In the name of God

Private Banking in the Bank of Tomorrow

In recent years and during the life of new Iranian Government, Iran has opened up towards the rest of the world and made considerable progress towards a market economy. The process challenges the institutional capacity of the country. In this context, of course, the reorganization of the banking system is central. A system that despite being a century old, due to the flawed interest rate structure, the considerable repayment problems and the general lack of banking profitability, and its overall poor functioning and deficiencies, now is unable to efficiently intermediate financial resources. For an Iranian banker who sincerely hopes that his nation will take advantage of the country's growth potential banking on the future potentials should be based on tomorrow's banking ideas. For private banking in future, the problem lingers on the legacy of the old structure, at least in countries like ours.

The business of private banking commonly involves looking after high net worth individuals who first and for most seek confidentiality. These individual investors expect very attractive financial and related services and products. They may be both within the mainland of a country or outside, e.g., an offshore, where both banks have established corporations veiled in secrecy laws. In this type of banking, future banking or banking for tomorrow mainly involves ways and means of providing the required secrecy, and the methods of compensating these high net worth clients.

In this article, I will provide the framework for future operation of banks as related to private banking, and try to delineate the future trends in this respect. Banks are aware of the importance of customer data to their continued existence. In future, their ability to provide innovative products and services to private clients will concentrate on the issue they are most interested in: privacy.

Change: Leads the Course of Tomorrow's Banking

Why are banks changing? The momentum of change in future banking is still a surge in significant financial innovations. The primary impetus for innovations has been and still is introduction of new banking products that are efficient to increase return, and redistribute risk among bank clients. Many innovations that have past the test of time and have not disappeared have been innovations that provided more efficient mechanism to respond to changing environment of banking.

The whole face of banking is changing. One of the primary reasons that banks are changing is due to the increased competition in the industry. Banks are no longer regulated as tightly (pre 1980) and it is becoming easier for a collective group of investors to start a bank. Also, banks are no longer bound by geographical boundaries, due to globalization process. This increased competition is changing the way banks are generating funds.

Many new entrants and factors into the banking market provide real competition for the established banking industry. The banking sector will become more competitive as customers have greater and easier access to information. Since banks will no longer be able to operate in the future as they have in the past, there has been an increasing trend in bank mergers and acquisitions. So, a special aspect of increased competitiveness of banks should be searched in increased trend in bank mergers that in turn provide geographical edge to specific banks, gives them ability to offer new products, and reduces the power of other banks who have not grown in size. Former restrictions on bank mergers and acquisitions have been almost eliminated.

Bigger also means cheaper. That is because financial powerhouses, i.e., large banks, have become master at leveraging their size and finding new ways to squeeze profit from greater economies of scale. Bank mergers have given them a competitive advantage over smaller sized banks. Not only do these banks have a geographical advantage, but they also have a capital advantage. This allows them to offer new products to their customers. This increase in capital allows banks to make more loans available to the public. This will further increase their net interest margin.

Nowadays, old laws that restricted banking operations are history, and "powerhouses" are the result. They have proven adept at expanding their businesses beyond traditional bank services, viewing their existing customer base as a natural source of sales for product ranges from life insurance to mutual funds. They even go as far as not referring to their branches as banks. Instead, they call them stores, citing retail chains as the retailing model they seek to emulate. This is a new sales culture that has been unique in the banking industry.

The other main reason for change in banking industry is of course technological advances that have reduced costs for banks today. The future of banking shall be different from the present due to technological advances. Banks are finding ways to increase revenues, and decrease costs by making ATM machines more available to the public. Also, it is much less expensive for banks to set up these machines. The average start-up cost for an ATM is much less than, say, $1 million to open a full service branch. Through innovations like automated teller machines (ATM), on-line banking, and bill paying via the Internet, they have been able to eliminate expensive "brick and mortar" operations, saving billions on salaries, rent, and other overhead expenses.

The third factor that is causing a shift in the industry is that of conveniences for the consumer. People need timely access to banking services, and have less time to spend at banks, and prefer the convenience of long distance banking. Of course, society's view of what is convenient is changing. People were accustomed to associating convenience with doing business in their neighborhood, and not traveling to a bank across town. Now, however, society has a different definition of bank convenience. Also, we should mention it is directly due to mergers that banks are able to offer more full service branches, and ATM machines. This is more convenient to the customers, and creates bank loyalty.

Increased use in ATM's, the growing use of home and office computers, fax machines, and point of sale terminals allowing consumers to make transaction electronically is now considered convenient. Thus, branch location is no longer a priority from the consumer's view.

