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Internet banking in Spain: Some stylized facts
Javier Delgado
María J. Nieto
1
Abstract
Spanish banks have been investing heavily in information technology, particularly, the
Internet. Their situation in relation to institutions in other industrialized countries may
be considered to be somewhat atypical, as Spain has a rate of utilization of Internet
banking that is higher than one would expect given the level to which the Internet has
been taken up by the population as a whole. This paper describes the state of play of
Internet banking in Spain; it draws upon the results of a voluntary survey of Internet
banking activity conducted by the Bank of Spain in 2002. The results of this survey
show that their deposit market share is small, although comparable to that in other
European countries, while their aggregate profitability was negative due to higher
financial costs and lower fee income. This seems to reflect the fierce competition
among Internet banks and between them and traditional banks in Spain, all of this in
spite of the apparent reduction in transaction costs the Internet channel is supposed to
bring. Finally, the paper assesses the challenges that the adoption of new technologies
pose for regulators as well as the approach followed by the Spanish authorities aimed at
preserving the stability of the banking system, in accordance with the principle of
neutrality respect to the distribution channel.
1 Bank of Spain. Alcalá 50, 28014 Madrid (Spain). Comments on this paper should be addressed to Javier
Delgado (javier.delgado@bde.es) and María J. Nieto (maria.nieto@bde.es). The opinions stated herein
are those of the authors and do not necessarily reflect those of the Bank of Spain (Banco de España). The
authors are grateful to the participants of the XI International "Tor Vergata" Conference on Banking and
Finance (Rome, December 2002) as well as Daniel Nolle (Office of the Comptroller of the Currency in
Washington DC) for their useful comments. Any errors, however, are entirely our own.
1
I. Introduction
The changes witnessed in recent years in the nature of the financial business in general
and banking in particular are the result of a series of trends: greater international
economic integration, deregulation, disintermediation and the introduction of new
technologies. This article focuses on this latter aspect.
The financial sector has been extremely quick to adopt new information technologies
because it is information intensive. The fact that information has a cost and, therefore
financial markets are not entirely efficient, makes it strategically advantageous to invest
in new technologies to both produce and distribute financial services. Financial
intermediaries to obtain a competitive advantage use information asymmetry, which the
economic and financial literature2 considers to be a market imperfection, as it assumes
that the cost of information is zero. However, technology per se does not produce
benefits in terms of increased transparency for users and reduced costs for financial
intermediaries. In order to realize these benefits it is necessary to transform the business
models used by credit institutions and the architecture of the financial markets3.
Retail equity markets (on-line brokers) have undergone the most profound
transformation due to the drastic cuts in brokerage costs brought about by the Internet.
This in turn has allowed users to access much more information cheaply and respond
more rapidly. The on-line brokerage business model, which is based on a separation of
2 Leland, H., Pyle , D. (1997). Freixas, X. , Rochet, J-C. (1997) have studied the importance of the
information asymmetry paradigm, according to which the various different economic agents have
fragmentary information about the relevant economic variables they use to their benefit.
3 Mishkin , F. , Strahan, P. (1999) .
2
the analysis, advice and transactional areas of the business, is widely seen as the most
successful business model in electronic finance.
The use of the Internet has also made possible a greater flexibility in the design of the
architecture of wholesale fixed income and equity markets. In this new context, access
to trading platforms, market operating hours, flows of interacting orders and the
transparency of the trading process are less dependent on the traditional limitations of
space and time. As with retail markets, the Internet has enabled significant cost
reductions, among other reasons, because it allows orders to be passed directly for
execution in real time without manual intervention (Straight Through Processing).
Nevertheless, unlike the case of retail equity markets, the effectiveness of Internet in
wholesale financial markets is more questionable. This is basically for two reasons:
firstly the adoption of new technologies has given rise, in some cases, to greater
fragmentation of market liquidity, thereby reducing the information content of prices;
secondly, the cost reductions have not been significant in those cases where the Internet
has not replaced physical trading in stock markets.
The technology has revolutionized retail banking by making it possible for institutions
to break their traditional value creation chain (figure 1) and by allowing the production
of financial services and their distribution to be separated into different businesses.
Thus, for example, although some would question the viability of the business model in
the medium term, Internet-only or standalone Internet banks4 distribute insurance and
securities as well as banking products, and not all the products they distribute are
produced by their group.
3
At the same time, the adoption of new information technologies appears to be reducing
the traditional economies of scale in the provision of certain financial services, such as
loans to small businesses or stock brokerage. Furthermore, technological advances
enable some of the traditional barriers to entry for the provision of banking services
(network of branches, knowledge of customers) to be reduced.
