Dr. Bimal Jalan - Governor, Reserve Bank of India     

SHORT COMMENTS

Information Technology and Banking *

It goes without saying that the two sectors of our economy - banking and IT - are vital for India’s growth and broad based development. There is also a tremendous mutuality of interest in these two sectors. In the banking sector, IT can reduce costs, increase volumes and facilitate customised financial products. Similarly, IT requires banking and financial services to facilitate its growth. The interesting background papers circulated for the conference amply bear this out. Financial services need IT and IT needs financial services to make the maximum impact.

We all know that the changes brought out by new development in information technology are truly revolutionary. An interesting question is: why now? Computers have been around for a long time and while internet in its present form is of relatively recent origin, other forms of fast global communications, particularly telephones and faxes, have also been around for quite a while. Why is it that only now - say in last five years or so - IT has become not only an instrument of communication or information, but also such an important contributor to growth and productivity?

The revolution in new technology has both been helped by, and in turn, has helped three other important global economic developments in the 90s.

The first is the declining importance of manufacturing - and increasing importance - of value added services as a source of income and growth. In industrial countries, the share of manufacturing in the total national income has declined very sharply over the years and today it is less than 20 per cent. In developing countries like India also, value added services such as transport, communication, banking, construction, management, marketing and administration are growing in proportion to national income. In India, the contribution of services to national income is more than 50 per cent. Interestingly, the fastest growing segment in the manufacturing sector is also connected with services, e.g. data processing equipment, semi-conductor devices and so on. Interestingly, “services” are generally more conducive to IT inputs in terms of quality and costs than manufacturing. In banking, for example, entire transactions including delivery, can be conducted over the Internet. This is not possible in respect of say, steel or clothing.

Secondly, in the last decade, there has been a substantial lowering of barriers to trade and capital mobility, the so called “globalisation process”. If quantitative restrictions on trade and tariffs had remained high, then it is obvious that global advantage that Internet has conferred in respect of trade or commerce would have been substantially less. Greater openness has contributed to the tremendous growth of market for IT, just as IT has helped in accelerating the globalisation process. As a result, distance is no longer crucial and geographical location is no longer a key to business decisions as was the case 20 or 30 years ago. Companies are likely to locate anywhere in the world where they can find the best skills and the best “time zone” advantage.

The third crucial factor, which is related to the second, is the growing integration of developing country markets with those of the developed country financial markets, including equity markets. Developments in Nasdaq, for example, or Dow Jones have world wide impact. In countries in different time zones this integration has increased importance of timely information, and therefore, of IT and information providers and analysts.

Interestingly, all the above developments, which have contributed to the IT revolution are also to India’s advantage. India has been able to take advantage of the IT because of its “skills” endowments. The increasing importance of the services revolution, and decreasing importance of distance, in defining comparative advantage has meant that it is now possible to unbundle the production and consumption of various types of services across the globe. This means that India does not necessarily have to be a low cost producer of certain types of goods (e.g. computer or discs) in order to become an efficient supplier of services embodied in them (e.g. software or music).

Similarly, freer capital mobility has meant that capital is no longer a binding constraint to development. Capital is available in plenty and any capital-deficit developing country or for that matter, any corporate entity, can attract capital in order to carry on value-added economic activity. Among developing countries, despite our many inefficiencies, India has one of the better financial institutional infrastructure, including one of the oldest equity markets in the world. Most of our financial practices and accounting standards also meet the test of international acceptance. Globalisation of financial services has provided substantial opportunities for export of software as well as management expertise from India to even the most sophisticated markets in the world.

I have highlighted some of these factors only to emphasise the two-way relationship between technology and global macro-economic developments. We have benefited from these global developments in the nineties because we have also adjusted our domestic policies to take advantage of the new economy and new developments in trade, capital and finance. It is important to emphasise that technology is not sufficient by and of itself to generate growth or bring about economic prosperity. It can contribute most when the economic environment and macro-economic policies are conducive to its inputs. Accelerating the momentum of economic reform and institutional innovations in our economy are major challenges for us in future, if we want to take maximum advantage of these new trends.

Nowhere is this more important than in the banking and the financial sector. We cannot benefit from IT as much as we can, and should, unless we transform the way in which we do our banking business. There are some specific characteristics of money and finance which make it particularly amenable to benefit from IT, provided we seize the new opportunities. Among these are:

 

  • As I mentioned earlier unlike most other goods and services, money and finance can actually be used, transferred and delivered electronically. In other words, no physical movement or physical delivery is required to complete transactions and their end use. This explains why financial volumes, with the aid of electronics and computerisation have grown phenomenally in recent years. Total financial transactions in a day can exceed the entire GDP of an industrial country.
     

