term investments. Such transactions require intense IT infrastructure for analysis and simulation, trading, confirmation of trades and settlement through clearing house and depositories. This support service is provided by specialized. It products marked by vendors who provide on-line news, rate movements, past data and also analytical tools.
EXTERNAL TRANSACTIONS OF THE BANKS
The international trade in commodities/services of bank's customers require banks to purchase foreign currencies from the exporters for domestic currency and sale foreign currency to importers against domestic currency. The transactions - known as foreign, exchange transactions- are characterised by its unique settlement system of correspondent banking in which the settlement is done in the respective countries by exchanging financial messages with correspondent banks in those countries. The exchange rate between two currencies is decided by 'numerous, economic, and political factors in these countries as well as other countries, perceptions of the market participants as well as actions of major market players. Thus, the exchange rates are continuously changing. This creates arbitrage opportunities for trading in foreign currencies. The banks, ,therefore, need very versatile IT solutions giving instantaneous information on exchange rates, economic indicators, political events, past data on various factors and ability to analyse the trends so as to take very fast decisions, At the same time banks need IT applications which can allow instantaneous communication for trading and confirmation. Specialised agencies like Reuters provide these IT solutions which involve high speed data communication and reliable software applications. Similarly, the differences in interest rates and scope for economic development in different countries have created global investment opportunities for the global investors. These transactions are similar to local investments discussed earlier but complex due to cross border settlement of funds, complex legal procedures and safe custody services required for effecting settlement . IT solutions are needed for collecting information, analysing trends, contracting deals and settlement. Again, specialised services like Knight Ridder, Telerate, and Bloomberg provide these IT solutions which are very complex involving high speed telecommunication and versatile software packages. The huge growth in foreign exchange and cross border investment transactions have posed serious problem for settlement and risk in settlement The volume and value of transactions done all over the world far exceed the1iqtidity available in the clearing systems in the world and geographical and. legal factors further add to the systematic risk for settlement. This problem requires development of IT, solutions like netting service, Real Time settlement. Delivery versus payment, payment versus payment, linked settlement etc. Impact on Human Resources , Productivity & Supervision The growing use of IT in banking has altered the job content of the employees at all levels of the bank. The routine jobs of transaction processing have been increasingly automated thereby the capability to process transaction has been enhanced. The time made available can be used more effectively for improved customer service, followup and devising strategies for individual customer. At the same time, the employees now require to acquire new skills in handling IT applications and computers, change their work procedures and get ready for new situation. The use of IT has created demand for new skill set for various functions such as IT planning and management, database administration, system designing, application development, quality assurance & system testing, system audit, network administration, computer operations, etc. This would alter the employees profile in the banks. There is need to develop human resources to have new skills and work as Knowledge Workers. The ease with which the transactions can be handled and funds can be transferred have necessitated new regulations and security measures which need to be interned by employees so as to safeguard their interests as well as interest of their banks. The banks are increasingly threatened by risk of misuse of technology. The bank management are required to adopt new techniques to manage their information assets and control the various risks using new risk control techniques for banking security in the computerized environment. There is increasing need for audit functions .to be organised through the computer and also auditing the computer applications themselves. This in itself has created new challenge for the banking community as well as regulating authorities. ORGANISATIONAL EFFECTIVENESS AND NEW INNOVATIONS As the IT has enabled improvement in the efficiency of bank operations, it has transformed the functioning of the banks and made them organisational1y mote effective. The networking of computers have relegated the geographical distances to the background and the concept of branch banking itself has undergone a change. The customers can have access to their funds and avail other banking services anytime and anywhere across the world As discussed earlier; banks can provide better service for fund transfer and collection service using on-line services, EFT solutions and clearing services. At the same time IT has also enabled banks to incorporate many control features on their operations such as financial limits, watching compliance to operational guidelines, exception handling and auditing, giving-statement of accounts to the customers etc. Thus, the role of IT has changed from assisting banks for transaction processing to become a strategic infrastructure around which services of the bank could be organised. Thus, IT has enabled the banks to concentrate on their innovation process with transaction processing taken care of. i) Better Customer Service: The banks can now analyse the pattern of transactions of any individual customer and analyse individual's savings pattern or credit