Geofinance, eurofinance and cyberfinance

In the past twenty-five years, financial services have undergone deep and extensive changes in all aspects of their business: products, delivery channels, market structure and regulatory oversight.

·        Products: Financial products have become more varied and more complex. The product cycle has been accelerated: products are conceived, deployed and made obsolete much more quickly than before.  They have become more liquid and tradable, as financial institutions seek to externalise and share their risks.

·          Delivery channels: Delivery channels have proliferated in order to enable customers remote and permanent access: ATMs, telephone banking, on-line banking, Internet banking, etc. Contrary to early expectations, new channels have reinforced rather than cannibalised the existing ones and have not fundamentally changed the market shares allocation as all major financial institutions were quick to adopt a multi-channel strategy.

·          Market structure: Boundaries between different categories of financial services become blurred. Banking, insurance and capital markets firms are invading each other’s turf and competing aggressively. Market structure is becoming more fluid and unstable. Established hierarchies can no longer be taken for granted. Deregulation has attracted many newcomers: retailers, industrial companies, telecom operators.  New entrants achieved significant inroads in a number of segments, particularly in the US. Yet, banks have demonstrated a remarkable resilience. In continental Europe, they successfully invaded life insurance and securities brokerage.

·          Regulatory oversight: Boundaries between various financial services activities are no longer rigid. Geographical restrictions to entry have been considerably reduced. The increased risk level has led regulators to monitor international banking activities on a consolidated basis. Specific steps have been taken to better track positions in derivatives instruments.

There were nevertheless significant differences in the rate and scope of change between various segments of financial services:

Globalisation has been particularly pronounced in wholesale banking and over-the counter financial markets such as foreign exchange. Corporate lending and investment banking are dominated by few global players, active in all markets, established or emergent. On the other hand, globalisation appears to have affected relatively less the retail banking, which remains largely fragmented and localised. This pattern of transformation of financial services, created by interactions between globalisation, information technology and deregulation,  can be called “geofinance”.

The pace and reach of change are actually likely to accelerate in the near future. In particular, European banking and financial markets are on the verge of a large-scale upheaval under a combined impact of euro and Internet, the emergence of eurofinance and cyberfinance.

·          Eurofinance: the creation of a common currency has set up a foundation for a very large integrated financial services market for 300 million people. Such market is already being built as evidenced by the explosion of activities in euro-denominated capital market instruments. Cross-border equity trading has also grown significantly.

·          Cyberfinance: Both Internet banking and brokerage are developing rapidly and Internet technologies are penetrating all aspects of business operations. Cyberfinance associates closely traditional banking financial institutions and technology providers. The latter are in position to either marginalize or disintermediate financial institutions.
Furthermore, numerous efforts are being carried out to design and implement Internet-based payment systems. Some of those systems, according to their proponents, have a revolutionary potential and can trigger the emergence of alternative monetary systems, which would be outside the reach of the existing banking structure and its regulators.

Europe is significantly overbanked and the need for consolidation in the retail banking sector has been widely acknowledged. However, until late 1990s, the pace of mergers and acquisitions in European banking has been rather lethargic. Since 1998 and even more since the official euro launch, the speed of consolidation has accelerated and is likely to further step up. The value of merger and acquisitions in financial sector has increased from 41 billion euros in 1997 to 174,5 billion in 1999.

In retail financial services, the consolidation remains primarily national, most banks and national authorities following the model of a “national champion” and giving priorities to the strengthening of their home base. Cross-borders mergers remain scarce and they primarily affect neighbouring countries (Benelux or Scandinavia): the “national champion” model is evolving toward the regional leader. It remains to be seen whether the takeover of Credit Commercial de France by HBSC constitutes a first sign of major wave of global alliances or an isolated case.

While the consolidation spotlight is on financial institutions, the success of euro-based financial services depends crucially on closer integration of the underlying infrastructure of payment systems and services. This infrastructure, while highly sophisticated, has been designed for national markets and treats crossborder transactions as marginal.  Its structure  is complex and hierarchical, with various systems for various payment categories (check/card, retail/wholesale). Those systems are interconnected by common membership and interoperability agreements but the degree of interconnection varies considerably.

This double fragmentation, national and functional, results in higher transaction costs and lower efficiency of crossborder retail payments and securities settlements. It also entails a proliferation of incompatible standards. To take just one example, while there are at present close to 100 million smart cards issued by financial institutions, they are splintered into over 20 incompatible schemes, both from the technical and the business viewpoints. Attempts to achieve interoperability have been laborious and, so far, met with limited success.

