Forthcoming study: Banking

This study by the Sectoral e-Business Watch is expected for June 2008.

Rationale and main research objectives

The banking industry (from hereon named BI) is an economically important sector, particularly with respect to investment capital and corporate finance representing approximately 7% of gross value added within the EU-25 (NACE sections C to K) and employing around 5% of the EU workforce.

The developments in recent years within ICT have had a profound impact on the BI. Thus, the emergence and further development of e-security, e-banking and e-marketing has been a topic of increasing interest in recent years for both academics and practitioners, as the changes taking place in the field are clearly observable. However, the growing interest has not been matched well enough with relevant studies that would give insight into the processes and behaviours underlying the rapid growth of new channels.

ICT allows banks to apply credit-scoring techniques to consumer credits, mortgages or credit cards, automating part of the process; in this way, products that used to be highly dependent on the institution’s evaluation of its consumer have become more standardised. As a result, increased disintermediation has taken place, firstly when banks loose a share of the financial intermediation to institutional investors (investment funds, insurance companies and pension funds); secondly, via centralisation of activities with large economics of scale (for instance, payments processing pooled between several banks or contracted out to specialists); thirdly, division of activities through the deployment of new distribution channels as well as outsourcing of these channels (for instance, some ATMs in the United Kingdom are not owned by banks and some banks use supermarket chains as a distribution channel in Spain) or through alliances with firms in the ICT sector (for instance, some Internet portals).

The tendencies above have also produced changes in the structure of bank income. As a result of increased competition that has lowered margins in lending operations (the banks’ traditional business), banks have diversified their sources of income and rely increasingly on income from fees services rather interest rate spreads. Fees charged for services include typical banking activities like payment transactions, safe custody and account administration.

There is also a noticeable power shift because the increasing use of e-business in the BI has not only increased competition among banks as well as competition from other actors in the financial markets; internet banking has also shifted power from banks to their customers, by allowing the customers to shop around for the best price for products.

e-Business W@tch covered the banking sector in its surveys of 2002 and 2003, but not in the more recent surveys of 2005 and 2006. Since banking is one of the sectors actively using ICT and new developments and, according to the previous study, banking is one of the sectors (together with tourism and ICT services) where customer facing online transactions are most important (according to e-maturity index, ICT services has a value of 100, while banking enjoys the 5th place with a value of 79),  it is likely that further developments have occurred and gained momentum in the BI since the sector was last covered by e-Business W@tch. We propose to assess the dynamics of the development and their impact on banks in a new sector study.

Research objectives

Since ICT has a fundamental impact on the banking sector, there may be several crucial topics to analyse and questions to answer.

Based on the above mentioned industry trends, and on findings in earlier studies conducted on the banking sector, the following questions are proposed for analysis in 2007:

• Dynamics of adoption: Has there been a dynamic adoption of ICT and e-business in the period since 2002/03?
• Key applications: Which are the key e-business application areas in the BI? Which technologies are typically used by financial institutions? Is there a fit between demand for and supply of e-business solutions in the market?
• Digital divide as a bottleneck: How pronounced is the digital divide between large and small players and their suppliers and customers in comparison to other service sectors?
• Impact on firm performance: What is the impact of ICT on employment, productivity and firm performance in this industry, in comparison to other sectors?
• Impact on international competition: Is there a link between e-business developments and international competition?

Sector definiton

For the purpose of the sector report a clear definition and separation of industry activities is needed. The sector definition in this report is limited to credit institutions and banks. This combined sector covers a number of financial activities. The respective NACE Rev. 2 groups and their correspondence in NACE Rev. 1.1 are shown in the table below. The names of financial activities refer to NACE Rev. 2.

