WORLD BANK DISCUSSION PAPER NO. 431 Work in progress WDP431 for public discussion March 2002 Electronic Finance A New Appiroath //[ J,inamil(f/ Se(tzo, Det -lo pment? Ih,ouaiis (G/daK;ss/wr 1)/Z/17i'la /fA ilf}-ebu)/fo Recent World Bank Discussion Papers No. 351 From Universal Food Subsidies to a Self-Targeted Program: A Case Study in Tunisian Reform. Laura Tuck and Kathy Lindert No. 352 China's Urban Transport Development Strategy: Proceedings of a Symposium in Beijing, November 8-10, 1995. Edited by Stephen Stares and Liu Zhi No. 353 Telecommunications Policiesfor Sub-Saharan Africa. Mohammad A. Mustafa, Bruce Laidlaw, ancd Mark Brand No. 354 Saving across the World: Puzzles and Policies. Klaus Schmidt-Hebbel and Luis Serven No. 355 Agriculture and German Reunification. Ulrich E. Koester and Karen M. Brooks No. 356 Evaluating Health Projects: Lessonsfrom the Literature. 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Garry Christensen and Richard Lacroix (Continued on the inside back cover) WORLD BANK DISCUSSION PAPER NO. 431 Electronic Finance A New Approach to Financial Sector Development? Stijn Claessens Thomas Glaessner Daniela Klingebiel The World Bank Washington, D.C Copyright © 2002 The International Bank for Reconstruction and Development/THE WORLD BANK 1818 H Street, N.W. Washington, D.C. 20433, U.S.A. All rights reserved Manufactured in the United States of America First printing March 2002 1 234040302 Discussion Papers present results of country analysis or research that are circulated to encourage discussion and comment within the development community. The typescript of this paper therefore has not been prepared in accordance with the procedures appropriate to formal printed texts, and the World Bank accepts no responsibility for errors. Some sources cited in this paper may be informal documents that are not readily available. 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Permission to photocopy items for internal or personal use, for the internal or personal use of specific clients, or for educational classroom use, is granted by the World Bank, provided that the appropriate fee is paid directly to Copyright Clearance Center, Inc., 222 Rosewood Drive, Danvers, MA 01923, U.S.A., telephone 978-750-8400, fax 978-750-4470. Please contact the Copyright Clearance Center before photocopying items. For permission to reprint individual articles or chapters, please fax your request with complete information to the Republication Department, Copyright Clearance Center, fax 978-750-4470. All other queries on rights and licenses should be addressed to the World Bank at the address above or faxed to 202-522-2422. ISBN: 0-8213-5104-4 ISSN: 0259-210X Stijn Claessens is a Professor at the University of Amsterdam. Thomas Glaessner is a Lead Financial Economist at the World Bank. Daniela Klingebiel is a Senior Financial Economist at the World Bank. Library of Congress Cataloging-in-Publication Data has been applied for. iR Contents Foreword v Abstract vii Acknowledgments ix Executive Summary I The Recent Past and Possible Future of Electronic Finance 5 The New World of Financial Services 17 Changes Needed in Financial Sector Policies 23 E-finance Applications-and Implications for Govemment 39 Annexes Annex 1. Data Sources and Meftodology for/ he Projections 47 Annex2.: Recent Repoo'tsby ln7teratobnalE-ffIance Working Grouos 49 Annex 3: Types of Onl/ne Trading Systems 59 Annex 4: Selected Smant Card Projects in Emerigng Markets and Developing Countries 67 Annex 5: SelectedE-finance Examples knEmergngfgMarkets and Deve/opIng Countries 75 E-Finance Web Links 81 References 89 Bibliographical Note 97 Tables Table 1. E-finance has achievedsign,ficantpenefrafton in most iodustrIaWcountrIes and many emerging markets 6 Table 2. Consumers and countries around/he world are gettfng better connected, 1999 8 Table 3: Emerging markets'capI,taliss ncreaszqgly owned, fraded, and /lsted abroad, 2000 10 Table 4' The takeoffpooitnforonlinfe banking depoends on the levelofconnectivity 12 Table 5: E-flnance will slash banks'net ifterest margIns, 2005 and 20 10 15 Table 6: The Inerneft is changlng features of inancialservices 20 iV Electronic Finance: A New Approach to Financial Sector Development? Table 7'A newparadog'm is emerging forfnancal sector development 24 Table 8: Progress Is being made in creating an enabling regulatoly environment 28 Table 9. E-finance regulation has yet to address some outstanding issues 33 Table A2-1.: Currente-finance initiAives by international bodies 50 TableA3-1.' Fixed-income trading systems 62 Table A3-2. Major US online stock brokerages 64 Figures Figure la.' Capital raised by companies inAmerkcan deposltolyreceilts, 1980-2000 9 Figure lb.' Value tradedbycompaniesIn Amerncan depoository recelpts, 1980-2000 9 Figure 2.' E-banking penetration.' actualandprojected rates for 2000, 2005, and 2010 13 Figure 3. Different seivice providers and deliveiy channels are combining to create a new world of financial services 18 Boxes Box 1.' Mobile phones.' The developing wor/ds technologicalsoringboard 7 Box 2' The new world of flnancialservice providers 17 Box 3.' The massive shifts in stock markets and exchanges 19 Box 4.' Leapfrogging around the globe.' Estonia, Republic of Korea, and Brazil 21 Box 5' The institutional approach to financial sector development 23 Box 6.' Enhancing connectivity in emerging markets byimnproving telecommunications regulation 25 Box 7. Privacy problems-the role of the publlc sector and private solutions 26 Box 8.' Securlties regulation, the Internet, and emerging markets 30 Box 9. Principles for managing riskin online banking 31 Box 10 Challenges for marketregulation within and across countries 37 Box 11. Making creative use of existing public infrastructure.' Post offIces 40 Box 12. Smant cards. A clever way to leapfrog? 40 Box 13.' Moltgage fnance.' The im,pact of the Internet 41 Box 14. Insurance. E-fAanceable? 42 Box 15' E-flnance for small and medlum-size enterorises 43 Box 16. Microflnance and e-finance-a vlable match? 44 Box 17' FinNet' Toward a paperless infrastructure backbone for flnanclal sel/ices 45 v Foreword E lectronic financial services whether the focus will be on actions that can improve the delivered online, through mobile phones or ability (through lower costs and increased E other remote mechanisms, or through smart competition) and willingness of private institutions cards have spread quickly in recent years. This e- to broaden access to financial services. finance revolution is dramatically changing the The Bank has also been helping countries deal structure and nature of financial services around the with the implications of e-finance for the world. The effects are not limited to industrial development of their capital markets. These efforts countries and advanced emerging markets. Already, will increasingly be coordinated with the operations countries with underdeveloped financial systems are of the International Finance Corporation (IFC). using e-finance to leapfrog in some areas. In Africa Furthermore, the Bank s extensive experience in electronic cash and other smart and even chip cards using and applying technology in its funding and are being offered as savings and payment services investment operations is being leveraged in our for low-income customers who do not have access advisory work. More generally, the Bank s efforts in to formal bank accounts. Other experiences as in this promising area will involve cross-departmental Brazil, Estonia, and the Republic of Korea suggest and multidisciplinary approaches to address this that e-finance can be introduced quickly even where new phenomenon in the needed comprehensive basic financial infrastructure is weak or nonexistent. way. Technological advances are also making it possible As part of this effort, and to advance the to deliver financial services from offshore, dialogue on the issues raised by e-finance, Bank providing some emerging markets with the Group staff have prepared a number of papers, one additional benefits of international technology and of which is presented here. This paper, and others oversight. on this topic, do not represent the World Bank The World Bank is helping countries benefit Group s policies. Rather, they have been developed from these new developments in a number of ways. to stimulate discussion and solicit the views of the Realizing the gains from e-finance will require development community on the opportunities changes in public policies toward financial services. offered by e-finance for better financial sector Better regulation will be needed in such critical development, sustained growth, and reduced areas as the telecommunications framework, poverty. information infrastructure, payment systems, and Although many questions remain to be competition policy. The Bank s advisory services answered, this paper contributes to the literature by are being adjusted to reflect the new possibilities laying out the policy issues in e-finance. It will be and changed public policy priorities. This work of particular interest to policymakers involved with involves diagnoses, under way in some countries, of financial regulation, but should also be of concern infrastructure s readiness to support e-finance and for those more generally interested in the potential related advice on needed policy changes. Much of and implications of this phenomemon. Cesare Calari Vice President, Financial Sector The World Bank vii Abstract In recent years electronic finance especially globalization more generally, affects financial sector online banking and brokerage services has policies in emerging markets including the need reshaped the financial landscape around the for changes in the approach to financial sector world. This paper reviews these developments and development. The paper then examines analyzes their implications for consumers, government s changing role in the financial sector governments, and financial service providers. First and identifies opportunities that e-finance offers it reviews the e-finance (r)evolution in emerging countries to leapfrog. Finally, the paper includes and other markets and projects its future growth. for policymakers and others involved in financial Then it analyzes e-finance s impact on the structure sector reform in emerging markets detailed of and competition in the financial services industry. information and Web links on public policy After that it assesses how e-finance, and activities related to e-finance. ix Acknowledgments his paper has drawn on a wide variety of Karen Furst, Joselito Gallardo, Charlie Guarrigues, T sources. The authors are grateful to the Andrew Hughes Hallet, Patrick Honahan, Leora T numerous authorities and individuals in Klapper, Jeppe Ladekarl, Bruno Lanvin, Ignacio many industrial countries and emerging markets Mas, Donald Mclsaac, Daniel Nolle, Mehmet who have been so kind to share their time with us Ozkaya, Andrew Procter, Larry Promisel, and provide useful data and background material. Roy Ramos, Bertrand Renaud, Antony Santomero, The authors are also grateful for the many valuable Sergio Schmukler, Andrew Sheng, Peer Stein, written and other inputs from Fatouma Toure Panos Varangis, and John Williamson. The Ibrahima, Zeynep Kantur, Tom Kellermann, Juliane authors would like to thank Paul Holtz of Kraska, Ying Lin, and Olga Sulla. Helpful Communications Development Incorporated for comments and contributions were provided by editorial assistance and Talfourd Pierce and Rose Vo Hanny Assaad, Gerard Caprio, Rodrigo Chaves, for crucial aid in preparing the manuscript for Loic Chiquier, Carlos Cuevas, Simeon Djankov, publication. Executive Summary Electronic finance is spreading E-finance is dramatically changing the quickly... structure and nature of financial Electronic financial services, whether delivered services online or through other remote mechanisms, have * E-finance will lead to much lower costs and spread quickly in recent years. Despite differences greater competition in financial services across countries including such factors as the through both new entry from outside today s readiness of telecommunications infrastructure and financial sector and greater competition among the quality of regulations there is much incumbent financial service providers. These commonality and convergence in the spread of e- developments will force banks to lower fees finance. and commissions because providing e-finance E-finance penetration varies by type of service. is much cheaper than providing traditional Most affected have been brokerage markets, where financial services. As a result incumbent online trading is becoming the norm. Increased financial institutions will likely experience a connectivity has also accelerated the migration of sharp decline in revenue. securities trading and capital raising by emerging * Internet and related technologies are more than markets to a few global financial centers, with just new delivery channels they are a capital raised offshore by emerging markets completely different way of providing financial increasing dramatically since the early 1990s. This services. Using data mining techniques, for shift has resulted in far greater integration and example, providers can tailor products without intermarket links. Consolidation is also occurring in much human input and at very low cost. They key middle and back office functions such as can also better stratify their customer base and custody, clearing of trades and retail payments, and allow consumers to build preference profiles central securities depositories. online enabling far more personalized pricing The spread of online banking services has been of financial services and much more effective more varied across countries. Spurred by the entry identification of credit risks. The Internet also of new providers from outside the financial sector, allows new financial service providers to however, many financial service providers are now compete more effectively for customers. All offering e-finance services. these forces are delivering large benefits to consumers of financial services at the retail and * ... and shows enormous potential . .................commercial levels. By 2005 online banking could account for 50 * Technological advances are also changing the percent of the market in industrial countries, up face of the financial services industry. New from 9 percent today, and for 10 percent in providers are emerging within and across emerging markets, up from 1 percent. With better countries, including online banks, online connectivity, online banking in emerging markets brokerages, and companies that allow could rise even further, to 20 percent by 2005. consumers to compare financial services such Similarly, in industrial countries the share of online as mortgage loans and insurance policies. brokerage could rise from 28 to 80 percent, and in Nonfinancial entities are also entering the emerging markets from 2 to 15 percent. With a market, including telecommunications and better business and enabling environment, the share utility companies that offer payment and other of online brokerage in emerging markets could even services. Vertically integrated financial service hit 40 percent by 2005. companies are growing rapidly and creating But these averages hide big differences, synergies by combining brand names, depending on whether a country s penetration rate distribution networks, and financial service has already passed a critical level. In Nordic production. countries, for example, online banking could reach * Trading systems for equities, fixed income, nearly 80 percent by 2005, while U.K. and U.S. and foreign exchange are consolidating and penetration would approach just 50 percent. For going global. Trading is moving toward online brokerage, penetration rates in Nordic electronic platforms not tied to any location. countries could hit 90 percent. Electronic trading and communication 2 Electronic Finance: A New Approach to Financial Sector Development? networks have lowered the costs of trading and In addition, steps should be taken to minimize risks allow for better price determination. for consumers and investors, adjust prudential * The Internet and other technological advances regulation, and improve the performance of have shrunk economies of scale in the markets. production of financial services. Lower scale * The telecommunications framework should economies have increased competition, avoid protecting incumbent providers and allow particularly among financial services that can private firms to enhance connectivity using easily be unbundled and commoditized through forms ranging from fixed lines to mobile and automation including bill payment services, satellite. mortgage loans, insurance, and even trade * Internet transactions require security measures technology. Competition is further fostered by in cases where innovative approaches to public declining up-front costs. In contrast, network and private partnerships will be necessary. For externalities exhibited by financial services example, government actions are needed to set such as payment services, trading systems, and up a framework for digital signatures. In exchanges tend to hamper competition. addition, there will be a need to establish secure systems for certification, and a number of Underdeveloped financial solutions involving the private and public systems can exploit opportunities sectors will be possible. Finally, there will be a for leapfrogging need to address the challenges of enforcing ,or zeaplrO9gll7g ~~~~~~~standards for electronic security and creating a The effects of e-finance are not limited to industrial database to benchmark electronic security countries and advanced emerging markets. For systems. countries with underdeveloped financial systems, e- * If information is good enough, e-finance will finance offers opportunities to leapfrog. Such extend the reach of financial institutions and systems tend to do a bad job of allocating resources capital markets. Governments will need to and have high intermediation costs, problems with review their information and privacy policies in establishing credible supervision, and possibly large light of the new possibilities. fiscal costs from bank recapitalizations. For such * With e-finance, contract enforcement has countries, e-finance can be a revolution and become more important within and across evidence indicates that this is starting to happen. In borders, but new technology may also help Africa electronic cash and other smart cards offer solve contract enforcement problems. Most savings and payment services to low-income rules will have to be set at the global level. customers including in remote areas who often * Managing risks will become more important to do not even have formal bank accounts. Other protect consumers and investors. E-finance can countries Brazil, Estonia, Republic of Korea increase long-standing risks such as theft and suggest that e-finance can be introduced quickly lack of privacy as well as create new ones. even where basic financial infrastructure is weak. E- Thus more emphasis is needed on better finance will also allow financial services to be disclosure, education, and information. The delivered to such countries from offshore, providing Internet is starting to provide solutions, with the additional benefits of international technology firms acting as certification agents, aggregators, and oversight. and vendors of security and privacy hardware But realizing the gains will require and software on behalf of consumers, investors, and financial service providers. changing public policies toward . Prudential regulation will probably become less financial services... effective, so it will be important especially in The most pressing policy issues involve the emerging markets to ensure that the financial enabling regulatory environment for e-finance. sector safety net is not extended to nonfinancial Adjustments are needed in approaches to firms that increasingly provide near substitutes telecommunications, security and related for financial services, including deposits. infrastructure for electronic transactions, * To make financial markets and institutions information and privacy, and contract enforcement. work better, more emphasis should be placed Executive Summary 3 on competition policy and clear rules for statutes). And existing infrastructure, such as markets. post office networks, can provide access to e-finance services. ... and adjusting government's role in U Goverment s role can change fundamentally the financial sector with less need for direct provision in areas Government intervention in the financial sector such as banking services, housing finance, has generally had poor results. Government insurance, nonbank financial services ownership of banks retards financial sector (factoring, leasing), storage finance, trade development and increases the risk of financial finance, small and medium-size enterprise crises. Efforts to reach underserved groups often lending, and even microlending. In all these fail or are captured by special interests, and can areas more efficient delivery of services can incur large fiscal costs. achieve savings, cut costs, and expand access. * E-finance reduces the need for government With the potential of e-finance, however, intervention because the private sector come some provisos. First, e-finance offers can provide financial services even when many opportunities but it is no panacea. Most a country s financial sector is weak. Market of the benefits, such as widening access to financial failures will be less likely because new services, can be realized only if complementary technology will make information more reforms are made in communications infrastructure, easily available and, with related reforms, security, contract enforcement, corporate of higher quality. This will permit financial governance, and other areas. Second, this services to be provided more widely and paper covers a variety of issues, each of which make markets to trade risks and assets more requires further research and analysis (often complete, reducing the need for government multidisciplinary). Finally, as with any new intervention. phenomenon, e-finance faces large data problems * But there will still be scope for government so the data presented here must be viewed with action beyond setting the enabling caution. More efforts are needed to develop a environment. As a start, government could consistent methodology for measuring concepts improve the way it shares information (such as such as Internet penetration and related basic data credit-related information, subject to privacy on e-finance. 5 The Recent Past and Possible Future of Electronic Finance his section addresses several questions: To customers to assimilate. Moreover, in countries with what extent have technological advances in weak financial services, customers may have a T financial services spread, and what is the strong incentive to move to e-finance providers. current penetration of e-finance in industrial Banking services may still be limited in these countries and emerging markets? What are countries, but e-finance offers an opportunity to connectivity rates across countries, and to what expand access. extent has capital migrated offshore? What is the Although online-only banking has been less growth potential for e-finance? And what effects successful than was anticipated, with several online- will e-finance have on the world s financial services only banks running into difficulties, incumbent industry particularly on the revenues of today s banks are starting to offer financial services financial institutions? electronically. The threat of new entrants has led many banks to offer e-finance ranging from basic to E-finance has spread quickly in a fully integrated Internet services. Speed and other diverse range of countries factors influencing this shift vary with an Although there has been some retrenchment in the institution s size and circumstances, but this trend technology sector, technology continues to has accelerated recently in Europe and the United transform the production and delivery of financial States (Furst, Lang, and Nolle 2000; Salomon Smith services. Electronic financial services, whether Barney 1999). Thus customers of incumbent banks delivered online or through other remote in other markets could soon migrate to e-finance as mechanisms, have spread quickly in recent years. well. As with any new phenomenon, data on e-finance E-finance has made the greatest inroads in are hard to collect and even harder to compare securities markets especially on the retail side, across countries and services. (For example, no where online trading has quickly taken large market standards have been developed for the measurement shares. About 28 percent of brokerage services are of such concepts as Internet penetration and related now provided online in industrial countries, and e-finance services.) Thus data should be interpreted shares are also high in some emerging markets. The with caution. rapid acceptance of e-finance in securities markets Using various sources, Table I shows the extent partly reflects the technology-driven nature of these of electronic banking and brokerage services in key markets and the ease with which consumers can industrial countries and emerging markets. There is switch brokers. Moreover, the low costs of significant variation, with differences not clearly introducing standalone and integrated brokerage related to each country s level of development. In services have permitted rapid growth around the some countries, industrial as well as developing, world. The rapid spread also suggests that the electronic delivery of financial services remains in technology of e-brokerage is easy to introduce and its infancy. Meanwhile, other countries have seen market to users, and that cost reductions are quickly rapid penetration of e-finance. In Sweden e-finance being passed on to consumers. accounts for more than one-third of financial Other e-finance products, such as e-money, transactions. In some emerging markets, such as the have seen various penetration rates. In some Czech Republic, Republic of Korea, and Mexico, e- countries (Denmark, the Netherlands, Norway) e- finance penetration is also high for some financial money penetration, as measured by the number of services. terminal units at which payments can be made by There is evidence of convergence in e-finance cards, is quite high (see Table 1). In these countries across countries. Despite institutional disadvantages e-cards have complemented or replaced existing (such as weaker telecommunications infrastructure) financial services. A stumbling block to greater and more adverse demand and supply factors, penetration has been standards and to some extent Internet-based services are sometimes as popular in security arrangements. Countries with more use emerging markets as in industrial countries or tend to be smaller, suggesting that it has been easier even more popular. For example, online banking is to introduce standards for e-money. But in larger nearly as widespread in Brazil as in the United countries a lack of standards and critical mass has States. Such findings suggest that around the globe, often not allowed stored value cards to catch on. As e-finance is fairly easy to introduce and for standards are being set and security arrangements 6 Electronic Finance: A New Approach to Financial Sector Development? Table 1 E-finance has achieved significant penetration in most industrial countries and many emerging markets Online brokerage Online banking (transactions as E-money (customers as percentage of (number of percentage of brokerage merchant terminals Business environment Income group/economy bank customers) transactions) per 100,000 people) ranking, 2000-04 Industrial country average 8 27 427 8.2 Australia 4 22 10 8.1 Belgium 4 20 8.2 Denmark 6 38 1,192 8.4 Finland 20 110 8.2 France 2 18 1 8.2 Germany 12 32 73 8.3 Italy 1 16 7 7.7 Japan 32 7.4 Netherands 15 40 1,898 8.8 Norway 8 25 1,059 8.0 Portugal 2 7 589 7.6 Singapore 5 10 332 8.6 Spain 2 8 251 8.0 Sweden 31 55 418 8.3 United Kingdom 6 26 3 8.8 United States 6 56 35 8.7 Emerging market average 5 30 71 7.0 Argentina 3 7.2 Brazil 5 6 1 6.4 China 3 5.9 Czech Republic 1 90 7.0 Hong Kong, China 5 1 351 8.5 Hungary 6 1 7.1 India 11 2 6.0 Korea, Rep. of 13 65 7.3 Mexico 3 41 2 6.8 Poland 1 7.2 Thailand 1 1 7.3 Average for all economies 7 28 333 7.7 Source: Data on online banking and online brokerage are from various sources, but mainly from DataMonitor and central banks. Data on e-money are frorn the Committee on Payment and Settlement Systems, Survey of Electronic Money Developments, 2000. Business environrent rankings are from the Economist Intelligence Unit Country Forecast, with a score of 10 as best and 5 as poor. The rankings combine more than 70 indicators including the strength of the economy, outlook for political stability, regulatory climate, taxation policy, and openness to trade and investment to measure the expected attractiveness of the general business environment through 2004. See Annex I for further details. The Recent Past and Possible Future of Electronic Finance 7 enhanced, e-cards and other forms of e-payments connectivity is being further enhanced by rapid are putting pressure on banks income from improvements in telecommunications regulation. payment services around the world. Still, many emerging markets require substantial Connectivity is also on the rise reforms in such regulation to enhance the enabling environment and allow the private sector to deliver Around the world, consumers and countries are financial services. increasingly getting connected. Advanced countries like the United States lead in terms of the Capital raising and securities trading percentage of the population that owns a personal are migrating abroad computer and has Internet access (Table 2). The Technology has also driven the large migration of density of Internet services is also highest in the capital raising and securities trading to international most advanced countries. Among these countries, financial centers. The share of capital raised abroad Nordic countries stand out with high connectivity. and traded offshore has been rising sharply, This high connectivity is augmented by the especially in emerging markets. Equity capital popularity of mobile phones, which are used by raised internationally (through American depository almost two-thirds of the people in Finland and receipts) jumped from less than $5 billion in 1990 Norway and three-fifths in Sweden. Connectivity to nearly $30 billion in 2000 (Figure la). This trend generally declines with income, though there are has been accompanied by an even sharper increase exceptions. For example, Portugal has low in offshore trading, with offshore trading in computer ownership and Korea has high connectivity, including through mobile phones yet the two countries per capita incomes are quite Mobile phones: The developing world's similar (in 1999 Portugal s was $11,384 and technological springboard Korea s was $9,878). In many countries connectivity has been In 1990 there were just 11 million mobile phone subscribers increasing sharply in recent years. Between 1995 worldwide. By 1998 that number had jumped to 320 million, and and 1998 the percentage of people owning a current estimates are of more than 500 million users. Privately persona 1998 mpuerentage some industale now m is abuilt wireless networks drive this growth. Mobile phones have personal computer in some industrial economies made telecommunications available even to the world's poor, rose almost 60 percent. In a sample of developing partly because of the widespread creation of telecenters and economies ownership jumped 150 percent, albeit public call offices. from a lower base.' Increased connectivity is not Recognizing the benefits, governments are adopting limited to advanced emerging markets it is also policies to encourage mobile telecommunications in rural areas. becoming important in some of the world s least Policies include license obligations to serve rural communities developed countries. Africa Online, for example, is (Mexico, the Philippines), subsidies through rural telecom development funds (Chile, Peru), variations of build-operate- a growing Internet provider in Africa (outside South transfer arrangements (Thailand), and low-interest loans. The Africa). Access to telecommunications is being spread of rural telecommunications is further facilitated by aided by new technology, such as mobile phones falling costs for mobile phones. with increasingly large bandwidths (Box 1). Some developing countries typify the possibilities of These new technologies not only allow leapfrogging using mobile phones. Zimbabwe saw wireless countries to leapfrog in connectivity, they also open subscribers skyrocket to 174,000 in 1999-annual growth of new channels for delivering e-finance services. In more than 800 percent, the fastest in the world. In Botswana, newichannels fordeivcountring, eourin es serviceas. C6te d'lvoire, and Rwanda wireless phone subscribers addition to Nordic countries, countries such as outnumber fixed-line users. Brazil has more than 15 million Cambodia, India, Malaysia, and Poland are seeing mobile phone subscribers, more than all Nordic nations financial service providers use mobile phones to combined. With a devastated fixed network after more than 20 deliver financial services. Around the world, years of civil war, adopting cellular technology was the obvious choice for Cambodia, and within a year mobile phones outnumbered fixed phones. Even though its per capita income 1 The industrial economies were Australia, Denmark, is among the world's lowest, Cambodia now surpasses 31 Hong Kong (China), Japan, the United Kingdom, and countries in telephone penetration-including countries with the United States. The developing economies were much higher incomes. Brazil, Chile, China, Guatemala, Hungary, India, Kenya, Source: See bibliographical note. Mexico, Peru, Senegal, Sudan, Vietnam, and Zimbabwe. 