Figure 1- Financial Services Value Chain
The spread of new information technologies has also lead to the emergence of new
business models for the provision of financial services5, which are challenging the
traditional advantages of credit institutions. Figure 2 shows the sources of value creation
in these new business models. Examples of such models include vertical portals,
intelligent agents and financial aggregators. In all these cases their promoters acquire
greater knowledge of their customers (through data mining) and they can use this
information to improve their customer risk assessments and commercialize their
4 Some authors are beginning to refer to online banks as being "primarily" Internet banks rather than
Internet "only" in view of the fact that in most cases these banks have found it necessary to have some
form of physical presence and/or use other channels such as the telephone.
5 Sato, S., Hawkins, J. (2001).
4
products at more competitive prices. This fact explains the interest credit institutions
have shown in adopting new business models of this kind.
Vertical portals allow consumers to compare prices of a range of financial services,
while intelligent agents choose the most price-competitive offer from among various
financial services offerings. Financial aggregators present users whose information is
distributed across various institutions and brokerages with all their financial information
(and sometimes also non-financial information) in one place so as to enable them to
manage their assets more effectively. Whereas in Spain only deposit-taking institutions
offer this service, in other countries such as the United States, these institutions are
associated with Internet portals to which customers give their authorization to obtain
this information for them. Aggregation can be performed in either of two ways:
Screen scraping, the institution performing the aggregation does not need the
permission of the institution providing the data. Each time it accesses the data it uses
the customer’s access code. This mode of access is the most problematic in terms of
transaction security and data privacy.
Data feeds, the institutions performing the aggregation have an agreement between
them (and where applicable, with the associated brokerage firms) allowing free
access to their databases without the need to use the customer’s access code. This
model is used when large volumes of data are aggregated and it is the most
frequently used system in the United States. The aggregation services can be
associated with other more sophisticated services, such as portfolio management,
payments and transfers, etc.
5
In addition to this introduction, this article is divided into three parts. The second
describes the state of play of Internet banking in Spain, and the new business models.
The third presents the challenges the adoption of new technologies implies for
managers, regulators and supervisors of credit institutions from the point of view of risk
management and regulation. To this end, the article draws upon the results of a
voluntary survey of Internet financial activity of all deposit institutions operating in
Spain conducted by the Bank of Spain in 2002. The final section offers a summary and
conclusions.
6
Figure 2- Sources of Value Creation in the New Business Models
7
II. Internet Banking and New Financial Intermediation Services in Spain
As in other countries, the Spanish financial sector has also benefited from incorporating
new technologies, and in particular the Internet. This has been made possible by the
rapid development of the technology infrastructure, in particular the growth in the
number of personal computers, the increased quality of Internet connections, the more
widespread use of Internet in both homes and businesses, and the significant reduction
in both the fixed and variable costs of Internet connections.
The number of Internet connections has increased significantly in recent years
(increasing from 12% of the population using the Internet in mid 2000 to 21% at the end
of 20016) and the quality of Internet connections has also improved (ADSL accounted
for 10% of all domestic connections7 in February 2002). On the business side,
companies have sought to use the Internet to develop e-commerce of which the
provision of financial services is a specific case. Table 1 lists the most frequent uses of
the Internet in Spain in 2001. As may be seen, approximately one in four Internet users
uses Internet banking services.
6 Fundación AUNA (2002).
7 Fundación AUNA (2002).
8
Table 1- Main uses of the Internet: Answer to the question
“Which of the following
activities do you use the Internet for?”
%
E banking 24,2
News reading 50,1
Info search 80,7
E commerce 11,6
Public Administration 15,5
Source: CIS. “Barómetro” (2001).
Spain is among the group of countries with the lowest rate of Internet penetration8,
together with France, Slovakia, Poland and Portugal (figure 3). The United States and
the Scandinavian countries have the highest penetration rates, at over 50%. Figure 3
shows the relationship between Internet penetration and the importance of Internet
banking in a number of countries. Although not linear, there is a clear positive
relationship between the variables, i.e. Internet banking develops as access to the
Internet becomes more widespread among the population in each country.
In Spain, despite the low penetration rate of the Internet, the take-up of Internet banking
is at levels above those in countries such as France, Germany, Italy, or even the United
States. Northern European countries show the highest levels of Internet banking use.
The situation in Spain compared to that of the countries analysed appears to be
somewhat atypical as it shows a level of utilization of this distribution channel above
that which would be expected from the level of Internet penetration. This seems to
reflect a determined strategy by the commercial and savings banks in Spain to develop
9
Internet-based financial business, and at the same time, the differences in the structure
of the sector and whether there has been prior development of telephone based systems
for the distribution of financial services, as is the case in France.