Business activities covered by the sector study

NACE Rev. 2	NACE Rev. 1.1 (Proxy)	Financial activity:
K 64	K 65.1	Financial intermediation, except insurance and pension funding
64.1		Monetary intermediation
64.19	65.12	Other monetary intermediation
64.92	65.22	Other credit granting

 

This definition excludes activities of holding companies found in NACE Rev. 1.1 65.23/74.15/NACE Rev. 2 64.2/64.20 and trusts, funds and other financial vehicles, found in NACE Rev. 1.1 65.23/ NACE Rev. 2 64.3 and 64.30. This sector definition is in line with the definition of “Banking” used in the Eurostat Community Survey in Enterprises of the Financial Sector.

It should be noted that the use of the Eurostat Community Survey in Enterprises of the Financial Sector does not allow for analysis of micro firms (<10 employees). The obligatory size class breakdown in the Eurostat Community Survey does not include the “micro-firm” category (viewed as optional). This limitation will, however, have limited impact on the analysis since only a limited number of credit institutions/ banks are expected to be found in this size class.

Data sources

The following sources will be used for collecting data and evidence on e-business adoption:

• Eurostat Community Survey on ICT Usage and e-Commerce in Enterprises of the Financial Sector, particularly insurance and credit institutions, banks.
• Case studies: 10 case studies on ICT use and development in banks will be conducted. A balanced mix of cases in terms of countries, financial activities (sub-sectors), and credit institution/ bank size-bands is to be achieved. Case studies will be selected according to the topics in focus .
• Interviews: In addition to the interviews conducted with bank representatives as part of the case study work, we will conduct in-depth interviews with further bank representatives and experts of monetary intermediation. Possible experts could be representatives from academia, the European Banking Federation, the International Banking Federation, national banking federations, the Bank for International Settlements.
• Banking/Industry federations: Annual reports and statistics of above-mentioned banking federations would also be valuable for the analysis.

Use of data from the Eurostat Community Survey

We propose to use the results of the Eurostat Community Survey on ICT usage and e-Commerce in Enterprises in the Financial Sector as input for the analysis of ICT adoption in the industry. The available data can be considered a reasonable proxy and the proposed sector is therefore in line with that of the Eurostat Community Survey.

On the basis of these considerations, we believe that the Eurostat Community Survey is a good point of departure in assessing the state of play in ICT adoption and e-business activity in the BI. A new SeBW CATI survey could possibly prove a valuable source of information for detailed analysis of the ICT uptake and usage in the BI especially in the analysis of the ICT and e-commerce aspects of the SEPA initiative.

Specific topics to be studied

The following suggestions for research topics are derived from the discussions and research into the BI and its use and development of ICT. It is a preliminary collection of ideas, for discussion with DG ENTR and industry, where a special focus is on the implementation of the Single Euro Payments Area (SEPA).

