by JIM PHILIPS
Notions of banking and finance have gradually changed over the past decade at the personal level, with the increasing spread of personal computers, personal finance software, and online services. Technological advances however have been hindered by administrative inertia in most traditional banks and the lack of accepted national and international policies for the management of digital cash. The radical efficiencies of virtual banking, in the absence of paper records, files, and documents, mean that financial services at both the institutional and personal level will change remarkably in the very near future.
Introduction
Money is Information
A Brief History of Digital Finance
Virtual Banks
Future Monies
Current Problems
Conclusion
Notes
In the not too distant past, money was identified with something solid, substantial, physical such as fine paper or precious metal. You could stuff your pockets with this stuff called money and carry it around, but that was risky. It was best to store it in a safe place until you actually needed to spend it. The problem with storage for many centuries was that money didn't actually do anything until it circulated. Value - real or imagined - and circulation are intimately tied together, and vital to the meaning of money.Money then is more than fragments of metal or ornate and colored sheets of paper. What is it, then? Money is a unit of value backed by a publicly recognized authority, usually a national government. However, money and coupons can be issued by smaller government entities and corporations of varying sizes and reputations. Banks can be their own authority in the case of cashier's checks and other instruments. And then there are three other notable exceptions to governments: American Express, Visa and MasterCard. These entities issue traveler's checks but for many it is their authorization that works as well as any physical bill or coin. For consumers and merchants, these agencies mean that there is no need to deal with physical objects other than a modem and a magnetic strip on the back of a small rectangle of plastic.
The concept of a traveler's check helped to refine further the concept of money. A traveler's check is just a piece of paper, but behind it stands an obligation to pay "real" money - as defined by a government or equivalent authority - whenever the bearer of the check demands it. A checking account is similar: an obligation to pay "real" money whenever the account holder demands it. In the lingo of the banking industry, a checking account is known as a "demand deposit account" in recognition of this obligation. Banking is based on the understanding that not all of the depositors will demand all of their money at one time. Runs on banks are fortunately rare. Banks are required to keep minimum reserves in cash to meet regular withdrawal demands, but most of the money that technically belongs in a bank in actuality circulates in one way or another.
What does all of this have to do with computerized banking? Ideas about money have evolved until we now are finally beginning to understand that money is just information. Of course, money is an obligation to pay or to deliver goods and services, but if data on specific obligations comes from trusted and publicly recognized sources, transactions will proceed on the basis of information alone. As the global information infrastructure grows, it is inevitable that this same infrastructure will move money in some form and exchange it for goods and services. This evolution has already happened in a limited way on private networks, but the Internet is already accelerating developments in new and secure ways. In August 1995, the accounting firm of Deloitte-Touche conducted a survey among the top banking executives of the United States to see how they thought online banking would impact their business [ 1 ]. Those executives concluded that in ten years fifty percent of the bank branches in the United States would close. Why? These branches are used to store mounds of notes and coins in heavy, secured vaults so it could be readily dispensed to merchants and everyday account holders. Those branches, and the employees that work in them, are one of the biggest expenses in running a bank. What happens to those branches if money is really defined as just information? The answer is obvious. The next question is how?
Electronic banking is not one technology, but an attempt to merge several different technologies. Each of these evolved in different ways, but in recent years different groups and industries have recognized the importance of working together. Bankers now see a kind of revolution going on now in their business in part because we have taken a quantum leap in the use of technologies in the last several years.The first step toward electronic banking was the automated teller machine or ATM. Even though ATMs are thirty years old, it will continue to grow as a vehicle in changing the way individuals bank. With ATMs, banks no longer are restricted to just one location, but multiple services points around the world. ATMs haven't caused the death of the local branches. In fact, there are even more branches now than there were at the birth of the first ATM in Ohio. It has meant, however, that there are fewer tellers at each real branch of a bank.
Diebold, one of the major manufacturers of ATMs, sees ATMs evolving into virtual branches [ 2 ]. With future ATMs, customers will interact with tellers through video-conferencing in virtual settings. These expanded ATMs will include expanded functions to provide a greater range of remote transactions from any location.
The next serious step toward electronic banking, after the acceptance of ATMs, came with personal finance software. The best known program in this category is Quicken from Intuit [ 3 ]. This gave many who were serious about money an easy way to track what was happening to it. Scott Cook, CEO of Intuit, designed his program initially in 1983 around the way people were used to handling their money and extended it with a wish list of what they hoped that they could do with their finances. Other programs like Meca's Managing Your Money have followed the lead of Quicken. The standard features of these programs include a smart register that reconciles itself, budgeting options, and "bill minders" that let you know when a debt should be paid.
Electronic bill payment is one of the key components of electronic banking and, in my view, it is the holy grail of electronic banking. Most of the credit for the rise of electronic bill payment goes to CheckFree Corporation. CheckFree's founder, Pete Kight, began the company in 1981 as a way to make payment of health club dues more efficient [ 4 ]. Payments went to one centralized payment center (small at that time) that then turned over the payments to the club in one lump sum with a list of what accounts received. CheckFree has grown to cover over one million merchants in the United States and is the largest company of its kind at the moment. Today, most of their customers set up bills through proprietary CheckFree software. CheckFree sends drafts, in most cases, to the merchant and the customer's local bank account is debited when the draft is presented and cashed by the merchant.