Figure 3- Penetration of Internet and Internet Banking in Various Countries (%)
Internet Banking
Source: OCDE (2001). Electronic Finance: Economic and Institutional Factors.
At the other extreme is the United States, which has a surprisingly low level of
utilization of this channel in spite of a high Internet penetration rate. This may be due to
the lesser importance of the banking sector in financial intermediation and the fact that
the Internet has contributed if anything to greater desintermediación via the unbundling
of typical banking activities (i.e. micro-payments).
Through its web site the Bank of Spain carried out a voluntary survey of all deposit
institutions9 operating in Spain with the dual objective of determining the nature of the
8 The variable representing Internet penetration has been calculated as a percentage of the total population
using the Internet in each country. The penetration of electronic banking is the number of customers
expressed as a percentage of the total population.
9 Questionnaire on Financial Activity over the Internet in Spain.
10
institutions’ Internet-based financial activities and ascertaining the risk profile these
activities entail. A total of 121 institutions (63% of total number that represents 97% of
the total owners' equity of the Spanish banking system) responded to the survey (14 of
which were branches of non-Spanish banks). Of these, 87 institutions stated that they
provided services over the Internet (one of these is the Spanish branch of a bank based
in another European Union Member State) and 34 institutions stated that they did not
provide services over the Internet (6 of these are the Spanish branches of banks based in
another European Union Member State and 7 are branches of banks based outside the
European Union). The period covered by the survey was 2000 and 2001. Estimates were
also requested for the full year 2002. The uneven quality of the data submitted seems to
reveal the limitations of multi channel institutions’ accounting records as a means of
differentiating operations by different distribution channels.
At the time of conducting this survey, five primary Internet10 banks were operating.
None of them is an independent bank: one is a subsidiary of a bank based in another
Member State of the European Union and four are subsidiaries of Spanish (multi
channel) banks11. In 2001, Internet banks had a market share of retail deposits of
approximately 1.3%, although that was highly concentrated in a single institution,
which had a share of 1.2%12. By operation volumes, deposits take the lead, followed at
a distance by transfers and share dealing.
10 In reality these are “primarily” Internet banks, as in most cases they have chosen to include some form
of physical presence. Also, they frequently use other channels such as the telephone.
11 During 2002 a new primarily Internet- bank (also a subsidiary of a Spanish bank) started operation after
the responses to the survey were received.
12 Source: Bank of Spain.
11
In terms of primarily Internet banks’ total number of active customers13 (those who
perform more than one transaction a month) the most rapid growth from 2000 to 2001
was produced in the demand for deposits and mortgage loans, although the latter started
out from a very low base.
Analysis of balance sheet structure as well as of profitability of primarily Internet banks
in Spain faces the important limitation of the absence of "de novo" banks in Spain. At
the same time, the comparison with the most recently created Spanish banks is flawed
by the important structural changes that have taken place in the Spanish and the
European banking system since the late 80´s. Bearing all this in mind, we have chosen a
group (peer group) of four traditional commercial banks of similar size in terms of total
assets that do not have internet activity and that, by comparison with the rest of mature
traditional banks, are relatively new since they were created in 1989.
Analysis of balance sheet structure of primarily Internet banks as compared with the
peer group (figure 4) shows the small significance of gross lending while inter bank
accounts make up the largest share of assets of primarily Internet banks. A large share
of these inter bank funds are invested in the parent bank. On the liabilities side, the
sources of financing are less diversified and primarily Internet banks are more
dependent on deposits as well as inter bank funding while owners equity make for a
comparatively smaller share of liabilities, which seems consistent with the lower credit
risk of these banks.
13 One of the institutions did not give details of its customers.
12
Figure 4: Primarily Internet banks - Balance sheet structure as compared with
traditional mature banks (a)
ASSETS
PEER GROUP
36%
18%
4%
5%
37%
Interbank & cash
Debt & stock
securities
Fixed assets
Other
Gross lending
PRIMARILY INTERNET BANKS EXCEPT
BRANCH
67%
18%
1%
7%
7% Interbank & cash
Debt & stock
securities
Fixed assets
Other
Gross lending
LIABILITIES
PEER GROUP
51%
13%
21%
10%
5%
Deposits
Provisions
Own Funds
Interbank
Other
PRIMARILY INTERNET BANKS EXCEPT
BRANCH
71%
0%
9%
19%
1%
Deposits
Provisions
Own Funds
Interbank
Other
Source: Bank of Spain (2001).
