In the 1980s, regulated financial institutions faced disintermediation from their depositors by mutual funds, from the home-buying public by mortgage bankers, and from commercial borrowers by the capital markets. Now the banks' last bastion of control, the payment system, is threatened by the advent of electronic currency and Internet commerce. There is a lot to lose. In 1994 there were approximately 9.2 billion credit card transactions, 57 billion check transactions, and 300 billion cash payments. Few of these were effected over the Internet or through the use of smart cards. But with Internet users expected to number 128 million by 1997, and with 6.7 million servers currently connected to the Net, any meaningful shift of commerce to that medium could significantly erode the historically privileged position of regulated financial institutions. The threat illustrates how an industry that has always prided itself on being "high touch" is faced with the daunting task of finding new centers of gravity in an increasingly "high tech" world. Technology and financial services companies that once sought to coexist or cooperate with banks, so that each could derive the economic benefits of the other's skills and customers, now understand that nonbanks can cherry- pick bank customers product by product. One way banks might cope with these challenges is to reinvent themselves as idea factories. In the past, regulated institutions' business was confined to well-worn lending and investment products and strategies. Risk-taking, and consequently productivity, was limited - to protect the Federal Deposit Insurance Corp., the guarantor of last resort. Thus, the financial institutions did not have to germinate three new ideas a week and five new products a month to remain competitive. Michael Eisner, chairman of the Walt Disney Co., describes his company's reliance on creativity and change in precisely those terms. The head of one of the most successful companies in the world believes it must constantly reinvent itself to remain relevant to its customers. Perhaps in a similar way electronic money technologies and the innovative techniques that will accompany smart cards, cyberspace currency, and computer shopping will unleash a new wave of creative thinking. Such thinking might transform banking into its own form of entertainment - a business that requires an ever-evolving array of products and services that do more than just dryly satisfy investment needs. The current inventory of available bank products will be affected in unprecedented ways. Restocking the inventory with technologically oriented products could dramatically boost the demand for fresh ideas, particularly as deregulation proceeds. Where are the idea factories? I have visited a few since exploring the Mondex smart card experiment in Swindon, England, a few months ago. (See the April 15 FutureBanking.) Mark Twain/Digicash There is a striking similarity between the Mondex electronic purse system and the virtual cash, or E-cash, that Mark Twain Bank in St. Louis is offering in conjunction with Digicash Inc. of Amsterdam. Both assume that electronic forms of money will have a profound impact on the business of banking. Since October 1995, Mark Twain has provided its users with money that can be stored on a personal computer hard drive and transmitted over the Internet. Some 1,000 Mark Twain customers have enrolled to try what is essentially a "cardless Mondex." First they open a World Currency Access account, which is FDIC-insured. Funds are converted from this account into E-cash and then, at the PC owner's discretion, transferred into the hard drive to buy goods and services from Web merchants. Once the value is transformed into E-cash, it is no longer a deposit and thus no longer insured. Functioning as cash, it is subject to the same risks of loss or theft. To avoid Regulation E and other legal requirements, the product is configured around the interaction of several account-like systems. Whether this method will survive government intervention remains to be seen. One can only hope that E-cash's simplicity and user-friendliness will not be undone in the name of consumer protection. E-cash is only a first step for Digicash. Its founder, David Chaum, carries and eagerly demonstrates a smart card and electronic wallet that transfer payments not chip to chip but through a laser-like infrared beam. This product, which raises security standards to a new level, is to be test-marketed in Europe later this year. Cybercash Cybercash Inc. of Reston, Va., bases its business case on an expected proliferation of the Internet, the convenience and entertainment values of interactive shopping, the importance of banks in the movement of insured funds, and the need for a low-maintenance, high-security Internet payment method. Cybercash's seductively simple wallet includes a credit card feature, electronic checks, and electronic coins. Recently visiting the Virtual Vineyards store on the World Wide Web, I selected a wine and then proceeded to choose among the secure payment alternatives. My choice was a cash transfer through Cybercash. After the initial transmission of encryption messages and authentication and verification procedures, our money in an FDIC-insured Cybercash agency account in a commercial bank was transferred to the wine merchant's Cybercash agency account in the same bank. FDIC opinions have confirmed that such accounts can remain insured, and that intermediaries like Cybercash not be subject to the restrictions of a deposit broker. As in Mark Twain's Digicash system, however, the applicabilities and vagaries of Regulation E could pose interesting issues for the future. Citibank Citibank's Electronic Monetary System, or EMS, scheduled for market testing later this year, takes yet another approach to electronic commerce. It is clear from senior technology officer Colin Crook and from the EMS developer, vice president Sholom Rosen, that EMS will be as thoroughly researched, tested, secured, and customer-friendly as possible. Their E-money ideas take off from the notions that consumers have an emotional relationship with money, security is essential but elusive, branding will be a critical determinant of electronic money products' success, and financial trust must be earned and constantly reinforced. In cyberspace, individuals or businesses not known to each other may be involved in a transaction. It may fall to special software intermediaries - "trusted agents" - to verify identities and ensure secure completion of transactions. In Citibank's view, the complexities of a money system that can operate in both the physical and electronic worlds cannot be overestimated. Lessons and Conclusions 1. As technology and customer tastes evolve, the movement of money will take on aspects of electronic entertainment. 2. Financial service providers will have to respond accordingly, by reinventing themselves as idea factories and nurturing creativity. 3. Simple ideas will often be best, if for no other reason than that they minimize legal and operational problems. 4. All financial rules, customs, and relationships are susceptible to alteration as electrons take the place of money and commerce is transacted incognito. 5. Relationships will continue to be the key to selling financial products. The relationships will be built around customer trust, market confidence, branding, and security. 6. Government has the capacity to definitively shape, curtail, or terminate the development of electronic money through currency laws and consumer protections like Reg E. The transformation from physical to electronic cash will change the boundaries of the business. The financial dogmas of a world defined by paper instruments and geographic location will dissolve. Welcome to the next "industrial revolution" in financial ideas.
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