Basic Economics of Future Banking: What Changes?

The basis of the new monetary universe is a computer chip rather than a central bank note. The advent of e-money offers the possibility of privatizing the supply of currency, paying interest on small deposits, and making offshore banking accessible to many individuals. In the future, government fiat money may disappear as people choose to hold digital money issued by private firms rather than non-interest-bearing paper money issued by central banks. These facts have major implications for any economy, and thus for tomorrow's banking as a whole. We need to consider the implications of the information revolution for financial innovation and the future of money and banking.

The transition from a paper-based monetary system to an electronic payments system will reduce transaction costs, expand markets, and empower individuals. The speed of that transition and the expected benefits, however, will depend on creating a legal infrastructure that penalizes failure and rewards success. The rules that govern the new monetary universe will have to be transparent, equally applied, and consistent with individual freedom if people are to have trust and confidence in cybermoney.

For banking in coming days, we bankers are interested to know how technological changes have affected the payment's system, making it possible to move from government paper bank notes and coins to privately issued e-cash. We still do not know whether this will end the government's currency monopoly, and change the monetary standard, and our central banks could still control monetary aggregates by controlling the monetary base, which would have lot of impact on the way we extend our credits.

Here is a list of what may change in the basic work of economy and its impact on tomorrow's banking, as we bankers know:

1. The most promising benefit of the transition to a financially innovative secure and low cost on-line banking system is the potential it offers for offshore banking. As soon as commercial on-line networks and Internet sites begin offering offshore banking services, with zero or very small fees for transferring funds, an exodus of retail banking business will begin from the regulated onshore sector, specially in developing countries with inefficient banking set-up to the untaxed and unregulated offshore sector. This is an escape from inefficient domestic financial regulations of mainly developing countries to offshore banking activities, hoping to remove inefficient regulations at home.

3. The above mentioned changes seem to alter the concept of liquidity for the banks. Liquidity can only be produced from a domain of trust. Trust is generated by feedback from statistical tracking or by an external guarantor. It is true to say that technological advances in particular in cryptography will create greater trust and efficiency in the electronic payments system and enables banks to provide greater liquidity. In other words, the information revolution will create more liquidity /trust.

4. An increased liberty of individuals using the Internet to globalize money and commerce may end the government's monetary sovereignty, thus sovereign individuals will construct new monetary institutions that must inherently rest on the consent of the participants. The World Wide Web provides in the foreseeable future a powerful new tool for entrepreneurs, provides consumers with greater freedom of choice, and makes e-cash and electronic banking feasible. Bankers look eagerly to this development to estimate the effects of a change in their sovereign body.

5. Bankers are interested to learn the role of government in financial innovation. Banks follow government decisions on regulation, taxation, and privacy as they relate to the financial services revolution. How does the transition to electronic cash will shape the future of the electronic payments system? If governments, especially in developing countries, take a protectionist attitude, the pace of banking innovation may be hindered and banking industry bear the costs. Government involvement in the design of new technology often deters private alternatives. The lesson for electronic money and banking is that consumers and merchants, not governments, should ultimately determine what new products are successful in the marketplace. This, of course, applies to financial products sold by banks. The trend is the movement toward greater freedom in the provision of financial products and services as the industry is deregulated. This trend will allow the industry to serve consumers better as they deal with complexity and strive for greater autonomy in planning their financial future.

6. In tomorrow's financial system, non-bank firms' liabilities will be used for making new electronic payment system. The question is whether they should be treated as banks and subject to the same supervision and regulation. It seems to many that a central authority is needed for preserving stability of the new payments system; all firms offering liabilities used by the public for making payments should be required to obtain bank charters and be supervised and regulated as banks, and have access to central banks to get help for their occasional liquidity problems.

7. In the long run, the electronic payments system may evolve into a system of free banking with competing private currencies based on the model of share banking. As e-cash crowds out central bank notes, the central bank's case for discretion will weaken. In such a situation, banks must learn to work with monetary rules, rather than central banks' communiques, since a new monetary standard will emerge as people shift to e-money. If banks succeed in developing secure electronic notes, then the money will be created on demand in any currency.

8. In a world of anonymous e-money, which can be transferred around the globe at the speed of light, governments everywhere will have to consider added pressures for tax reforms, specially for a low-rate consumption tax. The more the government, particularly in developing countries, tries to tax, regulate, control, and confiscate, the greater the incentive for money to leave. If the current tax system is retained, government will become even more intrusive as it tries to stop tax evasion; it is more probable to face massive capital outflows.