What we know at the moment as "online banking" is some combination of the features of a personal finance program combined with electronic bill payment. It operates through a dial-up connection to the bank. While you are online, you send your bill payments and receive your latest cleared transactions from the bank's mainframe system. Users of personal finance programs love the continuity this gives them, because nearly all of the "online banks" work with one or all of the popular personal finance programs. The program communicates directly with the bank's system. All of the records that an individual has stored for years are still on their hard drive in one continuous set. This interactivity means that the bank has a licensing arrangement with one, or several, vendors of personal finance software.
A natural spin-off of online banking is Internet banking. Security First Network Bank was the first bank to put fully transactional accounts on the Internet [ 5 ]. Other banks, most notably Wells Fargo, are moving forward quickly in this area [ 6 ]. Intuit, creator of Quicken, most recently announced OpenExchange, a way for individuals, businesses, and banks to take advantage of the Internet for financial services [ 7 ]. The Internet is by far the most efficient means of delivering financial information, but security concerns have caused most banks to move slowly in this area. Security First's model of Internet banking works a lot like Quicken, but doesn't require the user to have any special software beyond a compatible browser and a connection to the Internet. Mobile and displaced people are quick to see advantages in Internet banking. For a long time, they have been able to get cash from ATMs wherever they might be, but they could not pay bills back home easily. If you bank on the Internet, you can pay your local phone bill just as easily from Kuala Lumpur as you can from San Francisco.In the buildup to the Olympics in my city of Atlanta, many of the major banks promoted the use of cash cards [ 8 ]. "Change is in the chip" is the advertising slogan. The strategy called for the card readers at fast food restaurants, movie theaters and other places where large numbers of people typically offer small amounts of cash to pay for services and goods. Card recharging machines appeared in many places that once housed ATMs. These devices debited your account and moved money into the chip on the cash card. The cards reduced the need by banks to provide service to customers who withdrew cash for immediate needs. It also cut down enormously the amount of cash receipts that merchants had to transfer to the bank at the end of a business day.
The most tantalizing - and difficult - technology to come along is digital cash. The leader in this area is Digicash [ 9 ]. If you have your money stored in Digicash software, you actually have are a series of "coins" that are "signed" by a bank as an indication of validity. Once a coin passes from a customer to a Digicash merchant, it is marked as spent and cannot be passed again by the customer. The difficult part of this equation requires that there has to be a Digicash bank setting up Digicash merchants for customers with Digicash accounts. This three-way compatibility requirement puts a serious limit on the number of people using the technology. My own experience in electronic banking tells me that each new requirement you put on the customer will dramatically limit your pool of customers. There are only a few Digicash banks around the world so far.The tantalizing aspect is the privacy that Digicash offers. Once your Digicash coins are passed to the merchant, all traces of there origin - apart from the bank's signature of validity - are erased. In this respect, they resemble hard cash spent out on the street. This market is evolving quickly as Digicash now has a potentially challenging competitor in Cybank, an Australian digital cash firm [ 10 ].
Bankers and others see the potential for all of these technologies to converge and create a genuine revolution of electronic commerce [ 11 ]. The part that is a little frightening to bankers and to most governments is that the definition of a bank may be blurred beyond recognition from the changes wrought by these new technologies. In the United States, banks operate under tight regulatory restrictions. Many of these grew out of the experience of the Great Depression. Some others grew out of the new consumer awareness that emerged in the US in the 1960s. However American bankers may feel about these regulations, they do serve to protect the consumer from disasters and abusive practices. Federal regulators in the U. S. are still trying to work out the responsibilities of all involved parties, including software firms and bill payment processors. Practically none of the existing laws, related to banks, took in consideration these new relationships. So far, these regulators have tried to walk the line between developing new procedures for electronic banking without strangling and discouraging opportunities. Nevertheless, there will be some major battles in the courts and the legislatures on these issues.
While we really may be in for a financial revolution, there are some serious changes that will have to take place before electronic banking really moves forward. For example, in the United States, you can withdraw money from any ATM that your bank communicates with, but when it comes to making a deposit, the story is different. There is no system for clearing deposits from bank to bank yet in the United States, whether you walk into a bank where you have no account or you use a given ATM. While this practice obviously needs to change if electronic banking is to become the norm, I have not heard of any serious proposal toward a system that would allow for inter-bank clearing of deposits. There are services such as the Automated Clearing House or wire transfer to deposit money into a distant account, but both of these methods imply having two accounts: one to send from and one to send to [ 12 ]. Many banking consumers are not ready to bother with these services.Another brake on the advance of electronic banking is the relatively small number of merchants who accept electronic payments. CheckFree has broader reach than anyone else in the electronic bill payment business, but only 10% of their merchants are being paid electronically. Right now, there are efforts to convert as many utility companies as possible to electronic payment. Converting merchants is going to be hard work, because so many of them have built all of their processes around mailed checks and processing stubs - pieces of paper. A true electronic process would probably increase their efficiency and their cash flow many times over but old habits die hard.
