Vol. 2000-6

Banking Public Policy And The New Technologies

 Until recently I managed to remain unaffected by the fascination that so many seem to find in the latest developments in electronic banking, particularly Internet banking.  It is not that I think the subject boring or unimportant – far from it – but it simply struck me as being largely of operational interest.  Ever faster ways of obtaining and transmitting information, a process spawning, and in turn spawned by, the wizardry of electronics, must be heady stuff, not least because it holds out (if not immediately, then down the line) the glittering prospect of greater size and larger profits.  Financial products are being distributed more rapidly, in more convenient forms, and at lower cost, all of which is commendable.  But I have difficulty seeing important implications for public policy issues affecting banking – the stuff with which these reports are concerned.  Possibly I have been rooted too long in the belief that the last technological advance having a significant policy influence over the structure and future of banking was the development of the automobile industry in the early decades of the last century.  The policy implications, of course, arose from the automobile’s impact on the geographic restrictions on banking.

 If public policy as it relates to banking is described as a set of arrangements defining banking or regulating banks, based on statutory or administrative law, then the basis must be a belief that “banks are special.”  Which is to say that banks must be regulated differently than other business institutions, some of which are not regulated at all (or minimally so), while others may be extensively regulated but not in the same manner as banks.  The cluster of public policy elements that relate largely or solely to banks, most of them going back over many years, include (but are not restricted to): “dual banking” -- alternative federal-state charter routes into banking; “fragmentation of bank regulation responsibilities” -- particularly at the federal level; “deposit guarantee” -- which in one form or another appeared in the states in 1829, at the federal level in 1863, and is now largely included in the federal deposit insurance program; and “consumer legislation” -- primarily a post-World War II development intended to assure fair treatment of customers or communities, but directed largely or solely at banks.

 Whatever “special” may have meant in the past – clearly there were changes over the years -- whether banks are still special today is an open question.  Not least among the factors bearing on the answer may be recent technological developments, which prompted this report.  A few words on how this came about may help alert readers to the fact that what follows is far from an expert description of the new technologies or of their importance.  Rather, it consists of a group of observations, almost certainly debatable, on whether or how the reaction to technological change will have a significant public policy influence on banking.

What might be described as my “wake-up call” came from a subscriber a month or so ago, who said that he was reading a copy of the American Banker that had a cluster of articles dealing with electronic banking or the Internet, and asked when I was going to start to pay attention to this in one of our reports.  I thumbed quickly through my files and found that he was correct; it is not unusual nowadays to find two or three articles on that subject in a single issue of the American Banker, or in such prestigious industry journals as BAI’s Banking Strategies.  The May 20 issue of The Economist devoted 52 pages to a special report on “Online Finance.”  And I was impressed by the magnitude of some of the bets that have been placed on the profit potential of online banking.   For example, a recent issue of Banking Strategies said: “Citigroup’s e-City unit lost $179 million in 1999 . . . but by no means is the only one spilling red ink in the search for digital gold.”  (Banking Strategies, Bank Administration Institute, May/June 2000, p. 63)

I asked a former colleague, Robert Dickey, now a leading bank consultant and strategist headquartered in California, for his view of what is happening.  He wrote me that “the availability of more information, of better quality, at a faster pace is changing business models and, ultimately, economic values.”  What this means, he thinks, is that not only will the delivery – e.g. physical or electronic – of financial products change over time but so too will the products themselves.  Timing and information will add value (and/or competitiveness) to the products.  “More importantly,” he wrote, “it means that business models will change to incorporate capturing and providing information as core activities.”  I will not pretend that I understood all of this, but it did seem that he was talking about something much more important than electronic “three-card monte.”

            Also, while leafing through my files, I came across an account of an interview with Julie Williams, chief counsel in the Office of the Comptroller of the Currency, which carried important public policy implications.  The headline was the grabber: “Technology, More Than Reform Law, Driving Change, Regulators Insist.”  As readers know, I have devoted much time in these reports to the recent financial modernization legislation: the Gramm-Leach-Bliley Act of 1999 (GLB).  I treated it as something of underwhelming importance; financial modernization was preceding nicely, thank you, under the driving forces of the market and the industry.  I did think that the Act was of some usefulness, but concluded that its most important contribution was to get government out of the way of progress already underway – and even then it was not fully successful.  Chief counsel Williams took a somewhat different tack, suggesting that whatever the contribution made by the GLB Act to the modernization of present-day banking, it may be of minor relevance to tomorrow’s banking.  “It is ironic” she said, that: “the more fundamental changes affecting financial services are going to be occurring outside of the new law.”  (American Banker, March 21, 2000)

            Not surprisingly, I concluded that a report is called for.  The title I have given it may lead readers to expect a broadly based analysis of the public policy implications of recent developments in electronic banking.  Actually, my focus is much narrower – not on public policy broadly but on banking public policy, as I defined it earlier.  What I am looking for is the impact that changes in banking – a great proportion of the changes due to technological developments – are having on the way in which banking is regulated.  In particular, I often wonder whether the makers of public policy in the United States really understand how fundamentally technological change and its impact on the marketplace is challenging our existing regulatory structure.

I begin in Section I with a brief, almost cursory, review of where we are today with respect to electronic banking and the Internet.  My hunch is that many readers are in the same boat I am – generally aware that much of importance is happening in the technology world but are not very familiar with the process and the issues posed for banks and other financial institutions.  So with apologies to many, probably most, readers, Section I offers such a review, containing some pretty familiar stuff.  But it also addresses a specific question: is there a likely connection between technological change and changes in banking industry structure and regulation?

 A “banking public policy” exists because of the assumption that banks are unique organizations that must be treated differently than other businesses.  Within just the past six months, the question of whether banks are still “special” today has been addressed by two authoritative banking spokesmen, who reached quite different conclusions.  This is discussed in Section II because on the resolution of the issue hangs the fate of the elements that now make up banking public policy as we know it today.  If, for example, the elements were to disappear, then one would have to address those policy issues associated more generally with electronic banking – such as privacy or digital signatures – but it is too early for that now so far as banking alone is concerned.

 Section III discusses the changes that industry-blurring – a development often attributed, in part at least, to the new technologies – are having on the reform of supervision and regulation in many nations, with special emphasis on developments in the U.S.  This is the point I had in mind at the beginning of this summary, and I may be charged with plowing familiar ground.  If so, it will be a very brief excursion.  This Section seeks to identify the public policy implications for banking of regulatory reform.  Whether the changes made in the U.S., particularly by the GLB Act, will be of significance is discussed.  There have been some strange, short-term developments – disturbing to some – but we have no real indication of long-term consequences, at least so long as the question of the continued specialness of banking remains unsettled.

 This is as far as I will go in the present report.  It plainly implies one or several follow-up reports.  Section IV only ties together a few of the loose strings and offers some personal observations.