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Stan Wallis: Address to the ASC Electronic Commerce Conference, Sydney, 5th February 1997.

ADDRESS BY STAN WALLIS

CHAIRMAN OF FINANCIAL SYSTEM INQUIRY

ASC ELECTRONIC COMMERCE CONFERENCE

SYDNEY 5 FEBRUARY 1997

“The Impact of E-commerce on the Financial Services Industry and the Financial System Inquiry”

INTRODUCTION

I am pleased to have been invited to speak at this conference on electronic commerce, a subject which has fundamental implications for the financial sector. In fact, technology and its impact are explicitly acknowledged in the Financial System Inquiry’s Terms of Reference.

I must admit that, prior to taking up my role as Chairman of the Inquiry, my knowledge of the application of technology and e-commerce in the financial sector was a cursory one. A number of terms like ‘Stored Value Cards’, ‘e-cash’, ‘interconnectivity’, ‘pipe -width’ and so on, were unfamiliar to me when they appeared in our early discussions. Thankfully these terms are now familiar, as equally, there are many faces in the audience today that I recognise that were unknown to me some 8 months ago.

I have certainly found the months since the Inquiry began to be both stimulating and informative…and as the Committee formulates its views, we are aware of the range of issues that decisions on the financial sector must address - including obviously the future impact of e-commerce. How then do I intend to discuss the impact of electronic developments on the financial system?

I propose to address the issues by posing a series of questions. The questions broadly represent the approach that we are taking to these issues during the Inquiry.

Since the Inquiry Committee is still considering these questions and related issues, I will not seek to provide definitive answers today. Clearly the final position of the Inquiry will be known following the presentation of our Final Report to the Treasurer at the end of next month.

Let me begin by listing these questions, and then I’ll expand on them in the rest of this address.

Firstly, the scoping question of ‘What is electronic commerce?’.
Secondly to ask - What policy attitude should we adopt to technological developments like electronic commerce?
Thirdly - What impact may electronic commerce have on the financial system? This would necessarily include examination of what aspects of our system may change and what may stay the same.
Fourthly - Can we predict what will happen, and if we are able to influence what will happen, should we? Of particular interest here is the pace of change - are these impacts likely in 1 year or over 1 decade?
Finally - Once we have understood the answers or implications of all of these questions, we can finally ask - What are the implications for regulation in the financial system?

What is Electronic Commerce?

We now recognise that we are increasingly living in an age of information. If we stop to consider, the financial sector is about the efficient channeling of resources - an activity heavily dependent on information and particularly the compilation and analysis of financially relevant information. The pricing of most kinds of financial services revolves around assessment of various kinds of risk, and risk analysis depends above all on information.
At its broadest, electronic commerce is a term describing the technology platforms which allow:
firstly, the transfer and analysis of information;
secondly, transactions such as payments to occur; and
lastly, the distribution of products and services to customers.

These three functions enable the broader commercial system to operate, including the financial system itself.

I am the first to admit that others at this conference would have greater technical knowledge of these new electronic platforms than I have. From a basic perspective though, these new platforms involve the storage and transmission of information through electronic means, as distinct from traditional media such as voice and paper.
Because we’re obviously interested in the financial sector applications, I’ve concentrated today on the aspects of e-commerce that interact with the financial system.
E-commerce in the financial sector is not a new phenomenon - at least not in the wholesale area. The Australian OTC financial markets have been undertaking cross-border trading by electronic means since before the Campbell Inquiry. The largest single market in Australia - the foreign exchange market - executes most of its transactions by electronic means with both domestic and offshore counterparties. This e-commerce activity in the FX market relies on technology platforms which facilitate the conduct of information, transactions and electronic ‘delivery’.

…and technology is continuing to improve the ability of these platforms to facilitate all of the above functions. Information transfer is facilitated through improvements to screen trading, and through the development of specialised high technology trading systems that aren’t licensed markets, yet are more than simple bilateral OTC arrangements.

There are electronic forms of wholesaling, tendering and retailing that have been developed that also improve the transaction function - payments facilities are often included along with delivery of the product or service. Some of these new payments capabilities have meant that e-commerce has progressed between business-to-business far faster than between the vendor and retail customer in any “Internet cyber-mall”.

Although the Internet & other media are now involved in electronic commerce in all three of these functions, perhaps future ‘Intranet’ platforms may further facilitate business-to-business ordering and payments or perhaps there will be continued development of EDI in closed systems. Alternatively other platforms may include automated-voice-response phone systems or interactive TV links for ordering and paying for financial products.

I hope that those of you with slightly different definitions of e-commerce will bear with me today - the aspects that I’ve highlighted above are I believe important, especially the notion that e-commerce can affect not only delivery and transactions with ‘tangible’ products, but also the transfer and analysis of information.

What should our Overall Attitude be to these changes?

