E-BANKING IN ESTONIA: REASONS AND BENEFITS OF RAPID GROWTH

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1 E-BANKING IN ESTONIA: REASONS AND BENEFITS OF RAPID GROWTH Olga Luštšik Introduction New information technology is becoming an important factor in the development of financial services sector, especially banking. Banks are facing a number of important questions, for example, how to take full advantage of the opportunities the new technology offers, how does the development of e-banking affect the relationship of customers with service providers, etc. The present article analyses the main criteria for a successful internet-banking strategy. The first part introduces some electronic innovations in financial intermediation; the second part gives an overview of the development of e-banking in Estonia. Estonia has achieved significant success in the implementation of electronic banking, being on the top of the list in emerging countries and even outpacing the achievements of some of the developed countries. The third part analyses the advantages of e-banking in view of clients, banks and the whole economy. The fourth part examines the underlying reasons and factors behind the rapid growth of electronic banking in Estonia; the fifth part suggests possible future outlooks. The results of the article are partly based on the interviews with experts of e-banking in Estonian banks. Electronic Innovations in Financial Intermediation The financial services sector has undergone historic changes in the past decade. The socalled e-developments are rapidly emerging in all areas of financial intermediation and financial markets: we can talk about e-finance, e-money, e-banking, e-brokering, e-insurance, e-exchanges, and even e-supervision. New information technology is becoming the most important factor in the future development of banking, influencing marketing and business strategies of banks. The driving forces behind the rapid transformation of banks are radical changes in the economic environment: innovations in information technology, renewed financial products, liberalisation and consolidation of financial markets, deregulation of financial intermediation, 24

2 OLGA LUŠTŠIK etc. These and other factors make the formation of bank strategy complicated. The process is threatened by unpredictable developments and changes in the economic environment; and therefore, the strategies have to be flexible in order to make them adjustable to changes. The question is no longer whether the emergence of the Internet is a threat or an opportunity, as those who have decided to protect themselves from possible dangers instead of using the opening opportunities, are doomed to be ousted from the market. Electronic banking is the newest delivery channel for banking services. The definition of e- banking varies among studies, partially because electronic banking includes several types of services. Bank customers can request information and carry out most retail banking services via a computer, television or mobile phone 1. For example, Burr 2 describes it as an electronic connection between the bank and the customer in order to prepare, manage and control financial transactions. Electronic banking can also be defined as a variety of the following platforms: (a) Internet banking (or online banking); (b) telephone banking; (c) TV-based banking; (d) mobile phone banking; (e) PC banking (offline or automatic banking). As Internet banking and mobile phone banking are the most rapidly developing areas, the present article mainly focuses on their development and future outlooks. Development of Electronic Banking in Estonia Estonian financial services market is unique in several respects: it is very small and compact, and developing fast. Its controversial Soviet past could be seen as a negative or positive aspect depending on viewer s attitude. The history of Estonian electronic banking is only some years younger than the history of Estonian commercial banking in general. Hansabank launched its first offline electronic banking solution Telehansa in The first Internet banking services were introduced in Estonia in general is very suitable for electronic banking applications due to the relatively high distribution of personal computers and Internet access. In the IV quarter of % of Estonian population aged used Internet. Internet distribution is remarkably higher in Estonia than in other Eastern European countries (see Figure 1). Those who used Internet during a week had the following purposes: 76% for sending or receiving s, 62% for 1 Eg, Daniel, E. Provision of Electronic Banking in the UK and the Republic of Ireland, International Journal of Bank Marketing, , pp Mols, N. The Behavioural Consequences of PC Banking, International Journal of Bank Marketing, , pp Sathye, M. Adoption of Internet Banking by Australian Consumers: An Empirical Investigation, International Journal of Bank Marketing, , pp Burr, W. Wie Informationstechnik die Bankorganisation verändern könnte, Bank und Markt, , pp