• The Single Euro Payments Area (SEPA) will allow consumers, companies and other economic actors to make and receive payments, whether between or within national boundaries under the same basic conditions, rights and obligations, regardless of their location. However, despite the visible benefits both for customers and banks, the introduction and adaptation of SEPA poses several challenges for the European BI.
  • The implementation of SEPA-compliant payment systems and ability to offer SEPA payment services and products to the market by January 1, 2008 – a task that has been estimated to represent a collective investment of 5 billion Euro in order to scale up processing systems and overall IT infrastructure, migrate cards and adapt mandates and contracts to a level that would permit the scrapping of all domestic payment systems in favour of a fully harmonised, pan-European standard . Here the debate also focuses on how the payment cards – in particular debit cards – can become SEPA-compliant. The challenge in this area is to ensure a successful transition to a more integrated market while at the same time preserving the efficiency and low cost levels that characterise existing ICT-based national payment card schemes.
  • The requirement to plan and subsequently migrate customers to new SEPA instruments, ICT systems and products – here banks will face two opposing challenges. On the one hand, well-informed corporations, faced with significant change and potential disruption, will be tempted to review their payments services relationships before committing to a SEPA relationship. Such customers will be looking for value-added services while at the same time consolidating their payment provider relationships. On the other hand many customers will resist SEPA migration, making it difficult to meet the 2010 deadline. For smaller business and corporations in particular, SEPA implies modifications to their ICT systems and processes which they may be hesitant or unwilling to implement.
• Investment in new technologies and processes, technology migration – whilst banks are no strangers to updating systems to accommodate new legislation, standards, markets or technologies, the impact of SEPA on payment revenues requires that they must approach this evolution in a new way.
• Development of e-security in payment - security of the data and accounts of the customers is a large focus point for the BI. Protection through single password authentication, as is the case in most secure Internet shopping sites, is not considered secure enough for personal online banking applications in some countries, so banks have to concentrate their attention on the improvement of the personal data protection.
• According to recent surveys, although respondents view SEPA as a commercial opportunity, more than one in four (27%) describe the initiative as a “high-risk project with unrealistic timeframes". A survey conducted in 2005, polling 155 banks and corporations across Europe and the US, found that two thirds (66%) of corporates have not yet started on their SEPA strategy, compared with just six per cent of banks. The BI hence has an ICT-related challenge in implementing and supporting the development of a single payment area.
• ICT as a driver of process efficiency. Improving the efficiency and supply of financial services is a very important factor in the BI. Although rapid development of information technology has made some banking task more efficient and cheaper (for example, a transaction at a traditional “brick-and-mortar” office costs 1.07 euros, the same transaction costs 55 eurocents over the telephone, 27 eurocents at an ATM (Automated Tellers Machine), and 1 eurocent only through the internet), technological investments are taking a larger share of bank’s resources. Apart from the personnel costs, technology is usually the biggest item in the budget of a bank, and the fastest growing one. Any innovation or introduction of new products requires huge expenses, which may be repaid only in the longer perspective. In this case only big banks may use their financial resources in order to introduce innovations, while the smaller ones may be more precautious in doing that .
• The impact of e-banking on branch renewal. Since e-banking has become a commodity in Europe and banks are reporting that more than 30% of the overall amount of standard banking transactions is done online, this has led to an ever-increasing expectation to the branch front-office at the client’s side. Banking anytime, from anywhere, is usual, and has driven banks to improve processing capabilities. As clients expect standard services at minimum cost or free of charge, there are few margins left to settle the teller’s involvement. The high amount of self-service has taken away substantial workload from the Teller, who is expected to improve this situation to sell more high-level and high-margin products.
• e-Marketing and introduction and improvement of customer relationship management (CRM). Internet marketing is a component of electronic commerce. Internet Marketing includes pay per click advertising, banner ads, e-mail marketing, affiliate marketing, interactive advertising, search engine marketing (including search engine optimisation), blog marketing, article marketing and PPC (Pay Per Click ads). More than one third of consumers who have Internet access in their homes report using the Internet to make purchases. The BI has more opportunities to sell their products – by offering them on the Internet. More and more banks are offering the ability to perform banking tasks online. Online banking is believed to appeal to customers because it is more convenient than visiting bank branches. Online banking is now the fastest-growing Internet activity. The increasing speed of Internet connections is the main reason for the fast growth. Of those individuals who use the Internet, 44% now perform banking activities over the Internet. Moreover, banks may evolve now not only into B2B but also B2C.
• ICT as a tool in disaster recovery. With the rise in ICT and the reliance on business-critical data, the focus on protection of irreplaceable data has increased in recent years. This is especially evident in information technology, with most large computer systems backing up digital information to limit data loss and to aid data recovery. It is believed that some companies spend up to 25% of their budget on disaster recovery plans; however, this is to avoid bigger losses. Of companies that had a major loss of computerised records, 43% never reopen, 51% close within two years, and only 6% will survive long term. The BI is focused on preventing the loss of person/ enterprise sensitive data and on e-security both internally and towards customers/clients .

All these specific topics are linked to the overall theme of ICT and e-business impact. It is proposed to address impacts in two ways: first, by employing analytical statistics, to the extent that this can be made on the basis of aggregated data. The model, including research questions for this work, is to be developed during the inception phase. Second, the assessment of ICT impact will be made on the basis of the research on the above issues. This assessment will link the findings from analytical work with the data, which can then be used to confirm or challenge conclusions that are drawn from the empirical evidence of case studies and interviews.