8 Electronic Finance: A New Approach to Financial Sector Development? Table 2 Consumers and countries around the world are getting better connected, 1999 Mobile phone use Personal computer use Internet connectivity (percentage of people (percentage of population (Internet hosts per who are mobile or Income group/economy owning personal computers) 10,000 people) cellular subscribers) Industrial country average 33 337 42 Australia 47 417 34 Belgium 32 162 31 Denmark 41 72 49 Finland 36 1,057 65 France 22 83 36 Germany 30 161 29 Italy 19 59 53 Japan 29 133 45 Netherlands 36 357 44 Norway 45 715 62 Portugal 9 50 47 Singapore 44 208 42 Spain 12 67 3 Sweden 45 488 58 United Kingdom 31 241 46 United States 52 1,123 31 Emerging market average 7 31 16 Argentina 5 18 12 Brazil 4 13 9 China 1 0 3 Czech Republic 11 72 19 Egypt 1 0 1 Hong Kong, China 29 120 63 Hungary 7 83 16 India 0 0 0 Korea, Rep. of 18 40 50 Mexico 4 12 8 Poland 6 28 10 Russian Federation 4 10 1 South Africa 6 34 12 Thailand 2 3 4 Turkey 3 5 13 Average for all economies 20 194 30 Source: International Telecommunication Union, World Telecommunication Indicators Database 1999. See Annex I for details. The Recent Past and Possible Future of Electronic Finance 9 American depository receipts reaching more than $1 offshore capital, and offshore trading in American trillion in 2000 (Figure lb). In 2000 the top six depository receipts from these countries totaled emerging markets in terms of capital raised $180 billion. By 2000 about 19 percent of trading in Argentina, Brazil, China, India, Korea, and emerging market securities was occurring offshore Mexico collected more than $10 billion in (Table 3). Figure ia Capital raised by companies in American depository receipts, 1980-2000 Billions of U.S. dollars 18 16 _________ U High-income economies * Other middle-income economies 14 Z Other low-income economies N Top six emerging markets 12 - 10 0 I 1980-89 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 Figure lb Value traded by companies in American depository receipts, 1980-2000 Trillions of U.S. dollars 0.9 * High-income economies 0.8 * Other middle-income economies 0.7 Other low-income economies 0. Top six emerging markets 0.6 0.5 0.4 0.3 0.2 0.1 ,' D 0 /L ¶ 1 1980-89 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 Note: Figure la shows the amount of capital raised in international financial markets throughAmerican depository receipts. Figure lb shows trading on the New York Stock Exchange in American depository receipts. Data for 1980-89 are the annual average for the period. In both figures the top six emeing markets based on total capital raised in American depository receipts in 1980-2000 are Argenttna, Brazil, China, India, Republic of Korea, and Mexico. The high-income economies are Australia, Austria, Belgium, Denmark, Finland, France, Germany, Greece, Hong Kong (China), Ireland, Israel, Italy, Japan, Luxembourg, Netherlands, New Zealand, Norway, Portugal, Singapore, Slovenia, Spain, Sweden, Switzerland, Taiwan (China), and the United Kingdom. The other middle-income economies are Bahrain, Chile, Colombia, Croatia, Czech Republic, Dominican Republic, Egypt, Estonia, Hungary, Jordan, Kazakhstan, Latvia, Lebanon, Lithuania, Malta, Morocco, Papua New Guinea, Peru, Philippines, Poland, Romania, Russian Federation, Slovak Republic, South Africa, Sri Lanka, Thailand, Tunisia, Turkey, Uruguay, and Venezuela, RB. The other low-income economies are Ghana, Indonesia, Malawi, and Pakistan. Source: Claessens, Klingebiel, and Schmukler forthcoming. 10 Electronic Finance: A New Approach to Financial Sector Development? This migration has generally led to gains for 2000). Penetration for these products and services both issuers and investors. Issuers have seen higher tends to accelerate once a market has reached prices and increased liquidity for their securities. critical mass. This critical mass and subsequent And with remote access to global trading systems, growth is often similar across markets. Most institutional and individual investors can now analysts expect e-finance to exhibit this same execute their trades on the platforms with the best pattern of market penetration (see ongoing analysis prices and execution. by Forester Research, Jupiter Research, and E-finance has enormous potential- DataMonitor). So what determines when a country reaches especially in a supportive environment a critical mass of penetration? A variety of The rapid growth of e-finance reflects the expansion factors, including the quality of a country s patterns of certain products and services with telecommunications infrastructure, its approach network externalities, such as telecommunications to regulation, and the demand for and supply of and some financial services (Furst, Lang, and Nolle e-finance services (Sachs 2000). It is too early to Table 3 Emerging markets' capital is increasingly owned, traded, and listed abroad, 2000 Percent Share of Share of Share listed in Region/economy foreign ownership foreign value traded New York or London Latin America 24 54 53 Argentina 10 65 65 Brazil 28 43 63 Chile 13 55 46 Colombia 5 8 13 Mexico 42 58 48 Peru 9 59 24 Venezuela, RB 62 73 44 Asia 7 7 18 China 4 14 46 India 11 14 29 Indonesia 12 10 16 Korea, Rep. of 17 5 24 Philippines 11 14 17 Taiwan (China) 6 2 22 Thailand 12 0 0 Europe, Middle East, and Africa 15 60 50 Hungary 32 5 54 Israel 29 90 78 Poland 14 2 13 Russian Federation 14 13 88 South Africa 14 24 55 Turkey 10 1 13 All emerging markets 13 19 38 Source: Goldman Sachs Research estimates. The Recent Past and Possible Future of Electronic Finance 11 fully explain the determinants of e-finance e-finance. But by 2010 it might, and e-banking penetration. Nevertheless, in countries where e- penetration in Italy could exceed 70 percent. finance penetration has reached a level that should E-finance penetration could grow even faster lead to faster growth, the level of connectivity and if the environment for it improves. Figure 2 also the quality of the business environment appear to shows the results of a simulation in which explain the point of takeoff. This assessment is connectivity in emerging markets rises to about the based on simple regression analysis using level of today s lowest-ranked industrial country connectivity and the business environment as the a rating of 6. With better connectivity the explanatory variables and takeoff for online banking penetration of online banking in most emerging as the dependent variable (see Annex 1). The higher markets could rise to about 20 percent by 2005, is the level of connectivity, the earlier a country and online brokerage could increase to about reaches the point at which online banking can be 40 percent. With a more conducive environment, expected to take off. e-finance penetration around the world could thus This relationship indicates when countries can more than quadruple for banking, from 7 percent in expect a sharp increase in online banking (Table 4). 1999 to 30 percent in 2005, and almost double for For example, France can expect rapid growth by brokerage, from 28 percent to 45 percent. 2003, and Portugal by 2004. Russia, by contrast, Financial institutions should will not reach the takeoff point for online banking until 2006. A similar relationship holds for the anticipate lower revenues penetration of online trading, except e-brokerage Using new technology, new entrants will provide appears to depend not just on connectivity but also financial services at lower cost. Incumbent financial on the business environment. institutions will see pressures on their profits unless Using the actual and projected takeoff years they can quickly move their business online and cut for 19 industrial countries with extensive e-finance operating costs to levels similar to those of the new penetration, it is possible to project e-finance entrants. Leaders among incumbents in adopting penetration for a group of emerging markets new technology will challenge other incumbents (using the typical pattern of diffusion after takeoff). through cheaper, better services. Lower revenues for These projections indicate that by 2005 an average incumbents could pose problems in countries where of 50 percent of banking services will be provided financial institutions have been sheltered from online in the industrial countries and 10 percent competition and where branch networks have high in the emerging markets up from 9 percent fixed costs. and 1 percent in 2000. The change will be even The risks to revenues and profits will depend on more dramatic for online brokerage: from an the speed of penetration, the cost advantages of average of 28 percent to 80 percent in the industrial providing e-finance, and the ability of incumbents to countries and from 2 percent to 15 percent in the adjust. The marginal costs of e-finance are much emerging markets.2 lower than those of traditional delivery channels, But these averages hide big differences between with each transaction costing a few cents countries, depending on whether they have reached compared with $1 or so for transactions at bank critical mass. In Nordic countries online banking branches and $0.50 at automated teller machines. will shoot from an average of 20 percent in 2000 to Although there are significant up-front costs, in the nearly 80 percent in 2005 (Figure 2). And in Sweden medium term the costs of delivering bank services online trading will jump from 55 percent to 94 online will be much lower at least as low as in percent. But in Italy penetration in banking will rise today s most Internet-advanced banks, such as some from just I percent to 22 percent, because the in Sweden. As a result margins for banking services country has not yet achieved critical mass in could fall to 1.6 percentage points (the average margin in 1997-98 in Nordic countries) or less.3 2 The 2000 data on online banking and online brokerage for emerging markets differ from those in Table 1 3 Margins differ by financial product; to average margins, because Table 4 refers to a larger sample of emerging total net internet income is calculated as a share of bank markets. assets and then expressed in percentage points. 12 Electronic Finance: A New Approach to Financial Sector Development? Table 4 The takeoff point for online banking depends on the level of connectivity Actual or Connectivity rating Actual or Current projected with connectivity projected Income groupleconomy connectivity rating takeoff year improvement takeoff year Industrial countries Australia 8 2001 2001 Austria 8 2001 2001 Belgium-Luxembourg 8 2003 2003 Denmark 8 1998 1998 Finland 9 1998 1998 France 8 2003 2003 Germany 8 2001 2001 Ireland 8 2000 2000 Italy 8 2004 2004 Japan 8 2001 2001 Netherlands 8 2002 2002 Norway 9 1998 1998 Portugal 6 2004 2004 Singapore 8 2001 2001 Spain 7 2002 2002 Sweden 9 1998 1998 Switzeland 8 1999 1999 United Kingdom 8 2001 2001 United States 9 2001 2001 Emerging markets Argentina 6 2004 6 2004 Brazil 5 2006 6 2004 China 3 2010 6 2004 Czech Republic 5 2006 6 2004 Egypt 3 2010 6 2004 Hong Kong, China 8 2001 8 2001 Hungary 5 2006 6 2004 India 3 2010 6 2004 Korea, Rep. of 7 2003 7 2003 Mexico 5 2006 6 2004 Poland 5 2006 6 2004 Russian Federation 5 2006 6 2004 South Africa 5 2006 6 2004 Thailand 5 2006 6 2004 Turkey 5 2006 6 2004 Note: Connectivity ratings are from the Economist Intelligence Unit and range from 0-10. Connectivity ratings combine ratings on computer ownership, Intemet hosts, mobile phone use, and other telecommunications connectivity criteria. For industrial countries the projected takeoff year is based on the typical panem of penetration and the country s current level of penetration (see Table 1). For emerging markets the projected takeoff year is based on the country s current connectivity rating, with the projections based on a regression analysis using the industrial countries projected takeoff year, where the regression line is estimated as 2,014.6- 1.71 * ConnectivitySee Annex I for details on information sources and methodology. Sotirce: Authors calculations. The Recent Past and Possible Future of Electronic Finance 13 Figure 2 E-banking penetration: actual and projected rates for 2000, 2005, and 2010 Norway . | .- az ina; _ ll l -- - ~-; Finland - t _ _ _ Denmark - - Sweden _ - -__ - Switzedand. -- . Z ,_ Ireland , _____ Germany a. Singapore Japan _r _.{ Australia - - United Kingdom _ _ _ Austria _ _ F.-.--- = l r____ United States -_ - _- -=- Netherlands Spain . -. I = MEOW France _W_71~_ rbX-A-W"- L:1- _=I-. U 2000 Belgium-Luxembourg _= * 2005 Portugal - [] 2010 Italy e - - I 0 10 20 30 40 50 60 70 80 90 100 Korea, Rep. Of _ - - - -_ - __ :, . Hong Kong, China _ r-n --___ -- _ _ - - :_ Argentina - _ -. Brazil _ . -C - Czech Rep. -- = - - Egypt - - . __ Hungary -- -= India --- _ . . D Mexico . Poland -* -. Russian Federation - ' . - _ 200 South Africa --. - -, , u *2005 Thailand m - : - :. -- [1] 2010 Turkey - _ - -- 0 10 20 30 40 50 60 70 80 90 Note: The two figures show projections based on takeoffyears. with connectivity in all emerging markets assumed to be at the same level as in today s lowest-rated industrial country (a connectivity rating of 6, or better if the emerging market s rating is already higher). Thus the projections lead to the same minimum level of penetration in each emerging market. This is admittedly a substantial simplification, because it assumes that all emerging markets will improve their connectivity to the same degree. It also ignores the fact that several emerging markets already have higher e-finance penetration today even though their connectivity is perhaps not as high. See Annex I for more details. Source: Authors calculations. 14 Electronic Finance: A New Approach to Financial Sector Development? Because today s most Internet-active banks projections here assume that the costs of online have not completed their transformation to e- brokerage are just 25 percent of traditional costs, finance, their current cost structure might be higher which is still less than the drop in commissions than their long-run structure. Thus a margin of 1.6 in markets like the United States since online percentage points may overestimate the marginal brokerage was introduced. As online brokerage costs of providing e-finance services. But recent proceeds, commission revenues could decline by experience shows that banks may need to rely on a a factor of about 2 in many countries. With higher bricks and clicks approach that involves higher connectivity, and expressed as a share of bank marginal costs than just the clicks part. Because assets, brokerage revenues in industrial countries Nordic counties have seen the most e-finance, their could fall from 0.1 percent to 0.05 percent by 2005 current cost structure may be most indicative of and in emerging markets from 0.19 percent to fully electronic financial service provision. Still, 0.13 percent. Nordic, Dutch, and other banks involved in e- The projected decline in revenues will not be finance are making big cuts in branches and staff limited to banking and brokerage. Many other (Sveriges RiksBank 2000), and further cost financial services payments, underwriting, asset reductions are likely. management, personal financial advice could see These margins and the above projections for similar declines when they become subject to more online penetration rates would then imply that for competition from e-finance. More generally, the banks in industrial countries, bank margins will threat of entry has probably lowered the market drop from an average of 2.3 percentage points in value of incumbent banks and other financial 1997 to about 2.0 percentage points in 2005 (Table service providers, suggesting that markets are 5). Margins would fall less initially in emerging expecting lower profits. markets, from 4.4 percentage points in 1997 to 3.9 In the short run the impact on revenues will be percentage points in 2005. But some countries largest in countries such as Nordic countries would see more dramatic changes. In Denmark where e-finance has already reached critical levels. bank margins could drop by nearly half by 2005, In the medium run the impact could be greatest in and in Sweden and the United States margins could countries with less efficient financial services that slide more than a quarter. By 2010 the declines have seen little e-finance to date. Migration and cost would be even sharper, with especially big drops in differences are both likely to be higher in such Brazil, Denmark, Poland, Russian Federation, South markets once e-finance comes onstream. In Brazil Africa, Thailand, Turkey, and the United States. and Turkey, for example, bank margins are now For brokerage revenues, changes would be more than 7.7 percentage points which helps dramatic almost everywhere because penetration explain the spread of e-finance and the potential for has been fast and costs savings large. The new entry by e-finance providers. The Recent Past and Possible Future of Electronic Finance 15 Table 5 E-finance will slash banks' net interest margins, 2005 and 2010 Net interest income as a percentage of bank assets, with connectivity improvement Net interest Start of Net interest Net interest Income groupleconomy margin, 1997 rapid growth margin, 2005 margin. 2010 Industrial country average 2.34 1.96 1.69 Australia 2.03 2001 1.82 1.64 Austria 1.72 2001 1.66 1.61 Belgium-Luxembourg 1.25 2003 1.34 1.52 Denmark 4.20 1998 2.20 1.68 Finland 1.57 1998 1.59 1.60 France 3.30 2003 2.84 1.99 Germany 2.37 2001 1.95 1.67 Ireland 1.14 2000 1.42 1.57 Italy 2.74 2004 2.50 1.93 Japan 1.84 2001 1.72 1.62 Netherlands 1.62 2002 1.61 1.60 Norway 2.55 1998 1.82 1.63 Portugal 1.81 2004 1.76 1.66 Singapore 2.30 2001 1.95 1.67 Spain 3.19 2002 2.62 1.86 Sweden 2.46 1998 1.82 1.63 Switzerland 1.75 1999 1.65 1.61 United Kingdom 2.57 2001 2.09 1.70 United States 4.06 2001 2.91 1.87 Emerging market average 4.39 3.85 2.50 Argentina 4.20 2004 3.73 2.46 Brazil 7.76 2004 6.63 3.63 China 2.26 2004 2.14 1.82 Czech Republic 3.04 2004 2.77 2.07 Egypt 1.73 2004 1.71 1.64 Hong Kong, China 2.90 2001 2.26 1.73 Hungary 3.65 2004 3.28 2.28 India 2.89 2004 2.65 2.02 Korea, Rep. of 1.90 2003 1.80 1.66 Mexico 3.64 2004 3.26 2.27 Poland 5.50 2004 4.78 2.88 Russian Federation 4.79 2004 4.21 2.65 South Africa 4.96 2004 4.34 2.70 Thailand 5.50 2004 4.78 2.88 Turkey 11.17 2004 9.41 4.75 Note: Assumes a level of connectivity in each emerging market equal to at least the level of today s least advanced industrial country that is, a rating of 6 (or better if the emerging market s current rating is already higher). Source: Authors calculations. 17 The New World of Financial Services A s noted, e-finance has spread quickly in also assesses the opportunities these developments many countries and has enormous offer emerging markets to leapfrog. lk potential. The Internet and related technologies are more than just new delivery A new landscape is emerging for the channels they are a completely new way of provision of financial services providing financial services. E-finance is also E-finance is changing the face of the financial dramatically changing the structure and nature of services industry (Box 2). New types of service markets for financial services. This section analyzes providers are entering the market within and across the effects e-finance will have on the industry s countries, including online banks, brokerages, and structure, on trading systems, and on competition. so-called aggregators (which allow consumers to The focus is on industrial countries, but the section compare financial services such as mortgage Box 2 The new world of financial service providers Financial services are now offered through a multitude of different providers or even conduct single or block reverse delivery channels, from traditional brick-and-mortar branches to auctions of mortgage loans or insurance products (as with wireless devices. Six steps can be distinguished in the DollarDEX in Singapore). Finally, other specialized companies production and distribution of financial services, though in are undertaking functions on behalf of large banks or insurance practice these steps often overlap or are vertically integrated companies and developing online techniques to mine data and (see Figure 3). offer personalized financial products to consumers. Access devices (rather than tellers or branches) are becoming Financia/instilutions serve as conglomerate providers of many customers' first point of contact with financial service financial services that are global brands (Citigroup, Deutsche providers. These devices include personal computers, personal Bank, Warburg) and as specialized financial service companies. digital assistants (such as Palm Pilots), televisions equipped Partly in response to the entry of new competitors and to reap with Internet access, cellular phones, and other communication the benefits of new technology, incumbents (banks, large devices. These channels are being complemented by low-cost insurance companies) are consolidating around recognized "branches," kiosks (standalone computers connected to bank brand names to position themselves in an environment of systems), and other public access devices in supermarkets, increased commoditization and electronic delivery. Merrill Lynch convenience stores, and common areas (airports, train and HSBC, for example, recently announced a joint venture in stations). private banking that combines HSBC's network with Merrill Lynch's product range. Large telecommunications companies Pon'als are becoming the critical link between access devices that already have access to a large network of customers are and financial service companies. Portals offer access to a range starting to provide payment and other services. In addition, of financial service providers, often for free or a fixed price, but telecom companies are forming alliances to extend their global generate revenue from fees paid by providers referred through network to financial services delivered online. Examples include the portal. These include specialized portals developed by Deutsche Telecom, Telefonica, AT&T, and Telemex. And financial service companies as well as general portals such as increasingly specialized financial service providers-so-called the U.S.-based America Online, Lycos, Yahoo!, and Microsoft mono-liners in all the main financial service areas, from along with others in emerging markets (Paxnet and Thinkpool in mortgage loans to personal loans to insurance to brokerage to Korea, Terra in Latin America). Portal companies attempt to payment services-are establishing online operations. process and personalize information to capture consumers. Portals are proliferating rapidly, even in emerging markets. Financia/plooducts are being commoditized or tailored to the Korea, for example, is home to 300 portals, many of which needs of customers. Such products are distributed through function as gateways for financial service providers. In addition, specialized financial service providers and financial customers can access financial service providers through conglomerates. private networks, and some providers have established their own specialized portals. Electronlc enablers support general as well as specialized financial service providers and virtual banks. Specialized Aggregators complement portals, allowing consumers to software engineering companies such as Si, Checkfree, compare mortgage, insurance, or lending products offered by Sanchez, and System Access provide e-finance system financial service providers. In addition, quasi-aggregators solutions that are completely integrated and permit the rapid aggregate or display prices of financial products offered by adaptation needed in today's worid. Source: Claessens, Glaessner, Klingebiel, 2000. 18 Electronic Finance: A New Approach to Financial Sector Development? loans and insurance policies). Nonfinancial For example, companies associated with entities are also entering the market, including portals (America Online, Yahoo!, Microsoft) and telecommunications and utility companies that major telecommunications companies (Deutsche offer payment and other services through their Telecom, Telefonica) are developing strategic distribution networks and customer relationships. relationships and ownership links with major To reap the benefits of the new technology, and financial service companies, banks (such as the in response to this new entry, banks, insurance Bank of East Asia with Yahoo!), and each other companies, and the like are starting to deliver (Telefonica and Lycos). At the same time, many financial services electronically setting up major financial institutions (Goldman Sachs, in-house online activities or completely new Chase, Merrill Lynch, Morgan Stanley) are ventures such as virtual banks. part owners of promising Internet startups. Thus financial services are moving away And goods-producing companies are taking from brick-and-mortar delivery channels to a advantage of bank distribution networks multitude of electronic and other channels, with (Citidollars with a variety of consumer-related portals and aggregators offering new distribution companies). These developments are changing and advertisement channels for financial services. the competitive landscape for financial services Vertically integrated financial service companies and will continue to erode the franchise value are growing rapidly and creating synergies by of financial service providers that are inefficient combining brand names, distribution networks, or do not adopt competitive business models and service production (Figure 3). (see Figure 3). Figure 3 Different service providers and delivery channels are combining to create a new world of financial services Electronic enablers . . . , I . Financial * 1 . -. products 9 I 5;1 1; ( ~ ~~~~~~~~~~~D CO I Ei.a'' 1 -1 D.' Financial Financial Telecom/utility - (D Institutions - .; - conglomerates companies CD Q Aggregators * R.* r *M. *' . r-7im-T1a: *i 0.CD O C' | Portals Ak 1sj-oo! Iaos -fl-hk- .hHome W Nette ccls iti Private IIHOO! NeLi V JnCIiInetworks Access I devices c jj- Source. Claessens, Giaessner, Klingebiel. 2000. The New World of Financial Services 19 Trading systems are consolidating pay smaller commissions, effect trades more and going global-lowering costs and quickly, and maintain anonymity on placed orders increasing efficiency (Box 3). Driven by advances in communications technology, For several reasons, competition is trading systems are consolidating and going global. Trading is moving toward electronic platforms not increasig tied to any location. (Nasdaq s computers are based Smaller ecoo7mies of scale in Turnbull, Connecticut, for example, but traders The Internet and other technological advances have are located around the globe.) New electronic shrunk economies of scale in the provision of systems have lowered the transaction costs of financial services. The main financial service still trading and allow for better price determination exhibiting increasing returns to scale is the medium- because electronic execution and matching size loan market, because large databases of credit techniques imply less chance of market history are required to build a credit-scoring model manipulation. These advantages are more important for medium-size clients giving lar ger lenders a in markets that had not yet converted to electronic potential competitive advantage. For most credit, trading (such as the United States) than in those however, economies of scale have become small where electronic trading has been the norm (such as because the fixed costs associated with screening Europe). The new technology also allows for much small borrowers (less than $100,000) have dropped easier cross-border trading, and over time for significantly. intermarket trading systems. Smaller scale economies have increased Combined with globalization, these forces are competition, particularly among financial services putting pressure on incumbent stock exchanges, that can easily be unbundled and commoditized which have responded with mergers and alliances. through automation. These include payment and Because many exchanges are self-regulating brokerage services, mortgage loans, insurance, and organizations, the pressures for change usually even trade finance. Most of these services require do not come from within the industry. Rather, limited initial capital outlays and no unique they come from users and investors who want to technology. Box 3 The massive shifts in stock markets and exchanges A revolution is under way in how financial (and nonfinancial) other means. Eventually, traditional stock markets such as the contracts are traded. These changes have involved traditional New York Stock Exchange will cease to exist in their current exchanges as well as business-to-business (B2B) transactions. form. Several electronic order routing and trading networks have Reflecting these competitive pressures, and the more emerged in recent years. These networks have evolved into general desire for increased liquidity through larger markets, order-driven matching systems that are provided electronically many stock exchanges in industrial countries have established to participants seeking anonymity. Electronic communication links, merged, or even demutualized (that is, become for-profit networks started out as pools of liquidity feeding into existing organizations rather than cooperative, not-for-profit markets but now serve as alternative trading outlets in several organizations). Recent examples include the mergers between developed and some emerging capital markets. In some the Amsterdam, Brussels, and Paris exchanges (resulting in the markets these networks account for a large share of total creation of Euronext) and joint ventures and alliances between trading (one-quarter of the dollar volume of Nasdaq in the Nasdaq and stock exchanges in Australia, Canada, Hong Kong United States). (China), and Japan. Similarly, the stock exchanges in Singapore Other alternative trading systems are being set up around and Australia recently agreed to cross-list all traded shares. And the world, often with links to existing trading systems. For the New York Stock Exchange has formed alliances with the example, Instinet began as an electronic local interdealer broker Tokyo Stock Exchange, Hong Kong Stock Exchange, Australia and dealer but now has automatic routings to a number of stock Stock Exchange, Toronto Stock Exchange, Mexico Bolsa, Sao exchanges. There is speculation that a few trading systems will Paulo (Brazil) Bovespa, and Euronext to trade through linked soon allow investors to trade 24 hours a day. Exchanges are exchanges 24 hours a day. The consolidation of these recognizing that their services-trading systems-are markets-accounting for more than 60 percent of global market increasingly becoming a commoditized product offered through turnover-is leading to a smaller number of very large markets. Source: Claessens, Glaessner, Klingebiel, 2000. 20 Electronic Finance: A New Approach to Financial Sector Development? Lower transaction costs substantially increase browser, a display standard, and a Web server as the competition for providers and cut costs for access point to back-end operational systems. As a consumers. To retain market share, online result cross-selling of products becomes easier and brokerages have been forced to radically restructure economies of scope increase. the way they deliver services. Commissions and In the past, sunk costs were important entry fees fell from an average of $53 a trade in early barriers in the financial services industry. Examples 1996 to $16 in mid- 1998 and by mid-2000 some of sunk costs include branch networks, knowledge online brokerages had lowered their commissions about local borrowers, access to payments systems, to zero. Electronic communication network branding advantages involving large up-front commissions, now $0.05 a trade, are continuing advertising expenses, perceptions of size and safety, to fall. Barriers to entry based on ownership of long-lasting customer relationships, and substantial physical facilities are disappearing, and incumbent up-front investments in technology. But sunk cos:s institutions are being forced to merge or in some are becoming less important, partly because cases to demutualize to have a chance of remaining electronic delivery modes do not rely on branch viable. networks (Table 6). At the same time, new entry barriers are being Shrin,king up-front costs and created through first-mover advantages. Once a new changing entry barnirs entrant is an established service provider, other new Web-based financial services unify the Internet as a entrants will have to spend a lot on advertising to communication standard by combining a Web attract new customers (as E-trade and Ameritrade Table 6 The Internet is changing features of financial services Economies Up-front costs; Network Service of scale Commoditization branding, advertising externalities Retail services Payments *° 0000 c *@600 Loans and mortgages *c eeoc * o o Discount brokerage services *o *ose o00 s o Investment advice * 0 000 0000 0 0 Mutual funds *ee a00 * * Insurance cc Soo 000 so Wholesale services Commercial lending * Large *-e os * * Medium-size see *-- *o Corporate services (underwriting, mergers and *c c *000 o acquisitions advice, risk management) Large-value payment systems *cc eec -ees o o **o Markets Trading systems and exchanges * - 000* 0o0 00 0 0 -* B2B exchanges *0 0000 0*0 - o* . New services E-payment providers * o *c - c * 0 to Electronic enablers cc o * O * 000 Financial portals * * o *0-0* o Aggregators o s 0*0 *0 00 Note: 0 = none, * 0 = low, 00 = medium, and *--O = high. Source: Authors assessments. The New World of Financial Services 21 have done in the United States). Services such as large share of the market, decreasing competition. underwriting and mergers and acquisitions advice Similar characteristics apply to trading systems and exhibit low levels of commoditization and still exchanges (traditional or B2B), to financial portals, require relationship capital, a certain size, and a and to a lesser extent to e-enablers (see Table 6). brand name to compete effectively. But these services enjoy few or no network externalities Emerging markets have new and are increasingly subject to global competition. opportunities to leapfrog The scope for a contestable market then depends Most of the discussion above reflects current trends on the size of the market. A limited number of in advanced industrial countries; as such it does not financial institutions involved in underwriting, address the possibility of leapfrogging. But several but operating on a global basis, present a very emerging markets show that e-finance penetration different competitive environment than would a can proceed much faster than is implied by the few players in a small market (say, less than preceding analysis. Brazil, Estonia, and Korea have $1 billion). already moved beyond levels predicted on the basis of their current connectivity and business H/gher network externahltes environment (Box 4). Although declining economies of scale, increasing The diversity in these three countries levels of standardization and commoditization, and falling development, with per capita incomes ranging from up-front costs foster competition, this need not $3,500-10,000, suggests that leapfrogging is be the case for services that exhibit network possible for many other countries as well. It might externalities. A financial service exhibits network even be that what appear to be disadvantages, such externalities if the value of the service rises as poor financial services and weak financial with the number of market participants using it. infrastructure, actually accelerate the move to e- Payment services, for example, have decreasing finance. Just as in securities markets, where rapid economies of scale, low up-front costs, and easy migration offshore has partly been a response to commoditization. But payment services are subject weak market infrastructure and poor corporate to large network externalities, because the value of governance, many consumers could move quickly to electronic payment services largely depends on the e-finance delivered in part from remote locations. degree to which users adopt a common standard. But leapfrogging will not just emerge The financial service provider that manages to spontaneously it may require changes in policies create this common standard will end up with a for financial sector development. Box 4 Leapfrogging around the globe: Estonia, Republic of Korea, and Brazil Estonia has made impressive progress in information from 700,000 to 32 million a month. Online trading has been technology. After communism collapsed, this nation of 1.5 growing exponentially, with more than 65 percent of brokerage million people moved straight to wireless technologies, and transactions now conducted online. This revolution