Module 6

MODULE 6

INTERNET BANKING: REGULATIONS AND LEGAL
CHALLENGES

The potential benefits for banks to conclude their businesses on-line are
immense, with decreased transaction costs and access to new customers
providing seemingly irresistible advantages to conducting business on-line.
However, the uptake of Internet banking within India has been slow with
only a handful of players providing a true ‘Internet banking service. The
purpose of this chapter is to set out some of the regulatory challenges to
Internet banking within India and to provide a brief explanation of the
technology involved.

The Internet revolution is a worldwide phenomenon and moving forward by
the present progression data, India is looking towards an increase in the
Internet penetration in near future chiefly in the area of electronic
commerce.1 It is an apparent conception that Internet (Online) banking and
payments are expected to progress more or less together with e-commerce.
Researches indicate that Internet banking has a significant impact on the
business models of banks, securities trading firms, brokerage houses,
insurance companies etc. Internet banking has also attracted the attention of
regulators and lawmakers in the developing nations since the late 1990s.2

1Murshed, S. Mansood. (2000). "Globalization, Marginalization and Development. A UNU Working Paper. No.
175.
2Stiglitz, Joseph. (2002). Globalization and Its Discontents. W. W. Norton, New York.

The beginning of the Internet era and developments in information
technology and telecommunications undisputedly are inflicting major
impact on financial markets and institutions. Everyone seems to be
confident that, in the long run, online banking will result in more helpful
financial intermediation. Banks have customarily been in the race of
utilizing technology to make their products, services and efficiency better.3
They have, over a long time, been using electronic and telecommunication
networks for delivering a wide range of value added products and services.
The delivery channels include direct dial – up connections, private
networks, public networks etc and the devices include telephone, Personal
Computers including the Automated Teller Machines, etc. The term
“Electronic Banking” 4or “e-banking” is defined as remote banking services
provided by authorized banks, or their representatives through devices
operated either under the bank's direct control and management or under the
outsourcing agreement.5 In other words, e-banking is an umbrella term for
the process by which a customer may perform banking transactions
electronically without visiting a branch and includes the systems that enable
customers of banks, individuals or businesses, to access accounts, transact
business, or obtain information on financial products and services through
a public or private network, including the Internet.6Though such
technologies have affected a very substantial and wide array of business

3Walsham, G. (2001). Making a World of Difference: IT in a Global Context. John Wiley and Sons, New York.
4 The FSS in Korea defines the Internet banking as computer network based banking, which includes automated
transfer of money, settlement of bills, and realization of general financial service network. On the other hand,
Cave and Mason (2001) define Internet as a global network of networks. Their paper elaborates the mechanism
of Internet.

5DeYoung R. (2005) “The performance of internet-based business models: evidence from the banking industry”,
Journal of Business, vol.78, n.3, pp. 893-947.

6DeYoung R. (2006) “The limits of information technology: how much will the banking industry change?”, in
“Technology driven efficiencies in financial markets”, Heikkinen P., Korhonen K. (eds), pp. 35-46.

activities, the legal challenges displayed by the introduction and use of new
technological means to both, banking and financial services might be one of
the most defying tasks confronting the international business and legal
communities which has already required substantial amounts of discussions,
debates and lots of ink, and which is promising to ask for more. Banks have
been experimenting with various forms of online banking for many years.7
The Internet, as an enabling technology, has made banking and financial
products and services available to more customers and eliminated
geographic and proprietary systems barriers. With an expanded market,
banks and financial organizations can also have opportunities to expand or
change their product and service offerings.8

Broadly, the levels of banking services offered through Internet can be
categorized into three types:9 (i) The Basic Level Service, whereby the
banks’ websites, which disseminate information on different products and
services offered to customers and members of public in general. It may
receive and reply to customers’ queries through e-mail, (ii) In the next level
are Simple Transactional Websites which allow customers to submit their
instructions, applications for different services, queries on their account
balances, etc, but do not permit any fund-based transactions on their
accounts, (iii) The third level of Internet banking services are offered by
Fully Transactional Websites which allow the customers to operate on their
accounts for transfer of funds, payment of different bills, subscribing to

7Furst K., Lang W.W., Nolle D. E. (2000) “Special studies on technology and banking. Who offers internet
banking”, Quarterly Journal, vol.19, n.2, pp. 29-48.

8Sullivan R.J. (2000) “How has the adoption of internet banking affected performance and risk at banks? A look
at internet banking in the tenth Federal Reserve district”, Federal Reserve Bank of Kansas City Financial Industry
Perspectives, December, pp. 1-16.

