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Risk-Based Analysis of Electronic Banking

Article · January 2007

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 Risk-based analysis of electronic banking
Angeleski Marjan, Msc.
Faculty of Economics – Prilep
Kostoska Olivera, Msc.
Faculty of Economics – Prilep
Janeska Margarita, PhD
Faculty of Economics – Prilep

Abstract

Over the last decade, the concept of electronic banking has an extensive impact on the banking system as a whole, emerged as
a consequence of the new paradigm for the business process support. The permanence of technological innovation, as well as
the increased competition has pressurized the financial institutions to develop the new electronic banking products and
services aimed at better gratifying the costumers’ needs.

Notwithstanding, the outlined concept of technological breakthrough and rapid progress within the banking, induce many
benefits for the financial institutions and consumers, but harmful side effects, such as risks which should be managed in a
proper way. Furthermore, the electronic banking does not set up some new risk profiles, but highlights those that any
financial institution confronts with (strategic, transaction, compliance, reputation, information security, credit, interest rate,
liquidity, as well as foreign exchange risk). The purpose of this paper is to enunciate those major risks, but also critically
assess their impact on the bank running within the frame of the new electronic environment.

Key words: e – banking, risk management

Introduction

The payment is an integral part of the business, with no difference if it is conducted in a traditional or
electronic manner. The electronic mode of running the business, particularly the electronic trade
stipulates some payment techniques, which could be scrutinized as an electronic option of the traditional
system of payment. Due to these traditional instruments, nowadays-different appliances of electronic
payment are being developed. Those might be classified, as follows:

⇒ Electronic credit card

⇒ Electronic cheque
⇒ Electronic cash
⇒ Electronic payment peer-peer
⇒ Electronic wallet
⇒ Payment cards
⇒ Electronic payment via mobile devices
⇒ Electronic asset transfer etc.

Bearing in mind the traditional and electronic system of payment, the fundamental difference between
those might be seen in the scope of the design i.e. everything is digital within the second one. All the
activities mentioned above point at a kind of specific banking form that has been developed throughout
the recent years titled as internet or electronic banking. The concept of electronic banking (e-banking)
refers to the atomized deliverance of some new or conventional banking products and/or services in a
straight line to the consumers all the way through electronic or some additional communication channels.

Basic features of e-banking risks

The process of alteration from the traditional to the modern electronic way of running the business yields
some risks associated with the very same course. According to those, the financial institutions Internet
offerings could be roughly classified as follows:1

⇒ Informational - put forward some information about the products and services offered by the
bank and these are low risked;
⇒ Communicative – propose an information about the accounts and bring up to date the static data
i.e. addresses, numbers etc. Due to the limited access to the bank’s computer system, the risk
might be considered as a material one;
⇒ Transactional – taking into account that the costumer is permitted to accomplish the financial
transaction, these offerings bring the highest risk for the financial institution and costumers, as
well.

1
Ramakrishan, G. (2001), “Risk Management for Internet Banking”, Information System Control Journal, Volume 6.
In sequence to reduce the risks that burden the above-mentioned Internet offerings of the financial
institutions, the electronic banking has to comprise some exceptional threats, which could be appraised,
as follows:

⇒ Speed of technological change (hassles some new additional costs for the banks,
particularly for the smaller ones);
⇒ Changing costumer expectations (the banks could not always respond to all the
customers’ requests and preferences) ;
⇒ Less face-to-face interaction to financial institutions customers (increases the moral
hazard and non-ethical issues on one side, but also makes the institutions far off the
costumers);
⇒ Need to integrate e-banking with the institution’s legacy computer systems (the
inherited computer system might not be scalable enough, so it could not be integrated
within the new system easily. Due to this, very high changeover costs could be needled
aimed at replacing the old system with the new one);
⇒ Dependence on third parties for necessary technical expertise (the bank might be
negatively affected of not having the permanent maintenance of the system, that might
call forth losing the costumers reliance);
⇒ Proliferation of threats and vulnerabilities in policy accessible networks (increases the
visibility of publicly accessible networks, that possibly will have the major impact on
loosing the privacy, information accuracy etc).

The management should properly assess all of these perils in order to adapt and swell the risk
management practices of the institution as an indispensable component to tackle with the risks caused by
the e-banking activities. In other words, the management ought to lay down the appropriate height of e-
banking services taking into account the costumer needs and the institutional risk at the same time.