has been almost 30 percent of the population now owns a mobile phone. facilitated by the fact that while only one in five Koreans owns a In addition, about 35 percent has access to Internet services. E- personal computer, more than half have a mobile phone. finance has also taken off. Five of Estonia's seven banks offer Bradesco, Brazil's largest private bank, is the world's third online services, making for more than 250,000 Intemet banking largest Internet bank, with 1.7 million clients banking online. clients-a penetration rate almost as high as in the advanced Bradesco provides its more than 700,000 corporate clients with Nordic countries. As elsewhere, banks in Estonia see online a business to business site offering brokerage, insurance, and banking as a cost-efficient way of expanding, avoiding pension fund services used by more than 800 companies, and a expensive new branch offices. business to consumer site that facilitates financial transactions In Korea the number of people banking online shot up for 1,000 companies. Bradesco places its transaction payment from 120,000 at the end of 1999 to 4 million at the end of 2000. services on smart cards that consumers can download from Over the same period the number of transactions increased their computers. Source: See bibliographical note. 23 Changes Needed in Financial Sector Policies T he recent patterns and future potential show have become less important. Basic financial that e-finance could deliver large gains to services can now be efficiently produced and T consumers while changing the role of delivered from remote locations over the Internet. financial institutions. The potential is especially More sophisticated services, such as securities large for countries lacking well-functioning, trading and asset management, can be produced in efficient financial systems with wide access. But and delivered from a few global financial centers achieving the full gains of e-finance requires reducing the need for local systems and associated changing the model for financial sector investments in human and physical capital. Second, development. a financial system need no longer be built around Many questions need to be addressed. Are there banks, which used to be considered special. Rather, now better ways of building a robust, efficient governments can focus on how financial services financial system that provides wide access to a can be provided most efficiently, regardless of the broader set of consumers of financial services? location or the entity providing the service. What public policies best facilitate such a process? Table 7 summarizes how the new paradigm Will some traditional policy areas be less differs from current approaches to financial sector important? How will areas of emphasis differ by the development, with the last column showing areas of level of development of a country s financial emphasis of various international working groups sector? Which policy prescriptions are more (see also Annex 2). The changes in public policy for important for countries with better services and financial sector development will vary by the stage wide access, and which are more important for of development of a country s financial sector. To countries with limited financial infrastructure and really benefit from e-finance, emerging markets will little or no well-functioning financial system? In all need a significant change in emphasis. For more cases, what policy changes should be made to avoid developed financial systems that already have unnecessary risks and allow for the greatest gains? sophisticated services, wide access, much of the And what policy changes have countries already infrastructure to support e-finance, and much made in response to e-finance? innovative e-finance already occurring, public Moving from an institutional to a functional approach Box 5 T dtional approach . The institutional approach to financial The traditional approach to financial sector sector development development has been institution oriented, with a heavy emphasis on developing commercial banks Most of the public policies used to foster financial sector (Box 5). The institutional approach is increasingly development have been based on an institutional approach. This approach focuses on creating effective local institutions being overtaken in industrial countries by the (commercial banks) that provide payment services, intermediate functional approach (Merton 1995). In that resources, and help overcome problems of asymmetric approach financial services are unbundled into their information. At the same time, these banks are often considered various functions with their own production special (given their role in the payments system and credit structures, not necessarily associated with any intermediation) and are protected by a public safety net, particular type of financial institution. necessitating the development of good regulation and The range of institutions offering financial supervision. But creating credible, effective regulation and supervision services has also broadened, with less emphasis on has proven difficult in many emerging markets, as shown by commercial banks as financial service providers many costly banking crises. The development of other relative to large financial conglomerates or institutions-brokerage firms, investment banks, leasing increasingly specialized entities in areas such as companies, insurance companies, pension funds, exchanges, asset management, brokerage, and insurance. This and a host of other institutions and related legal frameworks- commoditization of financial products and functions has been supported by changes in overall legislation and is changing public policies toward financial sector actual institution building. Examples of institution building include the establishment of private entities (investment banks, developmnent In industral countries, stock exchanges), public development banks, and other public Rapid technological change and the Internet are intermediaries and the provision of special lending windows. making the functional approach relevant for Source: Claessens, Glaessner, Klingebiel, 2000. emerging markets as well. First, local institutions 24 Electronic Finance: A New Approach to Financial Sector Development? Table 7 A new paradigm is emerging for financial sector development O Not important or not addressed * Somewhat important * * Important * ** Very important Area Current paradigm New paradigm Working groups Creating an enabling environment Regulatory framework for telecommunications 0 * @ 0 0 Security framework and public key infrastructure o *00 0 0 Framework for information and privacy 0 *00 - * Framework for contract enforcement 0 00* 0 Financial system laws that are institution specific 000 0 0 00 Market infrastructure 00 0 0 0 0 0 Risks at the consumer, investor, and institution levels Consumer protection @0 @0 Investor protection *-0 000 @0 Prudential regulation 000 0 0 000 Markets-functioning, performance, and risks Competition policy 0 000 0 Functioning and volatility, rules for markets, liquidity, transparency, access, disturbances, liquidity risks, stress properties *0 *00 0 Forms of government intervention Development banks, public microlending institutions, and directed credit 00 0 0 Information provision and 'collateral' institutions 0 0 000 0 Modifying use of existing institutional infrastructure 0 0 000 0 Source: Authors assessments as the area relates to financial sector development. For working groups column, the assessments are based on various reports issued by international working groups and bodies (see also Annex 2). policy changes will be more evolutionary and less security and related public and private key pronounced, with many already under way. These infrastructure, information and privacy, and contract advanced countries still need policy changes, enforcement. In addition, financial system laws and however. market infrastructure will remain important, though Although the emphasis will vary by each less so than in the past. Countries are making country s stage of development, key reforms will progress in these areas. often include creating an enabling regulatory environment, minimizing risks for consumers, Telecommunications investors, and institutions, and improving the Telecommunications regulation for both fixed performance of markets especially in terms of and nonfixed lines is a key area for e-finance. competition policy. In addition, the role of government needs to be reconsidered. Creating an enabling Cregulator env iro nm4 A full treatment of these issues is beyond the scope of regulatory environment this paper. An excellent reference beyond documents The most important areas of the regulatory issued by the Intemational Telecommunication Union framework for e-finance are telecommunications, is Intven, Oliver, and Sepulveda (2000). Changes Needed in Financial Sector Policies 25 As noted, nonfixed lines are providing new sector, but evidence on intrusions suggests that opportunities in developing countries, including in these may not be sufficient. Actual penetrations into remote areas in Africa, China, and many less banks are understated because of the damaging developed Asian countries such as Cambodia. implications for banks reputations. Regulation must privatize post and telegraph For the whole set of security arrangements administrations, improve licensing of competitive that is, the so-called public key infrastructure to operators, enhance mandatory interconnections and work, four functions must be present: authentication unbundle public switched telephone networks, (knowing the parties when exchanging implement independent regulatory bodies, and information), integrity (messages cannot be changed implement proper pricing regulations (Box 6). during transmission), nonrepudiation (agreements Improving access to telecommunications for a cannot be later denied), and confidentiality larger portion of the population is especially (messages cannot be read or copied by unauthorized important in emerging markets. users). Authentication has been perhaps the most difficult to address. Electronlc security and infrastructure One approach to improving authentication that Both providers and consumers of e-finance view is being employed is the use of public and private security as a constraint and a concern. Serious keys. Authorities will have to address three main operational risks and potential liabilities are issues in designing a country s public key associated with security breaches in the transfer infrastructure. First, adequate penalties are needed of funds or instructions and the actual theft of for unauthorized access to or tampering with identification information over the Internet (Furst, computer systems and Websites penalties akin to Glaessner, and Kellermann 2001). In response, those for other crimes. Second, a proper encryption techniques and various protocols (secure certification process is needed for public and private socket layer, Financial Interchange Extended keys, as are secure systems for storing such keys language) have been developed by the private and adequate cross-certification for private key Box 6 Enhancing connectivity in emerging markets by improving telecommunications regulation Connectivity can be enhanced through a combination of a Regulatory authorities must be independent, and telecommunications policies: regulatory processes must be transparent. To enhance * Anticompetitive behavior by incumbent telecom the governance of such agencies-a complex issue companies-charging excessive rates for in emerging markets-certain international and interconnections, refusing to build or make available objective standards must be applied in such areas as adequate interconnection capacity, refusing to unbundle interconnections, licensing, and pricing. network elements or services needed for efficient * Price cap regulations that ensure price increases for interconnections-has retarded or prevented competition telecom services are in line with general price changes in telecom markets in many countries. Mandatory can make services more efficient and reduce regulatory interconnections and unbundling of public switched lags. Such regulations should not, however, place undue telephone networks are needed to make the sector more discretion in the hands of telecom companies or regulatory competitive. authorities. * Many emerging markets have not yet privatized * Targeted universal access funds may help increase access telecommunications. Privatization is essential for making to telecom services in countries with great income diversity. telecom services more efficient, because without it Chile and Peru provide examples of effective funds. competition will be hindered and key services will be * Removing barriers to trade in telecommunications and costly-widening the digital divide. harmonizing competition policy on a global basis will help. * In many countries the licensing of competitive operators Under the auspices of the European Commission and the must be enhanced to give domestic and international World Trade Organization, standards are being developed telecom providers sufficient incentives to compete within to define market dominance and identify barriers to and across media-fixed line, cellular, and so on. competition. Source: Intven, Oliver, and Sepulveda 2000. 26 Electronic Finance: A New Approach to Financial Sector Development? providers. This can involve a single public of e-finance. Thus general secrecy laws, along with. certification authority but need not: several other statutes such as bank secrecy laws, need to countries are successfully operating multiple private permit the sharing of not only negative but also and public agencies.5 Third, government may need positive credit information. As the Internet expands, to set minimum authentication or certification standards for information and privacy will standards while preserving incentives for private increasingly need to be global. solutions. Regulations should be flexible enough to allow for creative use of new technologies (such as biometrics) in improving authentication processes. Box 7 Privacy problems-the role of the public Information andoprivacy sector and private solutions E-finance makes it easier to manage customers and Many countries have started to adapt their privacy statutes tocustomizeprod rexample, a financial to the Internet. Although progress is uneven and national to customize products. For example, a financial statutes differ, an international move toward more institution linked with an Internet service provider homogeneous standards is under way. The Intemational can use information culled from a customer s Labour Organization, Intemational Telecommunication Union, Web use to offer the customer new financial Universal Postal Union, and World Trade Organization are products. But such efforts must respect people s developing in their specific areas of concern common standards desire for privacy and confidentiality. Information for a privacy law. In addition, the Council of Europe and the about a person or business can increasingly be United States are developing the first international treaty on seen as a property right that people can voluntarily cyber crime. Still, country approaches vary. In the United States self- share with others. That property right must be regulation and sector laws have generally been used to ensure clearly defined through information and privacy adequate privacy. An exception is the Gramm-Leach-Blily Act, standards. which requires the U.S. Securities and Exchange Commission Such standards should address four issues: to issue regulation that applies to broker-dealers, investment notice, choice, access, and security. Individuals companies, and registered investment advisers (financial must be given notice of what information is being institutions). This regulation protects all "nonpublic personal collected and how it is being used. They need to be information" about consumers, including information that consu.mers provide to financial institutions, results of given a choice of whether to allow such collection. transactions performed for consumers, and any other Once the information has been collected, the information about consumers that financial institutions obtain provider of such information must have access to it, outside public channels. and the collector must ensure its security. By contrast, the European Union has favored much more Privacy standards will mainly require private comprehensive privacy legislation enforced by freestanding sector actions, but these need to be backed by data protection agencies. The European Union's privacy govemment privacy frameworks within and across directives also authorize the cutting off of data flows to countries government privacy frameworks within and across not in compliance with EU standards. To avoid a trade war over countries (Box 7). Moreover, privacy and secrecy personal data and interruptions in companies' data flows, the laws should not become barriers to the development United States and the European Union have devised a safe harbor agreement. The private sector has played an important role in providing solutions to privacy issues on the Intemet. New 5 Certification authorities can be government agencies technologies have created new risks for privacy, but they can (such as postal authorities), technology providers (such also provide private solutions. In the United States many as GTE or Verisign), telecom service providers (such Websites certify companies or e-commerce sites as having as Nortells Entrust), or financial service providers good practices for information privacy (for example, TrustE, at themselves. The certificatio authort as t www.truste.com) or provide consumers with tips on themselves. The certification authority authenticates the safeguarding their privacy (for example, the Electronic Frontier public key by distributing it with a certificate that it Association). Many new companies offer software to ensure digitally signs. The potential liability of the certification anonymous browsing, disable cookies, and even develop authority and the reputation implications of security personal or company firewalls to enhance e-mail security. Direct breaches have been used as an argument for outsourcing govemment monitoring of privacy guidelines and private the public key infrastructure to private providers. Banks solutions have different costs and benefits, and thus can that are certification authorities include ABN, Bank of complement each other. America, Deutsche Bank, Barclays, Chase Citigroup, Source: OECD 2001. and Hypoverensbank. Changes Needed in Financial Sector Policies 27 Contract enforcement more sophisticated technology will allow them to Poor contract enforcement hinders finance and benefit without having to invest in expensive commerce regardless of the delivery channel. But systems and demanding oversight structures. Stock new technology can lower the costs of contract markets in smaller emerging markets, for example, verification and enforcement. The Internet increases could be linked to and integrated with those in the amount and speed of available information and larger markets. can easily link disparate sources of information. It can assist, for example, in the automation and Progress to date efficiency of registries. With digital signatures, A recent survey of 23 countries, including 15 credit risk assessments can be made much faster and emerging markets, shows that few have addressed more efficient. In addition, the Internet and global all the aspects of these key areas for creating an financial service provision allow for collateralized enabling environment (Table 8). But progress is loans extended from remote locations. E-finance being made in many areas, and over will thus make cross-border dispute resolution and time that will allow the full benefits of e-finance. contract enforcement more important. The North Digital signature laws, for example, are being America Free Trade Agreement (NAFTA) and EU introduced in many countries, often based on experiences provide useful examples of how to model laws promulgated by the United Nations address these issues. Commission on International Trade Law Technology can help enforce contracts directly. (UNCITRAL). Privacy and confidentiality laws When foreclosing because of late payments, for are also being adjusted. And while all these areas example, a lender can use remote devices to shut off are important, progress in all of them is not a and track down a leased car. Technology also allows precondition for e-finance. In some countries with for better methods of ensuring perfection of a otherwise underdeveloped financial infrastructure security interest in collateral in a dematerialized (lack of clearing, custody, and settlement environment, because databases can be linked arrangements, weak payment systems), developing directly. Finally, smart cards and other multipurpose communications and public key infrastructure can cards use technology to bypass many standard be sufficient to allow the import of many financial contract enforcement mechanisms, which may services and related forms of financial explain their popularity in Africa. infrastructure. FinaRnia&nd marketftIfrastrcture Minimizing risks for consumers, Laws and systems are a crucial element of financial investors, and institutions infrastructure. As noted, e-finance will allow for a E-finance can create new risks, whether at the level more functional, rather than institutional, approach of a financial service of fered at the retail or to financial sector development. This implies wholesale level or at the level of an institution. that the laws governing financial contracts will Reducing these risks will require authorities to become more important than the laws governing focus more on better disclosure, protection, and institutions that operate in the financial sector. education for consumers and investors, as well as Laws on secured transactions and capital market better risk management by providers of financial dealings, for example, will become more important services. All these issues will need to be addressed than laws on commercial banks and insurance at an increasingly global level. companies. E-finance also calls for rethinking approaches To date the impact of new technologies has to prudential regulation and issues related to been most pronounced in wholesale and securities extending the financial sector safety net (Claessens, markets, but gains are also becoming evident in Glaessner, and Klingebiel 2000). The second point retail markets. In Estonia and Finland, for example, is especially important in many emerging markets many retail financial transactions are done given their often extensive safety nets. Balancing electronically. A good technology infrastructure thus short-run financial stability with longer-run becomes key. Finally, linking financial service incentives will be challenging during this shift in providers or more broadly , entire financial the form of and approach to regulation and systems in emer ging markets to countries with supervision. 28 Electronic Finance: A New Approach to Financial Sector Development? Table 8 Progress is being made in creating an enabling regulatory environment Does a secrecy law Can financial service Do electronic signatures exist, and has it been providers obtain positive or online verification modified to address (A) or negative (B) Region/country of people exist? issues raised by e-finance? information on borrowers? Europe Czech Republic Pending Yes No European Union Yes Yes, but not modified A Finland Yes Yes Yes to both France Yes A Yes to both Germany Yes A A Hungary Pending Yes Yes to both Poland Pending Yes Pending Russian Federation Pending No A Sweden Yes Yes Yes to both Turkey No Yes Yes to B United Kingdom Yes Yes Yes to both Americas Argentina Pending Yes Yes to both Brazil Pending Yes Yes to B Mexico Yes Yes Yes to both United States Yes Yes Yes to both Asia Australia Yes Yes Yes to both China Pending Yes Yes to both Hong Kong, China Yes Yes Yes to B India Yes No Pending Japan Yes Pending Yes to both Korea, Rep. of Yes Yes Yes to both Singapore Yes Yes Pending Africa Morocco No No No South Africa Pending No Yes to both A Not enough information was available to determine the answer. Source: World Bank survey. More detailed descriptions of respondents replies are available from the authors. Consumer protection misused in others parts of a financial institution or E-finance and related innovations have made it elsewhere. possible to stratify customers through electronic At the same time, technological developments customer relationship management and to make it easier for authorities to enforce existing customize financial services. These developments regulations protecting customers because electronic can create risks for consumers. For example, audit trails are assured and Internet service information from an online bank account could be providers can be required to provide information to Changes Needed in Financial Sector Policies 29 authorities. Furthermore, many companies are reducing legal and regulatory impediments to offering smart agents that enable consumers to cooperation in cross-border securities enforcement search for and compare alternative products offered and to harmonizing legal and regulatory treatment on the Internet cutting search costs and of Internet-related securities transactions across empowering consumers. borders. Policy decisions must reflect the choices of E-finance has also led to a range of questions consumers and the incentives of financial service on how to oversee the many new infomediaries providers and Internet service or application directly or indirectly involved in providing financial software providers. The key policy step will be to services. Links between portals, Internet service require increased disclosure and greater providers (ISPs), telecommunications and software transparency on the terms of financial services providers, financial service companies, and offered over the Internet. Better privacy and specialized online brokers are becoming more security standards will also help consumers. ubiquitous but they raise new risks. Many portals Rules are also needed that limit the scope for and Internet service providers, for example, have conflicts of interest within financial institutions and exclusive links with financial service providers. between financial institutions and Internet-related Will those links create conflicts? firms. For example, limits may be needed on cross- Other questions arise. Should a portal or selling products within financial institutions. Internet service provider be allowed to charge for Governments may also need to clarify the liability leading customers to an electronic brokerage in of financial service providers for services contracted what amounts to online order routing? And if so, out, such as Internet banking software, as under what forms of securities regulations? When a recommended by the Electronic Banking Group of portal undertakes offline business that involves the Basel Committee on Banking Supervision. underwriting debt or shares, its incentives may be E-finance can more easily involve outright skewed toward its online services. How can fraud, theft, and other abuses hurting small electronic initial public offerings (IPOs) and road consumers and impinging on the confidence in and shows be properly regulated and supervised? use of e-finance. Actions such as the development Similar complications, not all new, arise when of a cyber-force (as is becoming common among advertising borders on investment advice. And securities regulators) can help weed out the worst when is the use of an electronic bulletin board by an offenders and send clear signals. But there will issuer only providing a forum and when is it a remain severe limits on government s ability to platform soliciting investors for an electronic prevent misuse, making disclosure more necessary offering? Can a portal refuse to allow advertising by (see Annex 2 for international working group efforts certain financial service providers? Box 8 outlines in this area). These risks also highlight the need for some of the guiding principles developed to date, more extensive consumer education, which could be some of which have been laid out by the provided through creative private-public International Organization of Securities partnerships. Commissions (see Annex 2) and other regulatory authorities. Investor,orotection As with consumer protection, issues relating to Prudentialregulatlon and the safety net investor protection and education will take on much Of particular short-run importance in prudential greater importance because new risks are regulation are changes needed to prevent the new particularly difficult to monitor in emerging risks posed by e-finance. Much of the work on such markets. In a more global and electronic world, risks is occurring in international forums such as the regulatory and supervisory approaches and Electronic Banking Group of the Basel Committee philosophies will have to put much greater on Banking Supervision (Box 9). Important risks emphasis on disclosure, the quality of information, identified by the group are operational risks related the timing and release of material information, the to the increased use of technology (including the definitions and obligations of investment advisers greater reliance on outside vendors), legal and and managers, and governance and conflicts. Much reputation risks, and conflicts that may be greater emphasis will also need to be placed on introduced by the electronic delivery of financial 30 Electronic Finance: A New Approach to Financial Sector Development? Box 8 Securities regulation, the Internet, and emerging markets Some basic principles have been developed to guide securities countries questions arise on how this process can be made regulators in markets that have experienced rapid growth in more efficient-through use of other authentication processes, connectivity and widespread electronic distribution of securities- including digital signatures-and not require physical interacticn related financial services (see Annex 2 for Internet principles with investors. established by the International Organization of Securities Online order routing by an associated Internet service Commissions). In protecting investors, it is useful to distinguish provider or portal in exchange for a fee raises the question of between the responsibilities of three groups: broker-dealers that whether this constitutes provision of brokerage services. Many provide online brokerage services, Internet service providers or countries are starting to view such arrangements as brokerage portals that provide online order routing services to brokers or unless the portal does not recommend specific securities or are themselves involved in offline services, and issuers (or participate in any financial services offered by the ultimate underwriters) that distribute their securities publicly or privately provider. Complicating matters, the extensive offline businesses over the Internet. of many portal companies can create conflicts about the Online brokers' communications with investors should accuracy of the company information they report. This problem satisfy the principles of notice (timely and adequate notice makes regulatory oversight difficult-and is becoming more that information is available electronically), access (access common in emerging markets that have seen a rapid increase given electronically should be comparable to that available in in financial service portals. Korea, for example, is home to 300 other forms), and evidence to show delivery (reason to believe such portals. that delivery requirements will be satisfied). When financial Online securities offerings can lead to conflicts of interest:. information is delivered electronically, there must be adequate Many securities issuers advertise using electronic bulletin protections for privacy and confidentiality. In many countries boards, but this can be viewed as an offering. In general, self-regulating organizations (often exchanges) have been issuers that use electronic bulletin boards on the Internet are encouraged to work with issuers and related brokerage firms being asked to maintain some status with regulators. They also and investment banks to establish review committees that need to provide on their Websites financial information required determine whether market participants meet requirements of registered issuers, keep records of quotes, provide no advice for proper communication and advertising to investors. In on buying or selling securities, receive no compensation for many cases written policies have been required of broker- creating the bulletin board, and receive and transfer no dealers as well as a pre-use review process and even "fair securities on behalf of third parties. Third-party bulletin boards disclosure" guidelines to ensure that all material nonpublic are complex to regulate because they may be acting as an information is disclosed simultaneously across all forms of exchange, alternative trading system, or broker-dealer. In communications. In some countries even public disclosure addition, online offerings of securities through an initial public reports on broker-dealers must be posted on Websites to offering (IPO) or a private placement or offering raise regulatory allow for better-informed investors. "Suitability" and "know and supervisory challenges. Similarly, attention must be paid to thy customer" rules are also important. These rules often stock purchase plans, stock giveaways, electronic road shows, oblige brokers to make certain determinations-such as and offshore or cross-border offerings over the Internet. Much of ascertaining investors' financial status, tax status, investment this will require developing global standards, taking into account objectives, and any other information deemed reasonable- issues such as differences in the definition and treatment of before making a transaction recommendation. In many solicitations. Source: U.S. Securities and Exchange Commission 2000; IOSCO 1998. services. Most of these risks are not new, but e- Some aspects of prudential regulation are finance intensifies them. becoming more important, while others may need to For the future, regulations relating to disclosure be reviewed in a new light, particularly in emerging and timing of information and to governance and markets. This is especially true for the financial conflicts will become more important, altering the sector safety net, defined here to include policies on traditional approach to bank supervision and deposit insurance, lender of last resort facilities, and regulation. This shift will be accompanied by risks government s role in the payments system at the of reduced profitability for existing financial wholesale level and the exact conditions under institutions a trend under way for a long time. But which it will guarantee payments. e-finance could sharply accelerate the drop in In the past the need for a financial sector safety profits, so the Electronic Banking Group has net and associated prudential regulation and identified strategic and business risks as one of the supervision has arisen from the need to treat main risks of e-finance. deposit-taking institutions differently from other Changes Needed in Financial Sector Policies 31 Box 9 Principles for managing risk in online banking A recent report by the Electronic Banking Group of the Basel users accountable for e-banking transactions and Committee on Banking Supervision identifies 14 key risk information. management principles for online banking. Banks and their * Comprehensive security control. Banks should supervisors should consider these principles when formulating ensure the appropriate use of activities and properly risk management policies and processes for online activities. safeguard the security of e-banking assets and * Management oversight. Effective management oversight information. of the risks associated with e-banking needs to be in * Integrity of transactions, records, and information. place, and e-banking risk management should be Banks should prevent unauthorized changes to and integrated with overall risk management. ensure the reliability, accuracy, and completeness of e- * Management of outsourcing and third party banking transactions, records, and information. dependencies. Comprehensive, well-defined, ongoing * Appropriate disclosure. To avoid legal and reputation oversight is needed for managing outsourced relationships risks, including for cross-border activities, banks should and third party dependencies supporting e-banking, have adequate disclosure for e-banking services. including adequate prior due diligence. * Confidentiality and privacy of customer information. * Segregation of duties. Appropriate measures are needed The confidentiality of customer information and adherence to ensure proper segregation of duties in e-banking to customer privacy requirements should be ensured. systems, databases, and applications. * Business continuity and contingency plans to ensure * Proper authorization measures and controls in the availability of systems and services. Plans should systems, databases, and applications. Appropriate ensure that e-banking systems and services are available authorization measures and proper controls need to be in to customers, internal users, and outsourced service place for e-banking systems, databases, and applications. providers when needed. * Clear audit trail for e-banking transactions. A clear * Incident response planning. Incident response plans audit trail is needed for all e-banking transactions. should be in place to manage and minimize problems * Authentication of all entities, counterparts, and data. arsing from unexpected events-including internal and Banks should authenticate the identity and origin of all external attacks that hamper the provision of e-banking entities, counterparts, and data transmitted over the systems and services. Internet. * Role of supervisors. Bank supervisors should assess * Nonrepudiation (accountability) for e-banking banks' management structures, practices, intemal transactions. Nonrepudiation should be ensured to hold controls, and contingency plans for e-banking. Source: Electronic Banking Group of the Basel Committee on Banking Supervision; see also Annex 2. economic agents and from banks special role in the particularly if the regulation is prudential as payments system. But banks are no longer the only opposed to consumer protection-related, because institutions providing deposit-like services, and prudential regulation implies that the services are many substitutes for bank deposits have emerged. covered by the safety net. Since the new types of On the payments side, banks have become less payment services cover a continuum of modalities, special because mutual funds and most brokerage authorities need to carefully evaluate where to draw houses offer payment services and technological the line and be cognizant of a possible shifting of progress is enabling the further development of the line over time due to political and other alternative payment mechanisms. For example, new pressures. Authorities should be especially wary of nonbank providers of payment services use new extending deposit guarantees to new deposit technology (e-mail transfers, stored value cards, substitutes because the moral hazard implications smart cards) to provide payment functions. can be substantial. Balances on stored value cards can typically be Similarly, authorities have to decide whether to transferred without directly involving a depository open access to the payments system to nonbanks institution (Osterberg and Thomson 1998). and, if so, in what form. In most countries only These developments raise the question of banks have access to the payments system, and which payment services should fall under regulatory alternative providers of payment services have to oversight and what institutions should have access clear through banks. Restricting access to the to the payments system. Decisions about which payments system to banks allows incumbent banks alternative services to regulate will matter a lot, to preserve a core part of their franchise value. 