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E - F I N A N C E
Electronic Banking: New Challenges
for Bank Regulation
The advent of electronic banking has raised new
concerns for banking regulation, specifically about
security and privacy. Worries about the security of
electronic banking and e-money are an important
barrier to their increased use. With electronic bank-
ing, you might worry that criminals can access your
bank account and steal your money by moving your
balances to someone else’s account. Indeed, a noto-
rious case of this happened in 1995, when a
Russian computer programmer got access to
Citibank’s computers and moved funds electronically
into his and his conspirators’ accounts. Private solu-
tions to deal with this problem have arisen with the
development of more secure encryption technologies
to prevent this kind of fraud. However, because bank
customers are not knowledgeable about computer
security issues, there is a role for the government in
regulating electronic banking to make sure that
encryption procedures are adequate. Similar encryp-
tion issues apply to e-money, so requirements that
banks make it difficult for criminals to engage in dig-
ital counterfeiting make sense. To meet these chal-
lenges, bank examiners in the United States assess
how a bank deals with the special security issues
raised by electronic banking and also oversee third-
party providers of electronic banking platforms.
Also, because consumers want to know that elec-
tronic banking transactions are executed correctly,
bank examiners assess the technical skills of banks in
setting up electronic banking services and the bank’s
capabilities for dealing with problems. Another secu-
rity issue of concern to bank customers is the validity
of digital signatures. The Electronic Signatures in
Global and National Commerce Act of 2000 makes
electronic signatures as legally binding as written
signatures in most circumstances.
Electronic banking also raises serious privacy con-
cerns. Because electronic transactions can be stored
on databases, banks are able to collect a huge
amount of information about their customers—their
assets, creditworthiness, purchases, and so on—that
can be sold to other financial institutions and busi-
nesses. This potential invasion of our privacy right-
fully makes us very nervous. To protect customers’
privacy, the Gramm-Leach-Bliley Act of 1999 has lim-
ited the distribution of these data, but it does not go
as far as the European Data Protection Directive,
which prohibits the transfer of information about
online transactions. How to protect consumers’ pri-
vacy in our electronic age is one of the great chal-
lenges our society faces, so privacy regulations for
electronic banking are likely to evolve over time.
regulation and supervision of the financial system are easy in practice. Getting reg-
ulators and supervisors to do their job properly is difficult for several reasons. First,
as we will see in the discussion of financial innovation in Chapter 19, in their search
for profits, financial institutions have strong incentives to avoid existing regula-
tions by loophole mining. Thus regulation applies to a moving target: Regulators
are continually playing cat-and-mouse with financial institutions—financial insti-
tutions think up clever ways to avoid regulations, which then lead regulators to mod-
ify their regulation activities. Regulators continually face new challenges in a
dynamically changing financial system—and unless they can respond rapidly to
change, they may not be able to keep financial institutions from taking on exces-
sive risk. This problem can be exacerbated if regulators and supervisors do not have
the resources or expertise to keep up with clever people in financial institutions
seeking to circumvent the existing regulations.
Financial regulation and supervision are difficult for two other reasons. In the
regulation and supervision game, the devil is in the details. Subtle differences
in the details may have unintended consequences; unless regulators get the reg-
ulation and supervision just right, they may be unable to prevent excessive risk
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