9. Since e-money will affect the conduct of monetary policy, i.e., it will influence the central bank's ability to control money and the price level, and since financial innovations such as e-money will provide individuals with more monetary freedom and make them less dependent on the central banks, all this will have a direct impact on banks-central bank relationship. Can we predict that e-money is likely to reduce the demand for bank reserves to near zero? What is the impact of such a phenomenon on our operations as retail commercial or even development banks?

10. How e-money may affect the Central Bank's position as the sole supplier of currency? It seems that market forces are on the side of private suppliers of e-cash and that those forces will make a system of private competing currencies inherently stable. In the future, what is money will be determined by what buyers and sellers accept and use as money rather than by government definitions.

11. In the long run a system of free banking could evolve as e-money and the model of share banking are widely accepted. Electronic payments and financial innovations could allow individuals to hold all their assets in highly liquid and divisible mutual-fund shares that reflect current market values and, consequently, would represent economically viable exchange media. The resultant accounting system of exchange would eliminate the problem of monetary disequilibrium, which is associated with the present par-value monetary system of exchange. The inherent stability of this private alternative to government fiat money, may end the need for banking regulation. Finally, in tomorrow's economy, while non bank providers of e-money will compete with banks, we bankers must make sure that banks will continue to have a comparative advantage in managing risk in the new monetary universe.

Major Trends in Tomorrow's Private Banking

1. Tomorrow's private banking like today must entail the most cost efficient manners of banking in which banks are able to fit their customers' definition of convenience; incorporated into private individual’s new definition of convenience are reliability and dependability. This is equal to an increase in service proliferation. Some existing examples are point of sale terminals, bank credit cards, limited service branches offering drive-through transactions provided by bank branches located inside shopping centers, supermarkets, office buildings, and other stores. In the future, sales-oriented employees will offer a full range of fee-based services at these branches. All future bankers will be forced to convert to the new methods of reaching their customers. The customer faced with the automated teller machines, automated loan machines, online banking via his personal computer, and banking via telephone, compared with the traditional face-to-face private banking transactions taking place in a physical bank structure, will find quite apparently the impacts of this rapid and global technological changes on the financial services he receives. Whether these technological changes advance exponentially, or slowly and incrementally, depends to some extent to where the customer lives on the globe.

From the perspective the private banking institutions, technology has made it so that data processing has virtually eliminated the differences between bank deposits and savings accounts, credit card advances and installment loans, money market funds and mortgage bonds, annuities and insurance. For consumers, the differences between financial products and the motivation behind using them remain high. Banks may be lowering costs, and may even pass some of those savings on to consumers.

In future, the current convenient new way of doing banking at home, work or traveling will continue. Bank customers or members can manage their accounts 24 hours a day. From anywhere in the world, they can check their balances, transfer funds, or pay their bills. Financial products such as brokerage accounts, insurance, and other capital market packages will be also provided to private customers.

2. The creation of "digital cash" will allow the private customers to be their own bank branches for certain transactions. This, indeed, will be a major trend in tomorrow’s private banking.

3. Virtual private banking on the World Wide Web will continue to make banking more convenient to customers. In October 1995, Security First Network Bank was the first bank to create home page. With society's increased knowledge base of computers and the Web, virtual banking will be the ultimate in convenience. Even now a days, it is a common practice to refer to bank web pages where we can find information about the bank, a description of the services offered, and many other details about buying banking products and services via the web. At present, most of the multi-branch banks provide home banking access via a direct-dial PC modem connection or the Internet. It is not pure financial motivation that is making banks move towards online banking, but a drive to enhance customer service.

It is not really difficult to foresee that in near future even in developing countries a very high percentage of solidly middle-income people will use a check card and an ATM to get cash, a PC to check their account balances and a call center to get help with questions they can not answer themselves.

The premise that future private banking will be highly involved with Internet network is well supported by viewing the astonishing numbers on this growing trend. The experienced growth rate of banking home pages states that this trend is the wave of the future. It is not difficult to foresee that more than 80 per cent of retail banking within the next 15 years, at least in countries with financial depth, will be some derivative of virtual banking. The technology craze that began in 90's shows no sign of slowing down, and banking on the web will continue to grow in popularity even in developing countries. The customers will have full access to their money via Internet. Almost all banks will be offering Internet banking to their customers/members with many features and customizable interface such as account inquiries, secure applications, opening new accounts, viewing detailed transactions, full statements, interactive financial calculators, comprehensive bill payment services, downloadable items of all sorts, cash management services, wire transfers, request and authorizations, etc.