32 Electronic Finance: A New Approach to Financial Sector Development? Allowing direct entry by nonbanks and nonfinancial related services, varying from use of electronic companies (telecom and utility companies, brokers) bulletin boards to online order routing by portals to will reduce the franchise value of banks and risk an electronic road show in the context of an increasing overlap and blurring lines between electronic debt offering. Moreover, few countries financial and nonfinancial companies. This could have clarified whether issuers of various forms of enlarge the safety net, even if by default. quasi deposits or multipurpose cards will be Redesigning the safety net is all the more guaranteed. urgent because of the risks that it will otherwise be For countries with underdeveloped financial extended in the short run rather than being reduced. systems, e-finance offers the opportunity to evaluate Financial services have become more complex, with the development of a safety net and the associated increasingly blurred distinctions between products prudential framework more carefully. In such and institutions and between the financial and countries many financial services can come from nonfinancial companies providing these services. As nonbanks, which should not fall under a public financial service providers expand their activities, safety net. Furthermore, in such countries financial the safety net could be extended to nonbanking services, and associated supervision and prudential activities of financial service providers unless regulation frameworks, can be imported if foreign policies are changed. Governments may end up multinational financial service conglomerates can taking on a much larger range of risks most of enter or deliver services remotely a trend that has them unrelated to any economic reasons for a public been increasing worldwide (Goldberg, Dages, and safety net in the first place. Kinney 1999). The reduced emphasis on prudential regulation Progress to date and the limits on the financial sector safety net For the most part a laissez-faire approach to will save not only scarce human resources but also regulation and supervision has been adopted for fiscal resources. Many governments have found e-finance. Among countries with sophisticated it difficult to credibly signal that they will not bail financial systems, most regulatory and supervisory out financial institutions. But with less emphasis adjustments to address e-finance have been on banks and a bigger role for foreign providers piecemeal (Table 9). These countries already have of financial services, governments may find it good financial services, and most income groups easier to resist bailouts, save valuable fiscal have access to at least basic financial services. As a resources, and improve the allocation of resources. result e-finance penetration is progressing fairly Of course, mechanisms are still needed to ensure smoothly, with no big new risks having arisen. In that financial services are imported only from some countries disclosure laws are being adjusted, good systems and to limit risks arising from links stored value cards are being regulated, and rules for between financial institutions and nonfinancial online banking are being introduced. In some cases companies. rules are being harmonized with international Finally, some countries have implemented standards, helping to define international best regulations that could stymie the development of e- practices. But as Table 8 shows, even industrial finance. Some industrial countries, for example, countries have not necessarily addressed all the have limited the establishment of online banks to issues. existing banks, suppressing the innovation and Industrial countries have also taken a piecemeal competition that come with new financial service approach to regulating e-finance providers which providers. Access to the large value transfer system means that new risks can arise. For example, some can be another barrier to entry for online service countries have not issued special legislation and providers. In the European Union money can be related operational criteria for online banks. Many issued electronically only by traditional credit have yet to review the rules applying to institutions and a new type of credit institution infomediaries such as portals that play a direct known as an electronic limited money institution or indirect role in providing financial services. (ELMI). But ELMIs face tougher prudential Many countries do not have adequate laws and restrictions on their investments, which may hamper regulations to address possible conflicts that arise the spread of e-finance as it increases the cost of through Internet-based offerings of securities- entry for new financial service providers. Changes Needed in Financial Sector Policies 33 Table 9 E-finance regulation has yet to address some outstanding issues Are issuers of deposit Is there regulation for substitutes required to stored value cards or inform their customers that Are there disclosure electronic payments (such the cards are not guaranteed Region/country requirements for portals? as deposit substitutes)? if the issuer fails? Europe Czech Republic No Pending new Banking Act Pending European Union No Yes No Finland No Yes Pending France No Yes A Germany No Yes No Hungary No Yes Yes Poland No Pending No Russian Federation No Yes A Sweden Yes Yes No Turkey No No A United Kingdom No No No Americas Argentina Yes No A Brazil Pending No A Mexico No No No United States Yes No Yes Asia Australia No Yes A China Yes Yes Yes Hong Kong, China Yes Yes No India No Yes A Japan No Yes A Korea, Rep. of No No No Singapore Yes Yes No Africa Morocco No No No South Africa No Yes Yes A Not enough infornation was available to determine the answer. Table continues on next page Improving the performance of markets corporate governance and highly concentrated Although it has gotten easier to create and access ownership and wealth. Yet effective competition markets as shown by the migration abroad of policies and good corporate governance are trading and listing by corporations from emerging essential to achieve the gains from e-finance that markets they do not necessarily function properly . come with increased efficiency, competition, and In emerging markets poorly defined and enforced credibility. Emerging markets also harbor competition policies often combine with weak significant risks of local markets becoming far less 34 Electronic Finance: A New Approach to Financial Sector Development? Table 9-continued E-finance regulation has yet to address some outstanding issues Are there separate Do statutes, regulations, or Institutions with access to the authorization requirements guidelines address issues government-sponsored (andlor for virtual providers of outsourcing for government-operated) large Regionleconomy of e-finance? financial institutions? value transfer system Europe Czech Republic No No Domestic banks and stock exchange institutions European Union Same as for 'brick and Yes Credit institutions and mortar' providers electronic limited money institutions Finland No (refers to EU) A Central Bank France No (refers to EU) A A Germany No (refers to EU) Pending Credit institutions Hungary No A Financial institutions Poland No Yes Banks and clearnghouses Russian Federation No A Bank of Russia clients Sweden No (refers to EU) A Credit institutions Turkey No No Banks United Kingdom No (refers to EU) A Banks Americas Argentina No A Banks and clearnghouses Brazil No Yes A Mexico No No Banks and brokers United States Pending Yes Depository institutions Asia Australia No Yes Depository institutions China No No Banks Hong Kong, China No Yes Depository institutions India No A Banks Japan Yes Yes Financial institutions Korea, Rep. of Pending Yes Commercial banks Singapore Yes Yes Banks Africa Morocco No No Banks South Africa No A Banks A Not enough information was available to determine the answer. Source: World Bank survey. More detailed descriptions of respondents replies are available from the authors. liquid and more subject to insider dealing. Compe6ftionooicy Moreover, e-finance and increased connectivity can As noted, recent changes are making financial raise risks of market fragmentation and volatility. services more like other goods and services and And across borders, there is a need to harmonize financial markets more like nonfinancial markets. market standards and practices. How can these Technology is leading to specialization in the weaknesses be addressed? provision of financial services and to the Changes Needed in Financial Sector Policies 35 development of separate markets, particularly easy to measure or likely to be harmonized in the wholesale markets, insulated from other financial short run. markets. Empirical techniques may be the only way to These developments make competition policy test a market s contestability, but it will be difficult for financial services more feasible. At the same to find robust models for this. Still, global markets time, the speed and associated benefits of call for a global framework for competition policy, technological innovation in financial service or at least for increased coordination among provision are increasingly becoming a function of countries competition policies. Furthermore, the degree to which entry by new entities financial because different industries are involved in the and nonfinancial is allowed. This is making production and delivery of financial services, competition policy more important but, as noted, regulators within and across countries will have to also raises issues for the extension of the financial coordinate how they define and assess violations of sector safety net. competition policy. Competition tests require defining a product In some product markets, network externalities and its market. But it is getting harder to precisely may become important for competition policy define financial products and their markets. Many because they can create entry barriers once critical traditionally nonfinancial services are taking on mass is reached, and market participants will have characteristics of financial contracts. The creation of strong incentives to internalize these externalities cash equivalents, derivative markets in weather and and the associated rents. Markets involving network power (such as enermetrix.com), and other externalities warrant regulation to ensure access and derivative contracts settled in cash defy efficient outcomes (Weinberg 1997; Shapiro and classification into distinct categories of financial or Varian 1999; Simons and Stavins 1998). As noted, nonfinancial services. The continuum from cash network externalities are especially important in (notes) to stored value cards to barter-type areas such as payment services and trading systems arrangements competing not just as cash substitutes, (see Table 6). but also along many other dimensions, makes it For example, automated teller machine (ATM) hard to precisely define the concept of payment systems in the United States started as small, private services or even deposits. proprietary systems, then standardized and, over It is obviously difficult to define entry barriers time, linked up nationally without creating serious for services that cannot be well defined. Moreover, competitive concerns. In many continental market sizes are changing. Changes in delivery European countries with concentrated banking modes for retail financial services are lowering systems, single nationwide networks with adequate entry barriers for many financial services that were access developed. But in some countries regulators once local, making traditional measures of market had to force more open access on these networks, concentration meaningless. As noted, many markets regulate pricing policies, limit exclusivity have gone global, making it more difficult to agreements, and overcome first-mover advantages. geographically define markets. In countries such as Similarly, governments may need to force New Zealand and in some Latin American and public access on other network services, trading Eastern European countries, foreign banks account systems, and electronic communication networks. for more than two-thirds of local markets. And in some cases governments may have a role With markets going global, nontariff and precisely when network externalities are difficult to nonquantity barriers have become more important internalize, as when a basic technology must be for financial services. The ability of foreign shown to be technologically feasible. For example, financial institutions to provide financial services the Internet may not have reached critical mass as on a global basis can be hampered by differences quickly as it did without early government in laws (such as in bank secrecy laws and in subsidies. know thy customer provisions related to Authorities have generally allowed markets and money laundering and fraud), regulations, and actors to proceed with little restriction, with entry in conventions. Globalization raises the importance financial services by nonfinancial entities and of such structural barriers because they can strategic alliances between financial and hinder competition. But such differences are not nonfinancial entities. Entry by nonfinancial entities 36 Electronic Finance: A New Approach to Financial Sector Development? has increased competition, particularly in services contestable system is needed for both foreign and traditionally provided by banks. Aggregators such domestic providers of financial services, including as Lending Tree in the United States, Advantage nonbanks. Mortgage in Hong Kong (China), and DollarDEX in Recognizing the potential gains, several Singapore have increased competition and widened countries with unsophisticated financial systems access in mortgage markets. New payment services, have taken an open stance toward imports of such as the Octopus card in Hong Kong (China), financial services. For example, in 1997 Ghana, bypass banks and lower the costs and increase the Kenya, Malawi, and Mozambique committed to quality of services. New entities in the brokerage almost entirely opening their financial systems to business have sharply lowered commissions in foreign competition. For these and other countries, many countries. effective opening will require removing indirect While entry by nonbanks has increased barriers, such as harmonizing standards in many competition in financial services, the mixing of areas. brand names, distribution networks, and financial Opening to foreign competition does more than services is leading to complex ownership and give countries access to more efficient financial alliance structures, and extensive vertical services. It also allows countries particularly less integration could undermine competition. Such developed ones to benefit from competition links can lead to fewer benefits for consumers when policies that the source country applies to financial they exploit reputation or involve sunk-cost service providers. As a result underdeveloped investment to reduce competition on price.6 Mixed countries can move forward without an elaborate conglomerate structures can also challenge a basic domestic competition policy especially important principle of competition policy, the separation of when institutional capacity is weak. content and carriage. Some mixed conglomerates Still, some issues, particularly the possible such as a telecom company merged with a financial links between network providers and financial service provider will be able to control content service providers, may require attention from local and carriage and can limit access to networks by policymakers. Given the potential for monopolistic buyers of services, or by suppliers that wish to behavior in markets such as telecommunications, access potential customers. vertical integration of financial service providers As long as new entry is possible in important and network providers whether through parts of the chain or the complete chain, vertical ownership, strategic alliances, or otherwise can links may not inhibit competition. Moreover, lack of raise issues for competition policy. Many such competition may not result in higher prices for issues are not specific to the financial sector, and financial services, but it could reduce product and arise more generally in e-commerce. But they can process innovation. To ensure competition and be important, particularly in smaller markets with innovation, restrictions may be called for on vertical only a few network providers. or horizontal links. In considering such restrictions, authorities will have to balance many issues, Marketfunctoning, fragmentation, including the potential risk diversification benefits and volatility of mixed conglomerates and the benefits for As noted, emerging markets are making greater use competition of entry by nonfinancial entities. of global trading systems, and capital raising is Securing more efficient production and increasingly moving to more liquid offshore delivery of financial services requires a competition exchanges. As a result liquidity has fallen in framework that provides for liberal entry to and local exchanges especially in small economies cross-border provision of financial services. A but also in larger emerging markets. The development of local capital markets and the role of local exchanges will likely continue to 6 Gual (1 999) suggests that competition through price and change. Exchanges will increasingly demutualize, variable costs leads to less concentration and lower entry merge, and spin off functions while developing barriers relative to competition based on taking other business lines (software production and advantage of brand or reputation through investments distribution to market participants, risk management involving sunk costs. services, cross-border clearing services, business Changes Needed in Financial Sector Policies 37 to business exchange development and support, and standards and practices. First is the degree to which so on). residents will be allowed to access financial The challenges in regulating and supervising services provided by foreign firms. While securities markets will require a new model for technology will provide domestic residents with authorities (Box 10). Issues include the scope of more flexible access to services from anywhere regulatory oversight within and across borders, such as an insurance product purchased on the constraints to joint enforcement as more trading of Internet from a foreign financial institution the emerging market securities takes place abroad, and ability to do so will be determined by the rules in definitions of what constitutes an exchange, an the country where the consumer resides. alternative trading system, an order routing system, Many countries limit the cross-border provision and a brokerage operation. How should governance of financial services. They require, for example, and ownership structures be restricted to avoid local establishment for foreign financial institutions conflicts of interest as demutualization proceeds, to be able to solicit business onshore. They and what self-regulating functions should be also limit solicitation more implicitly through performed? know thy customer rules that require physical registration before services can be delivered Harmonization of standards andpractices online. These limits will be harder to impose as The increased ability to deliver services across the Internet extends its reach and as the location borders raises issues for the harmonization of of providers becomes harder to pinpoint, Box 10 Challenges for market regulation within and across countries Securities market regulation confronts complex challenges actions. Such efforts may involve not just memorandums when it crosses borders. Three mutually nonexclusive of understanding but also changes in legal enforcement approaches should be considered. power-including investigatory powers and secrecy statutes One is where a country's regulator retains primary for financial institutions-to support active, timely, and responsibility for markets, with mutual recognition of effective cooperation. supervision. This approach would only work for countries with Across and within countries there is a need to more similar rules and would require some harmonization. Local carefully define the functions of exchanges and self-regulating regulators would maintain primary responsibility even when organizations given the trend toward demutualization and the trading plafforms are based offshore or when trades are for-profit nature of many intermediaries. A for-profit exchange primarily in foreign stocks (say, U.S. stocks traded on a may not be subject to conflicts of interest if maintaining its European exchange). This is essentially the European reputation and service are its key sources of order flow. But in approach-mutual recognition with some harmonization. many emerging markets, exchanges have few incentives to A second model is the exchange registration approach, undertake certain self-policing functions. A for-profit exchange, where the domestic regulator applies the same regulations to with the accompanying financial pressures for new foreign and domestic exchanges operating in the country. This shareholders, and given the increasing migration of order flow could imply that exchanges are subject to multiple regulations. abroad, could seek to block competition through legislation or For example, a European-based exchange operating in the regulation. Hence it will be important to ensure competition in United States and Europe would be subject to U.S. and the provision of trading and related services. European regulations. There is also a trend toward consolidation of back-end Finally, access providers-such as brokers that provide systems and clearing custody and clearing arrangements for investors with access to foreign exchanges-could be regulated securities. This trend is especially evident in Europe, where (in addition to whatever regulation applies to the exchanges). Euronext (Paris, Amsterdam, and Brussels) is consolidating the This approach does not overcome the problem that investors provision of depository services and establishing one central can get access in many ways, often with no clear jurisdictional clearing counterparty that will offer such services across all cash oversight. and derivative instruments traded in fixed income and equity in Whichever approach is taken, even more fundamental these three markets. A unified structure can greatly reduce risks questions arise in harmonizing definitions of an exchange, in securities markets. But for that to happen, solvency statutes an altemative trading system, or a broker-dealer. Furthermore, must be harmonized across countries. Proper supervision and countries that are home to many companies listed and traded regulation of central clearing counterparties will require more abroad will need to find ways to jointly enforce securities cooperation among supervisory agencies. Source: Aggarwal 2000; The Economist 2001. 38 Electronic Finance: A New Approach to Financial Sector Development? solicitation harder to define, and the definition the responsibility for supervision to the home of a financial service more complex. Such limits authority. But even with more harmonized can then just become costly, distortive, and standards, that may not be sufficient. Short of fully uncompetitive. harmonized regulation and supervision, regulators Regulators will have to decide on the best may need to act within their own jurisdictions. approach and timing to phase out such restrictions. Closer links through technology require closer A comprehensive approach would be the global coordination in many areas. The spread of equivalent to the EU approach of a single license alternative trading networks across borders and the (passport) allowing cross-border provision with entrance of nontraditional financial service home rule regulation (Key forthcoming). This providers, for example, can create new risks. process will take time to develop partly because Increased use of technology and networks adds to there will be concern that regulatory and operational risks of computer breakdowns or supervisory systems in some countries are not infiltration by hackers on a global scale. Safeguards sufficient to support such a system. across trading systems, within and across countries, Second, when allowed, cross-border provision will need to be developed. Cross-margining or ex raises the issue of which country s standards and post collateral-sharing agreements will become jurisdiction apply. Because standards differ in many essential as trading goes global and involves areas for listing requirements, insolvency position taking on many electronic exchanges. Even arrangements, accounting standards, and the like with safeguards, many new systems will have inconsistencies can easily arise, raising transaction untested market stability features, and their costs and reducing benefits. Differences can also operators may lack experience and be subject to lead to regulatory arbitrage and raise the possibility spillovers from nonfinancial parts of the group of a race to the bottom. While standards are anywhere in the world. Access of new systems to increasingly being harmonized for example, the contingent financing mechanisms is unclear, International Organization of Securities especially on a global basis. Commissions recently endorsed international In general, the links between operators and accounting standards proposed by the International systemic risks will become harder to understand. Accounting Standard Committee lar ge differences The Russian and Long Term Capital Management remain. crises of 1998 surprised many. The lines between Enforcement and legal recourse across borders financial and other markets will become even more can also be complicated. To some extent market blurred as trading spreads through power, natural forces will deal with the issue of legal jurisdiction gas, and agricultural commodity contracts, risking because consumers will prefer environments that greater spillovers from nonfinancial institutions and provide them with the greatest certainty as has markets to financial markets. Going forward, firns long been the case in wholesale markets, where and regulators will be pressed to respond quickly to corporations and sovereigns generally choose to any disruptive event anywhere in the world, issue or cross-list in a few markets. Nevertheless, as potentially turning once-manageable situations into: the Internet expands the access of less informed systemic crises. Risk safeguards will have to be issuers and investors to cross-border services, extended within countries and on a global basis, and investor protection and transparency issues may greater information sharing will be necessary arise. The global passport approach would assign among regulators and self-regulating organizations. 39 E-finance Applications-and Implications for Govemment P rivate solutions will help countries reap many In addition, government can make better use of of the benefits of e-finance even when the existing infrastructure and reduce duplicate P enabling environment is imperfect. But infrastructure (such as branches and agencies of further gains will require improving this development banks or state banks). Here creative environment. Thus e-finance calls for a review of use of the post office network (as proposed in India government s role direct and indirect in the and South Africa) and even telegraph offices (as financial sector. In general, e-finance allows proposed in Mexico) can have a major impact governments to curtail many of their direct efforts (Box 11). to provide financial services (for example, through Government s role can change dramatically in development banks). But other, less direct many areas where it once delivered financial approaches have become more attractive, such as services including retail payment and banking using government infrastructure including post services, housing finance, insurance, nonbank and telegraph offices for the private delivery of financial services (factoring, leasing), storage financial services. finance, trade finance, lending to small and Govemment's role in the financial medium-size enterprises, and even microlending. sector is changing-and becoming E-finance coupled with basic reforms will allow sector Is changmg-and becommg private market participants to deliver such services less direct far more effectively to a much wider audience Government intervention in the financial sector has with much smaller transactions, even in remote generally had very poor results. Attempts to reach areas. The Internet slashes processing costs for underserviced groups often miss their targets, are providers and search and switching costs for captured by special interests, and incur large fiscal consumers. As a result providers can market costs. Government ownership of banks tends to many financial services to low-income borrowers retard financial sector development and increase because smaller transactions still provide adequate the risk of financial crises (World Bank 2001; profit. As the rest of this paper shows, many Barth, Caprio, and Levine forthcoming; La Porta, financial services are already being delivered Lopez-de-Silanes, and Shleifer 2000). electronically, even in emerging markets. E-finance can reduce the need for government intervention. The increased availability of financial Smart cards provide a new way of services, almost regardless of a country s level of delivering financial services financial sector development, reduces the need for In advanced countries single and multipurpose government to provide financial services or to cards are replacing or complementing other direct intermediaries to do so. Moreover, market forms of payment (Box 12). In less advanced failures are less likely: information is more readily countries these cards are seen as a new way to available and, with reforms, can be of higher build financial systems. Issued by private providers quality. These improvements allow financial of financial services, such cards are used for services to be provided more widely and make small transactions and are often tied to payroll markets for trading risks and assets more systems. complete reducing the need for government to Over time these cards could be tied to cellular provide financial services and to mitigate risk. phones and other communication devices such as So, government s main remaining role is kiosks and be linked to other databases and to enhance the enabling environment. In addition, financial transfers, including publicly provided there can be scope to improve information and social services (see Annex 4 for examples of smart increase private access to that information. For card applications around the world). Cards can also example, information on public registries for be linked with public infrastructure, as between collateral could be shared more easily using new Mondex (an international electronic cash system) technology. Government can also make more and South Africa s post office, so that they can be information available, such as basic information offered in remote regions. Such cards can be a far on consumers (say, utility bills if administered more efficient alternative to traditional by a public agency). But this more active role development bank lending in regions such as needs to be balanced against privacy concerns. Africa. 