Thus the consolidation of financial institutions need to be accompanied by a consolidation of underlying financial transactions and processing systems.

Internet : Digital Tornado

Internet is considerably more than a networking protocol and set of communications standards. It is a broad environment, which encompasses both technical and business architectures. It leads to an ultimate blurring of boundaries between processing and communications Not only, as Sun affirms, “Network is the computer” but the converse is true is well: “Computer becomes the network.”  Today, use of Internet is synonymous with logging on the personal computer, but as all-encompassing communication set of protocols, Internet will also be embedded in voice communications and in video transmission. Internet makes multimedia a reality.

There is no Internet hype: forecasts on the speed and the extent of adoption of Internet-related technologies (Java) and applications (electronic commerce), as wildly optimistic they might have seemed at the time of their publication, are lagging behind the actual market development.  Internet will have a broader, deeper and more destabilising impact on both Information Technology and business sector than the personal computer (of which Internet is a logical extension). In a nutshell, Internet means:

·        Ubiquitous computing. The range of intelligent access and processing devices will continue to expand well beyond personal computers towards various forms of information appliances.

·        Ubiquitous networking. Internet is likely to accelerate the trend to lower communication costs and, more importantly, force network operators to pass cost savings to consumers.

·        Ubiquitous programming. Object technology and Internet carry the promise of democratisation of software application development process.

Computing and networking are increasingly mobile and this trend is likely to continue. It will be further stimulated by two technologies: wireless communications and smart cards. Both those technologies experience explosive growth, which is comparable to that of Internet.

Impact on financial services

Cyberfinance amplifies the trend toward dematerialisation and virtualisation.  The range of virtual channels will continue to expand: in addition to PC-based banking, mobile banking is likely to be deployed on a large-scale in Europe. More importantly, Internet will become the architectural core of all distribution channels, whether physical or virtual. Banks will need to move from a multi-channel to cross-channel distribution strategy.

Cyberfinance will also affect the transaction and payment infrastructure. Internet model dissociates the network from physical infrastructure. By providing common standards, it allows interconnection between heterogeneous networks. Furthermore, with encryption technology, digital certificates and smart cards, it is now possible to use security in a modular and flexible fashion.  A highly secure environment can be created on the public networks. To what extent these developments change the prevailing approaches to payment and transaction processing networks, based on dedicated infrastructure and proprietary protocols ? What are the implications for their architecture ? For their access and control policies ?

Does cyberfinance portends a banalisation of financial services ? Does it reduce barriers to entry to a point where any network can become a market, any computer a clearing system and anybody can issue electronic money ? In the new environment, what is the meaning of: financial transaction, financial intermediary (bank, broker, broker/dealer) and money ?

Imaginary and real gap

There is a widespread perception that the European Union is lagging behind the US in the deployment of cyberfinance. This perception should be qualified. European banks do not lag behind the US banks in the deployment of Internet banking, quite to the contrary. Banks such as Merita Nordbanken, Deutsche Bank or Barclays have more clients and offer a greater range of services than their US counterparts. Europe also leads in the development of pure Internet banks such as Egg in the UK, which boast 940 000 clients at the end of 1999 or e-bank or unofirst, the world's first global Internet banking group, valued in early 2000 at 2.4 billion euros.

The situation is quite different in Internet securities trading. In the US, Internet-based trades represent 20% of the total and their share is increasing. Industry structure has undergone a dramatic change: Internet brokers such as Charles Schwab and E-trade became a major market force. In Europe, Internet securities trading remains a largely marginal phenomenon.  Very few Internet brokers have attracted more than 100 000 clients and in countries such as UK or France, market leaders have less than 50 000 clients. No Internet-based alternative trading system has been created. Many senior technologists within the exchanges and large financial institutions look at Internet with a mix of doubt and loathing and are not ready to endorse it as a foundation of new architecture.

This lag is worrisome. While Internet banking is progressing rapidly, Internet securities trading shows a truly explosive growth. The former is still a relatively marginal phenomenon, affecting less than 5% of banking transactions, the latter already has a major impact on the overall equity business.

The combined impact of eurofinance and cyberfinance present European financial institutions with three major technology challenges :

From payment infrastructure to trust infrastructure

From national to European infrastructure

From centralised to distributed to ubiquitous computing/networking architecture .

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