These technological developments are all driven by the same major motivation, and that is to achieve more efficient means of fulfilling the functions of commerce and finance.
So, what are the benefits of this ‘brave new world’ of electronic commerce? (especially for those like me who at times still struggle with ATM’s and have trouble deciding how much extra cash to take out with my EFTPOS transaction at the supermarket!!).

Clearly however, e-commerce technologies will provide real benefits to consumers:

speed;
convenience - notably a dramatic reduction in search costs, possibilities for remote access, fewer needs for cash, since we may have electronic “purses”;
global reach;
lower cost - implying lower prices for users and scope for more competition among providers ;
combination with other information technologies allowing market analysis, record-building, internal business accounting, personal profiles, and automation. For example, in electronic transactions devices, incentives or restrictions could be built in to allow parents to control their childrens’ spending, or security features could be programmed into “electronic purses”.

If we see a generally positive balance between the emerging benefits of e-commerce and its costs or risks, our overall policy stance should be supportive. Greater efficiency and productivity is vital to the competitiveness of the economy and the financial sector.
If innovation in a competitive market produces benefits for consumers, it should be clear that we also need to ensure that:
regulation is provided where it is necessary to provide consumers with the necessary confidence to use these technologies; and
restrictions on pricing don’t act to restrict the adoption of the most efficient technologies.
So…the Inquiry is aware of the potential benefits of e-commerce as well as it’s risks and potential costs. The Inquiry intends to use the same principles for assessment of regulation of e-commerce as would be used for innovation elsewhere in the financial sector - competitive neutrality, cost effectiveness, transparency, flexibility and accountability will all apply.
…and, as we have stated in our Discussion Paper of last November, system stability, safety and the confidence of consumers are all critical in our deliberations.

What is the Impact of e-commerce ON THE Nature of financial SERVICES?

One may ask ‘What stays the same in this future world… a world which may include elements of ecommerce?’
To begin with, the basic functions of the financial system will stay the same:
…ie payments services will continue to be provided;
there will be continued pooling and allocation of funds,
…hence savers will have a range of investment opportunities and borrowers a range of financing opportunities, and risks  event, market and other risks  will be allocated and managed.
Secondly, the basic objectives of regulation will remain, ie.:
to facilitate competition, innovation and efficiency;
to provide security and confidence for consumers; &
to balance privacy and other needs.

What then will change?
Firstly, the method by which the main financial functions will be carried out will probably be altered through new electronic systems for processing information, conducting transactions and distributing products.
The conduct of financial markets may change, by being directly accessible through electronic means to even the smallest retail customer. E-commerce technologies may allow some of these customers access to information with which they could efficiently price risk for themselves - an alternative to being linked to financial markets through financial institutions such as bankers, brokers, and funds managers . Trading of financial claims, including deposit claims, insurance policies, loans and bonds, could occur through global bulletin boards, or through special communication networks.
As part of this, the traditional ‘on-balance-sheet’ funding of intermediaries may decline. The present financial institutions may seek to maintain their relationships with customers by developing more software and information products  or they may go into less visible roles of back-office financial processing, analogous to those of product manufacturers. A further alternative is that financial institutions may form alliances with other specialist providers to offer “full service” as bundles of intertwined services from different providers  perhaps with the composition of the bundles being switched continuously by computer programs!
Customers may be able to conduct much more of their business without employing either cash or balances in their own transaction accounts at financial institutions. They may be able to use short-term credit instead  as many are doing already with EFTPOS and phone payment technologies  or to use electronic stored value of various kinds.
As financial markets change, and methods of customer service change, the structure of the financial services industry may change. We may see the emergence of new players, some of whom have had no previous role in the financial sector, such as telecommunications utilities, or software providers, or retailers, or entertainment networks. It may not be unrealistic to see a pharmaceutical provider offering home delivery prescription drugs bundled with health insurance, with the service accessed with a “smart card” system operated by a trucking company with expertise in the technology developed in transport applications.
Secondly, the capacities and needs of customers may change, as:

they become empowered by new access to information; and

they are able to link financial services to new ways of conducting other business - most obviously their retail purchases and sales.

It has been suggested to us that some customers may come to want their whole set of financial relationships integrated, in “wealth” accounts. Those accounts could be continuously marked-to-market as a person’s income, debts and investments altered in value. They could offer instant credit, investment options and payment options, presented together on-line. This would represent the ultimate extension of today’s home equity loans, with the credit component secured against the net value in the “wealth” account, including the present value of future transactions.
So even though basic financial functions will stay the same, as will the objectives of regulation, there will definitely be some change brought about by e-commerce technologies - it’s the extent and timing of that change that are unknown.

Can we Predict this change? And can we influence it?

From our own investigations and from the spectrum of views we’ve been offered, it’s possible to distill contrasting views about how fast this set of likely e-commerce changes will happen.