The trend is so strong that all start-up banks in future will do all of their business over the Internet, due to little start-up costs and convenience as compared to a traditional financial institution. If this is true, then can we expect a growth of small banks similar to early American individual banking system along side the consolidated mega bank conglomerates?

4. To make private banking more efficient by providing more products to consumers, preserving bank safety and soundness, promoting investor protection, and creating an environment in which banks can keep the required privacy of the customer, a set of new laws are required in future to update the increasingly archaic depression-era and antiquated laws that constrain the development and competitiveness of even today’s financial system. Present laws no longer reflect the realities of today's financial system.

Online private banking holds much promise because the speed that makes the banking systems efficient and the anonymity that makes it secure are positive characteristics from the public's perspective as well as from law enforcement concerned with protecting the systems from security breaches. Unfortunately, same characteristics will make banking systems equally attractive to those who seek to use them for illicit purposes. Increased anonymity may provide security we bankers require for private banking, but may also impede law enforcement from obtaining the necessary information to enable them to detect illegal activity.

5. The future supervisory authorities and banking organizations will develop methods for identifying, assessing, managing and controlling the risks associated with electronic banking and electronic money.

At the present juncture, the development and use of electronic banking and electronic money are still in their early stages. While providing new opportunities for banks, electronic banking and electronic money activities carry risks as well as benefits and it is important that these risks are recognized and managed in a prudent manner.

The Basle Committee has already produced documents for an ongoing review and discussion of supervisory issues and responses related to technological advances in electronic retail products and services. Given the degree of uncertainty about future technological and market developments, it is important that supervisory authorities avoid policies that hamper useful innovation and experimentation. The future supervisory process should not drown electronic banking in a sea of regulation, but it should facilitate the development of appropriate supervisory approaches to the management of risks in electronic banking and electronic money activities.

In the area of private banking, the hottest issue is not whether the Web and the Internet will affect the ways banks will handle their private clients, but how far the technology can take banks into the future, and whether or not governments at all levels will let technology lead them. Of course, there are pitfalls, controversies and issues that must be addressed, but the bankers believe that industry-led solutions are best in the long run. Market-based regulations should be used to ensure successful growth of this medium while still providing full access for all customers. I think in dealing with Internet private banking, in future, the banks themselves would lead the Internet's economic progression, and when government actions are necessary, banks will ensure that they should be specific in scope and pay attention to the rapid growth of the Internet. Banking through the Internet, i.e., the first medium to have been born globally, will relieve banks from governments' zeal to impose regulations and taxes that may stifle its international growth.

In tomorrow's banking, global leaders of the financial industry will more concentrate on what type of government regulation should be placed on the growing electronic banking industry. I suspect bankers themselves in the developed countries will make sure that through industry-lead regulations the future development of electronic banking will be evolutionary rather than being chaotic, because if the future of electronic banking does in fact become chaotic, governments will have a much harder time protecting legitimate financial activity from illegal intrusion.

6. If Citicorp and Travelers Group have already created a powerhouse to become a diversified global leader in financial services, a premier global bank, a leading global asset management company, a preeminent global investment banking and trading firm, and a broad-based insurance capability through their impending merger that will serve over 100 million customers in 100 countries worldwide, with assets of approximately $750 billion dollars, then it is easy to foresee that the bankers of tomorrow will extend their geographical and functional span through more combinations and alliances. The impact of these mega-mergers between banks and other financial institutions on the banking industry and in specific on private banking, we hope, will not be the undesirable effect of having created a perceived need for greater government intervention to regulate the world of finance.

Future banking in all areas including transactions with private individuals will include mergers and consolidations. The trend has already been prominent if we look back to the experience of last 3 years: The bank merger of Citicorp and Travelers Group Inc that entered into a $70 billion deal to create the world's largest financial services, or the partnership of NationsBank and BankAmerica, and the merger of BancOne Corp. and First Chicago NBD Corp. tell us that the creation of mega-mergers financial institutions will likely reshape the way banking is conducted in future.

Merger is a general development of future, and the banking is no exception, and some of the so-called mega-mergers of the coming years that would change again the face of financial services will be in this economic section. A rising trend of strategic partnerships between financial service providers is in the limelight.

7. In tomorrow’s banking the changing nature of money is only one face of the financial services revolution. Complexity, self-reliance and less regulation have fostered a financial services industry that is even now essentially technology-based. In my opinion, the forgotten side to this development is the technological enhancements between banks and their customers that will be the growth direction of the private banking industry in coming years.