IMPACT OF INFORMATION TECHNOLOGY ON BANKINGBanking industry provides financial services to the customers such as accepting deposits grantingloans/advances providing facilities for transfer of funds, giving financial guarantees, providingforeign exchange facilities and other services. All these services are information-based with cashoperations forming the only physical process. The banks therefore process huge data in theirnormal operations to generate inforiilati6n to support their functions. The information requiredby banks need to be accurate and precise, secured and confidential, free from integrity errors andreliable and also ready available. As IT assures these features for data processing, the advent ofinformation technology has changed the way in which the data is processed. Therefore, almostall services provided by banks are influenced by information technology opening newopportunities as well as posing new threats before the banking industry. We shall attemptunderstanding this impact from basic functions of banking to the concept of money monetarypolicies of central bank.IMPACT ON TRANSACTION PROCESSING IN THE BANKHandling volume of transactions was first priority of the banks. The IT was therefore first usedfor transaction processing which required lot of manual records of transactions to be kept ,checks to be processed, interests to be calculated and funds to be transferred . The first stage ofcomputerization involved transaction processing and maintaining accurate accounts of all thetransactions. The first IT applications in banking, therefore, were ledger posting machines to postthe transactions. The clearing of checks issued by banks customers for settlement is anothertransaction intensive operation in Banking. Traditionally, it was done by manual sorting andexchanging of checks among the bankers. The automation of this work was another priorityapplication of IT in banking sector. The introduction of MICR (Magnetic Ink CharacterRecognition) check clearing for check sorting and settlement was introduced in the early monthsof 1950. The MICR check processing was done for clearing house operations, and involvedcomputers, magnetic encoders as wel1 as electromechanical reader sorters. These applicationswere recorded off line and processed in batch mode wherein the. transactions were entered afterthey were done at the counter. The phase started in 1950 and has been the first activity to betaken up for computerization. It continues to be an important application with banks increasinglyresorting to have data centers and data warehouses to store their data and even cross borderprocessing of their transactions to reduce the cost.RETAIL BANKING & ON-LINE SERVICE.After successful using IT for transaction processing arid accounting, the focus shifted toimproving customer service to its retail customers for their cash transactions. The focus was oninstantaneous processing of transactions, giving quick credit and quick delivery of customersfunds using on-line computer systems. These systems also improved the speed of transactionprocessing and built essential banking controls and checks in the computer systems.There were four generations of on line systems as under:a) 1965 -1970 : The focus during this time was on line balance checking and updation ofbalances with tellers at the counter accessing centralized computers.
b) 1970 -1980 : During this phase the banks developed applications for on-line specializedtransactions like foreign exchange and stock market transactions. During this time DistributedData Processing was introduced with data residing at different computers at different locations sothat customers could access their funds even from different locations.c) 1980-90 : Automation was done at the branch level with local processing and the banks hadthousands of online terminals. The transactions were also stored in Data centers havingDistributed Databases and these databases were interconnected to each other usingcommunication lines. The computer networks connected both local and long distances spreadcomputers in the banks. Decision support systems were developed during this period.d) 1990 onwards: This is the current phase during which the banks have developed networkswhich spread across the globe and also have provided computer based access to bankscustomers for their transactions. During this period, the banks have developed expert systemsfor quicker decision making and IT has become a strategic consideration in the planning process.The retail banking segment comprising all types of depositors and borrowers of the bank weretargeted for better service in terms of quicker cash delivery or transfer of funds, faster sanctionsof credit lines, improved reporting to customers for their transactions and accounting balances,etc. The IT applications in clearing houses have made it possible to execute bulk payments ofcorporate houses like interest or dividend payments. In developed countries, regular governmentpayments such as salary, pension or social security benefits are made through clearing houseswithout need for any paper instruments. This service known as Electronic Credit Clearing,credits the accounts of banks, which in turn credit to their customers. At the same time, routinecollection services like electricity bills, telephone bills could be executed through ElectronicDebit Clearing service.The banks in turn could reduce the cost of transaction processing for their retail banking,automation of routine and tedious activities like check handling, & clearing, execution ofstanding instructions. The speedy processing of customers details and transactions as well asappraisal of credit needs led to quicker credit sanctions. Further, the banks could also improvethe supervision of their loan assets by analyzing the transactions in their customers account withthe help of computers.IMPACT OF IT ON FUND TRANSFER AND SETTLEMENT MECHANISMHandling customers receipts and payments are an important service provided by banks.However, the transfer or receipt of funds for banks customers involves intense data processingand record keeping. There were many innovations in this area which have brought revolutionarychanges in the settlement mechanism by introduction of Electronic Fund Transfer (EFT) in thebanking industry. The developments in this regard can be traced to two district phases.
