Cyberspace is not just another mere alternative distribution system for banks; it is an electronic frontier in which banks can more cost effectively deploy products and services to a virtually boundless customer base, staking their claim to the vast spectrum of revenue opportunities in the emerging era of electronic commerce—provided, that is, they can redefine their roles as both service providers and transaction facilitators.
Strategy is critical in this intensely competitive time of electronic banking revolution, and it’s a question of how—not if—banks will enter this brave new cyberworld. Today, there are already some 30 million Internet users—all potential bank customers—and the numbers are growing by about 10 percent a month. The Internet represents a near-perfect alternative delivery channel for banks. Without having to make huge investments in technology, it is a way for banks to off-load some of their transaction-oriented retail business, while tapping into a market that sources say is ripe with financial services potential. Recent statistics indicate that the Net is dominated by users that earn more than $45,000 annually.
For now, the Internet is shaping up to be a consumer-driven retail banking infrastructure; in the near term, however, the world of electronic commerce will open up new opportunities for corporations and merchants on the Internet as well, and sources say, could become a catalyst for electronic data interchange (EDI), one of many Internet ideas currently being explored by Citibank, among others.
But for banks, this brave new world is still wrought with some of the trappings of more traditional banking. Different from their nonfinancial competitors, the highly regulated business of banking could face similar restrictions in Cyberspace. Software applications, for example, will have to be "intelligent" enough to impose the proper state regulations on interstate banking transactions because in Cyberspace, geographical divisions may evaporate, but state laws won’t, warns Matt Chapman, chairman and CEO of CFI ProServices, Inc., based in Portland, OR.
While regulatory guidelines still have to be hammered out, banks are forging ahead, notably through the delivery of bank products and services on the Internet. The traditional, old-line philosophy of the bank-owned distribution channel—where financial institutions owned the customer relationship—has been slow to dissipate. But Bank of America and NationBank's recent acquisition of MECA Software, Inc., maker of Managing Your Money, is a healthy sign that bankers have taken notice of personal finance management applications like Microsoft Money and Intuit’s Quicken, which sources argue could severely encroach on banks’ payments business and push banks farther from their customers.
Competition on the electronic frontier is forcing bankers to fundamentally reinvent the very business of banking, and, even more, develop relationships with software developers, despite their hesitancy to partner with nonfinancial companies that are forming their own payment systems relationships and threaten, by their broad-based appeal, to come between the banks and their customers. The choice: either expend vast resources to develop proprietary front-end applications or find a personal finance software company that will subscribe to a more traditional bank philosophy.
When Bank of America and NationsBank chose the latter route—and, in their eyes, rescued the banking industry—by purchasing MECA Software for the economical price of $35 million, it was to ensure the existence of a "bank-friendly" personal finance front-end application. "The relationship that someone has today for financial products is one that they have with a financial institution," says G. Patrick Phillips, EVP of Charlotte-based NationsBank." And being able to reinforce that relationship using software rather than reinforcing the software manufacturer as being provider of that financial service is important to our institution." Or, plainly put by San Francisco-based Bank of America’s vice chairman Thomas E. Peterson, "MECA licenses the bank to [use Managing Your Money], and the bank owns the customer. In other companies, the customer is not the bank customer anymore for all intents and purposes; he or she is the customer of the software company."
But some industry players contend that a bank-owned personal finance software package, for example, is reinventing the wheel. Enter Intuit CEO Scott Cook. "The best thing I could do is ask banks, ‘Have you asked your customers if they think you own them?’" says Cook. "The point is, customers don’t think you own them, and they don’t want to be owned...Look at it that way, then you have to do your level best to serve the customer in the best way possible."
Of course, Cook could be a little biased. As head of a company that is about to launch a financial services server that will allow Quicken customers to access not only their banks, but also every bank with which Intuit has an alliance (initially using just Quicken as its front-end), Cook has reason to be enthused. While the downside to this is that bank customers will have access to competitive products, including nonbank offerings, the upside is that these same banks have the opportunity to sell to a broader audience. And banks such as the new First Security Network Bank, a virtual bank launched by Pineville, KY-based Cardinal Bancshares, are agreeable to the new rules of the electronic frontier. Why? For the single reason that they will conform to whatever their customers demand, even at the risk of directly competing with other financial services institutions and software companies." We don’t want to try to tell our customers how they need to do banking," says Michael Karlin, president of First Security Network Bank. "We want, therefore, to be open to as many front ends as possible. If we work out a relationship with Intuit or Microsoft or MECA, where we can use those front ends, or our customers can use those front ends to get into the bank, that will be great."
