Remarks by

Julie L. Williams

1^st^ Senior Deputy Comptroller and Chief Counsel

Office of the Comptroller of the Currency

Before the

6^th^ Annual Institute

Emerging Law of

Cyberbanking and Electronic Commerce

Washington, DC

February 1, 2001

A conference on "The Emerging Law of Cyberbanking and Electronic
Commerce" is an excellent venue to take stock of important trends and
developments in the financial industry. During the past year, the
content, implications and implementation of the Gramm-Leach-Bliley Act
(GLBA) often were the centerpiece of discussions of change in the
financial industry. But, this year, one of the most significant \-- and
technology-driven \-- trends becoming evident in the banking industry
represents quite a different dimension of financial modernization.

Make no mistake: GLBA is landmark legislation. It allows types of
financial companies to affiliate that previously were not permitted to
do so, and it allows companies directly to provide products previously
allowed to be provided only by other types of firms. In broad terms,
GLBA facilitates growth in the size of financial services firms, and may
encourage consolidations, because it enables financial companies to
acquire more types of other financial companies and to commence new
lines of business.

In contrast to this trend, however, one of the most interesting and
potentially far-reaching developments in the financial industry today is
one based on a type of deconsolidation \-- I'll call it
"deconstruction." The process of separating out the different functions
of a financial instrument \-- origination, servicing, absorbing
particular risk components \-- has been a revolutionary development in
financial markets over the last 20 years. Today, we see this same
process of "deconstruction" engulfing all aspects of the banking
business. By "deconstruction" I mean the separation or segmentation of
banking products, services and operations into their component parts or
processes so that they can be provided or obtained separately.

Discussions of how "deconstruction" affects the banking business
typically focus on how deconstruction of banks' traditional functions
enables their *competitors* to "cherry-pick" segments of their business.
Certainly, advances in technology make the component functions of
banking ever more divisible. But my premise today is that a
deconstructed perspective of its own business may be a key to a bank's
success. Put another way, if banks' competitors gain advantages by
"cherry-picking" segments of their banking business, why shouldn't banks
do the same to themselves? The manifestations and implications of
deconstruction of the business of banking, and how those are aided and
abetted by technology, are what I will talk about today.

So what is being deconstructed? The traditional vertically and
horizontally integrated banking firm that produces and delivers *its*
products, through *its* outlets, to *its* customers is being picked
apart. Examples are easy to find. What is easy to miss, however, is how
the examples are pieces of a larger picture puzzle that represents a
fundamentally different way of looking at the business of banking; one
in which the different capacities, competencies and attributes of a
banking firm are the pieces.

Consider the example of the most traditional of bank products \-- a
loan. One way to look at a loan is as a single product. Deconstructed,
however, a loan is a series of functions: evaluating risk; originating
the loan; funding the loan; servicing/administering the loan; and
holding the loan asset. None of these functions is necessarily unique to
a bank, and any particular bank could chose to do some or all of them,
depending upon its comparative advantage relative to competitors
performing the same functions. A bank with a capacity for a particular
function, such as loan servicing, could "export" that capacity by
marketing it to other businesses, while another bank might determine
that it does not want to develop that capacity and would look for a
third party from which it can "import" the function.

Similarly, a bank may decide that it is important for its customers to
have access to a broad range of products, but rather than producing
those products itself, it will import the choices and, as finder, give
its customers access to products from other providers. Or, a bank may
even detach its name and regulatory status from its own products and
services and market under the bank's name products or services produced
or originated by a third party \-- in effect, deconstructing its brand
and its reputation.

This kind of "deconstructed" perspective on the banking business enables
a banking firm to analyze the components of how it does business, what
it does, what it does well, and where it may have a particular advantage
in an activity. A banking firm may decide, piece by piece, whether the
firm commits resources to perform a particular function itself, or hires
another company to do it; whether it produces a particular product, or
makes products originated by third parties available to its customers;
whether it has particular capacities and competencies that translate
into new business opportunities; and whether there are other attributes
of the bank that are marketable.

Why is all this important? Because a view of the banking business as
divisible into component pieces enables banks to play to their
strengths; to commit resources to the particular processes they do best,
where they have a comparative advantage, and to gain access to skills,
expertise and products that they need, without having to develop them
in-house. A bank's advantage in conducting an activity itself may come
from economies of scale, its particular competence, or attributes that
distinguish it from other providers of the same product or service. When
the banking firm does not have an advantage producing the product,
service or function itself, however, it can look to "import" it from
another source.

In addition, when a line of business is viewed as a series of functions,
entry and exit barriers should be lowered since a banking firm may enter
a new activity without developing an entire productive process, and may
exit a business line without having to dismantle the infrastructure for
an entire function. A bank may make a strategic, limited entry into a
particular activity, limit its expenditures, and exit with a containable
exposure. Thus, in general, it should be desirable for a banking firm to
have the ability \-- to have the option \-- of analyzing its current and
prospective business in a deconstructed fashion.

