Financial Times: Wednesday, September 4, 1996 IT: A Spider's Web for the Banking Sector Interview with Joseph De Feo By Paul Taylor The influence of network computing and other technologies extends into all aspects of the industry. Barclays' director of group operations and technology believes it will have a profound effect on traditional banking. 'It's going to change the whole way business is conducted,' he forecasts Joseph De Feo has built up a formidable reputation as an effective business leader and banking visionary since he joined Barclays Bank as director of group operations and technology nearly seven years ago. American-born Mr De Feo, who joined Barclays from merchant bankers Morgan Grenfell after spells with both Goldman Sachs, the Wall Street investment bank, and Chase Manhattan, the third-biggest US bank, is also widely regarded as one of the banking industry's most outspoken, and influential, IT users. He believes the main issue facing the banking industry is the impact of electronic delivery mechanisms and the changes which will be wrought by introducing electronic delivery to replace physical branch delivery in retail banking services. But although he believes changes in retail banking may be the most visible, he says the impact of the broader capability of networks and networking will be just as dramatic on the wholesale and investment banking business. "It is engendering a situation in which there will be a wholesale reconstruction of the value chains in the business model for the industry, where you could envision networks of specialist companies, each focused on a specific area - say research, analytics, trading, investment banking, distribution. . . "This sort of change has actually occurred in other industry sectors - the commodity end of the business is being concentrated into a smaller number of global producers, and the rest of the business is being fragmented among many thousands of very focused and specialised players." He believes that, faced with such challenges, banks will adopt different strategies. Some, such as JP Morgan in the US, will quit the "manufacturing" end of banking, and sub-contract out the processing. Others will specialise in transaction processing, in much the same way that National Westminster Bank is providing the back-office capability for supermarket chain Tesco's recently-launched loyalty card in Britain. Overall, he thinks the number of jobs in retail banking will fall as capital is substituted for labour. "I think the aggregate labour content in all aspects of the business will go down, but not at the same rate as it will in retail banking." In Britain, he warns, the adjustment will be disproportional, "because we hesitated on the capitalisation of the automation of the branch networks." Delaying automation of the traditional branch networks could also make it more difficult for the banks to respond to new and often lower-cost competitors, including retailers such as Marks and Spencer and Virgin which do not have the same infrastructure costs. In addition, he notes, it takes time to respond to new competition and new delivery channels. "You still have to support the branch network. The more inefficient that branch network is, the higher the burden of cost - so you are really stuck if you have huge costs." Unlike some of his colleagues, however, Mr De Feo does not believe that bank branch networks will disappear overnight. "When I first joined the group, lots of people were saying we need to cut the branch network in half in the long run. It was a real big issue - we were obsessed with the numbers of branches. I kept saying to them that you have to start on a more rational base and judge what is effective for the group to have as a physical branch distribution network." While he believes the bank's branch network is still costing a lot more, probably five or six times more, than it ought to, he argues that the decision on an individual outlet "could change very dramatically if the branch was much cheaper to keep open." "We have not closed nearly as many branches as people had originally thought we were going to, because the cost of us having an outlet open is much lower than many other banks," he says. Barclays has cut the cost of its branches "by reducing the labour content, by having more customer volume go though each branch, so that the effectiveness and efficiency of an outlet is improved." He notes that in the US, "if you count electronic branches, there are more branches opening - they are not closing branches. . . the individual cost of those locations is a fraction of what it is in this country." Even with the advent of electronic purses and smart cards, Mr De Feo believes there will still be a need for physical bank outlets. "We really need physical bits of paper in our hand to do business. . . so it is going to take a long time to get rid of the physical locations; probably 25-30 years." Ahead of that, he believes there could actually be an increase in bank outlets. "I would predict that you will see an increase in penetration in supermarkets of electronic branches, or [branches] where there is one person, in this country. "I think you will see more express branches like we have just put up in Tunbridge Wells, which will either be semi-manned or unmanned." He thinks these low cost "convenience branches" will be supplemented by telephone banking, or banking via a digital television or via personal computer. "We had better do it because we are going to struggle strategically to keep our branch identity, the way things are going," he says. "We have got strong branch identity in the industry, but that could be usurped very quickly, especially for the traditional products because we don't satisfy primary needs." Mr De Feo makes his point using a potential car buyer as an example. "If you need to borrow money for a car, it is not because you want to borrow money, it's because you want a car." If, as is beginning to happen, car manufacturers bundle in the financing, "why would you bother to go to a bank?" If the carmaker has a good credit rating, it can raise money cheaper than the banks - so it is sensible for the carmaker to arrange the finance because it can make an additional small profit on the loan. Like other large financial institutions, Barclays is a big IT spender. But does Mr De Feo think that the bank gets value for money? "I think that in Barclays we are now getting to the point where we are - and it shows in our results, and in the recognition we are getting, and the way in which the business attitude towards IT has changed. The level of suspicion that IT was sort of a thing that was on its own, and spending money because they wanted more toys, is dissipating. "If you look