Electronic banking – Perspective on Regulation Presentation at School of Management , IIT Mumbai August 23, 2003

Bank’s Role Resource Mobilisation through Deposits Resource Allocation through Credit Creation Provide Payment Services for economic transactions Financial intermediation through size, maturity and risk transformation Information based service Trust of Depositors is the main capital

Central Bank’s Role Ensure Financial stability for orderly economic growth Banker to Banks Banker to Government Debt Manager & custodian of Reserves Apex Payment & Settlement Agency Orderly Development of Banking and Financial Market

Changing Scenario Growth in global trade in goods and services aided by technological and socio-economic developments after world war II. Support role of financial services and banks Bank’s role as commanding height of economy. Movement of capital in search of better return from developed to developing economies. Emergence of Universal Banking for catering to variety of financial services.

Information Technology in Banks Evolution of Banking Technology : Book keeping -----transaction processing ------ decision supporting ----- substratum of banking services. Evolution of Payment Technology : Online checking ---Cheque processing---Teller machines ----card based payments---mass payments---Automated payments---Delivery vs payment--- Real Time Gross Settlements-internet payments.

Focus of Technology Retail Banking services : Any time anywhere access to funds, funds transfer, bill payments, cash management, other services for individual and corporate clients Wholesale Banking : Short and long term investments in money, capital, debt and foreign exchange market, derivatives market, Dealing among FIs only.

Balance sheet of a bank Equity Capital Different Reserves Provisions Cash & cash Reserves Short term investments Long term investments Loans & Advances ( short and term loans) Bills receivable Other assets Loss Equity Capital Different Reserves Provisions Borrowings Term and demand deposits –(Domestic and Forex ) Bills payable Profit Contingent liabilities

Information Flow Different operational units report to head office and head office deals with other institutions Decisions at different levels Aggregation of all transactions in balance-sheet All entities are mutually dependent , time sensitive and depend on market forces

Risks in banking Credit Risk Liquidity risk Market risk Operational risk Systemic risk Operational risks arise out of infirmities in internal controls & Technology based systems and lead to legal/ reputation risks.

Internal Controls and IT Segregation of duties, Delegation of authority and responsibility Professional and trained personnel System of authorisation Adequate documents & records, Physical control over assets, Management supervision, Independent checks on performance, Reconciliation of assets and responsibilities

Role of Technology Two Pillars of Modern banking : IT and Electronic Payment Systems. Banking products and services getting inseperable from underlying Technology Technology Providing Alternate Delivery channel for service delivery. Technology needs Process redesigning and also reduce visibility to some extent.

Mission, work processes and IT Regulatory Compliance, Vision/mission for Bank Define Accomplish Retail and Wholesale Banking, Payment services Execute Guide Pricing, Credit , Investments & Risk Management Consider Supports IS Audit Transaction processing , MIS for Fund Position Asset Quality, DSS, EIS Employs Processes IT Based Banking solutions , Payment solutions

Management Concerns Will IT provide efficiency, cost reduction & improved banking services ? Will IT help being competitive through innovation? Will IT spending worth the money? Will IT help in better risk management? Will IT provide Security and safety? Will IT be a Solution or a Problem itself?

Banking and currency crisis Numerous banking and currency crisis in different parts affected national and global systems. Focus on role of national supervisors and international financial agencies and informational infirmities. Emergence of New Financial Architecture with focus on capital adequacy, prudential standards, –Data Dissemination standards, international standards and codes.

Regulatory Concerns How to Safeguard interest of depositors and ensure credit allocation for development? How to build Competitive Financial sector- Liberate and control at same time? How to Integrate with global economy and insulate from adverse developments ? How to build a sound, resilient, vibrant and competitive banking sector?

Mission, work processes and IT Financial Stability for Economic Growth Define Accomplish Banker to banks & Government, Regulation Development of Financial Markets Execute Guide Monetary & Credit Policy, Bank Supervision Supports Consider IS Audit Economic Indicators, banking statistics, Employs Processes Banking Technology & Payment systems

Characteristics and challenges of e-banking Technological and customer service innovation reducing the time for deployment of new products. Ubiquitous and global nature of open electronic networks like internet. Integration of e-banking with legacy computer systems for Straight Through Processing. Increasing dependence on third parties to provide complex IT services through alliances, partnership creating complex operational & security issues.

Impact on traditional risk profile Although no new risks are created, traditional risks are increased and modified. Traditional risks are Strategic ,Operational, Legal and reputational risk Traditional risk management principles need to be tailored , adapted and even expanded to meet challenges. Board and senior management have to ensure review and modify the risk management process in banks.

Risk Management Principles Principles express supervisory expectations and guidance as risk management requirements could be counterproductive. The principles need to be tailored to each bank’s risk profile. Specific technical solutions or standards are to be addressed by institutions and standards setting bodies as technology evolves. Principles can be used as tools by national supervisory institutions.

Risk Management Principles- Categories Board and Management Oversight. Security controls Legal and Reputational Risk Management.

Board & Management Oversight Effective management oversight of e-banking activities. Establishment of a Comprehensive security control process. Comprehensive due diligence and management oversight process for outsourcing relationship and third party dependencies.

Security Controls -I Authentication of e-banking customers. Non Repudiation and accountability for e-banking transactions. Appropriate measures to ensure segregation of duties. Proper Authorisation controls within e-banking systems, databases and applications.

Security Controls - II Data integrity of e-banking transactions, records and information. Establishment of clear audit trailfor e-banking transactions. Confidentiality of key bank information.

Legal and Reputational risk management Appropriate disclosure for e-banking services. Privacy of customer information Capacity , business continuity and contingency planning to ensure availability of e-banking systems and services. Incident Response Planning.

Indian Banking sector & Adoption of IT Indian perspective Indian Banking sector & Adoption of IT

Banking sector reforms Initiated in 1991 after crisis. Focus on promoting competition, capital adequacy, autonomy and market determined rates, adoption of prudential norms, risk management. Technology issues identified and included as pert of reform process. Reforms in payment system for customer service, market development & RM.

Challenges before Indian banks Low productivity Low banking penetrartion