3 Denmark USA Netherlands Canada Finland Norway Germany Estonia Italy Great Britain France Czech Republic Poland Lithuania Latvia Source: Emor Figure 1. Internet distribution in the 2nd quarter of 2002 (Internet users, who used the Internet during previous 6 months at least once, percentage of the population aged 15 74) searching specific information from databases or homepages, 57% for visiting portals or using Internet banks, 56% for using search engines 3. Based on these data we can conclude that during March-May 2002 the number of Internet banking users was 260,000 in Estonia, which accounts for 23% of the Estonian population aged This, in turn, indicates that there is still a potential for growth in convincing people to use electronic channels for banking activities more intensively. Internet banking services are used quite actively; most of the payment transactions are concluded via e-channels. The growth of self-service has been increasingly rapid, however, further increase of the share of Internet payments is hindered by insufficient access to the Internet 4. Most of the consumers start using Internet banking because they need to pay bills frequently and would, therefore, like to do it with minimum effort. Besides that people use Internet banking to keep an eye on their money matters, view their account balance and check receiving payments from other parties (see Figure 2). Similar trends are present in other banks as well. On an average 95% of the total volume of payments are concluded via e-banking facilities via online and offline Internet banks and other electronic channels. Figure 3 shows that in Hansabank the percentage of transactions done via the Internet has been continuously growing and in last years e-channels have taken a position of the main transaction channels. The share of branch network in payments 3 Emor, E-seire aruanne,march-may Kerem, K., Luštšik, O., Sõrg, M., Vensel, V. The Development of E-Banking in an EU Candidate Country: An Estonian Case, Proceedings of International Atlantic Economic Society Conference, Vienna, March 11 17,

4 OLGA LUŠTŠIK domestic payments 32% defined payments 21% account statement 19% account balance 7% viewing mailbox 4% credit card information pending payments e-bills 1% 1% 2% other 13% Figure 2. Share of consumer operations in the Internet bank of Eesti Ühispank (Union Bank of Estonia) Source: Kerem et al, % % 35% 30% 25% 20% 15% 10% 5% 0% bank office telephone bank periodical payment ATM direct debit online bank offline bank Figure 3. Use of different transaction channels in Hansabank in (percentage of total domestic payments) Source: Hansabank has decreased from 27% in 1999 to 5% in In Hansabank, 31% of all private clients have also Internet banking contracts and they use Internet banking in an average 6,5 times a month. Looking at the share of payment methods it can be concluded that the clients of Internet banking are more active in using banking services in general. Compared with e- banking leaders in the world financial markets, Estonian banks have quite active clients on average every online banking customer concludes 2,5 transactions per month (see 27

5 online bank transactions per month (left scale, millions) number of online customers (left scale, millions) transactions per one customer a month (right scale) Nordea Swedbank Bank of America EGG Hansabank Figure 4. Online banking Notes: EGG the first fully electronic bank in the world with no offices providing traditional services ( Source: The Dynamo of E-Banking, April 16, 2001 Figure 4), whereas the number does not include automatic direct debits and periodic payments. The quality of services in Estonian online banks has been internationally recognised. According to the Forrester research, Hansabank Internet bank hanza.net was rated as one of the Europe s top solutions in e-banking, ranking in the 16th position 5. Hansabank was also the only bank from Central and Eastern European countries to make its way into the list. In the comments on the report Forrester marked hanza.net as a benchmark site from a smaller web leader. Benefits of Electronic Banking Benefits from the Banks Point of View The first benefits for the banks offering Internet banking services is better branding and faster reaction to market changes. Banks offering such services are perceived as leaders in technology implementation, and therefore, they enjoy a better brand image. Other benefits can be measured in monetary terms. The ultimate goal of a company is to maximise owners profit, and banks are no exception. Automated e-banking services offer 5 Forrester Research. Best of Europe s Net Banking, November

6 OLGA LUŠTŠIK a perfect opportunity for maximising profits. According to a survey by Booz, Allen and Hamilton, an estimated cost providing the routine business of a full service branch in USA is $1.07 per transaction, as compared to 54 cents for telephone banking, 27 cents for ATM banking and 1,5 cents for Internet banking 6. In Nordea Bank, Finland, one online transaction costs the bank an average of 11 US cents, compared to $1 for a transaction in a branch 7. The difference in net cost in the US and Finnish banks can be explained by smaller population in Finland and the scale effect in case of the USA. 100% 90% 80% 70% 60% 50% 40% 30% 20% 10% 0% 100% 12% 3% 5% 95% 35% 2% bank office offline bank online bank ATM telephone bank with an operator automatic telephone bank direct debit Figure 5. Relative costs of domestic payments in different Estonian bank channels In Estonia, the fee for an inland transaction concluded in a bank office is 9 12 kroons, transaction fee in automated telephone banking is 0 6 kroons 8, direct debits are free of charge, fees for ATM and Internet banking services are 0 3 kroons 9. Figure 5 illustrates relative costs of domestic simple payments in different bank channels according to the data provided by Hansabank. Comparing this information with services price list allows us to conclude that the profitability of e-channel banking services is high for banks. Regarding service fees (income side from banks point of view), an average payment in Internet bank costs four times less than a payment in a bank office. Regarding actual costs (costs from banks point of view), a payment via Internet bank costs seven times less than a payment in the office. 6 Nathan, L. Community Banks are Going Online, Community and Banking. Federal Reserve Bank of Boston, Pyun, Chong Soo; Scruggs, L.; Nam, N. Internet Banking in the US, Japan and Europe, Multinational Business Review, Fall 2002, pp The Dynamo of E-Banking, Business Week Online, April 16, content/01_16/b htm?mainwindow 8 The costs of automatic and semi-automatic telephone banking services are different. 9 Transactions are free of charge for customers under 25 and over 60 years old. 29