Technology both vastly enhances the ability of banking firms to
deconstruct and segment their business and creates new opportunities for
them based upon strategic exploitation of advantages associated with
particular segments of that business. Generally, we can see the effects
of deconstruction of the banking business, and the impact of technology
on this trend, in four basic ways:

-   ***Using third parties to perform functions on a bank's behalf.*** A
    bank contracts with third party providers to perform components of
    the bank's operations.

-   ***Providing access to products and services of other providers.***
    The bank makes products and services originated by others available
    to the bank's customers.

```{=html}
<!-- -->
```
-   ***Marketing processes and activities for which the bank has
    particular capacities and competencies.*** Functions and activities
    that the bank performs for its own operations are marketed to third
    parties.

```{=html}
<!-- -->
```
-   ***"Franchising" the bank's attributes.*** The bank "franchises" its
    attributes, lending its name or its regulated entity status to
    products and services originated by others or activities
    predominantly conducted by others.

    Let's look more closely at each of these situations.

***Using third parties to perform functions on a bank's behalf.***

It is well-recognized that third-party vendors, brokers, dealers and
agents offer banks a variety of systems and services, as well as
products designed to diversify bank assets and sources of revenue, and
to reduce costs. Use of third party vendors for various back-office
systems and software is common, and the more recent development of
banks' retaining third party vendors to establish and operate their
Internet web sites is becoming increasingly so. Other more unusual,
recent manifestations of this aspect of deconstruction are initiatives
by some banks to contract out bank internal functions, such as human
resources administration and internal audit.

When it comes to innovations in technology, this trend has some
interesting twists. In the typical, traditional third party vendor
scenario, a banking firm contracts with a third party vendor to provide
a specified back-office system or function. Today, a bank may be
exploring *new* technologies that support the creation and provision of
*new* financial products and services. In other words, the sought-after
technology or new product or function may not yet exist \-- is not on
the shelf \-- at least not in the form the banking firm wants it.

In this setting, participation in the development of standards and
industry protocols for new technology, and in the development of
delivery systems and equipment, are vital in order to ensure that the
new standards and equipment are optimal for delivering the types of
banking products and services that a bank wants to provide. And,
involvement of a continuing nature may be necessary in order to insure
that the product or system remains available to the bank and is
developed consistent with the bank's needs.

To be able to guide the creation, deployment, and access to an
innovation, however, may require that the banking firm participate in
some form of joint arrangement with the other companies participating in
the project. One efficient way is for a banking organization to do this
is to make strategic investments in those companies or ventures with
which it seeks to partner in the development of technology related to
producing and delivering financial products and services. This enables
the banking firm to explore a variety of initiatives, while containing
its exposure by making only the limited investments necessary to gain a
technology partner needed for particular technology-based initiatives.

The use of third parties to develop standards, products and services
based on new technologies is one current example of deconstruction. The
example also illustrates that the most effective \-- perhaps the
necessary \-- way to do so is through relationships with third parties
that go beyond simply contracting for a product or service. In this
context, the OCC's minority investment precedents are significant
because they recognize non-controlling investments by national banks in
companies where the investment is "incidental to banking" because they
are "convenient or useful" to accomplishing a bank's banking business.
Given the pervasive implications of technology on the banking business,
these investments could easily be viewed as *necessary* to the future
success of banking firms. The Federal Reserve Board also has recognized
this vital linkage in its recent proposal asking for comments on whether
such strategic investments should be viewed as financial in nature,
incidental to a financial activity, or "complementary" to a financial
activity.

***Providing access to products and services of other providers.***

Offering financial products and services also can be deconstructed;
banks have options how, and which, financial and non-financial products
and services to make available to their customers. A banking company may
decide that it wants to meet customers' desires for access to certain
non-financial products and services by arranging for them to be
available from a third party. For example, banking companies could offer
insurance from an affiliated insurance company, or securities brokerage
through an affiliated brokerage firm, or could chose to make
arrangements with one or more non-affiliated third parties to provide
those products and services to the bank's customers.

These choices may take the form of joint marketing arrangements, where,
for example, a bank will contract for a company to offer its products or
services to the bank's customers from the bank's premises. Or the bank
may provide statement stuffers and other marketing materials of sellers
of various financial products and services, or identify other service
providers as an accommodation to its customers. Essentially, these are
old-fashioned examples of how a bank deconstructs aspects of its
relationships with customers; determining what products and services
they want and then how best to provide them. Traditionally, these types
of activities were referred to as acting as a "finder."