(a) Includes only four primarily Internet banks in the survey. The branch of the EU bank has
been excluded
Profitability of the five Internet banks as a whole was negative until 2002 (figure 5) and,
as in other countries, this placed a question mark over the viability of this business
13
model in the medium term. However, when analysing this period it needs to be borne in
mind that four out of the five banks have only been operating since 2000.
Figure 5- Annualised half yearly ROA (%) of Primarily Internet Banks
-5,0
-4,5
-4,0
-3,5
-3,0
-2,5
-2,0
-1,5
-1,0
-0,5
0,0
S1-98 S2-98 S1-99 S2-99 S1-00 S2-00 S1-01 S2-01 S1-02
Source: Bank of Spain
The analysis of the structure of primarily Internet banks’ income statements in terms of
average total assets14 comparing them with those of the peer group should be made
bearing in mind that no matter what technology a new bank is relying on, it is likely to
perform worse than a mature bank for a number of years. Taking into consideration this
caveat, the analysis leads to the following conclusions: firstly, Internet banks have
considerably lower intermediation margins, resulting from lower financial income, and
above all, higher financial costs, which seems to reflect the fierce competition among
Internet banks and between them and traditional banks in order to acquire customers
(table 2).
14
At the same time, net fee income is also lower than in the case of the traditional banks
in the peer group. This again seems to reflect the level of competition between banks
already alluded to and the fact that these banks pass on to their customers, the reduction
in transaction costs the Internet channel is supposed to bring (table 3), even though this
is not apparent, at least not yet, in a reduction in the banks’ overall costs. Altogether
these factors seem to explain why the net operating margin of the Internet banks is
lower than that of the peer group.
Two effects emerge when analysing non-interest expenses. Firstly, the lower staff costs,
reflecting the fact that Internet banking is less human-resources intensive. Secondly,
information technology and advertising costs are higher in the case of primarily Internet
banks, due to the fact that they have only recently been created, and to the nature of the
distribution channel itself. Overall, the lower staff costs seem to compensate the higher
information technology and marketing costs.
14 This analysis was carried out using data from 2001 which was the first year that all five banks were
operating.
15
Table 2- Income Statement (% of total assets) of Primarily Internet Banks
vs
Traditional Mature Banks (a)
Primarily Internet Banks Peer Group
1. Financial Income 5,10 5,47
2. Financial Expenses -4,66 -2,86
3. Intermediation Margin 0,44 2,61
4. Net fee income 0,07 0,87
5. Net operating Revenue 0,50 3,48
6. Non-interest expenses -2,15 -2,61
6.1 Personnel costs -0,43 -1,35
6.2. General expenses
IT -0,40 -0,28
Marketing. -0,77 -0,06
Net operating profit -1,65 0,87
Pre-tax profit -1,80 0,96
Source: Bank of Spain (2001).
(a) Includes the five primarily Internet banks in the survey
As shown in figure 6, the oldest primarily Internet bank created in 1997 shows a better
performance both in terms of ROA and efficiency than the rest, all of which were
created either in 2000 or 2001. This finding seems to be consistent with the fact that as
the oldest Internet bank age, it accumulates experience that seems to allow it to operate
more efficiently15. Since no "de novo" banks do exist in Spain, it is not possible to
know whether they may generate scale-based savings over time not available to
traditional banks that use less capital intensive and distribution technologies. Bearing
all of this in mind, the data suggest that the oldest primarily Internet bank's performance
still lags that of the average traditional mature bank.
16
15 DeYoung (2001)
Figure 6: Primarily Internet banks- Performance measures compared with
traditional mature banks and among primarily Internet banks
New Internet = Internet banks aged 2 or younger Mature Internet = Internet banks over age 2
Source: Bank of Spain (2001).
New Internet Mature Internet Mature Traditional
ROA Non interest expenses/ Net operating revenue
-2,5
-2
-1,5
-1
-0,5
0
0,5
1
1,5
0
2
4
6
8
10
12
At the time the survey was conducted, the market share of the traditional banks making
significant use of the Internet as a distribution channel16 in terms of retail deposits
acquired via the Internet was 0.6% and that of the savings banks, slightly less, at 0.1%
in 2001. Use of the Internet by traditional deposit institutions seems to be aimed, as
already mentioned, at reducing transaction costs for intermediaries (table 3) -a process
from which customers also benefit- and enabling services to be accessed from anywhere
at any time (convenience).
16 “Significant use” is considered here to be, in absolute terms, a volume by type of operation (i.e.
deposits, money transfers) of equal or more than €1 million or, in relative terms, more than 0.5% of the
total average volume of operations contracted.