First Phase of EFT 1969 to 1984:During this period the banks introduced Automatic Teller-Machines (ATM) which was linked tobanks central computers over leased line or telephone line. The ATMs identify the customeridentity using magnetic coding on the cards supplied to customer and the password in the form ofPersonal Identification Number (PIN) keyed in by the customer, check the balance in hisaccount, dispense cash and update customers balance. There are other services rendered onATMs apart from cash dispensing. The ATMs quickly became popular as customers couldaccess their funds at their convenience and banks could recover their cost of opening branches toservice their customers.The introduction of credit cards and debit cards by banks began the era of plastic money whereinbanks would effecting payments on behalf of their customers who would in turn pay the banks.The use of credit cards became widespread in USA and Europe. Although initially the creditcards were not linked to computer systems, gradually the cards were provided with hardwareelements like magnetic stripes and memory chips for identification to the banks computersystems. Whereas credit cards check the validity of cards and allow credit to its customer forsettling the retail transactions, debit cards actually debit customers account for value oftransaction at the time of transaction. Another variation of cards is charged cards or smart cardswhich are magnetized or charged against payment and the payment is made through transfer ofmagnetic fields from one card to other card or machine.During this period, the banks developed private and co- operative interbank networks for securedfinancial messaging, such as Chemlink of Chemical bank. The co-operative society of Europeanand American banks namely the Society for Worldwide Interbank Financial Telecommunication(SWIFT) was formed in 1973 for developing a secured and reliable network for financialmessages. The network was made operational in 1976. The banks in United States of America(USA) formed an automatic clearing house called Clearing House Inter-bank Payment System(CHIPS) in 1970. During this phase the U.S. Federal Reserve Bank established electronicsettlement system called Fed wire for funds and securities settlement for institutions maintainingaccount with Federal Reserve Bank.EFT II 1985 onwards:During this current phase, the Banks have introduced new services like Electronic Fund, Transferat Point Of Sale (EFTPOS)" Electronic Fund Transfer through Automated Teller Machine acrossthe border, Electronic Data Interchange between different locations Using pre decided dataformats, etc., The advent of internet banking has introduced new retail payment instruments likee-cash, digi-cash, etc, These initiatives are still in their initial stages.The second stage of SWIFT network was introduced in 1990 and many other private networksfor trade settlement, securities transactions, funds transfer, etc. were also developed for bankingindustry, The CHAPS network (Clearing House Automated Payment System)in UK wasdeveloped on lines of CHIPS in USA. Banks sponsored Automated Clearing Houses (ACH)have, become common in the U.S. and the European countries.
A phenomenal growth in global foreign exchange transactions and cross border investmentoperations poses serious risks to the settlement systems all over the world. The central banks ofthe different countries have taken up net working projects for netting transactions for netsettlement as well as having a Real Time Gross Settlement Systems (RTGS) whereintransactions would be settled as Versus Payment (DVP) systems using Electronic PaymentNetworks are considered as most essential item of agenda before the central banks to controlsettlement risk arising out of accelerating growth in domestic as well as cross bordertransactions in money market, foreign exchange and securities markets. Impact of using IT inATMs, credit cards,-smart cards; EFTPOS, global ATM service have reduced the need forphysical cash for the banks customers thereby attempting to ushering an area of cashless,anytime society. The innovations in retail payments are continued by the banking industry andalso by non bank intermediaries like IT companies.WHOLESALE BANKINGThe IT enabled quick distribution of information on any issue of interest to the bankers. Thismeant that the banks could gather information about the short term and long term funds availablewith them at branches and various other offices. The high value transactions at the corporatelevel among the different financial institutions is known as wholesale banking which ischaracterized by low volume but high value of funds transacted, ever changing nature of marketand involvement of only the corporate participants like other banks, securities houses, financialinstitutions in the transactions. There are a variety of instruments traded in wholesale banking.These institutional transactions and their settlement are also referred to as financial markets.Very good telecommunication system and analytical tools from basic infrastructure for timelydecision making and speedy settlement of transactions of these transactions is the basicinfrastructure needed for the development of financial markets. IT, by its very nature, providesfor all these requirements. The versatility of IT solutions used for these operations decides thecompetitive edge of the bank in these operations. Further, as these are always high valuetransactions, the profitability of banks is decided by success or failure of banks in conductingthese operations. Some of the applications are discussed below:a) Maintenance of Statutory Reserves: As a statutory requirement, banks are required to maintaincertain part of their deposits in approved securities and certain part as cash with themselves andcentral banks. The banks need to take action well in time so that they do not keep excess fundsidle in cash form or invest in low yielding investments to meet statutory obligations. The speedyand accurate information on deposits, advances and cash positions is different branches of banksis needed for taking such decisions for which Information Technology is used.b) Money Market Operations The improved cash management makes it possible for banks toinvest excess funds in short term money market instruments like interbank deposits, treasurybills, overnight deposits, commercial papers, bills of exchange, etc. alternatively, banks can alsoborrow from other banks on a short term basis to meet its liquidity requirements. Such operationsneed intense As the market started growing, more instruments and more sophisticated ITapplications with better communication facilities are developed and continuously improvedupon.