40 Electronic Finance: A New Approach to Financial Sector Development? Box 11 Making creative use of existing public infrastructure: Post offices In emerging markets as different as South Africa and India, allow for unique identification and registration, then assigned e- efforts are under way to use publicly owned infrastructure- mail accounts and personal identification numbers for access. particulady post and telegraph offices-as conduits for The system also allows users to pay bills for retail services (see delivering nonfinancial and e-finance services, and as access Box 12). points for information. India is conducting a similar experiment. The government South Africa's post office provides a wide variety of has been investing in high-speed (DSL) Internet connections to services, including financial services, to more than 40 million link the country's 154,000 post office branches with 110 million people dispersed over some 1.2 million square kilometers. savings account holders (in a country with 1 billion people). The Under the citizens' post office concept the agency provides government is also using the VSAT (satellite system) to link all telephones, fax machines, computers, Internet access, and the branches and to permit international money transfers-at other value added financial services through alliances with a much cheaper rates. This infrastructure will be open to multiple growing number of private providers in search of appropriate private providers, including providers of financial services, and distribution channels. The post office has already formed promises to greatly expand access to financial services. Post alliances with e-commerce companies such as Compuquote offices can serve as points of origination for authentication, (offering comparative insurance and financial quotations) to sources of education about social and other services, gateways provide financial services through terminals in its branches. The to purchase retail goods, payment points for municipal and terminals also allow people in remote areas to access e-mail federal bills, vehicles for electronic debit card information and and obtain information online, such as comparative prices for related transfers, points for payment of key benefits (such as inputs and crops common in rural areas. Users are certified pensions), and even dissemination points for essential through biometric systems (based on their fingerprints) that information such as commodity prices. Source: Glaessner, Ladekarl, and Klapper 2000; Bell and others 2001. Box 12 Smart cards: A clever way to leapfrog? Smart cards hold value electronically and can be used to make cards. These initiatives could allow Ghana to move from having payments. Such cards can allow countries to leapfrog stages of almost no e-banking infrastructure to having full e-cash financial sector development because they ease the need for capability. costly and comprehensive financial infrastructure. Smart cards Other projects include a joint effort between Mondex and can also lower costs and reduce the need for traditional credit South Africa's post office (see Box 11). Using the country's history checking. 2,000 post bank counters, the project will give South Africa's Thus there is growing interest in smart cards in Africa. In most remote region its first banking services. Smart cards will 1999, 16 East and Southem African countries jointly purchased enable people to set up pseudo bank accounts, with biometrics franchise rights to Mondex, an international e-cash system. The technology providing reliable identification. The e-accounts can system permits the transfer of value between cards without the be used, after a cardholder has paid in benefits or wages, to need to centrally record every transaction, allows for offline make payments and to set up savings pools for specific transactions, and reduces cash handling costs. In addition, the investments. South Africa's post office also takes advantage of cards can handle multiple currencies and can be used across the existing payment settlement system on behalf of the post countries. office savings bank. It offers retail payment services such as This initiative has inspired similar efforts elsewhere. "Pay a Bill," which allows more than a hundred accounts to be Ghana plans to introduce a chip-based, preauthorized offline paid at post office counters-including accounts with Telkom, payment card-the first example of e-cash banking in West municipalities, mail order houses, financial institutions, and Africa-as well as other e-banking products based on smart credit cards. Source: Hitachi Research Institute 2000; Mondex 1999, 2000. The Internet offers a new approach to have been created to perform all relevant housing finance functions from loan origination to financing. Around the world, authorities have played a big role But housing finance can involve many steps in housing finance because of housing s importance from the time a house is appraised to the time all for economic development and because of social documentation has been obtained to underwrite a demands for such finance. As a result many loan. The Internet allows for the unbundling and government-backed housing development banks automation of mortgage loan processing. It can also E-finance Applications and Implications for Government 41 cut search costs for consumers of mortgage financing. Automated loan preparation can also services. Especially in emerging markets, many generate big savings (see Box 13). Finally, the mortgage services are quite costly, and the Internet clearing and information exchange functions made could make mortgage loan underwriting much more possible by the Internet through a business to efficient. business model applied to home buyers and Furthermore, when government development sellers can provide a powerful boost for banks subsidize mortgage finance, it discourages efficiency. private actors from developing ways to mitigate Insurance products are increasingly risks or cut transaction costs. Most of these distortions occur because authorities often do not being offered online separate the financing of mortgage loans from the Like housing, insurance is an industry where subsidies being provided. Where this distinction has governments in emerging markets have provided been made, mortgage loans are becoming more services directly such as reinsurance, crop efficient, including by using the Internet. insurance, and support for victims of natural Advantage Mortgage in Hong Kong (China) and disasters. Such insurance is often meant to DollarDEX in Singapore are two examples of what redistribute income or mitigate risks. will likely be a growing number of online providers In countries as diverse as Korea, Mexico, the of housing finance (Box 13). Like online Philippines, and Singapore, insurance products are brokerages, these companies are also starting to increasingly being offered electronically to offer their services across borders. Emerging consumers directly and through intermediaries, markets offer considerable potential for the allowing different roles for government (Box 14). electronic delivery of mortgage loans unlike some Most of the insurance companies offering services more advanced countries, where growth has been online allow consumers to shop for different slow because housing finance systems are products, using complex algorithms to ensure reasonably efficient. proper comparisons. Some companies have In addition to originating loans, the Internet established business to business exchanges like can play a role in housing markets by providing those for global risk and reinsurance. The information on financing and other options to a increasing penetration of insurance portals and the wide spectrum of potential homeowners. Given growing interest of major insurers in entering the many steps involved in buying a home, the emerging markets using e-finance make it far less Internet can also slash transaction costs. For likely that governments need to directly provide example, Internet platforms have been used to insurance products as long as an enabling lower the cost of real estate appraisals and to secure environment is in place. Box 13 Mortgage finance: The impact of the Internet Advantage Mortgage began operations as the only true borrowers. It is considering expanding to China, Korea, and specialized mortgage broker in Hong Kong (China). Over time Taiwan (China). the company has become an overall aggregator much like DollarDEX in Singapore is using the Internet to help lendingtree.com in the United States. Advantage derives its financial institutions sell products, including home loans, car revenue from fees paid by 15 of the biggest lenders in Hong loans, travel insurance, and a variety of others. DollarDEX has Kong's real estate market as well as 2 lenders not supervised become a kind of third-party aggregator of such products on by the Hong Kong Monetary Authority. Advantage solicits behalf of lenders. In particular, it has developed block reverse borrowers, evaluates mortgage loan packages for presentation auctions for home loans to lower the prices that consumers to borrowers, prepares all documentation required to underwrite pay-providing a kind of aggregation and search engine loans and send complete loan packages to final lenders, and service. Like Advantage, DollarDEX does not really take on provides offline support on documentation. Advantage assumes credit risk, but transfers the loan files to financial institutions that no underwrting risks and does not charge borrowers for then do the underwriting. The company is also targeting markets such services because prospective lenders pay all fees. such as Hong Kong (China), Malaysia, the Philippines, Taiwan Advantage is also acting as a backup underwriter for mortgage (China), and Thailand-precisely because the potential profits insurance given its expertise and knowledge about mortgage are higher in less developed, less efficient markets. Source: Claessens, Glaessner, Klingebiel, 2000. 42 Electronic Finance: A New Approach to Financial Sector Development? Box 14 Insurance: E-financeable? How e-finance will affect insurance is the subject of intense exchange for global insurance risks and reinsurance capacities. debate in the industry. Many insurance companies recognize Re2Re uses proprietary technology to improve reinsurance the Internet's potential as more than a marketing tool, but e- exchange between direct insurance companies, insurance insurance applications remain limited. In part this is because brokers, reinsurance companies, and reinsurance brokers most life insurance, pension products, health insurance, and worldwide. DollarDEX is a Singaporean company that enables commercial insurance appear to have limited suitability for sale online consumers to compare, shop, auction, and apply for on the Intemet. Still, many firms recognize that the Intemet will loans and insurance products from more than 30 leading lower costs and improve customer service. This realization is financial institutions in Asia. Customers can get instant perhaps more pronounced in some emerging markets, where quotations based on a full comparison of features and prices, traditional insurance products have had limited penetration. and can buy motor, travel, hospital, home, personal, long-term In 1999 Renaissance Insurance became the first Russian care, and other insurance. DollarDEX recently pioneered the insurer to go online. Clients can pay for eight different insurance first fully online life insurance product, M@xivalue, which policies using the company's payments system. In 2000 enables healthy applicants to get instant approval. Prudential Ingosstrakh, Russia's largest insurance company, launched a Insurance of the United States plans to introduce new Web- site allowing clients to apply for insurance online. So far, based investment products in Korea, Mexico, and Taiwan however, payments must be made in the offices of Ingosstrakh. (China). Its move, complemented by a greater brick-and-mortar In Mexico Grupo Nacional Provincial is offering online presence, is part of efforts to offer online insurance products automotive policies through a joint venture with the Intemational globally. Insurance Group. Consumers, agents, brokers, and insurance In March 2000 the first insurance Website was launched in companies can buy insurance policies directly from a Website. China. Wangxian delivers insurance documents to policyholders Yapster.com in the Philippines has set up an online portal that and allows customers to use credit cards to purchase offers end-to-end delivery of insurance products and services, insurance. Sohu.com, a major Web portal, and Taikang Online, with instant quotes available from a range of providers. a major insurer, followed the same trend in 2001. The two Re2Re, a Bermudas-incorporated company with offices in companies offer online insurance services to clients, agents, Hong Kong (China) and the Philippines, has developed an open and other insurance companies. Source: See bibliographical note. An e-revolution is occurring in opportunities for factoring, which is the sale of factoring, leasing, storage finance, accotnts receivable, and leasing, which are loans and trade finance collateralized by assets such as accounts receivable and inventory, as well as other forms of asset-based Factoring, leasing, storage finance, supplier credit, lending. Electronic transmission of sales and and trade finance are well-established financial receipts allows real-time information exchange, services. Companies use these techniques to obtain increases security, enables immediate credit finance by pledging receivables, leasing machinery decisions, and lowers transaction costs. Lenders can or other financial or nonfinancial assets, pledging continuously access firms ledgers to track changes. warehouse receipts to finance storage of goods in in outstanding receivables as inventory is sold and warehouses, and pledging actual or expected trade- receivables are collected, lowering the transaction related receipts. These forms of finance are costs for clients. New factoring companies offering important in many emerging markets especially online applications and more transparent rates have where banking systems are under stress and standard increased competition and reduced fees even further. means of contract enforcement are deficient. E- But as with other electronic transactions, more finance can improve the delivery of these services secure technology should be developed to prevent and substantially lower transaction costs given the fraud and to extend laws to cover electronic sales of often paper-intensive documentation required for receivables. these services. Storage finance Factoring and leasing Storage finance is an area where governments in New technology has lowered the cost and increased many emerging markets have played a large role by the availability and ease of transferring information. providing storage for agricultural commodities as This development has increased lender and client in India and by purchasing physical stocks on E-finance Applications and Implications for Government 43 grounds of security as in African and to a lesser mechanisms will also allow smaller transactions, extent Asian and Latin American countries. E- increasing access to trade finance for smaller finance offers interesting possibilities for storage businesses and so expanding the volume of trade finance. The ability to track commodities being financed. Electronic trade finance will require stored, to uniquely define storage certificates, and to adequate security arrangements as well as a keep warehouse receipts electronically can facilitate framework for using electronic signatures. the provision of credit against stored goods for farmers, exporters, and processing companies. In Small and medium-size enterprises India and Mexico Internet platforms are being can secure finance electronically developed to trade and pledge electronic warehouse Lending to small and medium-size enterprises is yet receipts. These developments will reduce the need another area where e-finance can obviate the need for government to purchase commodities for for direct government intervention. Small and stockpiling and to provide financing to farmers. medium-size enterprises are major sources of growth and employment, and authorities around the world Trade fi7ance are constantly evaluating how best to ensure their Trade finance is another area where governments access to finance including through existing or have provided credit to exporters and importers, even new government-owned development banks. often through development banks. New technology But development banks have often proven to be the will allow letters of credit, bills of lading, and other wrong approach (Barth, Caprio, and Levine documents associated with trade finance to be forthcoming; La Porta, Lopez-de-Silanes, and dematerialized and tracked electronically, resulting Shleifer 2000). in large savings. Bolero.net, a joint venture between Instead, governments need to provide the the Society for Worldwide Interbank Financial infrastructure and platforms needed for private Telecommunications, commercial banks, freight entities to offer such finance electronically forwarders, and shipping companies, is one of the including through public infrastructure such as post first platforms to completely automate trade finance, offices. E-finance for small and medium-size reducing handling time and delays caused by enterprises is already a reality in many parts of the improper documentation. This and other world; SMEloan in Hong Kong (China) and Pride Box 15 E-finance for small and medium-size enterprises SMEloan Hong Kong Limited (known as SMEloan) has microentrepreneurs with the formal financial sector, Pride Africa reengineered the commercial lending process using the Internet created Sunlink Cashpoints. Sunlink clients have smart cards and has become Hong Kong's (China) leading provider of that provide teller access, loan authorization, and client online financing for small and medium-size enterprises. identification, helping to establish credit ratings-and so SMEloan conducts most of its lending on the Internet and facilitating access by small and medium-size enterprises to manages credit risk using a Web-based risk management other financial services. model. In October 2000 SMEloan closed a HK$600 million Major financial conglomerates with worldwide operations (about US$75 million) financing facility with a group of banks, are also entering the market for small and medium-size a first for a startup e-finance company in Asia. The facility will enterprises. In 1999 Citigroup created CitiBusiness, a business enable SMEloan to expand its current customer base of 200 group that specializes in financial services for such enterprises. small and medium-size enterprises to well over 1,000 by In 2000 it launched the CitiBusiness Platinum Select Master mid-2002. Card, which in addition to providing credit gives access to Pride Africa is a financial institution that provides access to various services-including information on building a Website, credit to more than 80,000 small-scale entrepreneurs in Kenya, setting up an employee benefits program, and so on. In early Malawi, Tanzania, Uganda, and Zambia. Pride Africa has 2001 Citigroup introduced CitiBusiness Direct, a comprehensive created DrumNet, a virtual network linking clients to markets, Internet banking program, to small and medium-size enterprises information, and services. Through its network of microlending in the Czech Republic, Hungary, and India. In India CitiBusiness branches and information kiosks, Pride Africa's clients will have accounts for 15 percent of Citigroup's corporate bank business, access to wholesale supplies and services, advertising, and and counts 5,000 small and medium-size enterprises among its partnership and association building opportunities. To integrate clients. Source: See bibliographical note. 44 Electronic Finance: A New Approach to Financial Sector Development? Africa show what is possible (Box 15). Pride information about customers is pooled and provided. Africa s DrumNet, a network linking small clients in to credit bureaus, there can be a natural move by several African countries to markets, information, clients to more formal methods of finance. and services, may be replicable. Large financial n s m conglomerates are also starting to target small and Changes m securites markets offer medium-size enterprises because the lower chances for faster development transaction costs made possible by e-finance make E-finance and new technology will also allow for this market attractive. big changes in the operation of payments systems and other middle- and back-office functions for New technology can increase access financial service providers as well as for the faster to microfinance development of an entire communications networlc Governments often intervene in microfinance backbone. Hong Kong (China), Malaysia, and through direct programs that mix financing with Singapore are trying to interconnect all financial subsidies. As with lending for small and medium- service providers into financial nets that will size enterprises, the Internet and other new allow straight-through processing, payment versus technology will further weaken the case for such payment, significantly lower costs, and better risk direct intervention. Whether it is the development of management (Box 17). Because much of the an Internet-only bank that delivers services to the infrastructure for securities markets is starting to urban poor or the use of smart cards and even operate on a for-profit basis and because monopolies cellular phones to reduce processing time for are disappearing (as in clearing and settlement microloans (Box 16), technology can dramatically systems), governments will increasingly need to set lower the costs of delivering financial,services to the overall framework for connecting these systems such borrowers increasing access. In addition, to and assess the risks in doing so, rather than regulate the extent that such activities are automated and or own specific infrastructure components. Box 16 Microfinance and e-finance--a viable match? Access, cost, and technical expertise are the main factors loan officers to record client data, take applications, and make hindering the use of information and communications loan calculations on the spot. technology by microfinance institutions. Yet new technology can PlaNet Finance, launched in 1999, aims to share not only transform systems for delivering microcredit to the poor, knowledge among microfinance institutions and promote local it can also facilitate the microfinance business itself. initiatives. PlaNet Finance has created PlaNet Fund to provide In 1993 South Africa's Standard Bank created an affiliate, microfinance institutions with services like loans, guarantees, E Bank, to deliver basic bank services to the urban poor. Using joint funding, and bond purchases. For example, a carpenter in modified automated teller machines (ATMs), E Bank provides a Bolivia who needed new tools applied to a local microfinance package of financial services, including payment services and institution for a loan, but the institution could not provide the savings accounts, designed for low-income clients. By funds. So the microfinance institution made an Internet appeal rethinking the needs of basic bank customers, E Bank was able to PlaNet Fund, combining the applications of several to bundle services valued by poor clients while covering costs craftsmen. A specialist on Bolivia examined the case in La Paz, with low overall fees. In Nigeria, Gemcard plans to give smart Peru, and gave his approval to PlaNet Fund, which quickly cards to poor citizens so that they can participate in a disbursed the loan. microcredit scheme involving local banks. Bank services will be Similar to the PlaNet Finance concept, the United Nations provided by mobile vans that use facial biometrics to identify Conference on Trade and Development has created the Virtual customers. The project aims to encourage good banking habits Microfinance Market, an information exchange designed to among the poor and to collect funds from the informal sector. facilitate interactions between microfinance institutions, private ACCION International, one of the world's leading investors, governments, and other participants in the microfinance organizations, is using handheld computers to cut microfinance market. The Virtual Microfinance Market is aimed the time and cost of making microloans. Loan officers record all at creating sustainable market links between commercial loan data using Palm Pilots, which frees them from carrying investors and microenterprises in developing countries, and is burdensome equipment when visiting clients. Including the time expected to permit the investment (using commercial terms) of it takes to record data and upload it back at the office, it takes millions of dollars at the grassroots level and the creation of less than an hour to process a loan. New software will allow thousand of jobs. Source: See bibliographical note. E-finance Applications and Implications for Government 45 Box 17 FinNet: Toward a paperless infrastructure backbone for financial services Hong Kong (China), along with some other economies, has securities, derivatives, banking, and insurance activities; all been modemizing its financial network infrastructure to enhance licensed financial entities and key govemment agencies (such its status as a financial center and become one of Asia's most as regulatory agencies); law firms; independent mortgage convenient centers for business to business commerce. brokers and insurance companies; independent financial Governed by a public-private partnership, a financial network, planners; and even overseas systems if they meet certain FinNet, will be established (see Figure). FinNet will be a secure, standards. FinNet will allow straight-through processing of all open, scalable, and high-performance community network functions related to financial transactions, from the front end to interconnecting all types of financial services and all financial the back end. In addition, it will permit real-time delivery versus markets and institutions in Hong Kong (China). This includes all payment and payment versus payment. Overseas Systems Payment Systems Brokera e Houses Independent Financial MPF Managers \ \ / Planners ~~~~~~~Paner Independent Insurance FinNet 41* ~ Companies \ ~~~ ~ ~~TvP _ \ DvP/_ Boutique Financial \W STP Companies Insurance Companies Regulatory Bodies Law Firms Bankers DvP = delivery versus payment; RTGS = real time gross settlement system; PvP = payment versus payment; TvP = trade versus payment; STP = straight through processing; MPF=mutual portfolio funds; HKEC = Hong Kong exchanges Source: Hong Kong Monetary Authority. 47 Annex 1: Data Sources and Methodology for the Projections Data sources The share of online banking customers is from various sources. Data for for Table I Belgium, Denmark, France, Italy, the Netherlands, Norway, Portugal, Spain, Sweden, the United Kingdom, and the United States were furnished by DataMonitor for 1999. Data for Australia, the Czech Republic, Germany, Hong Kong (China), Hungary, Mexico, and Poland were furnished by their central banks for 1999. Data for Argentina, Brazil, Finland, and Singapore were provided by Credit Suisse in 1998. Data for India was provided by Netsense for 2000. The share of online brokerage customers is from various sources. Data for Belgium, Denmark, France, Germany, Italy, the Netherlands, Norway, Portugal, Spain, Sweden, the United Kingdom, and the United States were provided by DataMonitor for 1999. Data for Japan was furnished by Monex for 2000. Data for Australia, China, the Czech Republic, Hong Kong (China), Korea, and Mexico were furnished by their central banks for 2000. Data for Singapore was furnished by TD Waterhouse for 2000. Data for India was furnished by Netsense for 2000, and data for Brazil by E-Trade for 2000. Business environment rankings were furnished by the Economist Intelligence Unit Country Forecast. The rankings cover 60 countries, and have been used in other contexts to predict levels of foreign direct investment. Methodology for The projected takeoff years in Table 4 are based on the data on online banking the projections from Table 1. These are typically 2000 data for European countries and end-1999 data for the United States. The takeoff year is based on a pattern of penetration that can best be described as an S-curve. The shape of the S-curve is determined by the penetration rate at which takeoff occurs, the final level of saturation, and the rate of hyper growth. The final level of saturation is set at 100 percent. The rate of hyper growth is set at a value such that it would take 10 years after takeoff to reach full saturation. The current penetration level for each industrial country is then matched to the one implied by an S-curve. The S-curve chosen then implies a certain date at which hyper growth will start (or has already started if the current penetration level is higher than the penetration rate at which takeoff occurs). These (derived) hyper growth takeoff dates for the 16 industrial countries were used in conjunction with an ordinary least squares regression to find the relationship between takeoff dates (dependent variable) and the EIU business environment rankings and connectivity indexes (independent variables, as reported in Tables I and 4). For online banking, the connectivity index is a more important explanatory variable than the business environment ranking. Specifically, the regression results are: takeoff= 2014- 1.7 1* Conn, with R2 = 0.397. For online brokerage, both the business environment ranking and connectivity index are important explanatory factors. Specifically, the regression results are: takeoff= 2027.2-2.16 * BusEnv - 1.49 * Conn, with R2 = 0.8. Using these two regression results, the other countries business environment ranking and connectivity index are used to project the takeoff dates for banking and brokerage for each country. These projected takeoff dates and the corresponding S-curves imply certain projected shares of online banking and brokerage customers for each year in each industrial country and emerging market. We next use assumptions on net interest margins and brokerage revenues for traditional and online operations to project the future net interest margin and brokerage revenues given these shares of online 48 Electronic Finance: A New Approach to Financial Sector Development? activities in each country in each year. To do so, we need an assumption of the revenues generated from online transactions. Specifically, we assume that net interest income as a share of banking assets mar gins for online banking services would be 1.6 percentage points, which is below average for banking margins in most countries. While there are significant upfront costs, it is realistic to expect that in the medium term the online costs for delivering banking services will be much lower than current costs at least as low as those experienced by today s most Internet-savvy banks. Since Nordic counties have seen the most e- finance, their current cost structure may be indicative of a cost structure under fully electronic financial service provision. In 1997/98 margins in Nordic countries were 1.6 percentage points or less. Revenues for banks from providing traditional services in a fully e-finance world may be even lower since Nordic (and other) banks have not yet completed their transformation to a more e-finance world. Nordic, Dutch and other banks, for example, are still reducing branches and staff considerably (see the Financial Stability Report of RiksBank, November 2000). As such, their current cost structures might be higher than their long-run cost structure. The 1.6 percentage point margin, for example, is definitely higher than the marginal costs of providing e-finance services, which are estimated to be only a few cents per transaction, compared with about $1 for a branch transaction and 50 cents for an automated teller machine. On the other hand, recent experience has shown that banks may need a brick and clicks approach, which would involve higher overall costs than the marginal costs of providing a transaction online. On balance, the current revenues of Swedish banks may represent a good but low estimate of the long-run overall cost advantages of e-finance. For brokerage revenues, we assume that online-only revenues are about 25 percent of normal brokerage revenues. This share is still less than the drop in commissions in markets like the United States since the introduction of online brokerage. Again, the marginal costs of online-only provision are much lower than those of traditional sources. The competition already seen for this type of financial service implies that much of the cost savings can be expected to be passed on to consumers. In Korea, for example, online-only brokerage services have been provided for free by some competitors. Again, a bricks and clicks approach is likely necessary, so the 25 percent projection might represent a balanced estimate of the long-run overall cost advantages of e-brokering. Projections are undertaken using the margins and brokerage revenues prevailing in each country with 1997 as the starting point. We use 1997 because that year was less affected by the introduction of e-finance. We project new margins and revenues in each year in each country until 2010 given the specific projected shares of online banking and brokerage. This projection methodology assumes that incumbent financial institutions have to lower their margins and fees to the online-only costs in line with the projected shares of online banking and brokerage. Thus the projection assumes that the lower cost structures of online banking are being passed on to consumers in the form of lower margins and brokerage fees. This assumption is consistent with a model of strong competition among financial institutions and relative to new entrants. 