ELECTRONIC FINANCE CHAPTER 1 INTRODUCTION to EFINANCE Efinance

ELECTRONIC FINANCE CHAPTER 1 INTRODUCTION to E-FINANCE E-finance: Status, Innovations, Resources and Future Challenges, Manuchehr Shahrokhi, California Managerial Finance 2008 Vol. 34, Issue , Pages 365 -398 E-Finance: An introduction, Franklin Allen, James Mc. Andrews, Philip Strahan 01 -36 1

SERVICES BANKS HAVE OFFERED THROUGHOUT HISTORY ØCURRENCY EXCHANGE ØMAKING BUSINESS LOANS ØOFFERING SAVINGS DEPOSITS ØCERTIFICATION OF VALUE ØSUPPORTING GOVERNMENT ACTIVITIES WITH CREDIT ØOFFERING CHECKING ACCOUNTS (DEMAND DEPOSITS) ØOFFERING TRUST SERVICES 2

E-FINANCE ØElectronic Finance transaction is a financial transaction that depends on the internet or a similar network to which households or non-financial enterprises have access to bank. ØGlobal integration and deregulation are dramatically changing the structure and nature of financial services. World Bank study in 2000: E-finance has great potential to improve the quality and scope of financial services and expand opportunities for covering trading risks and can widen access to financial services for a much greater set of retail and commercial clients by offering more cost effective services 3

Key Drivers of Evolution of E-finance 1 -Technology: Computer, Internet and Telecommunication Technologies enabled businesses to be conducted in a fast, efficient and secure way. 2 -Globalization: Worldwide liberalization of trade and investment facilitated the growth of global business including the Internet based e-business and e-finance. 3 -Regulations: Both deregulations of the finance industry and re -regulations of e-commerce facilitated the growth though in some areas lacking behind technology. 4

Key Drivers of Evolution of E-finance (Cont. ) 4 -Entrepreneurship: Creativity allowed entrepreneurs, startups and seasoned companies to break ‘old economy’ traditions and deliver business solutions through new, exciting and often radically different structures. 5 -Capital: Capital provided the financial means to put these technical and human wheels in motion. 6 -Competition: The above factors created a globally competitive environment and pool of talents to compete for introducing new technologies, concepts, and models. 5

Difficulties in transition Ø Could lead to significant losses Ø Adopting a new way of life Ø Whole range of policy issues should be rechecked Ex: Future of branches, marketing of services Ø Large organizations are very often reluctant to undertake radical innovation. Ø They are generally blindsided by technological changes that alter their existing markets, procedures and systems of work. 6

STRATEGIC RATIONALE Why an organization should launch E-banking? Ø To protect and enhance the organization`s reputation for innovation Ø Added value for customers Ø Means for attracting customers Ø Actions taken by competitors Ø Potential to develop customized services 7

Internet substitute for traditional transactions 1 -Online Banking: It includes automatic payroll deposit, automatic bill payment and transfer funds from one account to another, viewing account status and transaction history. 2 -Purchasing by credit card: In these transaction credit card numbers are sent via internet from buyer to the seller 3 -Brokerage transactions: These transactions substitute the internet for the telephone or in person transaction. 4 -Investment research: Investors may perform research into companies whose shares they are considering for purchase or sale, future contracts or other derivatives. 5 -Filling of company reports and tax returns: Companies can file required reports with government agencies via internet. 8

E-FINANCE MODELS § The E-Finance sector can be divided into five broad categories: 1 -Business to business (B 2 B) 2 -Business to Consumer (B 2 C) 3 -Consumer to consumer (C 2 C) 4 -Technical infrastructure to support the e-Finance platform 5 -Global, institutional and regulatory environment that facilitate the functioning and growth of e-commerce and e-finance 9

E-FINANCE MODELS (CONT. ) 1 -Business to business (B 2 B): Internet platforms created by institutions to serve other institutions. Ø In B 2 B sector, businesses supply information, goods and services to other businesses and develop business related exchanges to serve other businesses. Ø B 2 B business exchanges bring together companies from identical (vertical) or different (horizontal) industries. 10

Trends in the B 2 B Financial Service Sector A-Reduced Transaction Costs B-Disintermediation and Electronic Re-intermediation C-Customized Solutions and Integrated Services D- Electronic Trading E- Electronic Funding – Venture Capital – IPOs 11

E-FINANCE MODELS (CONT. ) 2 -Business to Consumer (B 2 C): Retailing of goods and services directly to individual customers. Ø In B 2 C, business supply information, goods and services to individuals; they can purchase the goods directly from B 2 C platform. Ø Most established segment of E-commerce 12

Trends in B 2 C Financial Service Sector A-Customer-centered retailing B-Online Trading C- E-Banking - Online Banking D- Personal Finance/Wealth Management E- Insurance and Annuities 13

E-FINANCE MODELS (CONT. ) 3 -Consumer to consumer (C 2 C): Individuals using the web for private sales or exchange. Ø It is a small but emerging sector, is designed to let customers deal directly with one another through mechanisms such as electronic auctions. Trends in B 2 C Financial Service Sector: Ø A-Online Trading Ø B- Trading Circles 14