c) Investment Operations : Besides investing in the government securities for statutory reservesdirectly, the banks can also invest their funds in other securities or stocks as part of theirinvestments. There is also a secondary market in government and other securities wherein bankscan purchase and sale securities as per their fund position. These investments are basically longterm in nature and prices are subject to various parameters like interest rate movement, liquidityin the market maturity period of the securities, risk perceptions about the securities, etc. Theinvestment officers in banks need quick, reliable information of prices, yields and impact ofchanges in interest rates on securities for speedy decision making. Variety of hybrid instrumentsin securities like Repos, Reverse Repos, securities lending are developed which serve as bridgebetween long term and short term investments. Such transactions require intense ITinfrastructure for analysis and simulation, trading, confirmation of trades and settlement throughclearing house and depositories. This support service is provided by specialized. It productsmarked by vendors who provide on-line news, rate movements, past data and also analyticaltools.EXTERNAL TRANSACTIONS OF THE BANKSThe international trade in commodities/services of bank’s customers requires banks to purchaseforeign currencies from the exporters for domestic currency and sale foreign currency toimporters against domestic currency. The transactions - known as foreign exchange transactions-are characterized by its unique settlement system of correspondent banking in which thesettlement is done in the respective countries by exchanging financial messages withcorrespondent banks in those countries. The exchange rate between two currencies is decided bynumerous, economic, and political factors in these countries as well as other countries,perceptions of the market participants as well as actions of major market players. Thus, theexchange rates are continuously changing. This creates arbitrage opportunities for trading inforeign currencies. The banks, ,therefore, need very versatile IT solutions giving instantaneousinformation on exchange rates, economic indicators, political events, past data on various factorsand ability to analyze the trends so as to take very fast decisions, At the same time banks need ITapplications which can allow instantaneous communication for trading and confirmation.Specialized agencies like Reuters provide these IT solutions which involve high speed datacommunication and reliable software applications.Similarly, the differences in interest rates and scope for economic development in differentcountries have created global investment opportunities for the global investors. Thesetransactions are similar to local investments discussed earlier but complex due to cross bordersettlement of funds, complex legal procedures and safe custody services required for effectingsettlement IT solutions are needed for collecting information, analyzing trends, contracting dealsand settlement. Again, specialized services like Knight Ridder, Telerate, and Bloomberg providethese IT solutions which are very complex involving high speed telecommunication and versatilesoftware packages.
The huge growth in foreign exchange and cross border investment transactions have posedserious problem for settlement and risk in settlement The volume and value of transactions doneall over the world far exceed the 1iquidity available in the clearing systems in the world andgeographical and legal factors further add to the systematic risk for settlement. This problemrequires development of IT, solutions like netting service, Real Time settlement, Delivery versuspayment, payment versus payment, linked settlement etc.IMPACT ON HUMAN RESOURCES, PRODUCTIVITY & SUPERVISIONThe growing use of IT in banking has altered the job content of the employees at all levels of thebank. The routine jobs of transaction processing have been increasingly automated thereby thecapability to process transaction has been enhanced. The time made available can be used moreeffectively for improved customer service, follow-up and devising strategies for individualcustomer. At the same time, the employees now require to acquire new skills in handling ITapplications and computers, change their work procedures and get ready for new situation. Theuse of IT has created demand for new skill set for various functions such as IT planning andmanagement, database administration, system designing, application development, qualityassurance & system testing, system audit, network administration, computer operations, etc. Thiswould alter the employees profile in the banks. There is need to develop human resources tohave new skills and work as Knowledge Workers. The ease with which the transactions can behandled and funds can be transferred has necessitated new regulations and security measureswhich need to be interned by employees so as to safeguard their interests as well as interest oftheir banks. The banks are increasingly threatened by risk of misuse of technology. The bankmanagement are required to adopt new techniques to manage their information assets and controlthe various risks using new risk control techniques for banking security in thecomputerized environment. There is increasing need for audit functions to be organized throughthe computer and also auditing the computer applications themselves. This in itself has creatednew challenge for the banking community as well as regulating authorities.ORGANISATIONAL EFFECTIVENESS AND NEW INNOVATIONSAs the IT has enabled improvement in the efficiency of bank operations, it has transformed thefunctioning of the banks and made them organisational1y mote effective.The networking of computers has relegated the geographical distances to the background and theconcept of branch banking itself has undergone a change. The customers can have access to theirfunds and avail other banking services anytime and anywhere across the world. As discussedearlier, banks can provide better service for fund transfer and collection service using on-lineservices, EFT solutions and clearing services. At the same time IT has also enabled banks toincorporate many control features on their operations such as financial limits, watchingcompliance to operational guidelines, exception handling and auditing, giving-statement ofaccounts to the customers etc. Thus, the role of IT has changed from assisting banks fortransaction processing to become a strategic infrastructure around which services of the bankcould be organized. Thus, IT has enabled the banks to concentrate on their innovation processwith transaction processing taken care of.