49 - Annex 2: Recent Reports by International E-finance Working Groups Since early 2000 international agencies have established a variety of working groups to study e-commerce and e-finance (see Table A2-1). This Annex provides a brief synopsis of these groups reports, drawing largely on official documents. Where possible, Website links are provided. Ongoing and * The Basel Committee on Banking Supervision (BCBS) is reviewing recent work on developments in electronic banking in G- 10 countries. In October 2000 the sound financial BCBS Working Group on Electronic Banking released its Phase I Report and White Papers, which identified four areas for future work: developing systems guiding principles for prudent risk management of e-banking activities, consideration of cross-border issues, promoting international cooperation, and encouraging and facilitating supervisory training programs. The group issued a report on risk management principles for e-banking in May 2001. (www.bis.org) * The World Bank is reviewing the policy implications for financial sector development of changes in financial services, markets, and institutions driven by globalization and technological advances. (www.worldbank.org) * The Financial Action Task Force is identifying the vulnerability of Internet banking to money laundering specifically , how online banking, electronic cash, and smart cards can facilitate it. (www.oecd.org/fatf) * The International Organization of Securities Commissions is developing a follow-up report to the 1998 Internet Task Force Report laying out further principles for securities regulation. (www.iosco.org) * The International Association of Insurance Supervisors (IAIS) is reviewing developments in Internet-based insurance activities. There will be a detailed discussion on supervisory issues and subsequent standard setting. Principles on the supervision of insurance activities on the Internet were adopted at the IAIS 2000 annual meeting. (www.iaisweb.org) * The Committee on the Global Financial System is assessing electronic trading in financial markets and studying its implications for financial stability. A recent report on the implications of electronic trading examined how electronic trading systems function in wholesale financial markets. (www.bis.org) * The Committee on Payment and Systems Settlement is to study developments in Internet payment methods. It recently issued a report on clearing and settlement arrangements for retail payments in selected countries. (www.bis.org) * The Organisation for Economic Co-operation and Development is to review the impact of e-finance on public debt management. At a November 2000 meeting the working group discussed the impact of electronic systems on sovereign debt markets, the issuance of government debt securities, and the future of primary dealer systems. Electronic The Basel Committee established the Electronic Banking Group (EBG) in 1999 to Banking Group focus on: initiatives and . Developing guiding principles for the prudent risk management of e-banking services. output . Identifying where and if existing Basel Committee guidance needs to be adapted to facilitate the sound supervision of cross-border e-banking activities. 50 Electronic Finance: A New Approach to Financial Sector Development? Table A2-1 Current e-finance initiatives by international bodies Electronic Secure payment Protection of infrastructure: and Intemational privacy and authentication Consumer Commercial movement body personal data and certification protection law Taxation of goods BIS IEC ILO ISO0 ITC ITU * UN/CEFACT 0 0 UNCTAD * 0 UNESCO * 0 0 0 UNICITRAL * 0 * 0 UPU * 0 0 0 Wodd Bank * * * WCO 0 0 WIPO 0 WTO 0 Trade Small and International facilitation and Intellectual Internet Economic and medium-size body market access property govemarice Standards social impacts enterprlses BIS 0 IEC 0 ILO 0 ISO S ITC ITU 0 0 0 0 0 UN/CEFACT 0 0 UNCTAD 0 0 UNESCO 0 0 0 0 UNICITRAL 0 0 0 0 UPU 0 0 0 0 World Bank 0 0 0 0 WCO 0 0 WIPO 0 WTO 0 Source: OECD Emerging Market Economy Forum on Electronic Commerce, Dubai U.A.E., 16 January 2001. Annexes 51 * Promoting cooperative and international efforts within the banking industry and between the public and private sectors to identify e-banking risks and sound practices to deal with them. * Encouraging and facilitating the exchange of supervisor e-banking training programs and materials being developed by bank supervisors. Since e-banking is based on technology designed to expand the virtual geographic reach of banks and customers without necessarily requiring a similar physical expansion, market expansion can extend beyond national borders, which significantly increases cross-border cooperation challenges for bank supervisors. Adapting Basel Committee guidance to address e-banking issues is therefore a principal goal of the EBG. Specific cross-border risk factors raised by e-banking include: * The potential ease and speed with which a bank located anywhere in the world can conduct activities with customers over interconnected electronic networks in countries where the bank is not licensed or supervised. * The potential ability of a bank or nonbank to use the Internet to cross borders and to seamlessly link banking activities that have typically been subject to supervision with nonbanking activities that might be unsupervised by any financial market authority. * The practical difficulties faced by national authorities wishing to monitor or control local access to e-banking sites originating in other jurisdictions without the cooperation of home country authorities. Recent EBG surveys of supervisors and bankers in G- 10 countries cite trends and issues that could affect bank risk profiles: * A significant increase in competition in the electronic financial services industry as both banking and nonbanking firms rapidly introduce new products and services. * Rapid technological improvements in telecommunications and computer hardware and software enabling greater speed in processing transactions. * Bank management and staff often lack expertise in technology and e-banking risk issues. * Greater reliance on outsourcing to third-party service providers, and a proliferation of new alliances and joint ventures with nonfinancial firms. * Greater demand for global infrastructure for technology that is scaleable, flexible, and interoperable, both within and across enterprises that can ensure the security, integrity, and availability of information and services. * Increased potential for fraud due to the absence of standard business practices for customer verification and authentication on open networks like the Internet. * Legal and regulatory ambiguity and uncertainty with respect to the application and jurisdiction of current laws and regulations relative to evolving e-banking activities. * The collection, storage, and frequent sharing of significant quantities of customer data can lead to customer privacy issues that potentially create prudential risks for banks. * Questions regarding the effectiveness and efficiency of online disclosures. Although bank supervisors agree that the supervisory principles of traditional banking are applicable to e-banking, the amalgam of changes in technology and the degree of dependence exhibited by banks on service providers and technological distributors mutate and magnify the typical levels of risk. 52 Electronic Finance: A New Approach to Financial Sector Development? Following this work, the EBG issued 14 principles for managing risk in e-banking; see Box 9 in the main text. (The full text of the group s reports can be found at www.bis.org/publ/bcbs76.htm and www.bis.org/publ/bcbs82.htm) These principles fall into three categories: effective board and management oversight, security risk issues, and reputation risk issues. Banking institutions and their supervisors should consider these principles when formulating risk management policies and processes for e-banking activities. Implications of The Committee on Global Financial Systems (CGFS) was established in 1999. electronic Previously known as the Euro-Currency Standing Committee, the CGFS s current trading in mandate is to analyze the functioning of international interbank markets, financial f derivatives, and the systemic consequences of standard management practices. financial markets This working group took a preliminary look at the possible implications of electronic trading platforms for the functioning of global markets. It issued a report in January 2001 available at http://www.bis.org/publ/cgfsl6.pdf. The following are excerpts from the report. Electronic trading (ET) systems are systems that provide some or all of the following services: electronic order routing (the delivery of orders from users to the execution of the system), automated trade execution (the transformation of orders into trades) and post-trade information (transaction price and volume data). Electronic systems differ from traditional markets in several respects. ET is both location-neutral and allows continuous multilateral interaction. Consequently, ET systems facilitate cross-border alliances and mergers between trading systems to a greater extent than traditional markets. ET is scalable. ET is integrated. ET potentially allows straight through processing (STP), i.e. the seamless integration of the different parts of the trading process, starting from displaying pre-trade information and ending with risk management. Electronic systems are used for trading in financial markets worldwide. ET has become the dominant method in the inter-dealer foreign exchange market and is moving into preeminent position within the inter-dealer fixed-income market. At this stage, however, ET has not made a significant showing within the OTC derivatives market. The counterparty credit risk involved in these instruments is an important reason for its limited penetration. In general ET is not widely accepted within markets wherein this type of risk is prevalent. Only in systems that have been altered to, for example, incorporate a set of limits is the counterparty credit risk effectively managed. ET is changing market structures. The impact on market structure with regard to transparency and efficiency is vital to comprehension of the ramifications of this modern phenomenon. In the inter-dealer market, trading is moving from bilateral OTC relationships towards a marketplace with a more centralized price discovery and transparency. The foreign exchange market is being transformed, in this manner, at a significantly greater rate than the fixed-income markets wherein there are several competing systems. The role of voice booking and direct dealing between dealers is diminishing. The current market structure is one wherein mrany different trading mechanisms coexist. A full transformation is expected to occur to a fairly centralized and open network allowing all market participants to transact directly with each other. Another factor lies in the contestability of the electronic market. Although ET is associated with low variable costs, entry costs may be high if fixed costs for the creation of the IT infrastructure are taken into account. First mover advantages and Annexes 53 network externalities may make it difficult to attract business away form established systems. Liquidity does not move easily form one platform to another. Although ET makes markets more transparent, it has been noted that full disclosure of trading information does not always lead to better market functioning. Liquidity is not expected to suffer from the introduction of ET nor is the fragmentation of markets expected to profoundly affect the cost of arbitrage. But, ET does introduce new risks. The extent to which ET systems are designed to cope with counterparty credit risk may affect their use in times of stress. ET has the potential to improve the operational efficiency of individual firms, but it also increases the dependency on these systems the design of these systems, their robustness and their contingency plans therefore deserve careful attention from both system providers and the authorities. ET is lowering transaction costs but also raising the issue of breakdown. One example would be the automated execution by systems with pricing engines. These automated systems will need human intervention and whether or not this intervention will be possible, in a timely manner, remains to be seen. Supervision of Electronic commerce presents the insurance industry with new challenges. insurance Whereas the number of cross-border transactions will increase and insurance costs and inefficiencies will decline, the protection of policyholders becomes more activities on the difficult. In September 2000 the International Association of Insurance Supervisors Intemet issued a paper on Internet insurance activities (available at www.iaisweb.org. The paper proposes an environment for supervising insurance activities on the Internet that aims at ensuring relevant information is available to consumers, insurers, and insurance supervisors through a common set of principles. The paper proposes that insurance activities on the Internet be guided by three principles. * Principle 1: consistency of approach. The supervisory approach to insurance activities on the Internet should be consistent with that applied to insurance activities through other media. * Principle 2: transparency and disclosure. Insurance supervisors should require insurers and intermediaries over whom they exercise jurisdiction to ensure that the principles of transparency and disclosure applied to Internet insurance activities are equivalent to those applied to insurance activities though other media. * Principle 3: effective supervision of Internet activities based on cooperation. Supervisors should cooperate with one another, as necessary, in supervising insurance activities on the Internet. Securities In September 1998 the International Organization of Securities Commissions activity on the issued a report on securities activities on the Internet (available at www.iosco.org/ Interet docs-public/1 998-internet_security.html). The report highlights how the Internet presents new challenges for securities regulators and self-regulating organizations (SROs). Electronic communication and interactivity does not coincide within the parameters of statutes, regulations, and directives originally intended for a telephone- and paper-based environment, thus creating possible regulatory burdens or unintended regulatory gaps. The report addresses the regulatory and enforcement issues posed by securities activities conducted over the Internet; the following excerpts are drawn from the report. 54 Electronic Finance: A New Approach to Financial Sector Development? Key recommenda/lons Application of domestic regulatory requirements to securities activities on the Internet Offers and advertisements 1. Regulators and SROs should provide guidance to alert market participants and markets as to how their existing registration, licensing and other regulatory requirements apply to offers and advertisements conducted on the Internet and alert them to the possibility that other jurisdictions likewise may impose other requirements. 2. Regulators should amend, or seek to have the relevant authorities or legislative bodies amend, specific requirements when appropriate to accommodate and ensure appropriate regulatory coverage of the Internet environment. 3. General antifraud provisions should apply to all offers and advertisements involving securities or financial services, regardless of the medium and regardless of whether a regulator or SRO is involved in approving the offer or advertisement. 4. Regulators and, where appropriate, SROs should strengthen surveillance of Internet advertising and offerings for unauthorized or fraudulent activities. Delivery of disclosure documents and other information 5. Regulators should ensure that issuers who use the Internet to communicate with and send offering material to shareholders and potential investors provide the same disclosure about their operations, financial condition and securities that would be provided in a paper-based medium, so that investors can evaluate the risk and value of investing in the issuer. 6. Regulators should provide guidance for the financial service industry on the use of the Internet to satisfy their obligation to deliver disclosure documents. Regulators should permit the financial service industry to deliver disclosure documents electronically when an investor has given an informed consent to this form of delivery. Communications and customer orders 8. Regulators should require that financial service providers continue to satisfv suitability and general conduct requirements when transacting business over the Internet. 9. Regulators should require that financial service providers ensure that their computer networks have sufficient operational integrity (security, reliability, capacity, backup systems and alternative means of communication) and that they have adequate personnel to handle Internet communications, including trading instructions. 10. Regulators should consider requiring financial service providers to develop written procedures for the review of incoming and outgoing electronic correspondence between employees and the public relating to the financial service provider s securities business. 11. Regulators should clarify if, and under what circumstances, the use of authentication technologies will be allowed and when manual signatures will be required. Annexes 55 Recordkeeping 12. Recordkeeping requirements applicable to financial service providers should apply to Internet transactions. 13. Record keeping policies and requirements should address e-mail communications that relate to the securities business of a financial service provider. Exercise of regulatory authority over cross-border securities activities on the Internet 15. If an issuer s or financial service provider s offer or sales activities over the Internet occur within a regulator s jurisdiction, or if the issuer s or financial service provider s offshore activities, in fact, have a significant effect upon residents or markets in the regulator s jurisdiction, a regulator may impose its regulatory requirements (e.g., licensing and registration requirements) on such activities. 16. Regulators should examine the following factors in determining whether to assert regulatory authority over an offer of securities or financial services on the Internet. Factors that may support the assertion of regulatory authority include: Y It is evident that information is targeted to residents of the regulator s jurisdiction. Y The issuer or financial service provider accepts purchases from or provides services to residents of the regulator s jurisdiction (unless made pursuant to an exemption or under circumstances that may exclude a public offering). Y The issuer or financial service provider uses e-mail or other media to push the information to residents of the regulator s jurisdiction. Use of the Internet to foster investor education and transparency 17. Regulators and SROs should include use of the Internet in educating investors and providing guidance to the securities industry. 18. Regulators and SROs should educate investors about securities fraud on the Internet by providing information about possible fraudulent activities. For example, regulators and SROs could use their Websites to post warnings regarding false or misleading offerings or advertisements. 19. Regulators, SROs, and organized markets should consider using their Websites to provide current and potential investors with access to information about their institutions, including current laws, regulations, by-laws and governance procedures. 20. Regulators, SROs, and organized markets should facilitate investor access to corporate and market information by developing electronic databases for reports and legally required disclosure documents, and making the information publicly available on their Websites. 21. Regulators and SROs should strengthen surveillance of Internet activities by routinely monitoring for unauthorized or fraudulent activities. 22. Regulators and SROs should have staff sufficiently trained in current techniques for conducting surveillance on the Internet. 23. Regulators should assist one another by exchanging details about techniques for monitoring Internet advertising, offers of securities or financial services that may contain false or misleading information, and by sharing expertise 56 Electronic Finance: A New Approach to Financial Sector Development? with regulators who have limited experience in this area. International In 1999 the International Telecommunication Union (ITU) Council endorsed new Telecommunication initiatives for the Union to promote the growth of electronic commerce. The new Union initiatives program includes strategic planning workshops, telecommunications case studies, Internet policy, and Web publishing. Presently, the ITU serves as a forum to address policy issues related to electronic commerce in developing countries. In the program s first phase, during 1999-2000, three workshops were held. At its 2000 session the ITU Council endorsed the continuation of the program and approved guidelines for the strategic planning workshops. Broadband and 3G mobile will be the subjects of the next two workshops, to be held in 2001. In 2001 the World Telecommunication Policy Forum on IP telephony will examine challenges for developing countries, including skill shortages related to IP technology, and will likely issue an opinion on human resource development issues. Further information is available at: http://www.itu.int/itudoc/gs/subscirc/ itu-d/(245-01).html United Nations In December 2000 the Working Group on Electronic Commerce of the United Commission on Nations Commission on International Trade Law (UJNCITRAL) issued a study on lntemational transferable bills of lading in an electronic environment (available at .nternationa, www.uncitral.org/en-index.htm). The study found that: Trade Law . Developing electronic equivalents of traditional, mainly paper-based, methods for transferring or creating rights in tangible goods or intangible property may face serious obstacles where the law requires physical delivery of goods or paper documents for the purpose of transferring property or perfecting security interests in such goods or in the rights represented by the document. The problem presented by electronic commerce is how to provide a guarantee of uniqueness equivalent to possession of a document of title cr negotiable instrument. * Modern technology makes it possible to electronically transmit information down a chain of parties. The same process could conceivably be used by any of the parties to renounces its title in favor of another person, thus amounting to an endorsement of the instrument. It is true that no electronic message can be the very same as another. But so long as it is technically possible for a message to be replicated exactly and sent to someone else with no possibility of detection, there could be no guarantee of singularity. * Electronic equivalents of paper-based negotiability should rely on central registry systems in which a central entity manages the transfer of titles between parties. Harmonized rules are needed to support the development of such systems, which can be grouped into three categories: 1. Government registries. An agency of the state records transfers as public records and may authenticate or certify such transfers, as in the case of electronic registration of real estate in Canada. 2. Central registries. These can be established where a commercial group conducts its transactions over a private network (such as SWIFT) that is accessible only to its members. Annexes 57 3. Private registries. These registries are conducted over open or semi- open networks, where the issuer of the document, its agent, or a trusted third party administers the transfer or negotiation process. Related efforts include: * Conflict of law issues. In January 2001 the Secretary General of the Hague Conference convened a conference that examined the possibility of preparing and adopting, through a fast-track procedure, a new instrument dealing with the law applicable to the proprietary aspects of collateral transactions effected through indirect holding systems. * Substantive law issues. The UNCITRAL Secretariat is preparing a study on legal problems in secured credit law, including security interests in investment securities. Issues more specifically related to electronic communication such as conditions for cross-border recognition of records, standards of trustworthiness, or registry keepers and certification service providers and liability are inseparable from policy concerns on matters such as capital market regulation, interbank settlements, and monetary policy. The working group, in cooperation with the Comite Maritime International (CMI), is conducting a broad investigation of legal issues arising from the gaps left by international laws and international conventions on the international carriage of goods by sea. 59 Annex 3: Types of Online Trading Systems E-trading in Online trading in fixed-income securities started in 1998 with TradeWeb, the first fixed-income online bond market. Since then a highly fragmented industry has developed in securities which different online trading systems (platforms) compete with each other and with traditional trading systems. Intense competition has resulted in a transition toward systems that are able to attract greater liquidity to their platforms. Market participants expect this transition to be toward more centralized, open architecture that provides multiproduct coverage and wider access to investors. Online trading systems can be divided into categories according to the trading model used, the ownership structure of the systems, the sources of prices for securities, the customer base, and coverage and products. This annex summarizes these five categories and gives some examples. Trading model * Auction trading platforms. This model allows online auctions of primary issues of fixed-income securities. The issuing party posts the details of the security offering on an auction trading platform and collects bids from investors. The offering is then automatically awarded to the best price or lowest yield bidders. Certain platforms (such as the Bloomberg secondary market auction system) also enable auctions for secondary market offerings by institutional investors. While electronic auction trading enables disintermediation in primary markets, most issuers still rely on the other services by intermediaries, such as underwriting (ensuring the sale of a security) and market making in secondary markets. Examples of auction trading systems include TreasuryDirect (for trading Treasury bills and bonds), ValuBond (for primary and secondary offerings of fixed-income securities), and MuniAuction (for online auctions of municipal securities). * Inquiry-based systems. This trading model enables investors to get executable prices from multiple dealers for their inquiries to buy or sell a certain amount of securities. These systems are also able to collect information on the types and amounts of trades by large institutional investors information that is not lar gely accessible to retail investors, but instead is available only to dealers. The largest inquiry-based online trading system is TradeWeb, a multidealer consortium formed by 14 of the biggest dealers in the market. * Cross-matching (open architecture, exchange-based) systems. This trading system automatically matches the bid and ask prices submitted by institutional investors and dealers. By allowing traders to get prices from many dealers and trade in large amounts anonymously, eliminating the need for intermediaries, cross-matching systems capture all the advantages of increased liquidity and more efficient execution. Such systems allow participants to see a great portion or all of the order book (by type of order). This trading model is used by online trading platforms such as Apogean Technology, Currenex, and BondBook. Owners/uP structure * Investment banks. The emergence of online trading has been a significant threat for investment banks, lowering the barriers to entry in the industry. This development has challenged the hold that investment banks have in this market. In response, investment banks have moved toward creating proprietary online trading platforms. Examples include Web.ET (www.gs.com/) by Goldman Sachs, PrimeTrade (www.csfb.com/primetrade/ 60 Electronic Finance: A New Approach to Financial Sector Development? index.shtml) by Credit Suisse First Boston, AutoBahn (www.autobahn.db.com) by Deutsche Bank, and Lehman Live (www.lehmanlive.com/) by Lehman Brothers. * Consortiums. In order to bring competitive prices and increased liquidity, and share in the burdensome technology costs of building and maintaining these platforms, some investment banks came together to form online trading platforms, while maintaining their own proprietary systems. This move also made it possible to compete with independent platforms, which are not able to enjoy the support of dealers to provide liquidity. Examples of such systems include TradeWeb (www.tradeweb.com) by Credit Suisse First Boston, Goldman Sachs, Lehman Brothers, Merrill Lynch, Morgan Stanley Dean Witter, Salomon Smith Barney, Deutsche Bank, Barclays Capital, JP Morgan Chase, Greenwich Capital, ABN AMRO, Bear Steams, and UBS Warburg; BondClick (www.bondclick.com) by ABN AMRO, Barclays Capital, BNP Paribas, Caboto, Deutsche Bank, Dresdner Bank, and JP Morgan Chase; and Asiabondportal (wvw.asiabondportal.com) by ABN AMRO, Daiwa SBCM, Deutsche Bank, Income Partners, JP Morgan Chase, and UBS Warburg. Beyond joint liquidity support, large dealers have also joined together to roll out joint content sites such as BondHub (www.bondhub.com), which gives users access to all joint fixed-income and other research produced by a group of the largest U.S. dealers. * Independent systems. Online trading systems independent of dealers have had little success. Without the support of a dealer, these systems usually fail to meet investors liquidity and content needs. However, some systems that specialize in specific securities and markets have been able to survive. Better-known examples are Currenex, Blackbird, and Apogean Technology. Sources ofprices for securities * Single-dealer systems. These systems allow investors to execute transactions with a single dealer. These are less preferable to investors due to limited price competition and usually serve the existing customer base. But most single-dealer systems are able to offer trading in multiple products, so some institutional investors trading in more than one type of product still prefer these sites. Examples include Autobahn and WebET. * Multidealer systems. These systems allow traders to get prices from and trade with multiple dealers, increasing liquidity and price competition. Examples include MarketAxess and TradeWeb. Customer base * Dealer-to-dealer (interdealer) systems. Only dealers can access these systems. The multilateral interaction in an interdealer system allows dealers to get competitive prices for their positions and trade anonymously. Trading in foreign exchange and derivatives markets tends to take place on interdealer electronic platforms. Examples are Reuters Dealing 2000-2, EuroMTS, and eSpeed. * Dealer-to-customer systems. These systems allow online trading between dealers and institutional investors. Examples are TradeWeb, MarketAxess, and BondClick. Some interdealer systems, such as eSpeed, are getting ready to open their services to institutional investors. Annexes 61 Coverage andoproducts Online trading systems vary in terms of the products they cover and the markets in which they operate. Some multidealer trading systems specialize in one kind of security in one market (such as the United States), while some trading systems allow electronic trading of multiple securities in many markets. * eSpeed allows electronic trading of multiple types of securities (munis, treasury securities, repos) in G-10 countries and emerging markets. Asiabondportal is a consortium-owned trading platform that allows institutional investors to trade in Asian bonds. MuniAuction is a dealer-to- customer auction trading platform for municipal securities and money market instruments. * Trading in interdealer foreign exchange markets is dominated by electronic trading systems. Reuters Dealing 2000-1 and 2000-2, EBS, Currenex, and FX Connect are systems specializing in foreign exchange and foreign exchange derivatives trading. * In June 2000 Apogean Technology and IBM launched a business-to-business e-marketplace for trading emerging markets debt, including Brady bonds. POEMS (Phillips Online Electronic Mart System) and patagon.com are systems for e-trading stocks and fixed-income securities in Asia and Latin America. Table A3- 1 provides an overview of some fixed-income trading systems. E-trading in Online trading in global equity markets was led by the introduction of continental equity markets European electronic exchanges and electronic communication networks that used efficient technologies to lower transaction costs and geographic limitations in stock trading. This has created many opportunities for global financial markets as well as challenges in regulating and managing these opportunities. The trading models in equity markets can be divided into two categories. Order-driven systems combine all bid and ask orders into one central order book and automatically match the orders without any intermediaries. The major automated stock exchanges use these systems to automatically match the orders of dealers. Quote-driven systems bring together dealers that provide two-way prices for securities. The bid-ask spread generates the profit for these systems. Electronic communication networks Using a computerized network, investors can place their bid price for a share of stock or set their own selling price in an of f-exchange market. These systems are known as electronic communication networks (ECNs). The biggest users of ECNs are institutional investors, such as mutual fund and pension fund managers, who are not members of stock exchanges. ECNs connect buyers and sellers on en electronic network without relying on brokers, so trading is cheaper and quicker. Examples of ECNs are Instinet (owned by Reuters), Archipelago, Island, and Europe s Tradepoint. 