Adoption of E-finance by the financial service firms Ø This section is talking about how different types of financial service firms, depository institutions and security companies have deployed e-finance technologies. Financial Intermediaries: Ø Banks, insurance companies, mutual funds, finance companies and similar financial service providers are financial intermediaries. Ø Disintermediation? Ø Reintermediation (information providing companies) 15

Adoption of E-finance by the financial service firms Ø By the end of 1990 s, e-finance technologies affected all aspects of the business of banking and financial intermediation. Depository institutions have used electronic information technologies, for example, to make credit decisions to consumers since 1980 s. Ex: Credit Scoring: used by financial institutions to evaluate the loan applications received from the customers. Ø Handle large volume of credit applications quickly with minimal labor, thus reducing operating cost. 16

Adoption of E-finance by the financial service firms Ø The bank communicates with its small business borrower in person rather than with the phone or mail has declined from 59% in 1973 to 36% in 1993. Moreover, the average geographical distance from a bank to its small business borrower has increased from 16 miles during 1973 -1979 period to 68 miles during 1990 -93 period. Ø Transaction cost for a non cash payment is 1. 80$ for a branch, 54 cents for a telephone bank and 13 cents for an internet bank. 17

Adoption of E-finance by the financial service firms Insurance: The security underwriting business, the insurance industry has not adopted e-finance technologies largely yet. In 1999 12% of the US insurers used the internet to sell products amounting to 1% of total sales. Security Firms: How securities are issued? Ø Investment banks Ø Private placement Ø Initial Public Offering (IPOs) 18

Adoption of E-finance by the financial service firms • “Book Building” is a process by which investment banks assess the demand for a security issuance from a small number of well-connected institutional investors before finalizing the terms of the offering. • By lowering the search and information costs, however, e -finance technologies may reduce the comparative advantage of the relationship-based approach relative to a more arm’s length process, such as an online auction. • N ASDAQ 19

ORGANIZATIONS FACILITATING E-FINANCE 1 -Society for Worldwide Interbank Financial Telecommunication (SWIFT) SWIFT provides financial data communication and processing services to support the business activities of worldwide financial institutions for securities, payments, foreign exchange and money markets, as well as trade finance. SWIFT is designed for: Ø Eliminating the need for paper-based processes in the financial markets, Ø Lowering costs, Ø Increasing productivity, Ø Reducing cost in the financial service industry 20

ORGANIZATIONS FACILITATING E-FINANCE 2 - Automated Clearing House (ACH) Ø Ø Ø The ACH Network is a highly reliable and efficient nationwide batch-oriented electronic funds transfer system. ACH payments include: Direct Deposit of payroll, Social Security and other government benefits, and tax refunds; Direct Payment of consumer bills: mortgages, loans, utility bills and insurance premiums; Business-to-business payments; E-checks; E-commerce payments; Federal, state and local tax payments 21

ORGANIZATIONS FACILITATING E-FINANCE 3 -Online Trading Community Online trading communities exist to provide a structured method for trading, bartering, or selling goods or services. These communities often have forums and chartrooms designed to facilitate communication between the members. 22

ORGANIZATIONS FACILITATING E-FINANCE 3 -Online Trading Community These can be further divided into two parts: A. Formal Trading Communities are business run web sites maintained for the purpose of facilitating trades between members. Some of these charge a fee for each successful transaction. B. Informal Trading Communities are lesser-known sites known that specialize in a multitude of services including community trading. Examples include, 1 UP, Craig's List, IGN. 23

ORGANIZATIONS FACILITATING E-FINANCE 4 - E-Money allows payments (including P 2 P payments) without involvement of a third party during the payment transaction. • There are two main types of e-money: A. E-cash: including electronic purses and multi-purpose stored value smart cards and B. Cyber Money (Network Money) which are prepaid software products used for payments or transfers on cyberspace. 24

ORGANIZATIONS FACILITATING E-FINANCE 5 - Price Comparison Service On the internet, a price comparison service allows individuals to see lists of prices for specific products. Most price comparison services do not sell products themselves, but source prices from retailers from whom users can buy. Ex: Streetprices 6 - Value Proposition Give reasons why customers choose that firm and not other firms. 25

ORGANIZATIONS FACILITATING E-FINANCE 7 - Online Auction Business Model • The online auction business model is one in which participants bid for products and services over the Internet. • The strategic advantages of this business model include fewer time constraints, no geographical constraints, pressure of intense social interaction through large numbers of bidders and sellers, network economies, and the ability to capture consumers’ surplus. 26

ORGANIZATIONS FACILITATING E-FINANCE 8 - M-Finance: Mobile Banking Mobile banking (also known as M-Banking) is a term used for performing balance checks, account transactions, or payments via a mobile device such as a mobile phone. Ø In USA, customers mostly prefer E-banking. Ø In Japan, they prefer M-banking. 27

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