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Friday, 12th April 2024
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Realising the revolution Back  
OECD director William Witherell addresses why the share of e-finance remains a small portion of financial services.
No doubt the emergence of e-finance will provide great economic benefits: reduced costs, more efficient financial intermediation, increased competition, wider access to, and increases in the breadth and quality of, financial services. But with the internationalisation of our economies involving an increasing proportion of our enterprises and individuals, and with technological advances facilitating financial crime and other abuses that respect no national boundaries, policy makers, regulators and law enforcement officials will face important new challenges.

As governments seek to situate their economies to participate in and reap the benefits of the new, global economy and to manage the various problems that can arise, they are giving increased priority to combating financial crimes and abuse, including those facilitated by advances in communications and information technology. The reason why this issue is given prominence in recent Communiqu?s of the G8 and G10 and of the OECD is because such criminal activity is imposing incalculable costs to society. To give some impressionistic figures: money laundering, according to some estimates, probably amounts to several hundreds of billions of dollars a year; at least $100 billion a year flows into the bribery of foreign officials in the context of international commerce; some $50 billion in tax revenues are estimated to be lost annually to tax havens - approximately the equivalent of the world’s bilateral official development assistance (some $54billion).

E-finance revolution
The Internet has already gained a prominent role in many OECD member countries as one of the principal channels for financial institutions to communicate with the public, and to give existing clients access to information about their accounts. In addition to this, a large number of institutions and specialised operators offer product detection and price comparison online (notably the so-called ‘aggregators’). However, only a comparatively limited share of the contact between online financial institutions and the public results in transactions which would be characterised as e-finance in a strict sense. In our work we use the following definition: An e-finance transaction is a financial transaction conducted using the internet, or another open network platform, as the distribution channel. Moreover, since most institutions are unable to accept virtual signatures, e-finance has so far generally been limited to online value transactions subject to traditional contractual arrangements.

The differences in e-finance penetration among OECD member countries are striking. E-banking, for example, has gained significantly more acceptance in the Nordic countries than anywhere else (see diagram). More than a fourth of the entire population in Finland, Norway and Sweden do banking online. In some transition economy countries such as Poland and Slovakia the e-banking penetration is negligible, but some of the highly industrialised countries score little higher. At least five of the G10 countries had e-banking penetration rates below 5 per cent at end-2000. E-brokerage, on the other hand, is particularly developed in some of the most mature economies. There is a particularly high uptake of these services in North America, Sweden and, perhaps more surprisingly, in Korea. In the US online trading now accounts for 25-40 per cent of all stock trades.

The differences between segments of the financial industry are at least as significant as between countries. Recent estimates of internet usage in the conclusion of new business in selected financial services confirm that e-banking is one of the predominant forms of e-finance in most countries. Online acquisition of credit cards and mutual funds has gained ground in some countries together with bill payments and, of course, securities services. On the other hand, very few new mortgage and insurance contracts are traded via the Internet.

One of the main reasons for such differences is the issue of authentication: given that financial institutions need to verify the identity of an online client, e-finance lends itself more readily to sectors where one authentication is followed by a sequence of transactions. One-off transactions such as the purchase of insurance contracts and the obtaining of mortgage and other loans may greatly benefit from online information search, price discovery and, in some cases, loan application, but little is gained by moving the actual completion procedures online.

Evolution or revolution?
However, some caution is called for when interpreting these trends. While e-finance has become a very important, if not dominant, method of distribution for certain financial services in some countries, overall the current degree of acceptance and hence the share of e-finance in the total volume of financial services remains quite modest. Some conclude from this limited experience that the Internet is merely another distribution channel that will have only an evolutionary effect on financial markets. But it should be recognised that this channel is a profoundly different way of providing financial services that can lead to significant changes in business models, driving consolidation in some areas and fragmentation and increased competition in others. While the contribution of e-finance to reshaping the financial industry to date has been smaller than expected, this may change rapidly. Wholesale activities are already well advanced and are growing rapidly. With respect to retail activities, we are really in the early stages of development and customer acceptance, with more and more new applications and new providers, including non-financial entities, coming to the market. Trading systems are consolidating and going electronic and global. The trends already visible suggest to me that truly significant changes in the financial industry lie ahead.

To give one important example, continued increases in the usage of e-finance are expected to lead to a breakdown of the value chains in parts of the financial sector. In the field of online brokerage this process has already started, with specialised entities unbundling the traditional brokerage services. The advent of account aggregation, which allows individuals to obtain horizontally consolidated information about their financial accounts across several financial institutions as well as non-financial accounts, will almost certainly speed up the process, opening the road toward a commoditization of financial services and a (further) breakdown of the barriers between different parts of the financial sector. The uptake of account aggregation thus far is purely demand driven. Banks in the United States initially opposed this technique out of fear of losing control of proprietary data, but seeing consumers’ interest they are now embracing it. One fourth of e-banking clients in the US do account aggregation, and the client base is expected to increase explosively.

It is argued that e-finance clients will gradually transfer their client loyalty away from financial institutions and toward aggregators. The US banking community worries about the prospect of being reduced to sub-providers to aggregator sites. Thus, banks increasingly undertake aggregation on their own, and surveys indicate that most US banks expect to offer such services in less than two years. Aggregation is still in its infancy in Europe. It seems likely to grow in importance, although there are some important institutional obstacles. In particular, cross-border aggregation is technologically possible, but notoriously difficult due to national differences, for example between payment systems.

There could be considerable risks in connection with aggregation. For example, aggregation in real time makes it difficult to ensure that account information is up to date. If online lending picks up there will be an additional issue of credit risk. Some of the major players are non-financial portals; but liability for customers will remain the responsibility of financial institutions, notwithstanding that they may have lost control over the direct contact with clients.

Challenges for financial policy, regulation and law enforcement
The future course of this revolution and its many implications are, of course, difficult to predict. The rapid pace of developments adds to the uncertainty of market participants and to the concerns of policy makers, regulators and law enforcement officials. They may be faced with unanticipated stresses in financial markets. And more certainly, they will find that some familiar problems will be accentuated by the speed and in some cases trans-border and less regulated nature of e-finance, and the resulting changes in the financial industry. Some of these challenges are already discernible.

Money Laundering
The FATF is studying the vulnerabilities that the internet might offer for money laundering. Thus far its work indicates that ‘transactions performed by access to financial services through the internet do not appear to present specific risks for money laundering in and of themselves. Rather, it is three characteristics of the internet that together tend to aggravate certain ‘conventional’ money laundering risks: (1) the ease of access through the internet, (2) the depersonalisation of contact between the customer and the institution, and (3) the rapidity of electronic transactions.’

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