62 Electronic Finance: A New Approach to Financial Sector Development? Table A3-1 Fixed-income trading systems Auction systems Price Customer- System Ownership Owner source base Product Coverage MuniAuction Investment Grant Street Securities Single- Dealer-to- Municipal securities, money U.S. bank dealer customer market instruments EBondUSA.com Independent Prvately-held Multi- Dealer-to- Agency, asset-backed U.S. dealer customer corporate, mortgage-backed, and Treasury securities Bloomberg Independent Bloomberg Multi- Dealer-to- Federal agency, corporate, U.S. Secondary Market dealer customer mortgage-backed, and asset- Auction System backed securities Valubond Independent FTVentures, Alliance. Multi- Dealer-to- Agency, corporate, U.S. Technology Ventures, dealer customer municipal, and J.P. Morgan Chase, Treasury securities Zions Bancorporation and Wasatch Ventures Inquiry-based systems Price Customer- System Ownership Owner source base Product Coverage TradeWeb Consortium CSFB, Goldman Sachs, Multi- Dealer-to- U.S. Treasury, agency, U.S. Lehman Brothers, Merril dealer customer Euro Sovereigns, and TBA-MBS Lynch, MSDW, SSB, securities Deutsche Bank, Barclays, JP Morgan Chase, Greenwich Capital, ABN AMRO, Bear Stearns, UBS Warburg MarketAxess Consortium ABN AMRO, JP Morgan Multi- Dealer-to- Agency, corporate, U.S. Chase, Deutsche Bank, dealer customer European, municipal, Chase Manhattan, UBS and Treasury Warburg, Bear Steams, securities Lehman Brothers Holdings, Credit Suisse First Boston BondClick Consortium ABN AMRO, Barclays, BNP Multi- Dealer-to- Euro government bonds Europe Paribas, Caboto, Deutsche dealer customer Bank, Dresdner Bank, JP Morgan Chase PrimeTrade Investment bank Credit Suisse First Boston Single- Dealer-to- Derivatives, foreign exchange, U.S., Asizi dealer customer government and credit bonds Bloomberg Independent Bloomberg Multi- Dealer-to- Treasury securities U.S. dealer customer Annexes 63 Table A3-1 Fixed-income trading systems (continued) Cross-matching systems Price Customer- System Ownership Owners source base Product Coverage BondBook Consortium Goldman Sachs, Merrill Multi- Dealer-to- Investment grade and high-yield U.S. Lynch, MSDW dealer dealer corporate and municipal bonds BondDesk Consortium ABN AMRO, Bank of Multi- Dealer-to- Agency, corporate, municipal, U.S. America, BondExchange dealer customer and Treasury securities LLC, Bear Stearns First Union BondsinAsia Consortium BRIDGE eMarkets, Multi- Dealer-to- Domestic government and Asia Citigroup, Deutsche Bank, dealer dealer corporate bonds (regional HSBC franchises) Broker Tec Consortium ABN AMRO, Banco Multi- Dealer-to- Agency and Treasury securities U.S., Europe Santander, Barclays dealer dealer Capital, CSFB, Deutsche Bank, Dresdner Bank, Goldman Sachs, Lehman Brothers, Merrill Lynch, MSDW, SSB, UBS Warburg EuroMTS Consortium More than 20 dealers Multi- Dealer-to- Govemment bonds, eurobonds Europe dealer dealer eSpeed Investment Cantor Fitzgerald Multi- Dealer-to- Government bonds, Eurobonds, U.S., G-7, bank Securities dealer dealer corporate bonds, U.K. gilts, Europe, emerging market securities, emerging repos, and municipal securities markets Autobahn Investment Deutsche Bank Single- Dealer-to- U.S. Treasury and agency U.S., Europe dealer customer securities, European government and semi-government bonds Apogean Independent Apogean Capital Multi- Dealer-to- Emerging market debt securities Emerging Technologies dealer dealer markets Currenex Independent Venture capitalists Multi- Dealer-to- Foreign exchange U.S., Europe dealer dealer Instinet Independent Amerindo, Barclays Capital, Multi- Dealer-to- Treasury securties, euro U.S., Europe TH Lee.Putnam Internet dealer dealer sovereigns Partners, Dutch/Shell, WR Hambrecht & Co Note: Online trading systems that use cross-matching vary in the level of access they provide. At one extreme are open architecture systems that allow access to all kinds of traders, where an infinite number of clients can trade anonymously. At the other extreme are interdealer systems that give access only to dealers to trade on their site so, although the participants trade with each other anonymously , the number of traders is limited to the number of allowed users. Source: Claessens, Glaessner, Klingebiel, 2001. 64 Electronic Finance: A New Approach to Financial Sector Development? Online stock brokerages Online discount brokerages offer order routing services to their subscribers for a flat fee for each transaction. Due to the high competition in the industry, these fees can be as low as $6 a transaction. In Korea, where commissions on online trades are at an all-time low due to high trading volume and low fees, some online brokerages are incurring losses or even closing their doors. These online stock brokerages provide their customers with low-cost or free research and analysis on stocks. Most online brokerages give their customers the ability to make bids for initial public offerings (IPOs) and provide banking facilities, treating the accounts like regular bank checking accounts. Most online stock trading in emerging markets occurs through Internet brokerages that redirect orders to the major exchanges. In some of these countries alternative trading systems (ATSs), which are ECNs that function as exchanges, are allowed on a limited basis in order to avoid dilution of liquidity from exchanges in relatively small markets. Some big players in the U.S. market are listed in Table A3-2. Table A3-2 Major U.S. online stock brokerages Features Commission Online Checking Option Phone Bonds Mutual Brokerage (market/limit order) banking accounts trading helpline via phone funds Charles Schwab & Co. $29.95 * * Fidelity $25.00 * * o Merrill Lynch & Competitiveness $29.95 * * * * o TD Waterhouse Inc. $12.00 * * * * E*Trade $14.75/$19.95 * * * * Ameritrade $8.00/$13.00 * * DLJ Direct $20.00 * * Datek Online $9.99 National Discount Brokers $14.75/$19.75 * * Source: Basics of Stock Trading Online, http://onlinebrokerage.about.com/money/onlinebrokerage/cs/webtradingbasics/ Most of these brokerages are expanding their services globally and forming joint ventures with local brokerages in emerging markets. An example is SE Global Equities Company Limited (SEG), a subsidiary of Capital Alliance Group that has expanded its network of global trading alliances with more than 100 brokerages covering 50 stock exchanges around the world. Direct access trading Direct access trading is online trading where, when an investor makes an order online, the brokerage firm routes the order directly to a market maker and gets a commission from the market maker called a payment for order flow. Direct access usually routes the trade to an electronic clearing network or a small order execution system. Investors have to download special software to trade in this environment. This is a more complicated trading environment than the other online brokerages, so investors tend to be more sophisticated institutional investors or day traders. Examples of direct access brokerages include the following. Annexes 65 Brokerage Cost per 500 trades a month CyberTrader $9.95 SourceTrade $16.00 EdgeTrade $8.95 Firefly Platinum Pro $9.95 Trade WallStreet $9.95 Source: Claessens, Glaessner, Klingebiel, 2001. Emerging markets Examples of online stock trading initiatives in emerging markets include the following. Eastern Europe * Electronic System for Trading Securities on the Stock Exchange and OTC Market (Albania, Bosnia and Herzegovina, Bulgaria, Croatia, Macedonia, Romania). Economic Construction and Development in Southeast Europe a joint World Bank-European Commission Website that aims to coordinate assistance to countries in the region has posted a proposal to establish an electronic system for trading securities on the stock exchange and over the counter market. The project aims to establish an integrated, efficient, and transparent capital market, raise investment activity in these countries, legitimize and popularize trade companies, and attract foreign investments to the region. (www.seerecon.org/Newldeas/BIA/4.htm) * Sati Online Brokerage, the first broker in the Czech Republic, has developed a system of Internet-based stock handling that is used by clients from the Czech Republic and abroad. * Hungary has only a few brokerage firms using the Internet for online trading on the Budapest Stock Exchange. These firms include Quaestor Financial Group, Equitas, and Internet Broker Kft. Asia * Karachi Stock.com (Pakistan) offers its members and visitors online and offline stock trading on the Karachi Stock Exchange and processes orders to buy or sell stocks on the exchange. * DFNN.com is a Philippine-based application services provider, financial e- commerce solutions provider, financial portal, and online stock trading firm. The portal provides free access to updated stock quotes, research reports, technical analysis, news headlines, market commentary, and product information on various financial products and services, all of which helps users decide what financial transaction to make (online trading, online banking, and so on). * Phillips Online Electronic Mart System, a Singapore-based nonbank online broker, offers online trading on three regional exchanges Hong Kong (China), Kuala Lumpur (Malaysia), and Singapore. * Asian Capital Equities, a Philippines-based online stock broker, is a joint venture between the Hong Kong (China)-based Bank of East Asia, the Philippine investment banking pioneer East Asia Capital Corporation, the Malaysian conglomerate affiliate MUI Philippines, and individual Filipino 66 Electronic Finance: A New Approach to Financial Sector Development? investors. Incorporated in 1989, the company was the first Philippine brokerage house to go online and now averages I billion Philippine pesos in annual transactions. * Korea Samsung Securities Cyber Stock offers trading, quotes, charts, and real-time trading for Korean securities. * ARKaccess Asia Limited a multibroker trading platform that will allow efficient and virtually direct access to local members of multiple Asian- Pacific securities exchanges from anywhere in the world. The routing system, ARKlink, will be introduced in the second half of 2001 in five Asian markets Australia, Hong Kong (China), Japan, Singapore, and Thailand as well as the United Kingdom and the United States. ARKmatch, the matching system, will be introduced later. Latin America * Patagon.com is a Latin American online brokerage for stock trading and personal financial management. * Rava Sociedad de Bolsa is Argentina s online stock trading firm. * Hedging Griffo is Brazil s online stock trading firm. 67 Annex 4: Selected Smart Card Projects in Emerging Markets and Developing Countries Africa Card Institution Project description Common Market for Mondex e-cash: Eastem and Southem The Eastem and Southem African Trade and Development Bank Eastem and Southem multifunctional purse African Trade and (PTA Bank) purchased the franchise rights for Mondex, The Africa (COMESA) divided into five Development Bank deal, which is on behalf of the Committee of COMESA Central pockets allowing up to (PTA Bank) Bank Govemors, may be the largest government endorsement five currencies of smart card technology and follows on the five existing Mondex to be held at a time. franchises in Africa (Ghana, Lesotho, Namibia, South Africa, and Can also be used across Swaziland). Mondex e-cash application allows for offline open networks such as transactions and has multicurrency and cross-border capability. telephony or the Intemet Because it allows for the transfer of value between cards without the need to centrally record every transaction, the application can function without developing a costly and comprehensive traditional infrastructure to support it. Mondex also offers the ability to download value directly from chip to chip using a phone, bringing flexibility to retailers and consumers at relatively low cost. Mondex's unique security architecture allows for person to person transfer of e-cash and enables cardholders to carry up to five currencies at once. This interoperability means that Mondex's technology is flexible enough to be used as an altemative to cash across a number of COMESA tenritories. http:/Awww.mondex.ca/eng/media/pr23.htm Ghana Visa Horizon: Visa Intemational, Visa Intemational and Standard Chartered Bank Ghana chip-based, pre- Standard Chartered launched the first domestic Visa card in a West authorized offline Bank Ghana African country and the first public use of Visa Horizon, a chip- payment card based, preauthorized offline payment card. The program marks the first large-scale rollout of Visa Horizon, with up to 100,000 offline domestic debit cards being issued and over 300 merchant signups over the next five years. It is also the largest planned implementation of chip payment technology in West Africa and an example of how chip cards can be used to overcome telecommunications weaknesses in new markets. www.visa.com/av/news/press-release.ghtml?pr_form_edit-330&edit_file= Ghana Mondex e-cash: Mondex Ghana Ltd. Hitachi Europe won a contract to supply a smart card-based, multifunctional purse electronic banking solution to Mondex Ghana Ltd., divided into five a joint venture company established by Ghana's pockets allowing up to two leading financial institutions-Ghana five currencies Commercial Bank and Agricultural Development to be held at a time. Bank-to exploit the Mondex e-cash franchise. Can also be used across Mondex Ghana intends to deploy the innovative open networks such as Mondex e-cash system in phases to bring modern telephony or the Intemet banking to over 18 million Ghanaians (90 percent of whom do not have bank services). The project, worth in excessof $2 million, is the first example of an e-cash banking project in West Africa. http://www.hitachi-eu.com/smartcommerce/news/ghana.html Nigeria E-purse card Securecard Trust Securecard Trust Co. Ltd., which licenses the Proton technology Group in Nigeria, plans to have 100,000 mainly electronic purse cards in the market by the end of 2000 and 500,000 cards by the end of 2003. The Nigerian banks that make up the Securecard Trust Group plan to convert an existing 15,000-card e-purse project, Diamond Bank Paycard, to Proton. In addition, the banks will use Proton for salary payment and club membership cards they plan to issue. www.cardtech.faulknergray.com/archOO.htm 68 Electronic Finance: A New Approach to Financial Sector Development? Africa Card Institution Project description South Africa Visa Cash: Visa International, South Africa's PEP Bank will be the first issuer of Visa card loaded or with South Africa's Cash stored-value chip cards using Proton technology. In a one- predefined value PEP Bank year pilot launched in November 2000, the bank will issue designed for secure 10,000 chip cards to its customers and another 15,000 cards to payments over the individuals without bank accounts. Users will be able to load Intemet and mobile phones, money onto the cards at terminals in railways stations, banks, and for low-value shops, and other public areas in the Cape Town area. The cards purchases will have a $74 limit. Two stations of the commuter rail operator Metrorail will accept Proton for payment, and Visa International and Proton Worid executives say the pilot is their first step into the mass transit sector in a country where most adults lack bank accounts but often ride buses and trains. www.cardtech.faulknergray.com/archOO.htm South Africa Mondex e-cash: Mondex Intemational U.K-based smart card firm Mondex International multifunctional purse has designed an electronic cash and banking system to be divided into five adopted and incorporated through the South African Post Office's pockets allowing up to 2,000 Post Bank counters. This smart card project five currencies will enable people to set up pseudo bank accounts, to be held at a time. with biometrics technology using fingerprints Can also be used across to provide reliable identification. The e-bank accounts open networks such as can be used in a variety of ways. When a cardholder has paicl in telephony or the Internet benefits or wages, he or she can transfer direct payments to organizations such as the church (in most regions community members pay a regular subscription to the church). Altematively, they can set up savings pools in which they store money they are saving to pay for something specific, such as education. Although all the money is held on the same smart card, the different pools enable people to take a more planned approach to their finances, and the direct payment facility provides guaranteed transfer of funds without inappropriate and costly intervention. http://www.jrc.es/cfapp/leodb/kw.cfm?kword=241 Annexes 69 Asia Card Institution Project description China Chip-based cards: Major banks in China Several major banks in China have launched pilots of chip-based multifunctional debit and debit cards in Beijing and Changsha using standardized card credit smart cards and point-of-sale terminal software adopted by China's central bank, the People's Bank of China. The pilots could lead to the large-scale rollout of interoperable debit and credit smart cards nationwide as one of China's Golden Card projects. The pilots will last about two years. Many of the same banks, among them the state-run Bank of China, Industrial and Commercial Bank of China, and Construction Bank of China, launched a similar test of several thousand standardized cards in Shanghai in December 2000. www.cardtech.faulknergray.com/archOO.htm Hong Kong, China i.Life card: Hongkong and Hong Kong's major full-service communications provider, Cable multifunctional credit, Shanghai Banking & Wireless HKT, and the Hongkong and Shanghai Banking debit, and other Corporation Limited Corporation Limited (HSBC) jointly launched i.Life Card, a high- capacity smart card that will bring enhanced security and convenience to online shopping and electronic transactions. The multifunctional card is the first of its kind in the market and was developed to meet the growing need for sophisticated e-commerce applications. Credit and debit card functions, international calling, Mondex e-cash, and chip-based e-commerce applications have been combined on a single card. i.Life Card is also the first in Hong Kong to provide a carrier for electronic certificates such as Hongkong Post's e-Cert. The electronic certificate carrier facilitates e-commerce and online transactions that require identity authentication. It als demonstrates the card's vast ability to support innovative e-applications. http://www. multos.com/multos_cd2/Marketing/PressReleases/00-06-22.HSBC.iLife%20Card.Launch.PDF India E-purse and EMV- ALW In July 2000 Proton World and Alittleworld.com Private compliant debit: Limited (ALW) signed agreements granting ALW Proton e-purse targeted at operating licenses for India and the Philippines. ALW is an Indian micropayments and technology company with a mission to 'redefine the future of the debit application money' in developing countries. ALW will provide technology at higher-value day-to- integration, operational support, and a mass deployment day transactions implementation mcJel for issuers such as banks, post offices, and telecom companies. It will initially offer smart cards in both countries with either or both of two Proton applications, the electronic purse and Europay, MasterCard, Visa (EMV) compliant debit. The e-purse will be targeted at micropayments and the debit application at higher-value day-to-day transactions, with both offering full auditability and the world-renowned Proton end-to-end security. ALW's Proton-based dual-purpose smart cards will provide users with a secure and practical alternative to cash without the limitations on eligibility or restrictions on use associated with credit cards in developing countries. www.protonwortd.com/press/releases/press63index.htm 70 Electronic Finance: A New Approach to Financial Sector Development? Asia Card Institution Project description Indonesia Paspor BCAIMaestro/ MasterCard, BCA MasterCard International and BCA-the biggest private bank Cirrus card: in Indonesia, with 800 online branches and 8 million PIN-based, online, real- customers-introduced the Paspor BCA/Maestro/ time debit program Cirrus card, allowing millions of Paspor BCA cardholders to access Maestro and Cirrus facilities. Maestro, MasterCard's global debit brand, is the region's only personal identification number or PIN-based, online, real-time debit program. The MasterCard Cirrus/Maestro network allows cardholders to withdraw local currency from their accounts at over 560,000 Cirrus ATMs in 102 countries. www.mastercard.com/abouVpress/pressreleases.cgi?id=344 Korea, Rep. of Mondex e-cash and MasterCard Korea, One of Korea's largest credit card companies, Kookmin Credit MasterCard MlChip: Kookmin Credit Card Card, and MasterCard Korea are to jointly introduce one of the multifunctional-credit, first multifunctional smart cards, with both chip and e-cash debit, and other functionality. The card, called the Kookmin Trade Pass Card, will integrate multiple applications such as credit card, debit, electronic wallet, identification card, and automated passenger clearance. Operating on the Multos smart card plafform, the cards will have credit and debit functionality through MasterCard's credit and debit application, M/Chip. Cash purchases will be enabled by Mondex's e-cash application. Cardholders will be able to choose either program for specific financial transactions. www.epaynews.com/archives/index.cgi?ref=browse&f=view&id=9822511 3121212015050 Korea, Rep. of Multiapplication card: Pusan Bank of In July 2000 Pusan Bank of South Korea announced that it will with an electronic purse South Korea issue 1 million multiapplication smart cards, letting Pusan and credit application cardholders pay fares on trains and buses, make purchases at stores and vending machines, and even pay taxes over the Internet. According to KEB Technology Co., the Korean systems integrator on the project, the cards will include an electronic purse and credit application from the bank, which cardholders will be able to use at 10,000 point-of-sale terminals in 2000 and another 10,000 in 2001. Cardholders will also be able to recharge the transit and bank e-purses over the Internet at computer kiosks or on their home computers, as well as at 1,100 reloading machines and ATMs. www.cardtech.faulknergray.com/arch00.htm Korea, Rep. of Visa Cash: Visa International, In June 2000 Visa International announced that it would lead a card loaded or with various Korean group in Korea that includes 13 financial institutions and predefined value institutions mobile phone operator SK Telecom to issuel 0 million e-purse designed for secure cards over the next five years for making purchases over the payments over the Intemet and at physical retail shops. The system will use the Internet and mobile Network for Electronic Transfers (NETS), a Singaporean phones, and for low- company that processes more than 100 million card value purchases transactions a year. www.cardtech.faulknergray.com/archOO.htm Annexes 71 Asia Card Institution Project description Philippines Visa Cash: Visa International, Visa International has announced that several banks in the card loaded or with major banks in the Philippines intend to roll out 10 million Visa Cash electronic predefined value Philippines purse cards by 2005. The banks, among them designed for secure Equitable Bank, Metro Bank, Union Bank, Banco De Oro, and payments over the First E-Bank, signed a memo of understanding with several Intemet and mobile phones, other partners, including the Philippines Long Distance and for low-value purchases Telephone Co., the country's largest telecommunications company; 7-Eleven stores and other retailers; and two major theme parks. The partners will accept the reloadable cards, which will also be used on the Internet. The phone company now issues more than 14 million of its own chip-based prepaid phone cards each year. www.cardtech.faulknergray.com/archOO.htm Philippines Mondex e-cash: Mondex Philippines Inc. In October 2000 Mondex Philippines projected a cardholder multifunctional purse base of at least 800,000, with 500 Mondex loading stations and divided into five at least 15,000 commercial establishments in different pockets allowing up to industries. Mondex e-cash gives issuers greater flexibility five currencies and control over the range of services they can provide, to be held at a time. and can be used across open networks such as Can also be used across telephony or the Internet. It is ideal for high-volume, low-value open networks such as payments. Under an agreement with MasterCard International telephony or the Intemet and Mondex Asia, Mondex Philippines has the license to operate Mondex technology for the local market. The company also has the right to promote and license the technology to financial institutions, merchant establishments, and other service providers in its nationwide deployment of Mondex chip- based cards. http://www.mondexphil.com/press/press_CARDrollout.html Singapore Cash withdrawal Network for Electronic In March 2001 the Network for Electronic Transfers (NETS) Transfers (Singapore), launched a service that enables Singaporeans to withdraw local banks funds from their bank accounts at retail outlets using ATM cards. This is part of a move to improve accessibility to cash withdrawal facilities. The CashBack service is available to ATM cardholders of DBS Bank, Keppel TatLee Bank, OCBC Bank, Overseas Union Bank, and United Overseas Bank. The service operates as part of NETS's Electronic Funds Transfer at Point of Sale (EFTPOS) service, a direct payment facility that allows retailers to debit a customer's bank account at the time of purchase. Consumers are able to withdraw funds with or without making a purchase, depending on the retailer. The amount that can be withdrawn will depend on the availability of cash held in the store. Like all EFTPOS payments, NETS does not impose a charge on the consumer. www.nets.com .sginewslarticle.php?artlD=11 72 Electronic Finance: A New Approach to Financial Sector Development? Asia Card Institution Project description Singapore CashCard TopUp Network for Electronic In August 2000 the Network for Electronic Transfers (NETS) over the Internet: Transfers (Singapore), introduced a feature that will enable users o top up their uses E-Wallet, local banks telectronic purses over the Internet. CashCard TopUp over a software the Internet will provide users with more access points and application that enables greater ease. On launching the application, users will be guided the CashCard to be through a series of instructions that include entering the top-up credited and debited amount and a HomeNETS Personal Identification Number over the Internet (PIN). The HomeNETS PIN is used solely for CashCard top- ups on HomeNETS terminals, mobile phones, and the Interret. With the CashCard inserted in the smart card reader, E-Wallet will credit the CashCard with the amount to be topped up upon receiving approval from the user's bank. CashCards can be topped up using ATMs, NETS kiosks, HomeNETS terminals, and mobile phones, and at major gasoline stations. www.nets.com.sg/news/article.php?artlD=9 Singapore CashCard TopUp Network for Electronic In Aprl 2000 MobileOne (MI) and the Network for Electronic on mobile phones: Transfers (Singapore), Transfers (NETS) announced that CashCards, uses a dual-slot local banks widely used by motorists and other consumers in Singapore, mobile phone, a smart can now be topped up over mobile phones. All users require is ATM card, and a dual-slot mobile phone, a smart ATM card, and a HomeNETS a HomeNETS PIN PIN. The smart ATM card and HomeNETS PIN can be obtained from the user's bank. Customers can also use the service to check the balance on their CashCards and to view previous card transactions. Future applications include a service that will enable Ml customers to pay bills using their mobile phones. www.nets.com.sg/news/article.php?artlD=5 Thailand Visa Cash: Visa Intemational, The Thai Smart Card Consortium-formed by 7-Eleven, card loaded or with various Thai banks Bank, Siam Commercial Bank, and Bangkok Bank-has predefined value Visa Cash, Visa's e-purse, as the payment brand for the designed for secure consortium's electronic purse project. Visa Cash payments over the uses chip card technology and is designed for use for Intemet and mobile phones, secure payments over the Internet and mobile phones and for and for low-value low-value purchases such as those made in fast food purchases restaurants, convenience stores, vending machines, payphones, or gasoline stations. Visa Cash facilitates fast end convenient transactions without the need for signature or PIN. The introduction of Visa Cash will stimulate the use of electronic cash in Thailand and move the economy one step closer to a cashless society. www.businessinthailandmag.com/archive/jul00/29.html Annexes 73 Europe Card Institution Project description Baltic states Smart card retail Unibanka In January 2001, Proton Word and Netcard announced that (Estonia, Latvia, loyalty schemes Netcard has become the Proton licensee in Estonia, Latvia, and Lithuania) Lithuania. Netcard is a smart card company based in Riga, Latvia, that has developed two smart card retail loyalty schemes. In 1999, in association with information technology provider BISS and Unibanka (Latvia's largest bank), Netcard developed an access control system for cars in the Old Town district of Riga, where over 5,000 cards have been issued out of a planned total of 20,000. www.protonworld.com/press/releases/2001/press_2001_01 _03_index.htm Bulgaria Proton e-purse: BORICA In December 2000 Proton World and BORICA signed a binding with Proton R3 and agreement under which BORICA, the operator of Bulgaria's R4 technologies and payment card network, became the Proton licensee CEPS and EMV for Bulgaria. BORICA processes domestic and international payment card transactions for 25 Bulgarian banks and supports the ATM and point-of-sale terminal network. BORICA's smart card program will begin by the end of 2001 with three pilots managed by Proton World. The first will be the development of a domestic electronic purse smart card using well-established Proton R3 technology. The second will use Proton World's new R4 technology to provide secure access, digital signatures, and secure e-commerce and mobile-commerce. The third pilot will be a field test of the R4 e-purse, interoperable CEPS-based [Common Electronic Purse Specification] e-purse, and EMV credit and debit applications, which will precede the migration of Bulgaria's 550,000 magnetic-stripe payment cards to R4 smart cards. www.protonworld.com/press/releases/press76index.htm Croatia MBU smart cards Consortium of 27 In January 2000 MBU, a consortium of 27 banks in Croatia, with the Proton e-purse local banks licensed the Proton electronic purse system for smart and chip-based credit cards. Proton World will manage a two-stage project for MBU, and debit applications whose members have issued 500,000 debit cards. In the first phase, to begin in February 2001, MBU will replace its point-of- sale terminals with C-Zam/Smash POS terminals that accept smart cards from Belgium's Banksys bank association, a part owner of Proton World. In the second phase MBU members will replace their magnetic-stripe cards with smart cards carrying the Proton e-purse and chip-based credit and debit applications. www.cardtech.faulknergray.com/archOo.htm Turkey Multifunctional credit, Garanti Bank In July 2000 it was announced that Turkey's Garanti Bank debit, and other will issue 750,000 smart cards with credit, debit, and loyalty features. U.S.-based Hypercom is supplying 2,500 point-of-sale terminals to merchants participating in the program. The terminals have touch-screens that allow consumers to view their accumulated loyalty points and to use the points for discounts on purchases. The bank's card will carry a MasterCard logo and will comply with the EMV standards for chip-based credit and debit applications developed by Europay International, MasterCard International, and Visa International. www.cardtech.faulknergray.com/archOo.htm 74 Electronic Finance: A New Approach to Financial Sector Development? -U Latin America Card Institution Project description Brazil MasterCard M/Chip: MasterCard, major At least 240,000 of the 16 million MasterCard cardholders in multifunctional credit, banks in Brazil Brazil will take part in MasterCard's pioneedng project occurring debit, and other throughout Latin America. In partnership with its member financial institutions in Brazil-Bradesco, Caixa, Credicard, Itace, Real ABN AMRO, Unibanco and Redecard-MasterCard is initiating the migration from magnetic-stripe to smart cards. It expects that by the mid-2000s all the company's credit cards will be operating on the new plafform. This effort will provide aii infrastructure for combining several applications on a single card-including credit, debit, loyalty programs, and others-to create a powerful tool for launching and developing new products and services. www.mastercard.com/about/press/pressreleases.cgi?id=369 Latin America and Visa Cash: Visa LAC Region Proton World has signed an agreement with Visa Intemational the Caribbean card loaded or with Latin America and Caribbean Region for the joint marketing of predefined value Proton-based e-purse smart card systems that are compatible designed for secure with Visa Cash in most of the region. The Proton technology payments over the allows dynamic creation of applications, conforms to EMV Internet and mobile phones, specifications, will conform to CEPS and Global Plafform, and for low-value is open to multiple sourcing of chips, cards, and terminals from purchases certified manufacturers, and can be integrated with a contact or contactless system. The technology is also used in diverse applications such as telecommunications, access control, cardholder identification, closed user groups, automated transport fare collection, and secure Internet payments. It is compatible with all of the wortd's leading smart card plafforms. www.protonworld.com/press/releases/press47index.htm Mexico Proton e-purse: Grupo Carso A Mexican banking and telecommunications conglomerate multifunctional plans to issue 6 million smart cards in 2001. The cards can be used and reloaded at 350,000 pay phones. The cards will carry the Proton electronic purse and merchant loyalty programs. The bank is part of Grupo Carso, which also owns Mexico's major phone company, Telefonas de Mexico (TelMex), and retail stores. The bank plans to expand its ATM base from 300 machines to 2,000, and to deploy 20,000 public kiosks where consumers will be able to reload the Proton cards. The cards will have chip-based credit and debit features that comply with international EMV standards. www.ct-ctst.com/CT/ Venezuela, RB Mondex e-cash: Mondex Venezuela In August 2000 ACI Worldwide announced that multifunctional purse it has been chosen to provide Mondex system solutions to divided into five Mondex Venezuela and its members. Mondex Venezuela-a pockets allowing up to consortium formed by Banco Mercantil, Banco Universal, five currencies Banco Union, Consorcio Credicard, Banesco, to be held at a time. and InterBank-will enable members, whether banks or Can also be used across nonbanks, to handle Mondex value and risk management open networks such as services. The system will be able to handle Mondex smart card telephony or the Internet processing through traditional ATM and point-of-sale channels, as well as Mondex value transfer and customer service over the Internet. http://www.aciworldwide.com/news/newsdetail.asp?news id=145 75 Annex 5: Selected E-Finance Examples in Emerging Markets and Developing Countries Housing Location Project Project summary Hong Kong, Advantage Mortgage, Advantage Mortgage is a specialized mortgage broker in Hong Kong. The China specialized mortgage company derives its revenues from fees paid by 15 of the largest lenders in Hong broker Kong's real estate market as well as two lenders not supervised by the Hong Kong Monetary Authority. Advantage solicits borrowers, evaluates mortgage loan packages for presentation to borrowers through a kind of aggregator function, prepares all documentation required to underwrite the loan and ultimately send the loan package to final lenders, and provides offline support on documentation preparation by running a call center and interactive Web page dealing with such issues as the loan to value or debt service ratios required by lenders. Advantage is beginning to examine expansion to China, the Republic of Korea, and Taiwan (China). www.advantagemortgage.com.hk/pda/index.htm Asia (various countries) DollarDEX's online DollarDEX is a company that enables online consumers to compare, shop, auction, and Reverse Auction and apply for loans and insurance products from more than 30 leading financial institutions in Group Mortgage Asia. In April 2000 it introduced the online Reverse Auction for housing loans, and in August 2000 the online Group Mortgage. The Reverse Auction gets banks to bid for groups of home mortgages from potential customers even before those customers have committed to the loans. DollarDEX.com's participating banks not only know more about what other banks are offering, but can also reduce their cost of customer acquisition. Some of these savings could be passed onto customers. The Group Mortgage allows borrowers to band together to get better deals from banks. In an arrangement with seven banks in Hong Kong, DollarDEX's new service-a first in South Asia-allow homeowners to present their loans collectively online for better packages from banks. www.dollardex.com/ Insurance Location Project Project summary China Sohu.com and Taikang Sohu.com, a major web portal, and Taikang Online, a major Online's consumer- insurer, have agreed to offer consumer-oriented insurance services online. oriented online Insurance consulting, services, and transactions will be provided to a variety of insurance services customers, including Internet users, insurance clients, insurance agents, and insurance companies. Taikang will use its e-commerce insurance platform to provide Sohu's registered users with online insurance services. Meanwhile, Sohu will share its information on registered users with Taikang to help expand its specialized online insurance market. www.chinaonline.com/industry/financial/NewsArchive/Secure/200l/March/CO1 030606.asp Hong Kong, Re2R's online open Re2Re is the first and only online marketplace providing open exchange of insurance risk China exchange of insurance and reinsurance capacities on a global basis. Re2Re uses proprietary Intemet and e- risk and reinsurance commerce technology to dramatically improve reinsurance exchange capacities among direct insurance companies, insurance brokers, reinsurance brokers, and reinsurance companies worldwide. Re2Re is a Bermuda-incorporated company with a regional office in Hong Kong and a service office in the Philippines. www.re2re.com/ Philippines Yapster's online Yapster.com is a cyber corporation that is hoping to become a contender in the local insurance service dot-com arena. It is owned by a Filipino-Chinese family engaged in various traditional businesses in the Philippines, including travel, mining, stocks and securities, textiles, manufacturing, and real estate. Part of the Yapster.com portal is 2insureAll, an online insurance service that provides benefits in case of losses to an insured individual. 