17
Table 3– Transaction Cost (unitary based) for Spanish Banks of the various
Distribution Channels (a)
Branch Telephone Internet
Money transfers 1,00 0,75 0,22
Mortgage loans 1,00 0,70 0,54
Mutual Funds Brokerage 1,00 0,45 0,03
Demand Deposits 1,00 0,47 0,08
Stock Brokerage 1,00 0,54 0,07
Source: Estimates by Accenture (2002).
(a)Transaction costs include the cost of IT, staff and rent.
Figures 7 and 8 show the number of commercial and savings banks, respectively, which
perform operations of this kind. In both cases, according to the replies received to the
Questionnaire, the operations that the largest number of institutions contracted over the
Internet in 2001 and 2002 (estimates) were transfers, followed by stock and mutual fund
brokerage. In the latter case, the savings in transition costs are the highest (table 3).
Meanwhile, customer convenience and to lesser extent cost savings seem to explain the
larger volume of transfers.
The data obtained from the replies to the questionnaire reveal that the trading volumes
of each type of operation by commercial banks with a multi-channel strategy are greater
than those of the savings banks (with the exception of transfers). At the same time, the
number of active Internet customers17 dealing in shares or buying and selling unit trusts
(mutual funds) seems to be higher in the case of commercial banks, whereas the savings
banks seem to have more customers performing transfers.
18
17 The questionnaire referred to non-exclusive Internet customer in the case of commercial and savings
banks with a multi-channel strategy.
Most of the multi channel banks started to operate before primarily Internet banks were
launched. In spite of which, with the exception of the European Union branch, all
Internet banks are affiliates of multi-channel Spanish banks that have witnessed some
cannibalisation of their clients by their own Internet affiliates. This seems to show a
pre-emptive strategy oriented at taking control of the Spanish e banking market by the
incumbent banks. At the same time, adoption rates do seem to depend on the size of
the commercial or saving bank18 (figure 9) since the smallest institutions are less likely
to adopt Internet banking.
18 This finding is in line with the that of Furst et al (2000)
19
Figure 7- Number of Banks with a Multi-channel Strategy contracting each type of
operation over the Internet
0
2
4
6
8
10
12
14
16
18
Deposits Stock Brokerage Mutual Funds Brokerage Consumer Loans Mortgage Loans Money Transfers
2001
2002 - Estimates
Figure 8- Number of Savings Banks contracting each type of operation over the
Internet
0
5
10
15
20
25
Deposits Stock Brokerage Mutual Funds Brokerage Consumer Loans Mortgage Loans Money Transfers
2001
2002 - Estimates
Source: Questionnaire on Financial Activity via the Internet in Spain
20
Figure 9: Adoption rates of Internet as a delivery channel
vs
asset size (% of total of each size)
BANKS
0%
10%
20%
30%
40%
50%
60%
70%
80%
90%
100%
More than 185 billion € Between 95 and 185 billion € Less than 95 billion €
S&L
0%
10%
20%
30%
40%
50%
60%
70%
80%
90%
100%
More than 50 billion € Between 10 and 50 billion € Less than 10 billion €
Source: Bank of Spain (2001).
21
New Financial Intermediation Services
Information technologies have made possible a change in the relationship between
credit institutions and their customers, and as mentioned at the start of this article, this
has enabled new business models to be developed.
In particular, institutions now have the possibility of participating in or creating
electronic platforms through which they can act as intermediaries in financial
transactions between businesses and individual consumers (B2C) and between
businesses (B2B).
The development of B2C requires the implementation of an electronic commerce
platform that provides both the functions necessary to organize the e-commerce model
and typical activities of a traditional transaction model (e.g. means of payment,
certification). The most significant business models for e-commerce between businesses
and consumers are the online store, online auctions19 and online malls. In Spain, the
volume of B2C is relatively low compared with that of other European countries. For
example, in 2000 the total transaction value in Spain was 70 million dollars, whereas in
Germany the value was 1,199 million dollars20.
However, where the Internet has greatest potential to develop the growth of e-commerce
is in the business-to-business (B2B) area. There are two reasons for this. Firstly, the
Internet is an improvement on traditional electronic data interchange (EDI) systems in
terms, among other things, of reduced costs, enhanced access for a larger number of
participants, and the increased speed and volume of data. Secondly, the Internet enables
19 When both the buyer and seller are private individuals it is known as C2C (Consumer to Consumer).
20 Fundación AUNA (2002).
22
improvements to be made in companies’ value creation chains through greater
integration and closer links between activities. The main business models in the B2B
field are digital provisioning, collaborative planning21 of forecasts and restocking,
virtual customer management, management of prices and promotions, and virtual
implementation. According to the results of the Questionnaire on Financial Activity
over the Internet in Spain, twenty two percent of commercial banks and thirty six
percent of savings banks participate directly or indirectly (via affiliated companies) in e-
commerce in 2001.