requirements. This customer information service has led to a shift in the customer service from macro-banking wherein banks promoted schemes for their customers to join to micro-banking where banks design products to suit individual customers needs. The banks could develop new services like investment counseling and portfolio management for its customer. The banks could also undertake new activities like handling stock market transactions of their customer, arranging cover for their customer in the form of forward transactions, swaps, futures and options, etc. New products were developed for the customers using the IT skills acquired by the banks. ii) Improved Management Information : The ready availability of management information has improved the decision making at the top management leading to improved risk management of their assets as well as matching of the assets and liabilities of the banks (Asset/Liability management). The use of analytical tools and number crunching ability of computers enabled the management in building different 'What if…?' scenarios, analyzing different trends and patterns and take more studied decisions. The present trend is towards introduction of 'expert systems' to areas like credit sanction, planning and investment decisions. The use of 'Artificial Neural Network' for pattern recognation and learning through experience is also increasing among bankers for wide ranging activities like identifying the sickness of the borrower accounts, fraud detection, audit of anomalous transactions, portfolio analysis, etc. iii) Improved Regulatory Compliance :The task of reporting to. the regulatory authorities like central banks, deposits insurance corporations, government authorities0,etc.has been made more simple and effective as a result of adoption of IT thereby improving compliance to regulations and resultant effectiveness of the organization. Off site monitoring through networks is being adopted by the regulating authorities in different parts of the world using IT solutions. iv) Innovate Products : The banks have diversified their activities in other areas like insurance, mutual funds, factoring services, credit rating, housing finance, etc. Use of IT has therefore made banks as more proactive by anticipating the problems and potentials and running their services to their customers requirements.
BANK'S COST OF OPERATIONS AND REVENUE
The simplification of work procedures and automation of data processing enabled banks to increase their business without additional cost towards transaction processing and manpower. This enabled banks to expand their business with available infrastructure thereby reducing the cost. The developments in telecommunication reduced the cost of communication and improved management of funds thereby increasing the revenue. As the cost of operations is reduced and revenue generation ability of the banks has increased, the customers of the banks are benefited as the banks could reduce the spread between funds raised from its depositors and funds lent to its borrowers. The introduction of IT enabled value added services like cash management and treasury operations, portfolio management, custodial services and risk control services to the customers increased the revenue of the banks through non fund activities. Increased the revenue of the banks from sources other than lending. The improvement in profitability of banks help banks to share it with depositors in form of better rates on deposits and borrowers with reduced rate of interest on advances. Also, with additional revenue at its disposal banks could invest more in information technology and develop new Value added products to their customers. In the process, the cost of introducing IT products has become major source of capital expenditure (around forty percent in USA and Europe). The cost of maintaining the IT services has become major item of revenue expenditure (about 16 percent of total cost). The personnel and hardware depreciation forms major part of the cost to the bank. In view of this, the banks are under pressure not only to stay in competition with other banks but develop additional innovative services to maintain profitability of banks.
M0NETRAY POLICIES, REGULATORY FUNCTIONS ETC
. Introduction of new payment instruments such as smart cards, e-cash, digital cash have introduced new element in the concept of money. Traditionally, issue of currency is prerogative of governments and central banks. Introduction of new cards like smart cards and electronic purse cards means that the person owning a smart cards carry a magnetized card with him which can be used as currency for settlement. At the time of making payment, the card would transfer part of its magnetic charge to the receivers card and in the process get demagnetized. After it is demagnetized, the issuer of the card would refill the card for consideration. In other words, instead of currency note issued by the central banks, such magnetized cards would be used as money. The concept of credit would also undergo a change since these cards can be used as credits by one owner to another owner and the interest component would be in the form of additional magnetic fields. Although these issues would be important for central banks, as on today, these payment instruments are negligible as compared to traditional instruments. The regulations relating to banking services like negotiable instruments act, books of evidence act would need redefinition and new regulations for electronic funds transfer, issuance of charged cards etc. may be needed. The stability of the information systems based on IT would become an important parameter while deciding the soundness of the banking operations. Central banks would have to redefine their regulatory functions like inspections and monetary policies in light of IT products and new delivery mechanisms introduced by the banks.
Prepared by Shri A.K.Hire Member of Faculty Updated by Shri V.G.Sekar, Member of Faculty, CAB, Pune, September (2007)
IT Impact on Banking , By: A.K.Hirve/V.G.Sekar...