2insureAll products include automobile, accident, fire, comprehensive general liability, electronic equipment, medical, life, and pre-need insurance. www.yapster.com/ www.2insureall.com/ 76 Electronic Finance: A New Approach to Financial Sector Development? . Insurance (continued) Location Project Project summary Russian Federation Renaissance Insurance Since November 1999 the Renaissance Insurance Group has been offering insurance Group, Russia's first services over the Internet. The main hindrance is the underdevelopment of card payments e-insurance agency practice in the Russian Federation, but Renaissance Insurance has solved this problem by allowing customers who do not have a credit card to print the bill from the insurance site and pay it in the nearest bank office. In addition, the renins.com portal provides complete information on insurance markets, procedures, and terms. The virtual office is overseen by an online manager who can provide immediate help to customers. agency.infoart.ruAit/newslengnews/99/12/06_584.htm www.renins.com Turkey The World Bank's The Turkish Catastrophic Insurance Pool is an Intemet platform created by the Turkish Turkish Catastrophic government that allows customers to enter all personal information, including policy Insurance Pool number and premium. Policies are issued on the Intemet and the pool is monitored in real time. Since the pool's creation, 100,000 policies have been issued on the Web. Asia (various DollarDEX Customized DollarDEX enables online consumers to compare, shop, auction, and apply for loans countries) Travel Insurance and insurance products from more than 30 leading financial institutions. Its Customized Travel Insurance lets insurance firms tailor travel insurance to consumers at flexible prices, and allows customers to request instant insurance quotations. www.dollardex.com/insurance/travel/index.cfm?show=travel_moreinfo.cfm Asia (various Asia's first fully online DollarDEX recently pioneered the first fully online life insurance product, M@xivalue, countries) insurance product, which enables healthy applicants to get instant approval. DollarDEX's customers can get from DollarDEX instant quotations based on a full comparison of features and prices, and can also buy online motor, travel, hospital, home, personal, long-term care, and even golfer's insurance. www.dollardex.com/press/index.cfm?show=i_insurance.htm Annexes 77 Microfinance Location Project Project summary Bangladesh Grameen Bank and Grameen Bank, whose mission is to provide credit to the poorest of the rural poor, Grameen Phone's established Grameen Telecom to bring the information revolution to rural Bangladesh. mobile phone project Grameen Telecom provides two products. First, selected bank borrowers purchase pay in rural Bangladesh phones (under the bank's lease program) and make them available to other villagers. Second, the Direct Subscriber program provides telephone service in rural areas that are not directly engaged in Grameen Bank activities. The phones have helped many poor women earn fair profits from their cow rearing, grocery stores, poultry farms, and vegetable gardening. www.cisp.org/imp/december_99/12_.99camp.htm www.nation-online.com/200002/1 7/nO021 706.htm#BODY8 Nigeria Smart cards for Gemcard Nigeria Limited has concluded plans to introduce smart cards targeted at the microcredit scheme nonbanking segment of Nigerian society. The project is aimed at encouraging banking habits among the lower class as well as moving funds from the informal sector into the banking system. In addition, poor citizens will be given free smart cards and, with the active participation of banks in the smart pay scheme, a microcredit scheme will be created. Online banking services, available in a mobile van, will use a facial biometrc system to recognize customers. Source: Lagos Post Express, 23 November 2000. South Africa Modified ATM services In 1993 Standard Bank of South Afrca created an affiliate, E Bank, to deliver basic for the urban poor banking services to the urban poor. E Bank provides financial services designed specifically for low-income clients, offenng greater convenience for users while keeping under control the costs to the bank of providing services. E Bank combines the innovative technology of modified ATM services with staff available to help all clients. By rethinking the needs of basic bank customers, E Bank was able to bundle services valued by poorer clients to justify a fee high enough to cover costs. Source: JoAnn Paulson, Financial Services for the Urban Poor, Policy Research Working Paper 2016, 1998, World Bank, Washington, D.C. Various countries ACCION's Palm Pilot ACCION International, one of the world's leading microfinance organizations, is using project for handheld computer technology (Palm Pilots) to cut the time and cost it takes to make a microcredit lending microloan. Loan officers typically record all data by hand because of the difficulty of carrying burdensome equipment when visiting clients. Recording data this way takes an average of 25 minutes per client. After the data is reentered at the office, total processing time stretches to an hour. New processing software, designed for Palm Pilots, allows loan officers to record client data, take applications, and make loan calculations on the spot. Back at the office, data can be quickly uploaded to a centralized database, eliminating the time-consuming task of entering it. Evaluating a client this way takes about 15 minutes. The new software was funded by the U.S. Agency for International Development. www.accion .org/pdf/ventures_fall99.pdf www.accion.org/press/main.asp Various countries PlaNet Finance PlaNet Fund is the first intemational organization to refinance microfinance institutions. By project using the using the Intemet for worldwide coverage and maximum efficiency, PlaNet Fund aims to Internet to refinance help microfinance institutions through all stages of their development. Its objective is to microfinance supply services such as loans, guarantees, joint funding, and bond purchases. In Bolivia, institutions for example, a carpenter who needs new tools applies to a microfinance institution for a loan. The institution does not have sufficient funds at the time and so cannot provide the loan. But it can appeal over the Internet to PlaNet Fund, combining the applications of several craftsmen. A specialist on Bolivia and its institutions then examines the case. He gives his opinion to the operating committee of PlaNet Fund, which rapidly makes a decision-allowing the microfinance institution to meet its clients' needs. www.planetfinance.org 78 Electronic Finance: A New Approach to Financial Sector Development? Microfinance (continued) Location Project Project summary Various countries UNCTAD's Virtual The Virtual Microfinance Market, developed by the United Nations Conference on Microfinance Market Trade and Development (UNCTAD), is an information exchange system designed to facilitate interactions between microfinance institutions, private investors, governments, and other participants in the microfinance market. The system is aimed at creating sustainable market links between commercial investors worldwide and microenterprises in developing countries. It is expected to permit the investment, under commercial terms, of millions of dollars at the grassroots level and the creation of thousands of jobs. On its Internet site the Virtual Microfinance Market provides contact and financial information on microfinance institutions willing to mobilize commercial funding, information on the legal and regulatory conditions for investment in these institutions and links permitting direct contact with regulatory authorities in each country, contact data on investors and financial intermediaries and information on conditions attached to past or current offers, and access to sources of knowledge, technical advice, and training on state-of-the-art techniques and tools for improving microfinance institutions' financial management and access to capital markets. www.vmm.dpn.ch/ Small and medium-size enterprises Location Project Project description Ghana Computerized Mobile The Computerized Mobile Bank is an initiative of Ghana's Advanced Engineering Design Bank and Research Corporation. It was funded by Infodev, a multidonor grant facility managec by the World Bank. The project designs, deploys, and operates a mobile bank to provide banking services to susu operators and small and medium-size enterprises in Ghana over 18 months. The objective is to determine the extent to which such a bank can expand the outreach of formal banking institutions and reduce the transaction costs of providing complete banking services to informal bankers (such as susu operators) and small and medium-size enterprises. http://www.infodev.org/exchange/exch5.htm Hong Kong, SMEloan SMEloan is Hong Kong's leading provider of online financing to small and medium-size China enterprises. The company has reengineered the commercial lending process by leveraging the power of the Internet. In addition, it manages and monitors credit risk using its proprietary Web-based risk management model. In October 2000 SMEloan achieved a first for a startup e-finance company in Asia by closing a HK$600 million financing facility with a group of banks led by Standard Chartered Bank and backed by a surety bond from Centre Solutions (Asia) Ltd. www.gorillasia.com/tc/readarticle?id=1 524 Various countries CitiBusiness In April 1999 Citigroup created a new business group, CitiBusiness, that specializes in (Czech Republic, financial services for small and medium-size enterprises. In May 2000 the group launched Hungary, India) CitiBusiness Platinum Select MasterCard, which in addition to providing generous lines cf credit, gives access to various services-including the CitiBusiness Resource Network, which provides information on a range of subjects, from building a Website to setting up an employee benefits program. In early 2001 the group offered CitiBusiness Direct to small and medium-size enterprises in the Czech Republic, Hungary, and India. CitiBusiness Direct is a comprehensive Internet banking solution that previously was available only to large companies and multinational clients. www.citibank.com www.citibusinessdirect.com Annexes 79 Small and medium-size enterprises (continued) Location Project Project Summary Various countries Tradehub Virtual In June 2000 MasterCard International signed a memorandum of understanding with an MasterCard electronic trading activity center, Tradehub Asia.com, that builds and networks business- to-business multiproduct portals in Asia and the Pacific. MasterCard will act as the payment mechanism for all transactions undertaken through the TradeHub system, providing financial settlement across borders and currencies. The Tradehub Virtual MasterCard will be a catalyst for small and medium-size enterprises to trade with each other as well as major companies, both domestically and internationally. www.mastercard.com/abouVpress/pressreleases.cgi?id=321 Various countries Virtual information and Pride Africa, a financial institution that provides access to credit to over 80,000 services network and entrepreneurs in Kenya, Malawi, Tanzania, Uganda, and Zambia, created Drumnet and smart cards for small Sunlink to overcome barriers to the growth of small and medium-size enterprises. and medium-size DrumNet is a virtual information and services network linking clients to markets, enterprises information, and services. Through its network of microlending branches and information kiosks, Pride Africa's clients will have access to wholesale supplies and services, advertising, and partnership and association-building opportunities. To integrate microentrepreneurs with the formal financial sector, Pride Africa created Sunlink Cashpoints. Among others, Sunlink clients received smart cards that will serve as a client identification card helping to establish credit ratings, as a loan authorization card, and as a teller access card, facilitating access to formal financial services by small and medium- size enterprises. www.prideafrica.com/ Various countries E-Finance Small The E-Finance Small Business Initiative aims to help financial institutions increase the Business, sponsored efficiency and volume of financial services targeted to small and medium-size enterprises by the World Bank by capitalizing on recent advancements in financial information and communication Group's International technologies. The goal is to create a model that will enable financial institutions to focus Finance Corporation on the risk profiles and product needs of small and medium-size enterprises. To that end, the model will integrate technologies that allow financial institutions to collect and analyze significant amounts of client information on a real-time basis. The model is built around three factors that ensure sustained profitability in lending to small and medium-size enterprises: operating efficiency, asset quality, and growth. The pilot projects that are to put the e-finance model into practice will be launched in six regions. The International Finance Corporation's holistic approach to the initiative calls for several support activities, including a global credit bureau and a technology practice area for mobile banking and payment systems to facilitate noncash payment options for small and medium-size enterprises. www.worldbank.org/html/fpd/privatesector/sme.htm www.ifc.org/sme/ 81 E-Finance Web Links Annex 2: Intemational E-finance working groups Electronic Banking Group of the Basel Committee on Banking Supervision The group issued Fourteen Principles for Risk Management of Electronic Banking. The full text of the report can be found at www.bis.org/publ.bcbs76.htm or www.bis.org World Bank The World Bank is reviewing the policy implications of changes in financial services, markets, and institutions driven by globalization and technological advances. http://wwwl.worldbank.org/finance Financial Action Task Force (FATF) The FATF is identifying the vulnerability of Internet banking to money laundering activities. www.oecd.org/ fatf International Organization of Securities Commissions (IOSC) The Internet taskforce s report can be found at www.iosco.org/docs-public/1998-internet_security.html International Association of Insurance Supervisors (IAIS) The IAIS is reviewing developments in insurance activities on the Internet. www.iaisweb.org/framesets/about.html Committee on the Global Financial System (CGFS) The CGFS is assessing electronic trading in financial markets and studying its implications for financial stability. www.bis.org/cgfs/index.htm#pgtop International Telecommunication Union (ITU) The ITU serves as a forum to address policy issues related to e-commerce in developing countries. www.itu.int United Nations Commission on International Trade Law (UNCITRAL) The commission s study focused on transferable bills of lading in an electronic environment. www.uncitral.org/en-index.htm Annex 3: Online trading systems Trading plafforms for fixed-income securities Auction systems * MuniAuction: conducts online auctions of municipal securities. www.grantstreet.com * EBondUSA.com: provides price discovery and online trading services for investment grade municipal bonds. http://www.bondmarkets.com/research/ecommerce/eBONDUSA.shtml (Municipal bond trader eBondUSA is struggling to stay alive and is down to just five staffers as it waits for its trading technology to come online.) m Bloomberg Secondary Market Auction System: www.bloomberg.com 82 Electronic Finance: A New Approach to Financial Sector Development? * Valubond: a Web-based centralized marketplace for municipal, investment grade corporate, government, and federal agency debt. www.valubond.com Inquiry-based systems * TradeWeb: allows institutional customers to buy and sell U.S. Treasury and federal agency securities electronically with multiple primary dealers. www.tradeweb.com * Market Axess: an Internet-based multidealer research and trading platform for credit products. www.marketaxess.com * BondClick: a multidealer online trading platform designed for institutional investors. www.bondclick.com/ (BondVision and BondClick, the two Internet-based Dealer-to-Customer trading platforms for fixed income products have signed an agreement to merge their activities.) * PrimeTrade: an Internet- and intranet-based real-time trading system of Credit Suisse First Boston. www.csfb.com/primetrade/index.shtml * Bloomberg BondTrader: a multidealer electronic trading system for U.S. Treasury securities. www.bloomberg.com Cross-matching systems * BondBook: offers an online marketplace for investment grade and high-yield corporate and municipal bonds. www.bondbook.com * BondDesk: a comprehensive trading platform for a wide array of fixed-income products. www.bonddesk.com/ * BondsInAsia: a regional electronic trading platform for Asian fixed-income securities. www.bondsinasia.com/ * BrokerTec Global LLC: a fully electronic interdealer broker active in U.S. and European capital markets. www.btec.com/ * EuroMTS Limited: a European e-trading system for euro-denominated benchmark government bonds. www.euromts-ltd.com/ * eSpeed: an interactive electronic marketplace that allows customers to execute transactions in a range of financial instruments. www.espeed.com * Autobahn: launched by Deutsche Bank Securities, allows customers to conduct transactions electronically in U.S., European, and emerging market fixed-income securities, globally on a 24-hour basis. www.autobahn.db.com/ * Apogean Technology: an electronic trading system for dealers in emerging market debt securities. www.apogean.net * Currenex: an independent, open financial exchange linking institutional foreign exchange buyers anld sellers worldwide. www.currenex.com/ E-Finance Web Links 83 * Instinet Fixed-income: a global electronic broker service that facilitates trading in U.S. Treasury and Euro sovereign debt securities. www.instinet.com/ The Bond Market Association Survey offers a more comprehensive list of online trading platforms for fixed- income markets: www.bondmarkets.com/research/ecommerce/ Trading plafforms for equity trading Eastem Europe * Sati Online Brokerage (Czech Republic): www.sati.cz/ * Quaestor Financial Group (Hungary): www.quaestor.hu/ * Equitas (Hungary): http://online.equitas.hu/ * Internet Broker Kft (Hungary): www.cd.hu/fw/vis/index.html Asia * Karachistocks.com (Pakistan): www.karachistocks.com * Phillips Online Electronic Mart System (Singapore): www.poems.com.sg * Asian Capital Equities (Phillipines, Malaysia, Thailand and Indonesia): https://www.psedirect.net * Korea Samsung Securities Cyber Stock: http://english.samsungff.com/ * ARKaccess Asia Limited (Global): www.arkaccess.com La/k7AmeMca * Patagon.com (Brazil; Mexico; Venezuela, RB; Chile; Argentina; and Spain): www.patagon.com * Rava Sociedad de Bolsa (Argentina): www2.rava.com.ar/cgi-bin/rt/index.cgi * Hedging Griffo (Brazil): www.hedginggriffo.com.br/home/ Annex 4: Smart card providers Ghana: Mondex e-cash is a multifunctional purse divided into five pockets allowing up to five currencies to be held at a time. It can also be used across open networks such as telephony or the Internet. Mondex Ghana Ltd. controls Ghana s Mondex e-cash franchise. www.mondex.com Hong Kong, China: i.Life card is a multifunctional card providing credit, debit, and other services. The card is offered by Hongkong and Shanghai Banking Corporation Limited. www.hsbc.com.hk/hk/waming.htm 84 Electronic Finance: A New Approach to Financial Sector Development? India: an e-purse is targeted at micropayments and an EMV-compliant debit card is intended for higher- value day-to-day transactions. Sponsors of this program are Proton World (PW) and Alittleworld.com Private Limited (ALW). www.protonworld.com/press/releases/press63 index.htm Indonesia: the Paspor BCA/Maestro/Cirrus card provides PIN-based online real time debit. The card is offered by MasterCard and BCA. www.mastercard.com/about/press/pressreleases.cgi?id=3444 Korea, Rep. of: the Mondex e-cash, MasterCard M/Chip>> card, and Kookmin Credit Card provides credii:, debit, and other services. The card is offered by MasterCard Korea. www.epaynews.com/archives/index.cgi?ref=browse&f=view&id=982251131212120150500 Korea, Rep. of: A multiapplication card with an electronic purse and credit application is offered by the Pusan Bank of Korea, Rep. of www.cardtech.faulknergray.com/archOO.htm Korea, Rep. of: Visa Cash: The Visa Cash card is loaded or has a predefined value, and is designed for secure payments over the Internet and mobile phones, and for low-value purchases. www.cardtech.faulknergray.com/archOO.htm Latin America and the Caribbean: The Visa Cash card is loaded or has a predefined value, and is designed for secure payments over the Internet and mobile phones, and for low-value purchases. www.protonworld.com/press/releases/press47index.htm Nigeria: The e-purse card relies on Proton technology and is licensed by the Securecard Trust Group. www.cardtech.faulknergray.com/archOO.htm Philippines: The Visa Cash card is loaded or has a predefined value, and is designed for secure payments over the Internet and mobile phones, and for low-value purchases. www.cardtech.faulknergray.com/ archOO.htm Singapore: A cash withdrawal card is offered by the Network for Electronic Transfers and local banks. www.nets.com.sg/news/article.php?artlD= 1I Singapore: The CashCard< TopUp on mobile phones system uses a dual-slot mobile phoe, a smart ATM card, and a HomeNETS PIN. It is offered by the Network for Electronic Transfers and local banks. www.nets.com.sg/news/article.php?artlD=5 South Africa: The Visa Cash card is loaded or has a predefined value, and is designed for secre payments over the Internet and mobile phones, and for low-value purchases. www.cardtech.faulknergray.com/ archOO.htm Thailand: The Visa Cash card is loaded or has a predefined value, and is designed for secure payments over the Internet and mobile phones, and for low-value purchases. www.businessinthailandmag.com/archive/julOO/29.html Turkey: Garanti Bank offers a multifunctional card that provides credit, debit, and other services. www.cardtech.faulknergray.com/archOO.htm E-Finance Web Links 85 Venezuela, RB: Mondex e-cash is a multifunctional purse divided into five pockets allowing up to five currencies to be held at a time. It can also be used across open networks such as telephony or the Internet. http://www.mondex.com/ Annex 5: E-finance examples Insurance China: Sohu.com, a web portal, and Taikang Online, an insurer www.chinaonline.com/industry/financial/NewsArchive/Secure/200 1/March/CO 1 030606.asp Hong Kong, China: Re2R s online open exchange of insurance risk and reinsurance capacities. www.re2re.com/ Mexico: Mexican insurer Grupo Nacional Provincial S.A. will begin offering online Mexican tourist automobile policies through a joint venture with International Insurance Group Inc. www.mexicaninsuranceonline.com Philippines: Yapster s online insurance service. www.yapster.com/ and www.2insureall.com/ Russian Federation: Renaissance Insurance Group, an e-insurance agency in the Russian Federation. www.renins.com Various Asian countries: DollarDEX Customized Travel Insurance. www.dollardex.com/insurance/travel/index.cfm?show=travel_moreinfo.cfmn Various Asian countries: Asia s fully online insurance product, from DollarDEX. www.dollardex.com/press/index.cfmn?show=i_insurance.htm Microfinance Bangladesh: Grameen Bank and Grameen Phone s mobile phone project in rural Bangladesh. www.cisp.org/imp/december_99/12_99camp.htm and www.nation-online.com/200002/1 7/ n0021706.htm#BODY8 Various countries: PlaNet Finance project using the Internet to refinance microfinance institutions. www.planetfinance.org Various countries: UNCTAD s Virtual Microfinance Market. www.vmm.dpn.ch/ Small and medium-size enterprises Ghana: Computerized Mobile Bank, an initiative of Advanced Engineering Design and Research Corporation. http://pacific.worldbank.org/ext/results.jsp?DOC_QUERY_TERMS= Computerized+Mobile+Bank%2C+an+initiative+of+Advanced+Engineering+ Design+and+Research+Corporation.&QUERY_TREATMENT=ANY_TERMS &x=39&y= 12 86 Electronic Finance: A New Approach to Financial Sector Development? Hong Kong, China: SMEloan, a provider of online financing for small and medium-size enterprises. www.gorillasia.com/tc/readarticle?id= 1 524 Vietnam: MeetVietnam, an Internet trading tool for small and medium-size enterprises. www.ifc.org Various countries: CitiBusiness in the Czech Republic, India, and Hungary www.citibank.com and www.citibusinessdirect.com Various countries: The Tradehub Virtual MasterCard. www.mastercard.com/about/press/pressreleases.cgi?id=32 1 Various countries: PrideAfrica s virtual information and services network and smart cards for small and medium-size enterprises. www.prideafrica.com/ Various countries: The International Finance Corporation s E-Finance Small Business Initiative. www.worldbank.org/html/fpd/privatesector/sme.htm and www.ifc.org/sme/ Communications infrastructure International Telecommunication Union. www.itu.org Public key infrastructure and security American Society for Industrial Security: The American Society for Industrial Security (ASIS) is the largest international educational organization for security professionals, with over 32,000 members worldwide. ASIS is dedicated to increasing the effectiveness and productivity of security professionals by developing educational programs and materials that focus on both the fundamentals and the most recent advancements in security management. www.asisonline.org Attrition.org: Documents hacker attacks worldwide. www.attrition.org BITS: BITS, the Technology Group for The Financial Services Roundtable, was formed by the CEOs of the largest bank-holding institutions in the United States as the strategic brain trust for the financial services industry in the e-commerce arena. www.bitsinfo.org CERT: The CERT' Coordination Center (CERT/CC) is a center of Internet security expertise. It is located at the Software Engineering Institute, a federally funded research and development center operated by Carnegie Mellon University. www.cert.org Hong Kong Monetary Authority: The Authority provides information on the security of banking transactions over the Internet. www.info.gov.hk/hkma/eng/guide/guide_no/guide- 51 lxb.htm Internet Security System: Internet Security Systems (ISS), founded in 1994, is the world s leading provider of security management solutions for the Internet. 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Information was garnered from the International Telecommunication Union s World Telecommunication Development Report 1999. A. Romero describes these technological advances in his article Cell Phone Surge among the World s Poor in the 12 December 2000 New York Times (www.nyt.com). Box 4: Leapfrogging around the globe: Estonia, Republic of Korea, and BraziL Estonia s progress in information technology is discussed in Maheshwari (2000). Charlie Garrigues s (2000) back to office report on the Estonia Payment System Project provided valuable information. The data on the number of online clients are from the Baltic News Service (2000) . The International Telecommunication Union s World Telecommunication Indicators Database (1999) also provided information (www.itu.org). Box 14: Insurance: E-financeable? The use of the Internet in the insurance industry is discussed in Kelly (1998). For further information on the Renaissance Insurance Group, see the company s Website (www.renins.com). The information on online automobile policies in Mexico is from Bestwire (2000). The examples on Yapster, Re2Re, DollarDEX, and China are from their Websites (www.yapster.com, www.re2re.com, www.dollardex.com, www.chinaonline.com). Box 15: E-financefor small and medium-size enterprises. The SMEloan example draws largely on the information provided on SMEloan s Website (www.smeloan.com) and Gorillasia.com (www.gorillasia.com/tc/readarticle?id= 1524). The examples on DrumNet and Sunlink are from Biashara News Letter (2000), Pride Africa s Website (www.prideafrica.com), and www.geocities.com/Starsys2000/page3.html. The information on CitiBusiness Direct comes mainly from the Citibank and Citibusiness Direct Websites (www.citibank.com and www.citibusinessdirect.com). Box 16: Microf nance and e-flnance a viable match? The factors that hinder the use of informnation technology in microfinance institutions are discussed in Miehlbradt and Chua (1999). The E Bank example in South Africa is from Paulson (1998), the Gemcard example in Nigeria is from Ungwu (2000), the ACCI N Palm Pilot example is from ACCI N Fall Ventures (1999), and the PlaNet Finance and Virtual Microfinance Market information is from their Websites (www.planetfinance.org/en/institutionnel/index.htm and www.vmm.dpn.ch/). Recent World Bank Discussion Papers (continued) No. 384 Integrating Social Concerns into Private Sector Decisionmaking: A Review of Corporate Practices in the Mining, Oil, and Gas Sectors. Kathryn McPhail and Aidan Davy No. 385 Case-by-Case Privatization in the Russian Federation: Lessonsfrom International Experience. Harry G. Broadman, editor No. 386 Strategic Managementfor Government Agencies: An Institutional Approachfor Developing and Transition Economies. Navin Girishankar and Migara De Silva No. 387 The Agrarian Economies of Central and Eastern Europe and the Commonwealth of Independent States: Situation and Perspectives, 1997. Csaba Csaki and John Nash No. 388 China: A Strategyfor International Assistance to Accelerate Renewable Energy Development. Robert P. Taylor and V. Susan Bogach No. 389 World Bank HIV/AIDS Interventions: Ex-ante and Ex-post Evaluation. Julia Dayton No. 390 Evolution of Agricultural Services in Sub-Saharan Africa: Trends and Prospects. V. Venkatesan and Jacob Kampen No. 391 Financial Incentivesfor Renewable Energy Development: Proceedings of an International Workshop, February 17-21. 1997, Amsterdam, Netherlands. E. Scott Piscitello and V. Susan Bogach No. 392 Choices in Financing Health Care and Old Age Security: Proceedings of a Conference Sponsored by the Institute of Policy Studies, Singapore, and the World Bank, November 8, 1997. Nicholas Prescott, editor No. 393 Energy in Europe and Central Asia: A Sector Strategyfor the World Bank Group. Laszlo Lovei No. 394 Kyrgyz Republic: Strategyfor Rural Growth and Poverty Alleviation. Mohinder S. Mudahar No. 395 School Enrollment Decline in Sub-Saharan Africa: Beyond the Supply Constraint. Joseph Bredie and Girindre Beeharry No. 396 Transforming Agricultural Research Systems in Transition Economies: The Case of Russia. Mohinder S. Mudahar, Robert W. Jolly, and Jitendra P. Srivastava No. 398 Land Reform and Farm Restructuring in Moldova: Progress and Prospects. Zvi Lerman, Csaba Csaki, and Victor Moroz No. 400 Russian Enterprise Reform: Policies to Further the Transition. Harry G. Broadman, editor No. 401 Russian Trade Policy Reformfor WTO Accession. Harry G. Broadman, editor No. 402 Trade, Global Policy, and the Environment. Per G. Gredriksson, editor No. 403 Ghana: Gender Analysis and Policymakingfor Development. Shiyan Chao, editor No. 404 Health Care in Uganda: Selected Issues. Paul Hutchinson, in collaboration with Demissie Habte and Mary Mulusa No. 405 Gender-Related Legal Reform and Access to Economic Resources in Eastern Africa, Gita Gopal No. 406 The Private Sector and Power Generation in China. Energy and Mining Sector Unit, East Asia and Pacific Region, World Bank No. 407 Economic Growth with Equity: Ukrainian Perspectives. John Hansen, editor No. 408 Economic Growth with Equity: Which Strategyfor Ukraine? John Hansen and Diana Cook No. 409 East Asian Corporations: Heroes or Villains? Stijn Claessens, Simeon Djankov, and Larry H. P. Lang No. 411 Making the Transition Workfor Women in Europe and Central Asia. Marnia Lazreg, editor No. 412 Intellectual Property Rights and Economic Development. Carlos A. Primo Braga, Carsten Fink, and Claudia Paz Sepulveda No. 413 Management and Resolution of Banking Crises: Lessonsfrom the Republic of Korea and Mexico. Jose De Luna-Martinez No. 414 Liquefied Natural Gas in China: Options for Markets, Institutions, and Finance. Dean Girdis, Stratos Tavoulareas, and Ray Tomkins No. 416 Fostering Competition in China's Power Markets. Noureddine Berrah, Ranjit Lamech, and Jianping Zhao No. 417 Hungary: Modernizing the Subnational Government System. Mihaly Kopanyi, Samir El Daher, Deborah Wetzel, Michel Noel, and Anita Papp No. 419 Measuring and Apportioning Rentsfrom Hydroelectric Power Developments. Mitchell Rothman No. 420 Financing of Private Hydropower Projects. Chris Head No. 421 Free Trade Area Membership as a Stepping Stone to Development: The Case of ASEAN. Emiko Fukase and Will Martin No. 422 Environmental Health: Bridging the Gaps. James A. Listorti and Fadi M. Doumani THE WORLD BANK 1818 H St-ect, N.WV Washington, D).C. 20433 USA 'lelephionie: 202-477-1234 Facsimile: 202-477-6391 Internct: www.vvorldbank.org Ei--mail: feedhack(oorldhank.org ISBN 0-8213-5104-4