7 Such price scissors can be given several controversial explanations: for different distribution channels banks use cross-subsidisation of the difference in actual net costs and actual transaction fees paid by customers; banks earn additional profit on transactions concluded via electronic channels; the profitability of payments is not the aim of the banks any more, but rather crosssubsidisation is applied between different service groups, for example, returns on lending compensate for the smaller returns on payments. Benefits from Customers Point of View The main benefit from bank customers point of view is significant saving of time due to the automation of banking services processing and introduction of easy maintenance tools for managing customers money. The main advantages of e-banking for corporate customers are the following 10 : Reduced costs in accessing and using banking services. Increased comfort and saving of time transactions can be made 24 hours a day, without direct interaction with the bank. Quick and continuous access to information. It is easier for companies to check on multiple accounts at the click of a button. Better cash management. E-banking facilities speed up cash cycle and increase the efficiency of business processes, as large variety of cash management instruments are available on Internet sites of Estonian banks. For example, it is possible to manage a company s short-term cash via Internet banks (investments in overnight, short- and long-term deposits, commercial papers, bonds, shares and money market funds). Private customers seek slightly different kind of benefits from e-banking. In a study on online banking drivers Aladwani 11 found that providing faster, easier and more reliable services to customers were amongst the top drivers of e-banking development. The main benefits from e-banking for private customers are as follows 12 : Reduced costs. Regarding the costs of availability and using of various banking products and services. Convenience. All banking transactions can be performed from the comfort of one s home, office or any other place a customer wants. 10 BankAway! Net Banking Benefits! Sheer Acceleration. Electronic Banking: The Ultimate Guide to Business and Technology of Online Banking. Edited by SCN Education B.V. 11 Aladwani, A. Online Bnaking: A Field Study of Drivers, Development Challenges and Expectations, International Journal of Information Management, 21, 2001, pp BankAway! Net Banking Benefits! Sheer Acceleration. Electronic Banking: The Ultimate Guide to Business and Technology of Online Banking. Edited by SCN Education B.V. 30

8 OLGA LUŠTŠIK Speed. Operating speed of the medium is very fast; therefore, customers can postpone the transactions till the last minute. Funds management. Customers can download their history of different accounts and do a what-if analysis on their PC before performing any transaction on the web. This allows better funds management. Economic Benefits The impact of the new economy on economic growth has been studied in several research projects. For example, Pohjola proves that the contribution of the use of information technology to the growth of output in the Finnish market has increased from 0.3 percentage points in early 1990s to 0.7 percentage points by late 1990s 13. However, unlike in the US, no trend towards labour productivity growth has been observed in Finland. According to the recent study conducted in Estonia 14, bank customers use bank office services on an average of times per month, and wait in a queue in a bank office on an average of hours. A simple calculation shows that making payments via e-banking facilities (eg using Internet bank) rather than in the bank offices helps to save the economy 0.93% of GDP, whereas an average distance to the nearest bank office is approximately 4.14 km, which takes about 0.21 hours to go to. Estonian GDP in 2001 was 10 billion kroons and average hourly wage kroons 15. There are 0.5 million people in Estonia who use traditional bank offices. Factors Determining the Development of E-Banking in Estonia It is important to consider the development of e-banking from the point of view of two counterparts the provider of services and the consumer of services. Preconditions for development from a provider s point of view are personal interest in the service and the ability to provide it. The provider has to have some financial or other incentives to run the business, as well as technical and financial abilities to perform it. The consumer s attitude towards new technologies and his/her interest towards innovations in general are essential. As Karjaluoto et al found in their study of Finnish consumer beliefs and attitudes towards e-banking, the more familiar the consumer is with technology the more positive beliefs he or she seems to hold about an object 16. In other words, the acceptance of new technologies helps to apply Internet banking. 13 Pohjola, M. The New Economy: Facts, Impacts and Policies, Information Economics and Policy, 14, 2002, pp Aarma, A., Vensel, V. Banks Retail Customer Satisfaction and Development of Bank-Customer Relationships, in V. Vensel, Wihlborg, C. (eds) Estonia on the Threshold of the European Union: Financial Sector and Enterprise Restructuring in the Changing Economic Environment. Tallinna Tehnikaülikool, 2001, pp Statistical Office of Estonia, Karjaluoto, H., Mattila, M., Pento, T. Electronic Banking in Finland: Consumer Beliefs and Reactions to a New Delivery Channel, Journal of Financial Services Marketing, , pp

