Introduction

This study is part of a Benchmarking Pilot Project on the diffusion and utilisation Of Information and Communication Technologies and New Organisational Arrangements (ICT-0), undertaken on the behalf of the European Commission, with the view to assess the feasibility of benchmarking as a policy tool by applying the benchmarking approach to the utilisation and performance impacts of ICT-O and their relationships to framework conditions. The study analyses the use of ICT-O in the financial services in Europe and seek to draw preliminary conclusions concerning potential actions facilitating the uptake of ICT-O and in particular the framework conditions.

The study covers two broad areas:

- Retail Banking

- Equity markets and investment banking

within the European Union countries. For the purpose of comparison, data from the United States financial sector have been used.

Given the strict time limitations, the study relies on the existing data and documentation and literature review. No specific data were generated and no formal interview programme was carried out. The study focuses on the use of Information and Communication Technology, particularly on the externally-oriented applications, which support the relationships with other financial institutions and with customers.

The study is organised in five parts:

- A conceptual framework of ICT in Financial Services

- An overview of European Financial Services :

- A preliminary analysis of ICT use in European Financial Services

- Benchmarking challenges and framework conditions

Conceptual framework of ICT in Financial Services 

The basis of the proposed framework is a strong mutual dependence:

- Financial services represent a critical application area of ICT expenditures

- ICT is a strategic development vector for financial services

Importance of financial services for ICT

Financial services constitute the largest segment of ICT spending. In Europe, financial services in 1996, financial services amounted to 48.8 billion ECU or 27% of the total spending (see diagram 1 below). However, the importance of financial services goes beyond their quantitative weight. Banking has been the fastest growing ICT sector in Europe in 1997 and 1998. Financial services institutions are among the most sophisticated ICT users and play a key role in deployment of key technologies. For instance, while client/server architecture has been deployed in 50.2% of European enterprises sites, within financial sector the deployment level is 64.5% (in 1997). Financial sector is seen as critical to the large-scale take-up of electronic commerce, with Internet banking and Internet securities trading seen as "killer applications."

Diagram 1.

ICT Spending in Europe 1996

source: EITO

Five financial institutions are among top European ICT spenders. Five out of ten largest ICT spenders are financial institutions. Moreover, financial institutions ICT spending

is growing more rapidly than overall IT spending and represents a higher share of overall revenues. However, as we will see below, the level of sophistication in ICT use varies considerably among banks.

Diagram 2

ICT Spending

Growth rate 1996-1997 Share of revenues

Source: EITO, Information Strategy

Importance of ICT for financial services

ICT has become an integral part of financial services, whether in product/services offering, delivery channels or internal management. IT spending represents between 2% and 8% of European banks’ revenue and constitutes the fastest growing cost category.

IT employment in European banks represents an average of 8% of their total employment and its relative importance is increasing, with IT specialists often acceding into senior management ranks.

ICT penetration in financial services is a dynamic and on-going process. ICT has started as an administrative back-office function support. It has then moved to the front office to facilitate contacts with customers and to support financial transactions. For Mitchell Madison Group, the process, can be divided into four stages, starting in the 1970s:

- Back Office Automation, when the key motivation is to reduce transaction costs and administrative overhead

- Front Office Automation, when personnel dealing with external parties (customers or other financial institutions) were able to access centrally-held information

- Bringing Customers On-line, when customer gain direct access to their accounts in the core processing and accounting function.

- An Integrated System, where various elements of ICT are brought together to provide a complete picture of customers' relationships and bank's position.

The three core requirements for ICT in financial services are:

- Transaction processing

- Customer interaction

ž Delivery channels

ž Product development

ž Advice

- Risk management

ICT impact is pervasive. It is both tactical and strategic. It provides the essential set of tools that every financial institution need to carry out its business. It also enables some institutions to develop competitive advantage in terms of product/service offerings, delivery channels and risk management. The relationship between tactical and strategic use are dynamic: strategic can become tactical, once a technology is widely adopted. This was the case of ATM networks. On the other hand, tactical can become strategic: this is the case when the bank card was transformed into a vector for loyalty-building services.

ICT impact goes beyond competitive positioning. It has changed the nature of financial markets and financial transactions. These have been dematerialised: what is being exchanged between financial institutions are digital representations of underlying instruments and positions. The dematerialisation has been relatively greater in the wholesale banking and financial markets, where it had two major consequences:

- an explosive growth of transactions, requiring greater processing power

- a proliferation and greater complexity of new instruments, requiring sophisticated analytical tools and approaches to develop and manage new instruments.

Last but not the least, ICT in financial services profoundly influences public policy, in particular the nature of money and monetary systems. By blurring distinctions between various category of money and financial accounts (checking, saving, investment), ICT has made more difficult the conduct of monetary policy and the supervision of financial institutions.

Three approaches

Financial institutions’ approaches to ICT can be classified into three broad categories:

· Tactical approach

- Technology is seen primarily as a cost reduction tool

- Preference for cooperative solution

- Selective ICT investments

· Strategic approach

- Fascination with technology

- Emphasis on proprietary solutions

- Stop-and-go investment approach

· Metastrategic approach

- Intimate understanding of technology

- Integrating proprietary and co-operative solutions

- Continuing ICT investment

Most financial institutions adopt tactical approach. Strategic approach is adopted by large-scale institutions, with necessary resources to sustain. Very few financial institutions were able to develop the meta-strategic approach, which seek to weave ICT into the core strategy.

Duality: individual and co-operative systems

ICT in financial services has a dual character. On the one hand, there are systems used by individual financial institutions. On the other hand, there co-operative systems, whose development and operations are shared by several financial institutions. These systems manage functions which ensure the integrity of financial transactions, their correct execution and settlement. They include:

· Payment infrastructure

ž Clearing and settlement

· Payment services

ž Debit and credit cards

ž Automated Teller Machines

· Financial markets

ž Trading

ž Settlement/clearing

ž Custody

Co-operative systems are numerous and varied. They differ in their scope, their coverage, their access conditions and their mode of operations. Some systems are highly visible and accessible to all customers, whether retail or wholesale. This is the case of ATMs or credit card terminals. Table 1 below shows the deployment of such systems within 6 major European countries and, for comparative purposes, their deployment in the USA and in Japan. The table shows a very wide dispersion of use pattern, even in neighbouring countries with similar standards of living. It points to considerable differences in the way households approach and consume financial services.

Table 1

ICT Retail Co-operative Systems

source: BIS

Other co-operative systems are more selective and oriented toward large corporate or institutional customers. Still others are restricted to financial institutions only. An example of such restricted system is the TARGET system, designed to process cross-border Euro transactions starting on January 1, 1999. The diagram 3 below shows the overall structure of TARGET.

Diagram 3

TARGET Payment System

Source: EMI

Various co-operative systems are not independent, they are often interconnected and interact intensively with each other. On the other hand, they are rarely developed as part of an overall and co-ordinated scheme. More often than not, they are created on ad hoc basis in response to specific requirements. This accounts for their institutional and functional complexity, as demonstrated by Diagram 4 showing the overall architecture of the two main US equity markets, New York Stock Exchange and NASDAQ. This architecture is particularly interesting because it shows how two entities, which on the one hand compete intensely for their main business of listings and transactions, on the other hand, co-operate closely in both front-office (price dissemination) and back-office (clearing and custody).

Diagram 4

US Equity Markets Architecture

source: GEF

One of the major objectives of co-operative systems is to provide interoperability between various participants and financial services schemes. Interoperability has two aspects:

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