Lastly, the development of mobile telephony has made it technically possible to use
mobile telephones to perform financial transactions. In Spain there are two mobile
payment platforms, although one of them brings together the greatest number of
institutions from among the major Spanish financial groups and mobile telephony
operators. This is an open system, which uses existing infrastructure and is based on
cooperation between mobile telephony operators, means of payment firms, and deposit
institutions.
III. The Challenges from the point of view of Banking Management and
Regulation
In the late 80s financial derivatives represented a revolution in the management of
traditional financial risk. Since the 90s the intensive use of the Internet in the financial
sector has been revolutionizing the distribution of banking products and, in general, the
ways in which financial services are provided.
21 Collaboration between manufacturers and distributors.
23
As well as offering advantages, providing financial services over the Internet, and in
particular, banking services, implies potential risks. Although it is true that the most
important risks involved in Internet banking are not new, when compared with
traditional banking, Internet banking potentially increases and modifies22 traditional
banking risks and influences their risk profile. Internet banking can increase traditional
financial risks. For example market risk and liquidity risk are greater when customers
can transfer their deposits from one institution to another rapidly to take advantage of
higher interest rates. At the same time, strategic and operational risks (which include
legal and security risks), and reputational and systemic risks are potentially greater and
differ somewhat from those faced by traditional banks. The changing nature of the
technology and the business strategies accompanying its adoption, make it necessary to
constantly review these risks (box). The results of the Questionnaire on Financial
Activity over the Internet in Spain reveal that the risk profile just described is also
characteristic of Spanish institutions. More precisely, institutions providing financial
services over the Internet incur high potential security, legal and reputational risks. In
the case of multi channel banks, no correlation seems to exist between size and risk
level.
22 “Risk Management for Electronic Banking and Electronic Money Activities”, BIS, March 1998
“Electronic Banking Group Initiatives and White Papers”, BIS, October, 2000.
24
Box: Deposit Institutions and B2B Platforms
Deposit institutions participate in B2B initiatives in two different ways. In the first
mode of participation the institution plays the traditional role of financial intermediary
and is involved solely in providing finance, accepting documentation and settling the
transaction when it has been concluded. The risks the institution takes on are traditional
ones, although the legal risk arising out of a possible falsification of identity by a
contracting party could be highlighted as being of particular significance, although this
may, however, be mitigated by electronic certification of identity.
In the second mode as well as playing a traditional financial intermediary role the
institution also provides the portal and the search engines, and thereby takes a more
active part in the B2B platform or e-marketplace. In this mode the financial institution
brings in its knowledge of the contracting parties (buyers and sellers), thereby
facilitating contracts. In addition to the traditional risks, these institutions can also face
other risks arising out of aspects of the activity that are not strictly financial but which
are basically reputational and legal risks (e.g. falsification of identity by a contracting
party, non-delivery of material or defective material). These risks may be mitigated by
insisting on deposits being made (either goods or merchandise) to the extent the
contracting parties allow, by buyer and seller solvency ratings based on experience with
the party’s delivering in accordance with the agreed conditions, or by guarantees from
third parties.
Source: Calabia, C., Juncker, G. (May 2001)
The changes in the structure of the financial sector and in financial institutions’ risk
profiles that are taking place as a result of the adoption of new technologies demand a
new approach from regulators and supervisors if they are to achieve their two main
objectives: financial stability and protection of consumers and investors. As regards
financial stability, the existence of a mechanism to protect depositors (deposit insurance
scheme) and the payments system (lender of last resort) requires that prudential
supervision and regulation create incentives to avoid taking excessive risks as a result of
the partial loss of the disciplinary effect of the market due to the these two mechanisms
(table 5).
From the point of view of financial stability, two issues give cause for concern. Firstly,
the dependence on a small number of providers of outsourcing services, who on
25
occasions, serve several institutions under an increasingly complex contractual
relationship. Secondly, the development of an Internet-based system of micro-payments
and deposits by companies that are not regulated as deposit institutions. In both cases it
would be increasingly difficult for regulators and supervisors to monitor the potential
sources of systemic risk and the scope of cover of deposit insurance. Thus, for example,
in the United States, the provision of financial services that are typical banking services,
such as payments and even deposits, via the Internet by non-bank institutions23 is
raising questions about the scope of action of the supervisory authority and the coverage
of the network of protection characteristic of the banks24. Worldwide, the outsourcing
of management activities, other strategic activities or even computing, when they
remain outside the scope of supervision, is a cause for concern among regulators and
supervisors.
