Module 9

MODULE 9: THE LEGAL CHALLENGES TO INTERNET BANKING

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 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

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.
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.

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array of business 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 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

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
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.

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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 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 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.

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

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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 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, and the unending paperwork
involved in regular banking. The speed with which this process happens online, as well as
the other services achievable by this process, has converted into a literal growth in the
banking industry. The development of Internet banking has helped a lot to banks and their
customers. It has benefited the banks in many ways such as expand outreach, reduce
transaction costs, improve efficiency, and provide virtual banking services. Customers also
have gained from effective banking services at comparatively lower costs and holding then
choice to select from alternate delivery channels.20 The Internet banking has also enabled
fast transfer of funds domestically and across borders.
A main influence over the fast spread of Online banking across the globe is its approval as an
exceptionally low cost delivery means of banking services as rivalled to the other traditional
means. However, Internet is also mixed with certain disadvantages. Along with decrease in

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

20Mason, R. and H. Weeds (2001), “Networks, Options and Pre-emption”, mimeo, Universityof Southampton.

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