i) Better Customer Service: The banks can now analyze the pattern of transactions of anyindividual customer and analyze individuals savings pattern or credit requirements. Thiscustomer information service has led to a shift in the customer service from macro-bankingwherein banks promoted schemes for their customers to join to micro-banking where banksdesign products to suit individual customer’s needs. The banks could develop new services likeinvestment counseling and portfolio management for its customer. The banks could alsoundertake new activities like handling stock market transactions of their customer, arrangingcover for their customer in the form of forward transactions, swaps, futures and options, etc.New products were developed for the customers using the IT skills acquired by the banks.ii) Improved Management Information: The ready availability of management information hasimproved the decision making at the top management leading to improved risk management oftheir assets as well as matching of the assets and liabilities of the banks (Asset/Liabilitymanagement). The use of analytical tools and number crunching ability of computers enabled themanagement in building different What if…? scenarios, analyzing different trends and patternsand take more studied decisions. The present trend is towards introduction of expert systems toareas like credit sanction, planning and investment decisions. The use of Artificial NeuralNetwork for pattern recognition and learning through experience is also increasing amongbankers for wide ranging activities like identifying the sickness of the borrower accounts, frauddetection, audit of anomalous transactions, portfolio analysis, etc.iii) Improved Regulatory Compliance: The task of reporting to. the regulatory authorities likecentral banks, deposits insurance corporations, government authorities, etc has been made moresimple and effective as a result of adoption of IT thereby improving compliance to regulationsand resultant effectiveness of the organization. Off site monitoring through networks is beingadopted by the regulating authorities in different parts of the world using IT solutions.iv) Innovative Products: The banks have diversified their activities in other areas like insurance,mutual funds, factoring services, credit rating, housing finance, etc. Use of IT has therefore madebanks as more proactive by anticipating the problems and potentials and running their services totheir customer’s requirements.BANKS COST OF OPERATIONS AND REVENUEThe simplification of work procedures and automation of data processing enabled banks toincrease their business without additional cost towards transaction processing and manpower.This enabled banks to expand their business with available infrastructure thereby reducing thecost. The developments in telecommunication reduced the cost of communication and improvedmanagement of funds thereby increasing the revenue.As the cost of operations is reduced and revenue generation ability of the banks has increased,the customers of the banks are benefited as the banks could reduce the spread between fundsraised from its depositors and funds lent to its borrowers.The introduction of IT enabled value added services like cash management and treasury
operations, portfolio management, custodial services and risk control services to the customersincreased the revenue of the banks through non fund activities and increased the revenue of thebanks from sources other than lending. The improvement in profitability of banks help banks toshare it with depositors in form of better rates on deposits and borrowers with reduced rate ofinterest on advances. Also, with additional revenue at its disposal banks could invest more ininformation technology and develop new Value added products to their customers. In theprocess, the cost of introducing IT products has become major source of capital expenditure(around forty percent in USA and Europe). The cost of maintaining the IT services has becomemajor item of revenue expenditure (about 16 percent of total cost). The personnel and hardwaredepreciation forms major part of the cost to the bank. In view of this, the banks are underpressure not only to stay in competition with other banks but develop additional innovativeservices to maintain profitability of banks.M0NETRAY POLICIES, REGULATORY FUNCTIONS ETCIntroduction of new payment instruments such as smart cards, e-cash, digital cash haveintroduced new element in the concept of money. Traditionally, issue of currency is prerogativeof governments and central banks. Introduction of new cards like smart cards and electronicpurse cards means that the person owning smart cards carry a magnetized card with him whichcan be used as currency for settlement. At the time of making payment, the card would transferpart of its magnetic charge to the receiver’s card and in the process get demagnetized. After it isdemagnetized, the issuer of the card would refill the card for consideration. In other words,instead of currency note issued by the central banks, such magnetized cards would be used asmoney. The concept of credit would also undergo a change since these cards can be used ascredits by one owner to another owner and the interest component would be in the form ofadditional magnetic fields. Although these issues would be important for central banks, as ontoday, these payment instruments are negligible as compared to traditional instruments. Theregulations relating to banking services like negotiable instruments act, books of evidence actwould need redefinition and new regulations for electronic funds transfer, issuance of chargedcards etc. may be needed. The stability of the information systems based on IT would become animportant parameter while deciding the soundness of the banking operations. Central bankswould have to redefine their regulatory functions like inspections and monetary policies in lightof IT products and new delivery mechanisms introduced by the banks.