In most places, the only legally valid documents are on pieces of paper that include hand-written signatures. So, an electronic bank that can carry out most transactions over the Internet or over a modem connection ends up waiting on a piece of paper to be faxed or mailed before they can act, in many instances. Several state legislatures in the United States are working toward granting legal validity to digital signatures; the National Institute of Standards and Technology (NIST) accepted the Digital Signature Standard (DSS) in 1994 [ 13 ]. With digital signatures legally accepted, the next task will be to standardize around a reliable and easy-to-use program for the digital signing of documents. One example of a system is already available from Verisign, which can be loaded into your copy of Netscape, version 3.0, and automatically sent to a Web site that requests proof of identity [ 14 ]. It still isn't clear to me, though, how this will work for mobile computer users who may be thousands of miles from home and using someone else's computer. A truly useful digital signature would have to be as portable as a pen.
Another limit on the horizon is that banks have often not been on the leading edge in their use of computers. Most small banks only make use of dumb terminals connected to mainframes that are often hundreds of miles away. Moving from this situation to doing business on the Internet is a big step. I recently talked with a banker who did not understand clearly how banks would interact with their customers over the Internet. I laid out a basic strategy for her, explaining the links from help desk software to e-mail programs, and so on. She was puzzled and remarked that she could not understand how her IS department was going to fit all of that into their existing computer systems. She did not have access to electronic mail in her office even though she was an executive and her bank is one of the largest and most prosperous in the United States.
The number of computer owners around the United States is still relatively small. Banking is a consumer product, and it will require lots of customers with computers and some kind of access to the Internet to force changes in procedures. This problem will probably find its resolution, though, not in the spread of computers as we know them now, but in the spread of alternative delivery systems. The most heavily promoted among these is the Network Computer being developed by Oracle Corporation and others [ 15 ] . Another promising system is the WebTV now in distribution in the United States [ 16 ]. Whatever system gets adopted, it will have to be cheap, reliable and easy to use. The Network Computer, for example, is aiming for a $500 price tag. My own sense is that the broader public will only accept a device that approaches the cost of owning and using a cellular telephone. If a reliable device hits that price point, it has a chance of catching on.
All of these issues will be dealt with, but they make it clear that the revolution in electronic banking is not going to happen overnight.
There are other larger issues as well. Digital cash offers a most tantalizing efficiency if it were broadly adopted. Some have talked about a "friction-free" economy that could evolve through the use of digital cash [ 17 ]. If you could shop from your armchair and computer and send money to a vendor, a whole group of middlemen would be cut out. Theoretically, goods should be cheaper and money should circulate more efficiently through the economy. While I do not doubt that money would flow more efficiently in a digital cash economy, no one can anticipate the consequences of this sort of system.
How might the world economy behave without the brakes imposed by national regulators, the banking industry, and sheer borders between nation states? If digital cash spreads, all of the current limits could be removed. The world economy has no experience with this sort of open system. For an example of what "efficiency" could mean, a careful look at the stock market crash in October, 1987 proved the effects of computerized efficiencies. Many traders now believe that this particular crash was made possible by the efficiencies introduced with computerized trading. Law in the United States now provides for a halt to computerized trading if the stock market moves too much in one or another direction in one day.
With all of the difficulties and complexities before us, electronic banking and digital commerce will still move ahead. It will move in jerks and starts; the technologies surrounding it will work together in some cases, and fail in others. No one's vision of the future comes true completely. Technology is already outpacing the abilities of many governmental agencies; there will be another revolution as governments develop their own systems to adapt to these changes. The United States Congress is just beginning to grasp some of the consequences of digital commerce; U. S. Comptroller of the Currency Eugene Ludwig remarked recently that "electronic money is not an economic Chernobyl.[ 18 ]" For politicians, bureaucrats, bankers, programmers, and ordinary citizens, we will all be in for a wild and exciting ride over the next decade.
Jim Philips, jimp@sfnb.com
4. http://www.checkfree.com/empnpart.html
7. http://www.intuit.com/int-corp-press-release/091696_white_paper.html
8. For example, http://www.worldgames.com/visa/wacho.html
11. See, for example, Tatsuo Tanaka, 1996. "Possible Economic Consequences of Digital Cash," First Monday, vol. 1, no. 2 (August), at http://www.firstmonday.org//issues/issue2/digital_cash/
12. On the Automated Clearing House, see for example http://www.nationsbank.com/tms/acha.htm
13. http://www.cylink.com/products/security/digsig/
16. http://vhost2.systemv.com/
17. For example, John Case, 1996. "The Friction-Free Economy," Inc. Magazine (June), p. 27, and at http://www.inc.com/incmagazine/archives/06960271.html
18. http://www.spa.org/sigs/internet/fedgov.htm
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