The authority of national and many state banks to act as "finders,"
bringing together buyers and sellers of products and services for
transactions that the parties themselves negotiate and consummate, is
well-recognized. With advances in technology and increased use of the
Internet, however, banking firms are able to act as a finder
electronically on a far broader scale. The new technology introduces a
new dimension of finder activities, providing not just a new channel for
banks to market their own financial products and services, but a vastly
expanded means to provide customers with access to those of third
parties. Technology also helps a bank couple functions offered by the
bank with the products and services of third parties that the bank makes
available. Banks may become full service providers without being full
service producers.

For example, both national banks, and more recently, financial holding
companies, have

been recognized to have authority as finders to host "virtual mall" web
sites that provide links to the web sites of third party buyers and
sellers, and allows sellers (or buyers) to submit expressions of
interest, bids, offers, orders and confirmations at the linked sites.
Similarly, both national banks and financial holding companies are able
to operate Internet marketplace web sites that allow multiple buyers and
sellers to exchange information concerning the products and services
they are willing to buy or sell, locate potential counterparties for
transactions, aggregate orders for goods and services with those made by
other parties, and enter into transactions between themselves at the
bank's site.

In either approach, the bank or financial holding company may negotiate
with sellers to provide preferred terms to buyers that purchase through
the web link or web site, and may establish rules of general
applicability governing how its finder function operates. These
operating rules could, for example, establish parameters under which
buyers and sellers submit bids and offers to the finder, the
circumstances under which the finder will match bids and offers, and
rules that govern the manner in which buyers and sellers bind themselves
to the terms of a transaction that is facilitated by the finder. The
finder authority is not limited to provision of financial products and
services, so these activities could pertain to transactions involving
*anything.*

This last point raises various issues. One vital question concerning the
bank's role is the extent to which it may couple its functions and
activities with the products and services of third parties that it makes
available. In the case of financial holding companies, the finder
authority has just been recognized and no precedents yet exist outside
of the new rule. In the case of national banks, precedents support
combining the finder authority with other functions that are permissible
as part of the business of banking, such as payments processing and
information management, as well as with a limited amount of non-banking
activity that is permissible because it is "incidental" \-- convenient
or useful \-- to the bank-permissible activities including the finder
function. For example, national banks offering to host commercially
enabled web sites may also, as an incidental service, offer web site
design and development.

Finally, whenever a banking firm is providing its customers access to
products not originated by the bank, a wide range of customer
relationship issues arise. Does the customer using a bank's finder
service understand that the products and services being obtained are
those of a third party, not the bank, and that the bank does not warrant
their quality? How realistic is it for the bank to assume that it can
divorce itself entirely from the product or service procured through the
bank's facilities and how involved does the bank want to become in
quality control of those products and services?

What risks does a consumer face? If a banking organization establishes
operating rules for transactions conducted via its web-based finder
capacity, can its rules allocate the risk of unauthorized use of an
access device to the consumer? If so, what is the consumer's potential
exposure and how effectively is he or she informed of this?

High-tech finder functions are also fertile ground for privacy issues.
When a bank acts as a finder, what kind of information does the bank
acquire about the customers of that service and transactions they
execute? What does it do with that information?

***Marketing processes and activities for which the bank has particular
capacities***

***and competencies.***

Yet another manifestation of a deconstructed perspective of the banking
business happens when a banking firm has a particular skill, competency
or other advantage in providing a product or service. In that case, the
reverse of the first example occurs. Rather than "importing" a
particular function from a third party vendor, the bank "exports" to
third parties components of operations that it conducts for itself. In
doing this, the banking firm is optimizing the use and value of its
facilities and competencies as well as avoiding economic waste. It is
effectively cherry-picking its own operations.

This can occur in a variety of settings. There may be some activities
where large scale is a comparative advantage, and a bank with a capacity
for the activity will exploit that competency by performing the
activity, not just for itself, but for other banks and non-banks.
Current examples include mortgage servicing, credit cards, payments
processing and administration and the fiduciary and securities custodial
business.

Technology affords new opportunities here as well. And national banks
have authority to pursue these opportunities in marketing their
electronic competencies and capacities to others. For example, a
subsidiary of a national bank approved to act as a certification
authority is also "manufacturing" digital certificates for third party
certificate authorities. Since the issuance of digital certificates is
part of the business of banking, the production of the certificates for
others to issue is likewise permissible. Here, the bank is exporting to
others its competence in producing digital certificates.

Likewise, the OCC has authorized a national bank that has developed
extensive competence in digital imaging to export that service to other
financial institutions. This is a permissible correspondent service. We
also have found that national banks may, as part of the business of
banking, market to non-financial firms imaging services that focus
predominantly on banking, financial or economic data. The OCC has also
held that where a national bank has acquired good faith excess capacity
in imaging (due to, for example, the batch nature of its operations),
the bank may sell that capacity to others without regard to the nature
of the firm or its images.