Types of e-banking risks

The hasty banking steps forward induce many benefits for the financial institutions and consumers, but
harmful side effects (risks mentioned above). Nevertheless, the electronic banking does not set up some
new risk profiles, but draw attention to those that any financial institution deals with. Those risks, which
might be partly covered, will be briefly described below2:

⇒ Operational/Transaction risk – a kind of risk emerged from the deceptions, errors which
appear during the transaction processing, as well as system disruptions come out form the
differences between the new and legacy based information system platform. The transaction
risk could also emerge from the bank inability to control the third party – provider of the
service.

2
Bank for International Settlements (2003), “Risk Management Principles for Electronic Banking”, Basel Committee on
Banking Supervision.
⇒ Strategic risk – sort of risk that has an impact on the long-term earnings of the investment due
to the improper business decisions, as well as their inadequate accomplishment. Nevertheless,
the huge banks despite the smaller ones, do not reach their decisions about the
implementation of the e-banking system by reason of the return of investment and cost-
benefit analysis, but from the challenge to succeed within the sharp competition. Frequently,
does not mean a definite success.

⇒ Technology risk – a present and potential risk emerged from the losses, violations,
abnormality and breakdown of the usage or dependence on the computer hardware, software,
online services etc.

⇒ Compliance risk – a type of risk appeared from the inconformity with the state law, policy
instruments and ethical principles. Subsequently, the financial institution needs to be aware of
the obtainable law and to make certain its appliance with the other directions such as branch
banking. The compliance risk also comprises the necessity of remaining the consumers’ data
confidential.

⇒ Reputation risk – variety of risk come into view from the public judgment that could be quite
negative. This could emerge from the inadequate methods selected to execute the e-banking
services.

⇒ Information security risk – the financial institution has to identify some critical factors aimed
at protecting itself and consumers, throughout assuming several preventive activities, such as:
the institution has to ensure its logo and more over to retain its commercial reputation created
by the web site. Those might be damaged by the non – ethical and criminal attitude of the
individuals and groups, due to it could be considered as a threat for the e-banking system as a
whole, but for the consumers as well.

⇒ Credit risk – a category of risk appeared from the inability of the consumer to fill out his/her
financial obligations. E-banking offers the opportunity to the costumers to apply for a credit
from anywhere in the world, but this makes the complexity for the bank to recognize the
credit ability of the applicants.

⇒ Interest rate risk – risk associated with the movements of the interest rates. Owing the fact
that e – banking gives the possibility to the costumers to compare different banks interest
rates, the banks have to proceed quickly in order to retain or acquire the costumers’ loans and
deposits.

⇒ Liquidity risk – appears from the inability of the bank to fulfill its financial responsibilities.
Thus, the costumers are likely to draw out from the association with the bank and to go
anywhere else where the rate clauses are better.
 ⇒ Foreign exchange risk – e-banking may support the inhabitants of one state to achieve the
transactions in their domestic currency, owing to the costumers may undertake many
speculative actions.

Conclusions

Nowadays, financial institutions are facing with a very high competitive pressure due to they have to
renew their products and services in order to meet the consumers needs in a better way. E-banking
system is relatively easy to be set up, because the new entrants associated with are usually not impeded
by the old systems and structures. However, there are many risks closely related to these new banks
opportunities. Those do not vary intensively from the traditional ones, but they have to be taken into
account when bank management reaches the financial decisions i.e. the main e-banking risks are
classified as follows: strategic, transaction, compliance, reputation, information security, credit, interest
rate, liquidity, as well as foreign exchange risk.

References
[1] Bank for International Settlements (2003), “Risk Management Principles for Electronic Banking”, Basel
Committee on Banking Supervision.

[2] Harris, L. and Spence, J. L. (2002),”The ethics of E-banking”, Journal of Electronic Commerce Research.

[3] Internet banking – comptroller’s handbook, comptroller of the currency (1999)

[4] Pezier, J. (2002), “Operational Risk Management”, Discussion Paper in Finance 2002-21,, Mastering
Operational Risks FT – Printice Hall.

[5] Ramakrishan, G. (2001), “Risk Management for Internet Banking”, Information System Control Journal,
Volume 6.

[6] The Central Banks of Bahamas (2006), “Guidelines for Electronic Banking”.

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