9 It is important to discuss the reasons for rapid development of e-banking in Estonia in the light of three different components: users, service providers and public sector/environment. User Component As the Estonian banking sector is relatively young, users lack possible negative banking habits. Under negative banking habits we mean non-effective, expensive and timeconsuming financial instruments, such as cheques and ATM-only bank cards. For example, in the United States there are 69 billion paper cheques written every year 17. In Estonia, cheques have never found wide implementation. When ATM-only bank cards were introduced they were quickly replaced by multi-functional bank cards, which allow the holder to withdraw money from ATMs and to pay for purchases. Service Provider Component Service provider has several reasons for developing e-banking in Estonia. Firstly, Estonian e-banking service providers did not use old technologies before launching e-banking facilities. All banking technologies were relatively modern compared, for example, to French and German IT hardware 18, and therefore more efficient. Secondly, the wave of mergers and acquisitions that took place in the Estonian banking sector in had no unfavourable effects on the development of domestic e- banking. New owners did not demand local branches to take over e-banking infrastructure from their Nordic parent banks. Local IT infrastructure remained under the influence of Estonian know-how. At the same time, Estonian IT specialists were used even in Latvia and Lithuania, when Hansabank started operating in these countries 19. The third factor supporting e-banking development is the relative cheapness of the services provided by the Estonian credit institutions via electronic channels, which made e-banking more profitable (see Benefits of Electronic Banking). Another aspect is the high concentration of Estonian banking sector: at present there are only five credit institutions operating in Estonia, whereas the two largest banks Hansabank and Eesti Ühispank (Union Bank of Estonia) hold 83% of the sector s total assets. This situation is perfect for the development of common standards for e-banking services in all Estonian banks. Up to now, all the developed standards have been public and not patented, that allowed fast and coordinated spreading of cross-usage of bank-link 17 The Dynamo of E-Banking, Business Week Online, April 16, content/01_16/b htm?mainwindow 18 Interview with Olari Ilison, Head of Hansabank s E-Banking Division, on 2 September Interview with Rein Süld, Head of Sampo Bank s E-Banking Division, on 6 September

10 OLGA LUŠTŠIK and ATMs. Common standards are useful and efficient not only for the users of these services, but also for traditional as well as virtual shop owners, as the implementation of common standards requires no considerable technological expenses. In Finland, for example, there are several technological standards for some e-banking services that complicate fast spreading of these innovations 20. Public Sector/Environment Component In Estonia, public component was also very important for the fast introduction of e-banking. It is crucial that current legislation supports technological innovations. The best example here is the Digital Signatures Act, which came into force in The Act stipulates the digital signatures standard in Estonia and regulates the release of the certificates. Digital signature is an important component for Internet banking as well as for payments concluded via bank-link. The second factor is a relatively low price level of Internet connection in Estonia. One of the explanations for this is free telecom market in Estonia, with two big competitors on integrated digital network (ISDN) market. For example, in the Netherlands the monthly fee for ISDN connection is 30 euros, in Finland 65 euros and in Estonia 15 euros 21. Dial-up connection is also much cheaper in Estonia than in other countries. It is also important that Estonian government supports several programmes for technical assistance in secondary schools (eg project Tiger Jump) and is involved in a number of national projects for increasing computer skills and knowledge about the Internet among rural residents (eg project Look@World). The main aim of the latter project is to support the use of the Internet by creating public Internet access points, as well as by providing basic computer and Internet training for 100,000 persons who are currently non- Internet users. Estonian banks themselves are also interested in wide spreading of IT knowledge and skills among Estonians, which is why they participate actively in these government projects (especially in Look@World), providing significant financial aid and distributing free hardware. Future Outlook of E-Banking Development in Estonia The entire information technology environment changes rapidly. According to estimates, the number of Internet users in Estonia will increase to 50% from the current 43%. The number of bank offices will decrease, they will be turned into advice and support centres and most of the transactions will be concluded via main e-banking channels: online 20 Rein Süld, Ibid. 33