at the core businesses of the group, whether you are talking about BZW or the asset management business, we are now much more thoroughly integrated in terms of how technology is being used. We have still got a way to go because we are not on an appropriate strategic platform because the knowledge gap is still there and we need to understand better how these technologies are going to transform business. Sophisticated banking IT systems, such as those used in credit behaviour scoring, knowledge-based techniques and corporate lending assessment, are now commonplace. "IT has improved the quality of our lending, our decision-making, our communication with our customers, because it is clearly more objective. It is more explainable; it is not like I turned you down for a loan because I don't like the look of you." He believes the relationship between banks and the IT vendors has also changed. "It is a matter of choosing partners now," he says, "the functional differences are less significant in vendor selection than they used to be." Mr De Feo argues that one of the biggest challenges facing the financial services sector is ensuring that the wide variety of legacy systems work together. "That glue - how you get the network of these applications brought together - is extraordinarily important. Mr De Feo says that IT users need infrastructure standards which would allow different proprietary technologies to be brought together. "The Internet offers some of it but the Internet is weak in systems management and security. The most important aspect of the Internet is that it has given a glimmer of what is possible with network-based computing. "It is like a very weak light-bulb going on in an absolutely dark room, and what I worry about is that we will not be able to fulfil the promise because there are so many holes in the management and the security side of it. "We are OK now because it is being used as an information dissemination vehicle, and an e-mail vehicle, but when we start doing serious applications using that technology it's all going to bubble to the surface and we're going to see the same sort of problems with the Internet as enterprises are having in gluing together computer systems that were built on IBM or Digital Equipment technology." Eventually, Mr de Feo believes Microsoft will produce the "glue" to bind disparate systems together, but he cautions: "It is going to be very hard for Microsoft because it is going to push them into spaces they have never occupied before." Similarly, he believes that the real potential of network computing will only be realised if it enters the commercial sphere. He says: "That will only happen if the financial services element is solved. We have got to get all that sorted out, so all of this has got to be brought together at some point soon, otherwise things will go into a slowdown until they get resolved. "There are all sorts of initiatives to work on: the security, and work on the systems management, and so on. But the cohesiveness of those efforts is not apparent." Ultimately he believes network computing and other technologies will have a profound effect on traditional banking. "It's going to change the whole way business is conducted," he says. "The influences of all these technologies extends like a spider's web out into all aspects of the industry." Financial Times: Wednesday, September 4, 1996 Global Finance Sector Maintains Its IT Edge By Paul Taylor

From Internet banking and multimedia kiosks to electronic trading rooms and risk management systems, the future of the global financial services industry is inextricably linked to information technology.

The financial services sector is already one of the biggest spenders on information technology -- spending made necessary not just to reduce costs, but also to maintain an edge in an increasingly competitive market where new entrants and new channels to market are eroding traditional boundaries. For example, in the insurance sector, Datamonitor, the market research firm, predicts that 95 per cent of the UK's largest insurance intermediaries will have direct operations by 1998. Datamonitor also believes that by 1998 some 70 per cent of insurance companies will have Internet sites. The intensification of competition within the financial services sector reflects the deregulation of the industry which has attracted new entrants. Other factors are globalisation and technology which have swept aside barriers to entry and lowered the cost of doing business. As a result, in order to thrive in the 1990s, financial service organisations are as much in the business of managing and manipulating information as managing and making money. "Our industry is information based - it is absolutely essential - and the relationship of technology management, technology usage and business management is one of the critical skills," says Joseph De Feo, director of group operations and technology at Barclays bank. "If people in financial services companies say they don't understand technology, or are afraid of technology, it is just like saying 'I am not qualified to do my job'," says Mr De Feo. The fate of many financial institutions, as they gear up to face this new competition, will depend on the successful deployment of data processing resources, telecommunications systems and software. "The financial services industry is faced with unprecedented challenges - increasing competition, a technology revolution, a highly unpredictable economic and political climate, consumerism and rapidly evolving legislation," said Andersen Consulting in a recent report*. John Reed, chairman of leading US commercial bank Citicorp, has expressed concern that banks and securities firms risk being reduced to "a line or two of application code on a network." Such concerns are understandable given the competitive pressures that banks and other financial institutions now face. "Financial services companies are trying to drive down or stabilise costs," says Ian Peackock, a consultant with Logica, the UK-based computer services group. "Another big area for them is systems integration." "When the banking history of this century is written, the decade from 1990 to 2000 will be seen as the defining moment," said Price Waterhouse in a recently published report on the challenge of virtual banking. "A new generation of non-bank competitors poised to harness new forms of technology could radically alter the structure of the traditional banking system as we know it. Today, opportunities are being exploited by software companies, consumer companies and even large and influential media owners. The threat to the traditional 'bricks and mortar' banking system is very real." In America, US telecoms group AT&T became