Some argue that the most likely scenario is modest change through gradual evolution, with most of the existing institutions and markets continuing to function in roles similar to their current ones.

They point out that customer attitudes, rather than technology availability, will determine the take-up of new technologies - and that many customers are conservative

Some have also argued that payments services will continue to be provided by entities called ‘banks’, because they have inherent advantages for doing so; and that banks are likely also to have most public acceptance as issuers of re-loadable stored value cards.

These same groups suggest that payment mechanisms such as cyber-cash on the Internet have been slow to ‘catch on’ because of low consumer confidence in security of applications generally on the Internet;

Some have observed that a proportion of customers will continue to demand over the counter service.

However, others have talked to us, or framed their submissions, from a very different perspective. They believe that what we are now experiencing, or will experience in the next 5 years or so, is a paradigm shift - a sharp discontinuity, which will radically transform the financial system, and quickly  particularly in a 5-10 year timeframe.

One argument for this seems to be that some, if not most, of this potentially revolutionary technology is already developed  at least to the stage of trial products or prototypes.

Whilst the Committee members were overseas in September, we had the opportunity to examine developments in a number of countries, including Canada, the US, England and continental Europe.

As an example, software which provides the means for examining other financial products and services, selecting them and transacting in them - termed ‘program navigators’ or ‘intelligent agents’ -are already available in the US. These intelligent agents have created electronic market places for banking products and mutual funds which are used by large numbers of consumers.

…fine for the US, but what about Australia? Clearly, the speed of development will depend on a range of interacting factors. Traditionally, our take up of technology has been rapid, once it has become available. The Consumer Credit Legal Centre’s original submission to the Inquiry noted that Australia had been chosen as the “guinea pig” for trials of smart card technology; presumably one factor in these decisions is our acceptance of new technology. Trials of this type suggest that developments here may help shape the world industry.

However a recent survey quoted in one consumer group submission cites over 90% of the most avid computer users as still harbouring security concerns with Internet banking transactions.

A number of surveys in Australia suggest that institutions themselves expect electronic channels to be increasingly important over the coming decade as the proportion of the population that are familiar and comfortable with technology increases. In the mean time, the biggest growth in electronic delivery channels may be in technologies familiar to a wider customer range, such as phone transactions and EFTPOS. But these may represent a prelude to adoption of broader e-commerce technologies. They are making many customers familiar and comfortable with remote electronic methods of payment, and with transacting using credit rather than account balances.

Financial service consumers may well adapt to change in much the same manner as retail consumers have in the past. Not that long ago, one may have purchased shoes from a specialty shop in the suburbs - now footwear can be bought everywhere from small ‘High St.’ boutiques to large discount stores which also sell hardware and food. Some aspects of the experience of retail consumers may translate to financial services - brand name or brand franchise may become important as consumers face an increasing range of providers, some of whom are unknown to them.

Let me illustrate this paradigm-shift or radical-change argument by sketching, from a customer’s perspective, how differently financial services could work if already existing e-commerce technologies were in general use.

One morning I might buy whole-wheat bread and skim milk using a multi-application stored value card. I may have chosen this multi-application card rather than a disposable card, because it allows me to gain discounts on my health insurance premiums, if I avoid foods which increase my risk of a heart attack! The stored value card may have the diet favoured by my health insurer programmed in as part of its functionality, and the transaction processing for the card itself may be conducted off-shore under the direction of a US-based telecommunications company.

The store owner may aggregate this payment and others on another stored value card, and use this value to make business-to-business payments to inventory or service suppliers. In technology terms, no bank accounts are necessarily involved at this stage. Meanwhile I may return home, flick on the PC or other access device, connect to the Internet and then use an offshore ‘intelligent agent’ to compare domestic and offshore offers of (say) insurance products, order the product which best fits the preferences I have specified, and pay for it with part of the cybercash generated when my most recent share dividends were paid to me.

The provider of the insurance policy may not be an Australian insurer, but my intelligent agent reports that it is satisfactorily rated in an acceptable foreign jurisdiction.

Meanwhile, another intelligent agent is deciding whether to reload my card from the cybercash or by dialing my bank and debiting my account (I still have one!)

So what does all this say ?  there are real differences of view over how quickly, and how pervasively, e-commerce will change our financial system…and what may be important to different groups in accommodating this change.

Participants in the wholesale markets for example note that issues such as evidentiary recognition in electronic netting, electronic delivery of notices and the importance of compatibility with international arrangements are all areas in which there are impediments to e-commerce.

Consumer groups see other issues as equally important - privacy issues, the importance of a continuing range of choice in financial services, including non-electronic access, and a pro-active approach to new technology that involves consumer representatives - all concerns raised in submissions.

Regardless of the perspective, virtually all submissions recognise the increasing role of e-commerce technologies, and in recognition of this, a number of institutional and consumer groups have recommended the formation of a government sponsored Technology group.