23 This is the case of certain initiatives for electronic payments between individuals (i.e. peer-to-peer or
P2P) in the US.
24 Claessens, S, et al. (2000).
26
Table 5: Challenges for Banking Regulators brought by the adoption of New
Information Technologies
Objectives of the Regulator Traditional Approach Challenges brought by the
adoption of new IT
Consumer and investor
protection
Transparency rules
New technology increases
transparency. Regulatory focus
on:
Information quality
Access to information
Consumer and investor
education
Rules on proper business
functioning
Security and data privacy
Cross-border activity without
physical presence
Financial stability Minimizing systemic impact
(deposit guarantees and lender of
last resort)
Systemic risk is potentially higher:
Dependence on a small number
of outsourcing service providers
for strategic IT services and for
management which can supply
various institutions under an
increasingly complex contractual
relationship
Minimizing the moral hazard the
guarantees above may induce
Strategic technology
infrastructures for the
management of the institution that
are outside the perimeter of
supervision and may potentially
endanger solvency
Clear differentiation between
different financial intermediaries
(banks, insurers, stock brokers)
The traditional clear differentiation
between financial intermediaries
is blurred.
Clear delimitation of the
geographical barriers for the
purposes of regulatory
compliance
Cross-border activity without
physical presence.
Need to secure technological
neutrality and desirable
technological innovation
Source: BIS Papers Nº7, 2001
As regards protecting consumers and investors, which is the other objective of
regulators and supervisors, it has been argued that thanks to the greater price
transparency offered by the Internet, the traditional information asymmetry between the
consumer and the credit institution has become more balanced, thus favouring
27
consumers. Thus, technology has reduced two traditional problems associated with the
lack of information: adverse selection in the decision-making process and moral hazard
once a decision has been made. Therefore, in this new setting, regulators are focusing
on facilitating access to information and ensuring its quality. At the same time,
regulators and supervisors are facing greater challenges to the preservation of
transaction security and data privacy, thus highlighting the growing need for closer
coordination between prudential regulation and consumer and investor protection in the
financial services area.
There is no specific regulation of electronic banking in the European Union, although
several relevant directives on e-commerce have been or are in the process of being
translated into Spanish legislation. All of them deal with aspects that are relevant from
the financial consumer/investor protection point of view. These include the Law on
Internet Society Services and Electronic Commerce which translates the Directive on
Electronic Commerce 2000/31/EC, of 8 June 2000 into Spanish legislation. This
Directive introduces significant changes to the legislation in force regarding investment
services by establishing a generally applicable principle of regulation in the country of
origin, although it permits derogations where necessary to protect investors. However,
before imposing regulation in the host country, the competent authorities there must
first require that the institution’s home country take any necessary measures. If these
measures are not taken, prior to imposing the host country’s regulations, the country of
origin and the Commission must be informed. The latter must, within reasonable time
limits, assess whether the restrictions imposed by the host country are justified.
28
The Electronic Signature Directive 1999/93/EC, of 13 December 1999, which regulates
the provision of electronic certification services in a competitive framework has been
enacted in Spanish law. A number of companies have been set up under this law in
which Spanish deposit institutions have a direct or indirect (via affiliated companies)
stake. The aim of the Directive is to provide security services to enable the development
of electronic commerce. While, at the same time, promotes the idea of self-regulation by
service providers in this field, so that it is the service providers themselves who design
and manage voluntary certification systems.
The European Commission has also issued a communication on Electronic Commerce
and Financial Services25 in which it sets outs plans to facilitate the provision of
financial services over the Internet throughout the European Union in order to ensure a
greater level of convergence between national regulations on consumer and investor
protection.
Furthermore, the Commission has prepared a proposal for a Directive on the distance
marketing of consumer financial services applicable to financial activities over the
Internet. This envisages the rights of consumers where financial services are marketed,
and among other things, the information to be made available prior to conclusion of a
contract, and the right of withdrawal.
In the field of money laundering, Directive 2001/97/EC, 4 December 2001, on
prevention of the use of the financial system for the purpose of money laundering, lays
down that institutions must adopt the appropriate specific measures necessary to offset
25 9 February 2001.
29
the greater risk of money laundering that exists when business relationships are entered
into or transactions carried out with customers who have not been identified physically.
In Spain, as in all other European Union countries26, in accordance with the principle of
neutrality with regard to the distribution channel, there is no special prudential
regulation applicable to electronic banking. However, in order to protect consumers’
interests, the Bank of Spain has specified for this distribution channel the general rules
on transparency of operations and customer protection.