the second-largest card issuer in the world with more than 15m accounts in just five years. Ford Motor, which now generates 20 per cent of its US revenues from financial services, now positions itself in the UK as "the branchless bank". Business Week magazine noted: "Banking is essential to a modern economy. Banks are not" -a view echoed by Bill Gates, chairman of Microsoft, who warned: "Banks are dinosaurs. Give me a piece of the transaction business and they are history." Meanwhile, the IT specialists at Deloitte & Touche argue that "Technology will change the retail banking industry fundamentally in the years to come." They believe that banks will lose their monopoly as centres for money transmission - in other words, the activity of transmitting money from one person or company to another will increasingly be carried out by a variety of competing providers. In addition, distribution channels for retail banking products will proliferate. "Whereas in the past the bank branch was the only channel for distributing most financial services products, in the future a number of different channels will continue to erode the branch's predominance," say Deloitte & Touche. Finally they argue that the fully integrated bank will fragment into specialist categories. Braxxon Technology, an IT management and systems consultancy, estimated recently that leading international banking institutions face a combined IT bill of $ 4bn to replace their existing global trading settlement systems for bonds and equities. After a survey of large banks, Braxxon concluded that the top 50 world investment banks would need a global investment of at least $ 80m each to replace existing settlement systems which have failed to keep pace with business and regulatory requirements. The survey also revealed that 30 per cent of banking systems are more than 10 years old - and three out of every five banks have already started replacing their systems. Financial institution spending on IT is also likely to be increased over the next few years in order to tackle issues such as the so-called millennium problem which affects older software, much of which is running on mainframe machines. Ultimately, as the worlds of information processing and financial services collide, most financial institutions realise that they have little choice but to increase their IT expenditure while ensuring that they use technology as efficiently as possible to deliver their customers fast, flexible and competitively priced services. *Financial Services in a Virtual World. Forbes ASAP: August 26, 1996 The Money Changers: Digital cash Innovators Sholem Rosen: Citibank V.P., Emerging Technologies SHOLOM ROSEN heads Citibank's emerging technologies group, which has devised a digital cash system. Rosen invented the technology, slated to be released in late 1998, that will make possible the electronic management of cash. The 55-year-old Rosen, a former math professor at Johns Hopkins University, talked with FORBES ASAP's Lee Patterson about Citibank's digital cash plan. ASAP: What has Citibank developed that's different from other electronic money technology? ROSEN: We've developed EMS, which stands for Electronic Monetary System. It allows you to transact personal or commercial business without the need of a third party. If you pay me $10 for a good or service, the money goes directly to me -- it doesn't go through a bank. EMS supports all currencies, so you could pay someone in yen, dollars or marks. In our system, the money circulates just like cash, except our "EMS note" carries a complete audit trail. If your e-money is lost or stolen, it can be redeemed. ASAP: Software companies are aggressively pursuing the electronic commerce and banking markets. How do you think Citibank's name will stand up to the likes of Microsoft or DigiCash? ROSEN: Citibank understands consumer marketing. Every card in my wallet has the Citibank brand name on it. You may not lie loyal to your bank yet, but the idea is to make you loyal by providing services that make your life a lot easier. If Microsoft or another software company wants to be a competitor, it's still going to have to sign up with banks to do business. Internet money is not going to be of any value if you can't turn it into real money you can use in the physical world. You have to go through the banking system to do that. ASAP: How did you feel a year ago when you heard the plans for a Microsoft/Intuit merger? ROSEN: Personally, I didn't think much of it at all. I believe banks are more concerned they'll be captive to what technology companies deliver to the consumer rather than having their businesses taken over. ASAP: But why will consumers come to Citibank for their technology needs when they can go to Microsoft or Intuit? ROSEN: Because Citibank has better technology. We give away our home banking software, and it's much more functional than anything you're going to pay to get from Intuit. Technology companies are definitely competition, but we have been approaching electronic money from an application standpoint and applying technology to it -- not the other way around. ASAP: Much of the focus of e-money technology centers on security. How secure is Citibank's system? ROSEN: Security has to be in the hardware, not the software. Our security is built into a proprietary chip we've developed. We're going to use cryptography that only national labs will be capable of breaking. I would let all the hackers in the world take their cracks at our system. ASAP: Will e-money replace the coin and papernote system we use today? ROSEN: We're not here to replace paper money. Our system will be valuable on the Net. Internet transactions are flaky now. We're trying to take the flakiness out of it. We want to give the user more of the feeling of trust and security experienced in the physical marketplace. ASAP: What's the federal government's role in electronic money? ROSEN: They're watching. They're letting people experiment. The official party line is "We're going to keep our hands off and our nose in." ASAP: Will digital cash make it easy to launder money or evade taxes offshore? ROSEN: It's true that with e-money, geography is gone. All the laws that have been created here and abroad have been based on geography. Two-thirds of our currency now is abroad. So what's the big deal if [e-money] moves abroad? With our system, the feds will have a lot more control over what's going on than they do with the present paper currency system. EMS notes will leave electronic audit trails, and their circulation can be blocked if the system detects that they've been tampered with or duplicated. --- Dr.Dimitri Vulis KOTM Brighton Beach Boardwalk BBS, Forest Hills, N.Y.: +1-718-261-2013, 14.4Kbps