Virtual Banking

1. Introduction 1

2. Executive Summary 1

3. Trends in Retail Banking 2

4. About the Internet 2

5. Virtual Banking and Applications 3

5.01. Interactive Application 4

5.02. Smart Cards 4

6. Online Banking System Security 5

6.01. Cryptography 6

6.02. Firewalls and Routers 7

6.03. Trusted Operating Systems 7

7. Supervision and Regulations of Network Banking 8

8. Conclusion 12

9. References 14

Introduction

The Internet's explosive growth has initiated considerable activity in the financial services industry. For this industry, the Internet and, in particular, the World Wide Web, serve as a new vehicle for transmitting financial information, comparable to the invention of the telegraph 150 years ago and its use for transmitting financial information. Although computer networks only transport financial information, many predict radical changes including the "dissolution of geographic markets into virtual financial systems" and the "loss of national independence."

These predictions are simplistic and are not based on analyzing this issue. However, the facts are (a) financial services are information commodities and (b) public computer networks offer a fast, cheap way to trade information. Public computer networks can radically improve efficiency and competition in the financial services sector. Increased efficiency and competition rely on three characteristics of these networks:

* Marginal costs of selling financial information over computer networks are small - in fact, typically negligible - compared with more traditional information channels;

* Public computer networks are essentially borderless, giving rise to the cross-border provision of financial services;

* Setup costs to establish a financial services business on a public computer network are small, which increases the contestability of financial services markets

Executive Summary

The Internet is emerging as an efficient delivery channel for financial services. With Internet banking, customers do not need to have special bank-issued software. Banks maintain their identity and can differentiate themselves by customizing the services and information they provide over the Internet.

Trends in Retail Banking

What does better customer mean? Increasingly, customers are demanding more convenient ways to do their banking. An Ernst and Young study (Technology in Banking Report) concluded "nothing changes in the banking world if customers cannot get financial services when and where they wish...this means anywhere, at any time." Statistics show that ATM's, telephone banking, and home banking account for over fifty percent of all banking transactions today, and total non-branch activity is growing at fifteen percent a year. In one survey (Web-Tech, Inc., May 17, 1995), eighty-two percent of 18- to 34-year olds polled preferred banks with 24-hour service.

Customers are also demanding a more sophisticated mix of products tailored specifically to their financial needs, and non-bank competitors are better fulfilling these needs. Banks today hold only 20% of household financial assets, versus 34% twenty years ago; they have 30% of business deposits, versus 42% only seven years ago. Nonbank credit card providers have gained inroads against banks, holding a 25% market share versus 5% in 1986 (WebTech, Inc., May 17, 1995).

Internet banking offers an attractive solution to this redesigned products and services. Customers have 24-hour graphical-interface access to their accounts and appreciate that their bank is doing something to make banking easier for them.

About the Internet

The Internet has exploded in the last two years thanks to the invention of the so-called "browser." A browser is a point-and-click software program that allows "surfers" to navigate around the Internet without knowing any UNIX commands. The first browser was developed by the National Center for Supercomputing Applications, a government agency. With a browser and access to the Internet, you can order a pizza, listen to and purchase a CD, stroll through the Louvre, or view satellite photographs of Scotland.

Although it may get congested from time to time, the Internet itself is extremely reliable. There is not actually any one network that is the Internet; it is made up of thousands of networks that connect to each other through common routes, and they all agree to carry each other's traffic. There is a lot of money flowing up from local access providers to these national players, guaranteeing that the infrastructure will continue to expand to meet demand.

Because so many resources are shared, the Internet is also very efficient. It costs a lot less to connect a business to the Internet than to lease telephone lines that customers dial into with their modems. Most likely Internet users will continue to be charged for the size of the "pipe" connecting them to the Internet.

The number of commercial entities with an Internet presence doubled in the first three months of 1995. Modems will keep getting faster, allowing more information, better graphics, and full-motion video to be downloaded more easily. However, in five years most households will probably buy their Internet access from their cable company, who will provide them with a 10 megabit-per-second connection through their cable wire. A 10-MB connection would download in one second a file that takes a 28.8K modem five and a half minutes to download (WebTech, Inc., May 17 1995).

Virtual Banking and Applications

Picture a bank without any branches. No tellers. No rows of desks. No racks of brochures, no automated teller machines outside. Picture, in