  • In the financial sector, credits and debits need to be settled in real time so that the value risk and default risk are minimised. Earlier, when payment and settlement system was based on movements of papers, it used to take several days to reconcile debits and credits. Today, payment and settlement system can happen on real time basis.
     

  • A related characteristic is that, with the possibility of payment and settlement taking place simultaneously in real time, risks and uncertainties can be reduced. This reduces the cost of capital. This has tremendous advantages for increasing productivity and generating higher output at lower cost. IT has also made it possible to devise complex financial products, such as derivatives, without adding to risk or uncertainty, which has expanded the scope for meeting various kinds of financial preferences, risk profiles and different requirements of savers and investors.

These characteristics represent a tremendous PLUS for growth of IT in finance. There are, however, certain limitations also in respect of financial transactions compared with e-commerce in physical products. There is a greater need for supervisory and regulatory system since many financial institutions such as banks, mutual funds, and pension funds, etc. deal with other people’s money. It is important to ensure that peoples’ savings are safe and not diverted away or misused.

Financial system can also be highly ‘leveraged’. In order to safeguard investors’ interest, it becomes necessary to impose some limits on leveraging in relation to the size of owned funds. A related requirement is that the total volume of money in the system has to be related to the size of the real economy. In other words, financial agencies, unless specifically authorised to do so, cannot be allowed to create “new” money. Otherwise, money itself will lose its value and the economy can be characterised by high inflation.

Unlike the physical exchange of goods, the financial system also has ‘negative externalities’. Instability here can hurt those who do not directly participate as savers or lenders, as happened in East Asia.

The growth of IT has also posed certain special challenges for the banking system. There is a real possibility of disintermediation, that is, there are new opportunities for savers and investors to deal directly with each other rather than through the banking system, unless banks can provide some value added in terms of return and safety of funds or investment advice. Banks have to change the old ways of doing things. This poses a challenge, particularly for public sector banks. The Human Resources Development (HRD), which has been a relatively neglected area in our banks, is absolutely crucial. Increasingly, it is the “people” who contribute to value addition in services rather than “materials” or fixed assets.

I have outlined some considerations that distinguish financial markets from other markets where IT is going to revolutionalise the ways of doing business. What does all this add up to? Increasing use of IT in finance is inevitable and we are going to see more and more transactions taking place across the Internet and the Web. At the same time, much greater supervision, surveillance and regulation of money transactions conducted electronically or over the Web is going to be required. In India, these systems are yet to evolve but we have made a beginning by setting up an INFINET system, an electronic RTGS system and faster computerisation of bank branches.

But there is a long way to go. As new methods of supervision are yet to be evolved, there is also substantial need for legislative changes. The new IT Bill has made an important advance but as we go along, new needs will arise. I hope that the discussions here will help in working out a road map for coping with increasing digitilisation of banking services.

Let me now end on a somewhat different note if I may. There is no doubt that new opportunities are opening for us and for our knowledge based industries. At the same time, we cannot ignore the deterioration that is taking place in our public institutions, including knowledge based universities, public administration and delivery of public services. Looking at the long run, the expansion of knowledge based industries and services, including IT and banking, are not likely to be viable with stagnation and deterioration in our public institutional framework. I would, therefore, request you to give some consideration to this question. How - and in what ways can we, as a group, who are benefiting from the current global trends can contribute to establishing a new collaborative relationship with our public administration and public delivery mechanisms?

An equally important task for the future is to improve corporate governance in our country. Many of our companies, particularly in the “old economy”, are still operating in an environment where public trust in their business practices is not very high. For example, a recent survey showed that only 20 per cent of the persons surveyed preferred to put their savings deposits with private sector corporations, however high their market capitalisation. As many as 50 per cent of the persons surveyed complained about not receiving proper service in respect of deposits made by them. Interestingly, as many as 80 per cent said that they would prefer to put deposits with public sector financial institutions, even though, they pay lower rates of interest.

I hope that our new economy firms would not only become models to emulate but also set the standards and infuse a new culture in management practices in all sectors of the economy.


* Excerpts from the Inaugural Address at the BancIT 2000 held at Bangalore on July 14, 2000.

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