Chase Manhattan Bank’s early adoption of Microsoft Money and its relationship with Intuit are evidence of the bank’s multi-channel distribution philosophy. "Any one company, whether it’s Intuit, Microsoft or anyone else, will not automatically disrupt [the bank-customer] relationship," says Steve Hirsch, vice president in charge of emerging delivery at Chase Manhattan. While Microsoft Corp. is viewed by many in banking circles as a legitimate threat, Hirsch suggests the company, as with any potential competitor, bares watching. "Competition in banking has changed dramatically over the past [several] years, so there are any number of new competitors interested in financial services, and Microsoft clearly is one of them. But there is no overreaction on our part."
As for Microsoft, CEO Bill Gates—retrenching in the wake of the aborted merger with Intuit—is revamping his electronic commerce strategy using the less popular Microsoft Money as the company’s front end to a potentially Goliath electronic financial services plan that could very well touch all facets of banking. For starters, Gates is planning an introduction of the revamped Money product to seize market share in the personal finance arena. Even more, the imminent launch of Microsoft Network—which the company intends to bundle with Windows 95—is Gates’ bid to dominate the on-line services market. Add in Microsoft’s alliance with Visa International to establish secure on-line transactions and, in doing so, achieve a stake in the lucrative payment systems business, and its newly announced electronic cash card venture to give it yet another piece of the payments business. This is the Age of Electronic Banking, in a big way.
Such vast resources—and so little regulation, the U.S. Department of Justice aside —understandably give bankers pause. Microsoft Windows’s 80-percent market share is the "virtual bank" link to every PC user in the country. Some industry players argue that Microsoft could potentially monopolize retail banking. The threat is not that Microsoft wants to become a bank per se, but that the software giant will dominate the transaction business, potentially leaving banks to become mere monetary depositories, says Peter Levine, senior vice president of Stamford, CT-based Gartner Group. "Banks are no longer interested in making the interest they make off of a $2,500 minimum balance—the difference between what they pay you and what they charge [for loans]— they want transaction revenue," he says. "Well guess what? If Gates takes the transaction revenue, banks are left with the ugly side of the business."
Which is precisely what banks are working to avoid. No matter which front-end applications banks choose, they must also securely and efficiently connect them to the bank’s systems for an effective home banking system. In the past, banks developed custom connectivity solutions. While banks have to incorporate firewalls to safeguard their data, connectivity to front-end applications does not have to be bank-specific should middleware vendors be able to tie their systems to a uniform connection. The appeal of a uniform connection is its economy—a single type of connection compatible with multiple vendor applications. In an attempt to provide that uniform connection, Visa Interactive has developed two standards: the access device messaging standard, connecting front-end applications to a Visa host system, and the electronic banking messaging standard, to be used by middleware companies connecting banks to the host system. Together, Visa’s communications standards create a uniform method for banks to tie their systems into as many front-ends as they wish. In addition, by using the Visa host, banks can access a bill payment system, Visa’s bi-directional, back-end authorization and settlement system called E-pay. E-pay, which launched last month and competes with Intuit’s NPCI, uses VisaNet to not only transfer funds, but also to transfer data relative to bill payment so that bills can be both sent out to consumers and paid to merchants. As VisaNet is a worldwide processing system that handles billions of transactions, banks can take advantage of its economies of scale, says D. Fraser Bullock, president and COO of Visa Interactive. Visa Interactive’s technology is currently compatible with MECA Software and its own front-end application. On the back-end, Applied Communications, Inc., Tandem Computers, Deluxe Data, Braun, Simmons & Co., Early, Cloud & Co., and US Order have agreed to meet Visa’s electronic banking messaging standard.
Once electronic commerce is in full swing, the move by players from home banking into the payments business is what sources say will drive its exponential growth. Credit cards, a natural form of payment for Internet and on-line services shopping, will be the interim solution until alternate forms of payment, such as electronic cash, emerge. Regardless of how consumers make payment, the most pressing issue of electronic commerce centers on securing Internet-based transactions against exposure to hackers and merchant fraud.
Today, ensuring payment security is a twofold process: safeguarding disclosure of financial information and verifying that consumers are whom they purport to be. To this end, encryption technology and personal identification numbers (PINs) are used. But there is a range of ways this security is delivered. Three big players in the credit card payment systems business are First Virtual Holdings, CyberCash, Inc., and Netscape Communications Corp., each of which secure consumers’ financial information differently.
San Diego-based First Virtual protects consumers by never allowing their information to go on-line. Rather, information is disclosed over the telephone; First Virtual then assigns consumers PINs. Upon making an Internet transaction, merchants send the consumer’s PIN to First Virtual, which then e-mails the consumer to verify that he or she actually wants to make the purchase. When the consumer consents, First Virtual dials Visa or MasterCard, collects the money and deposits it into the merchant’s account. To further facilitate consumer PIN registration, First Virtual is working with several large bank credit card issuers to assign cardholders a First Virtual PIN in the same manner as bank ATM PINs are assigned. "That way we can enable a very large installed base very easily, and, at the same time, provide greater security for the banking world," says First Virtual CEO Lee Stein.
