roger w ferguson, jr : information technology in banking and supervision remarks by roger w ferguson, jr, vice - chairman of the board of governors of the us federal reserve system, at the financial services conference 2000, st. louis university, st. louis, missouri on 20 october 2000. * * * i am pleased to speak with you today on technological innovation in the financial services sector. as you may know, technology and its impact have been key areas of focus at the federal reserve in recent years. as my colleagues on the federal reserve board have often noted, technological innovation affects not just banking, financial services, and regulatory policy, but also the direction of the economy and its capacity for continued growth. some argue that dramatic structural changes are in store for the financial services industry as a result of the internet revolution ; others see a continuation of trends already under way. what is clear is that the last few years have seen a truly phenomenal pace of new technology adoption among even the most conservative banking organizations. a number of financial trade publications are now devoted almost entirely to emerging technologies and the latest financial technology ventures. we know that many banks are making what seem like huge investments in technology to maintain and upgrade their infrastructure, in order not only to provide new electronic information - based services, but also to manage their risk positions and pricing. at the same time, new off - the - shelf electronic services, such as on - line retail banking, are making it possible for very small institutions to take advantage of new technologies at quite reasonable costs. these developments may ultimately change the competitive landscape in financial services in ways that we cannot predict today. technology is also changing the supervisory and regulatory landscape. it is creating new tools for supervisors and new supervisory challenges. technology - driven issues such as privacy and the nature of electronic communications have reached the forefront of the policy agenda. and the line between electronic banking and electronic commerce is becoming more difficult to define clearly. i would like to explore more deeply a few of these issues in my remarks today. technology investments more than most other industries, financial institutions rely on gathering, processing, analyzing, and providing information in order to meet the needs of customers. given the importance of information in banking, it is not surprising that banks were among the earliest adopters of automated information processing technology. the technological revolution in banking actually began in the 1950s, well before it began in most other industries, when the first automated bookkeeping machines were installed at a few us banks. automation in banking became common over

the supervisory process, any reporting of technology - related investments and expenditures. lack of consistent data significantly limits systematic industrywide or peer group analysis by supervisors or economic researchers that would shed light on some of these questions. as i consider the very recent, admittedly mixed, experience of the financial services sector with technologies - looking at the examples of internet banking, on - line banking, smart cards, and atms - it seems that several lessons emerge. first, many of the investments have been made to automate existing processes, but the challenge of fundamentally rethinking the process from start to finish - the so - called core process redesign that is necessary to reap the full benefit of the current generation of technologies - has proved daunting. this is in part because many of the services that banks are attempting to automate currently are “ joint goods ”, that is, the production and consumption of the product or service depend on the inputs or behaviors of many players outside of the bank and even outside of the financial industry. for example, the flow of services from checks depends on a complex of economic actors, including consumers willing to write checks, merchants willing to accept them, and an infrastructure in place to clear and settle them. attempting to automate part of the check process by imaging or to replace checks with a single instrument, such as the debit card, requires cooperation among all the organizations that support a checking transaction. internet banks are another example of these interdependencies. many internet banks have discovered that they are using any savings in “ brick and mortar ” operating costs to pay “ bounties ”, or fees, to other internet sites that refer new customers and to operate call centers to field the customer inquiries that invariably arise. another lesson from the history of technology in banking is that so many of the costs in banking are shared across products, and even across customers. therefore, an investment that might have a positive impact on one customer base or product may not have the desired impact on the overall cost base. i believe that the early history of atms illustrates this lesson. the atm was originally introduced as a way to reduce costs of the branch network. although the atm succeeded in moving small - value withdrawal transactions from branches, that accounted for only a portion of the customers served and the transactions performed by a branch network. therefore, early atm networks added cost without substituting for branch networks. for atms to become truly economically attractive, they had to evolve to offer a fuller range