11 Internet banking and m-banking services. Rapid growth of e-banking in Latvia and Lithuania is also expected. This trend was promoted by the Estonian banks opening the branches in these countries and implementing e-banking services that work well in their home country. According to estimates, the level of e-banking services in all three countries will be standardised in five years 22. In Lithuania, the growth of telephone banking rather than Internet banking can be expected, as the purchasing power is still low and telephones are much cheaper than personal computers 23. Estonian e-banking development experts 24 forecast that in the coming years more attention will be focused on mobile phone-based services, such as account balance inquires by text messages and payments via mobile phone (see Figure 6). More and more government services will move into Internet banks. Currently it is possible to fill in and send income tax returns to Tax Board and make inquires to databases of Social Insurance Board and population register. As the experts claim, telephone banking will remain an additional distribution channel only. The future of TV banking is rather questionable, although some positive perspective may open after switching to digital TV. Offline banking is currently used by corporate clients, whose volume of payments is big enough to slow down online transaction speed. Some companies also prefer to store all financial data in their own databases, not in banks databases. Banks are working on finding a solution to this problem and directing all corporate clients to online Internet banks. offline banking telephone banking TV-based banking WINNERS e-banking m-banking (mobile phone banking) e-government services Internet banking LOSERS Figure 6. E-banking winners and losers in the near future Mobile payments (m-payments, payment concluded using mobile phone), as part of m- banking, were first introduced in Estonia in summer 2000, when larger banks and mobile 22 Rein Süld, Olari Ilison, O. Ilison, R. Süld,

12 OLGA LUŠTŠIK network providers launched m-parking services. M-parking makes it possible to pay for car parking in the biggest Estonian towns via a mobile phone. The next step was taken the year later, when Hansabank and the Union Bank introduced m-payments in a bar called Wall Street in Tallinn. According to the Card Centre for Banks, 570 service providers had joined this payment technology system by end-august M-payment is actually a substitute for cash and bank card payments. According to estimates, m-payments will replace 20% of bank card payments and 50% of cash payments in the next two-three years 25. M-payments will change the current cash circulation practice in many ways: ATM usage decreases, as people use less cash. If the amount of cash in circulation decreases, the efficiency of banking sector will increase, as: - customer-related banking transaction costs decrease (less cash fees to pay), - shop keeper and service provider costs decrease (no need for encashment services and cash accounting), - bank costs decrease (cash storage, checking and processing costs decrease). Other m-banking services, such as WAP, have certain technical constrictions that prevent their wide spreading 26 : - mobile phone interface is not very user-friendly (the screen is small, it is difficult to handle long texts); - it is difficult to input data through a mobile phone, as mobile phones and the buttons are becoming increasingly smaller; - data transfer is constricted due to slow speed and the cost of connections (even GPRS systems allow connection with a speed comparable to modem data transfer speed); - security constrictions (scripting is less secure than Internet bank script, possible SIM card (smart card containing user data) copying). Conclusion In recent years Estonian banks have rapidly introduced innovative banking technologies and e-banking services. Almost all banks have invested in expanding and improving their IT systems and a number of new e-banking services have been developed. All major banks have declared e-business as one of the core strategies for the future developments. At the same time, e-banking acceptance depends on the quality of bank services, customer preferences and satisfaction. Estonia has achieved significant success in the implementation of electronic banking; being on the top of the list among emerging countries and even 25 R. Süld, Ibid. 35

13 outpacing the achievements of some of the developed countries. This progress is not incidental; it has external and subjective reasons. At present, the strategies of Estonian banks tend to outdistance successful banks in developed countries in the field of Internet banking. In order to achieve this goal, banks use a wide variety of measures, such as price concessions, sales of bank-service packages as well as offering additional non-banking services. The latest e-banking development was m- banking, which was introduced in autumn 2002 and allows paying for goods and services by a mobile phone. The results of the present article are mainly based on interviews with e-banking experts of Estonian banks. The analysis shows that e-banking is not merely a niche application for computer fans and innovative adopters, but rather a profound research is needed to map its consumer base and the impact of e-banking on the development of bank-customer relationships in the value creation process. 36