Without using encryption technology, Stein has been able to establish First Virtual as a viable transaction payment provider in a market that potentially spans the entire Internet consumer base. And because encrypted transaction technology development has not kept pace with consumer demand to shop on the Net, says Stein, First Virtual has amassed much bank business and merchant allegiance.
But First Virtual is one of many players looking at financial services as a way to hit it big in Cyberspace, not the least of which is Netscape. Netscape’s secure transaction technology is a more evolved method of protecting consumer information in that information within its browser is protected in the Netscape-developed secure sockets layer (SSL), a security protocol which rests between an Internet application and the Internet protocol (IP), whereby data is encrypted using RSA Data Security Corp.’s public key technology. This ensures that the pipeline between the consumer, merchant, and credit card company is hack-free. As a result, a consumer can disclose credit card information over the Net knowing that only the merchant, the bank, and MasterCard International—the credit card company with which Netscape has an alliance—are able to de-encrypt that information, says Netscape’s Charles Jadallah, director of financial services.
What is at issue is the development of an industry-wide standard security protocol, which has given way to the Netscape-MasterCard and Microsoft-Visa alliances. This activity means that consumers could see a seamless secure transaction system adopted more quickly, thereby creating a forum for electronic commerce that wouldn’t require consumers to register with any one company to secure their credit card transactions. But a crucial aspect of developing that standard will be implementing a public key certification authority, says Cathy Medich, executive director of Menlo Park, CA-based CommerceNet, a consortium of financial institutions and corporations working to ensure secure Internet transactions. A certification authority would assign Internet users public key certificates which would then be used for authentication and digital signature verification.
Such a standard could be problematic in the future for Reston, VA-based CyberCash, which currently secures credit and debit card payment transactions with RSA Data Security’s encryption technology, but does so through an application that runs on top of browsers, as opposed to being integrated within them. Thus, access to this service requires account registration, which is not a seamless consumer-Internet interface. Still, until all browsers are secure, this cross-platform solution has been adopted by banks such as Wells Fargo and First National Bank of Omaha. And because it only secures the payment transaction, CyberCash has been able to negotiate export licenses for its software, which opens up international markets.
Beyond secure bank card transactions, CyberCash is also developing two electronic money products which will be piloted in August and introduced in the last quarter of 1995. The products are a money messaging service and micro payments service. The money messaging service is the equivalent of a check or hard currency, says CyberCash CEO William Melton. "It has all the best benefits of cash: there is no float involved, there is no risk involved. And it has the advantage of a check in that you can use it at a distance. It can be used to purchase a product and it can be used for "peer-to-peer" transactions (individuals sending money to each other, regardless if the receiver has a CyberCash account) although an account must be opened to take ownership of the transferred funds. CyberCash earns its revenue by charging a postage fee to transfer funds.
For small value transactions, consumers can access CyberCash’s micro payments product. For consumers downloading New York Times articles for 25 cents, or maps of the San Fernando Valley for a nickel a piece off of the Internet, this product can quickly make transactions without forcing consumers to key in what they want and to whom the money goes. So CyberCash has created a cyberpurse in which funds can be transferred from DDAs or the electronic messaging service to pay for small-ticket items. As a product is purchased, the value in the purse decreases. "It’s a virtual smart card," says Melton. And rather than charge a postage fee, which could be more expensive than the item purchased, CyberCash charges three to five percent of the transaction value as payment for its service.
Where CyberCash micro payments end, Amsterdam-based DigiCash gets started. "CyberCash is [currently] an online account-based system," says DigiCash’s CEO David Chaum. "[DigiCash’s] E-cash is a bearer instrument. Possession of the bits is possession of the money." By this fall, DigiCash will bring E-cash to the Internet, after a wildly successful and somewhat controversial pilot where DigiCash introduced free "cyberbucks" into Internet commerce to attract customers. The result: DigiCash’s 75 retailers have accepted the "monopoly" money at a two-bucks-to-the-dollar exchange rate. As more people sign up with DigiCash, this new form of currency—totally outside the Federal Reserve’s reach—raises issues about the potentially disastrous economic implications of taking monetary control away from the centralized agency.
But E-cash is different; it’s the electronic equivalent of real money, incorporating the Chaum-developed blinding technology to keep individuals, merchants, and their banks in the dark as to a consumer’s identity. The DigiCash consumers, however, are able to track their transactions straight to the payee’s bank to ensure against the misappropriation of funds. "It’s more traceable than plain cash," says Chaum. And unlike cyberbucks, E-cash will be issued by banks and controlled by central banks that will be responsible for monetary security and to protect against systemic risk. "Our company doesn’t intend to actually operate an electronic cash system. We intend to license the technology to banks," he says.
With the dawn of electronic commerce, Chaum says, retail banks will serve an important function in society, adding: "There’s no reason to think that other people should be able to piggy-back on the payment system banks have built."
* Reprinted by permission of the author and publisher from Bank Systems + Technology magazine (July 1995).
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