Finally, OCC has permitted national banks that develop competence and
capacity in electronic finder activities (including commercially enabled
web hosting) to sell these wholesale to other financial institutions
that wish to offer these services to their merchant customers. This is
both an exercise of the bank's electronic finder authority and a valid
correspondent service.

***"Franchising" the bank's attributes.***

Finally, some banks have recognized that deconstruction can go so far as
to enable them to exploit certain reputational and regulatory attributes
that may give them a competitive advantage. To that end, the bank
performs services in its own name, but in association with third parties
and, thereby, effectively endows that third party's products or
activities with the bank's attributes.

Technology both encourages and facilitates this approach. Non-banks
increasingly find that technology enables them to successfully enter
"bank-like" services, but without the expense of a bank branch system or
a bank charter. Computer systems enable these non-banks to integrate a
set of distinct operations \-- some performed by banks and some by
themselves \-- such a scoring a loan applicant and funding a loan, into
what appears to the consumer as a single seamless product or service.

This approach goes beyond deconstruction of the bank's special skills
and competencies, discussed above; it involves deconstructing the
advantages in market perception and legal treatment that arise from
status as a regulated financial institution. For example, because they
are subject to an extensive regulatory regime, banks generally benefit
from a high level of public trust. In addition, banks have unique access
to payments systems that non-banks covet. And, in the case of national
banks and federal thrifts, certain state laws are not applicable because
of principles of federal preemption.

This fourth type of deconstruction is the newest, and potentially most
problematic. In this type of deconstruction, a bank is detaching its
name and reputation from its own activities and permitting its
attributes to be used in connection with the products and services of a
third party. The implications of this type of "franchising" of a bank's
attributes are considerably more complex than when Harley Davidson
decides to associate its brand with a new line of clothing.

Recent manifestations of this type of deconstruction appear in various
efforts by non-banks to obtain access to bank funding and payments
systems. One example is the so-called "Rent-a-BIN" arrangement, designed
to afford a non-bank access to a credit card payments system. In this
type arrangement, a bank permits a non-bank to use the bank's BIN ("Bank
Identification Number") issued by VISA, by issuing a credit card to be
used for the third party's products or services. In exchange for a fee
paid to the bank when the account is opened and periodically thereafter,
the non-bank acquires all the credit card receivables, receives all
interest payments and other finance charges, and benefits from the
bank's authority to use the interest rates permitted in the state in
which the bank is located, regardless of the limits on rates that may
apply in the state in which the customer is located.

In another example, non-bank financial product vendors seeking to avoid
the application of state consumer protection laws may approach banks to
enter into marketing arrangements where banks fund certain types of
loans marketed by the vendor, such as so-called "payday" or "title"
loans. The loans are actually offered, not at the bank's regular
branches, but at offices of the third party vendor at other locations.
After the bank funds the loan, the third party then immediately
purchases all or virtually all of the loans from the bank. For this
activity, the bank is paid a fee.

In these situations, the third party's objective is to involve a
national bank or a federal thrift. By having its loans funded by an
entity that enjoys federal preemption, the third party seeks to avoid
compliance with a variety of state consumer protection laws, yet the
third party itself is not subject to the responsibilities and federal
regulation applicable to a national bank or federal thrift.

However, when a bank is offering products and services actually
originated by third parties as its own, the bank can be exposed to
substantial financial loss and damage to its reputation if it fails to
maintain adequate quality control over those products and services and
adequate oversight over the third party activities. Simply the act of
delegating customer interactions to a third party also risks a priceless
asset \-- the bank's good name \-- if customers are not treated
according to standards expected from the bank.

Unfortunately, in recent examples of this type of deconstruction, we
have seen banks associate their name and special status with products
that were abusive to consumers and with third party vendors that did not
conduct their operations with the diligence expected of a regulated
financial institution.

This is not to say that this category of deconstruction is always
inadvisable or inappropriate. Experience does strongly indicate,
however, that when a bank's role in the origination and marketing of a
product or service is only superficial and its actual involvement in the
substance of the transaction is limited, the bank may have placed its
reputation and safety and soundness at risk. Moreover, in those cases,
it is questionable as a policy matter whether the bank or thrift should
be able to simply bestow the benefits and attributes of its regulated
entity status on a third party that is not subject to the
responsibilities and regulation that apply to the bank and thrift.

**Conclusion.**

This framework of analysis demonstrates how technology is propelling
fundamental changes in the financial industry. Although I have touched
on many issues in this review, in many ways, I have barely scratched the
surface. But, the abundance of issues to consider should not obscure the
core message: "Deconstruction" of banking functions should not be
confused with "destruction" of the banking business. To the contrary,
when coupled with the potential of technology, prudent, strategic and
responsible deconstruction of banking functions may be vital to the
future of the business of banking.