26 With the exception of Belgium.
30
IV. Summary and conclusions
Being an information-intensive sector, the financial industry has adopted information
technology extremely quickly. This process is transforming banking institutions’
traditional business models and Spanish financial institutions, in particular deposit
institutions, have been no exception. Furthermore, their situation in relation to
institutions in other industrialized countries may be considered to be somewhat atypical,
as Spain has a rate of utilization of Internet banking that is higher than one would
expect given the level to which the Internet has been taken up by the population as a
whole.
Spain had five primarily Internet banks in 2001; none of them is an independent bank.
Their market share (including deposits taken by telephone) was approximately 1.3% of
retail bank deposits. However, these deposits were highly concentrated in the hands of
one institution, which had a share of approximately 1.2%. Moreover, traditional
commercial and savings banks are making significant use of the Internet as a
distribution channel, according to the criteria used here. In terms of retail deposits
acquired via the Internet channel, commercial banks accounted for 0.6% and savings
banks for 0.1%. The adoption rates do depend on the size of the deposit institution.
Most of the multi channel banks started to operate before their primarily Internet
affiliates were launched. This strategy seemed to be oriented at taking control of the
Spanish e-banking market by the incumbents. Besides, Spanish financial institutions
are actively developing new business models for the provision of financial services such
as B2B and B2C platforms or mobile payments systems. Nevertheless, the financial
31
aggregator business model seems to have been less successful in Spain, in part as a
result of legal restrictions arising from data protection legislation.
The use of the Internet as a distribution channel by Spanish deposit institutions seems to
be accompanied by a reduction in the transaction costs institutions charge their
customers. In the case of primarily Internet banks, this apparent transaction cost
reduction has not yet been translated into an overall cost reduction. Thus the
profitability in terms of the return on average total assets of the five Internet banks in
operation in 2001 was negative up until 2002. However, the oldest Internet bank
launched in 1997 seems to accumulate experience that allows it to operate more
efficiently. The data also suggest that the oldest primarily Internet bank, still lags
performance of the average traditional mature bank.
As well as offering advantages, the provision of financial services over the Internet, and
in particular, banking services, also implies potential risks. Although the most
significant risks of electronic banking are not new compared with traditional banking, it
is nevertheless the case that the Internet potentially modifies and increases traditional
banking risks by influencing risk profiles. Thus, the strategic risk, operational risk (legal
and security), reputational risk and systemic risk are potentially greater and have
different characteristics from those of traditional banks. The results of the Questionnaire
on Financial Activity over the Internet in Spain highlight that this risk profile is also
characteristic of Spanish financial institutions using this channel. In the case of multi
channel banks, no correlation seems to exist between size and risk level.
32
The reality described makes it necessary for regulators and supervisors to change their
approach in order to fulfil their two main objectives: financial stability and
consumer/investor protection. From the point of view of financial stability, new
challenges have arisen. One of these is a dependence on a relatively small number of
outsourcing service providers who at times provide services to several financial
institutions through increasingly complex contractual arrangements. Another is the
emergence of micro-payments systems and/or Internet deposits services by companies
that are not regulated as deposit institutions. Both of these cases imply increasing
difficulties for regulators and supervisors wishing to monitor possible sources of
systemic risk and the scope of coverage of deposit insurance. In Spain, the adoption of
information technology and Internet in particular has not divested deposit institutions of
their traditional role in the payment system. Furthermore, retail e-payments have
experienced only limited customer adoption so far. At the same time, Spanish deposit
Institutions only outsource support functions and even though they often share the same
providers, it does not seem to pose a systemic risk as yet. Against this background, in
Spain, in common with the rest of the European Union (with the exception of Belgium),
there is no specific prudential regulation applicable to electronic banking and aimed at
preserving the stability of the banking system, in accordance with the principle of
neutrality with respect to the distribution channel.
In terms of consumer/investor protection, regulators’ attention has focused on
facilitating access to information and ensuring that the information given is of adequate
quality. In this new context, regulators and supervisors face greater challenges when
seeking to ensure transactional security and data privacy. This further highlights the
need for close coordination between prudential supervision and protection of financial
33
services customers and investors. It is in the realm of consumer protection where
Spanish regulators, both on their own initiative and in the context of transposition of
European Union Directives, have been more active.
Although there is no specific regulation of financial activities over the Internet at the
European Union level, a number of directives have been or are being transposed in
Spanish legislation. All of them deal with aspects that are relevant from the financial
consumer/investor protection point of view.
34
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