9Internet Banking in India - Guidelines, www.banknetindia.com/banking/ibguide2.htm

other products of the bank and to transact purchase and sale of securities,
etc. Traditional banks, offer the forms of Internet banking services as an
additional method of serving the customer or by new banks, who deliver
banking services primarily through Internet or other electronic delivery
channels as the value added services. Some of these banks are known as
‘virtual’ banks or ‘Internet-only’ banks and may not have any physical
presence in a country despite offering different banking services.10Certainly,
as banks and financial organizations have in their huge majority presented
new technologies service delivery, an assembly of concerns have been
raised, the dealing with which shall be one of the most interesting and
complicated legal challenges in the coming few years. Among these issues,
worries over security, authentication, privacy, liabilities are undoubtedly to
trouble all of suppliers of banking and financial services, the users thereof
in addition to lawmakers and practitioners.11

Actually, the suitable legal structure associated to e-banking and financial
services shall possibly institute one of the extremely analytical and
important sections in a infrastructure of a country and notwithstanding the
fact that most of the banks and financial institutions are already providing a
considerable amount of their services through the use of new technologies,
the amount of users of e-banking or financial services shall largely depend
on existing domestic and international legal support provided by the laws
and regulations. Such users shall only feel comfortable in using new

10Birch D., Young M. (1997) “Financial services and the internet-what does the cyberspace mean for the financial
services industry?”, Internet Research: Electronic Networking Applications and Policy, vol.7, n.2, pp. 120-128.
11Jayawardhena C., Foley P. (2000) “Changes in the banking sector-the case of internet banking in the UK”,
Internet Research: Electronic Networking Applications and Policy, vol.10, n.1, pp. 19-30.

electronic services if they are aware of defined legal framework that would
allow them to identify their rights and obligations with the least possible
uncertainties.12Uniformly it should be extended to banks and financial
institutions which are presently using such new technologies possibly
thinking of the commercial facets of presenting new services to their
customers but with important concerns over the existence of an
appropriately explained legal framework which by result in the absence
thereof, shall abstain the institutions from expanding the scale of their
services and may also result in disregarding such use, a concern that would
harmfully affect their business and the quality of services provided to the
clients.

For these reasons, the requirement of a revision of domestic and
international legal framework has been acknowledged as being of highest
significance in the development of e-banking activities and transactions,
which would establish one of the major constituents for a strong growth of
these sectors.

Electronic banking was firstly introduced in the United States of America
(USA) in the early of 1990s and it has since extended globally gradually.13
The phenomenon of online banking with which we are familiar today,
started in the early 1980s, when it was first planned and tried out with. In
the beginning computers and Internet stood less developed; the idea of home
banking came into being, which basically used fax machines and telephones

12 Cronin, M.J. (1997), Banking and Finance on the Internet, VNR
13Davies, S. (1979), The Diffusion of Process Innovations, Cambridge University Press

to interact with their customers.14 With time extensive use of computer and
Internet facilities produced further opportunities for evolution of home
banking which is popularly known as Internet Banking in today’s world. It
was only in 1995 that Presidential Savings Bank first announced the facility
for regular client use. Other banks like Wells Fargo, Chase Manhattan and
Security First Network Bank quickly snapped up the idea.15 Today, quite a
few banks operate solely via the Internet and have no 'four walls' entity at
all. The first online banking service in the United States was introduced, in
October 1994.16Stanford Federal Credit Union developed this service,
which is a financial institution. The online banking services are becoming
more and more prevalent due to the well- developed systems. Though there
are pros and cons of electronic cash, it has become a revolution that is
enhancing the banking sector.

In the commencement of the Online banking system, its inventors and
experts had forecasted that soon the new system would take over and replace
completely the traditional banks. Evidences have proved that it was an
overestimated calculation done by the investors; Lots of customers still
depend on the traditional system of banking because of an intrinsic distrust
in the new system. Some of the customers are reluctant to use all the offered
facilities because they had bad experience with cyber frauds. Still the

14Gourlay, A. and E. Pentecost (2002), “The Determinants of Technology Diffusion: Evidence from the UK
Financial Sector”, The Manchester School. Vol.70, No.2, pp.185-203
15Hoppe, H.C. (2002), “The Timing of New Technology Adoption: Theoretical Models and Empirical evidence”,
The Manchester School Vol.70, No.1, pp.56-76
16Mansfield, E. (1968), The Economics of Technical Change, New York, Norton.

number of online banking customers has been increasing at an exponential
rate.

There is no denying the fact that information technology has been the most
rapidly changing industry in India, and the marriage of technology and
banking has to occur for India to keep pace with changes in the global
scenario.17 Looking back, the Narasimham Committee deserves mention in
that it was instrumental in forcing Indian banks to become competitive. Fleet
footed private sector banks, forced the public sector banks to embrace
technology and improve their level of customer service. Next, the Khan
Committee was highly important in that it recommended the setting up of
universal banks.18 Preference was given to financial institutions, which
could provide a whole range of corporate financial solutions under one roof.
But most importantly, the Verma Committee recommended the need for
greater use of IT even in the weak Public sector banks. Actually, the
nationalization of banks back in the 80s is proving to be a major obstacle in
bringing about the required technological changes.19 Nationalization of the
banking sector has led to occurrences of pseudo developmental activities for
nurturing vote banks, loss of accent on performance and profitability,
creation of unions etc to name a few.

Primarily, the main desirability of the new system of Internet Banking is the
exclusion of wearisome bureaucratic red tape in registering for an account,

17Bose Jayshree (2006),ǁE-Banking in India, The paradigm Shiftǁ, PP. 22-23, The ICFAI Unversity Press.
18Gurusamy S.(2005), ―Merchant Banking and Financial Servicesǁ. PP. 406-410, Nicole Imprints Pvt. Ltd
19Uppal R.K., ―Customer Perception of E – Banking Services of Indian Banks: Some
Survey Evidenceǁ,

The ICFAI Journal of Bank Management, Vol. VII No.10