How safe is your money?

The Payment Services Directive 2 (PSD2), the push from the Financial Services Authority (FCA) for a more competitive “Banking Landscape” and the rise of cloud platforms have created, over the past 4 years, massive opportunities for entrepreneurs to create tech platforms offering customers fully-digital banking services. These start-ups, commonly referred to as fintechs cover one or more aspects of what one may expect from a bank. Here, we focus on “E-Money Institutions (EMI)” which is a new type of regulated entity introduced by PSD2. The UK currently has 147 EMI authorized firms, included well-known names such as Google, Transferwise, Revolut and Tide.

Being an EMI allows a firm to take customer funds in exchange for electronic money (which is an electronic store  (i.e. non-cash) of monetary value on a technical device), pre-paid cards or electronic wallets being the most common examples of e-money.

As stated, a common concern of customers using the services of these e-money institutions is the perception that their money isn’t “as safe as if it were in a bank”. This perception often contributes to customers sticking with their traditional bank and being reluctant to have large sums of money with the EMI.

This stickiness is the main business risk to many EMI fintechs whose strategy is to grow their customer and “deposit” base. So let us look at how safe one’s money is with an EMI.

WHAT PSD2 REGULATION TELLS US

In a nutshell, PSD2 requires e-money institutions to safeguard customer funds, either:

• segregating those funds
• as deposits at an authorized credit institution (i.e. a bank) or with the Bank of England
• as secure and liquid assets deposited at an authorized custodian
• insuring those funds at an authorized insurer 

The above is a (slightly) simplified view of those regulatory requirements (which include many technicality such as defining secure and liquid assets, as well as the timing of safeguarding for funds in transit) but they do highlight the fact that an EMI customer’s credit risk is not against the EMI he/she is client of, but rather:

• against the bank (or basket of banks) the EMI uses to safeguard its customer funds;
• and virtually nonexistent when deposited at the BoE or insured at an authorized insurer

WHAT ABOUT THE FSCS

An important aspect of this discussion is the Financial Services Compensation Scheme (FSCS) which protects  depositors (in authorized credit institutions, not EMIs) up to £85.000. This scheme essentially means that banks customers are only exposed to their banks (in terms of credit risk) for the deposits above £85.000 banks 

LET'S WRAP UP

The bank’s customer:

• exposed to the FSCS credit risk up to £85.000 (the FSCS is a regulated but private firm which *may* default in the unlikely of a large systemic shock triggering several large banks default)
• exposed to the bank’s default risk over £85.000 deposits 

The EMI’s customer’s risk profile is more complex and depends on the safeguarding strategy of the EMI. The risk ranges from:

• being exposed to a single bank from the £1 deposited in case the EMI safeguards funds at a single credit institution - assuming the EMI does not have sufficient capital to absorb the loss due to the bank’s default;
• to essentially risk free if the funds are insured at an authorized insurer or deposited at the Bank of England;
• A whole range of complex risk profile when the EMI’s strategy involves depositing funds at several banks, mixed with insurers.

Overall, the message here is that both EMIs and Banks customers funds are similarly safe and importantly fintech customers are not, because of safeguarding requirements, exposed to the default risk of the fintech they “bank with”. 

HOW WE CAN HELP

Alpha Reply helps EMIs define their safeguarding strategy and processes and communicate it back to its customers.

Get in touch at ! 

REFERENCES

“Bank of England intends to open its vaults to tech companies” article published on the official website of Financial Times by Chris Giles, Caroline Binham and Delphine Strauss in London on 20 June 2019, accessed on 03 July 2019

 “Capital Requirement Directive IV” information provided on the official website of the Bank of England, accessed on 29 June 2019

“Information you must send with a transfer of funds to prevent money laundering. Guidance” information provided on the official website HM Revenue & Customs of the Government of the United Kingdom in the section “How to comply with EU payments regulation?” published on 25 February 2014, accessed on 29 June 2019

“PSD2 – a game-changing regulation. What challenges and opportunities could the new directive provide”? article provided by PricewaterhouseCoopers (PwC) in the United Kingdom on their main website, accessed on 28 June 2019

“Switching your bank account” article provided on the official website of the Financial Conduct Authority (FCA), first published on 18 April 2016, last updated on 08 December 2017, accessed on 29 June 2019

“Supervisory guidance for managing risks associated with the settlement of foreign exchange transactions” issued as a consultative document by the Basel Committee on Banking Supervision on 12 October 2012, accessed on 29 June 2019

“The revised Payment Services Directive (PSD2). What you need to know” regulatory agenda updates published by EY in 2018, accessed on 28 June 2019