Electronic money – digital payment instruments that store value – can be seen simply as a technological innovation for holding and accessing regular money. This column argues that how it is used and regulated will determine whether e-money instead serves as a replacement for existing money, and discusses the regulatory implications.
By Biagio Bossone*
The Committee on Payment and Market Infrastructures – the international standard setter for payment systems – defines electronic money (e-money) as “value stored electronically in a device such as a chip card or a hard drive in a personal computer” (CPSS 2003), and the GSM Association – the trade body that represents mobile money operators globally – further indicates that “the total value of e-money is mirrored in (a) bank account(s), such that even if the provider…were to fail, users could recover 100% of the value stored in their accounts” (GSMA 2010).
These features are integral to e-money regulations worldwide, which refer to e-money as a prepaid payment instrument issued against the receipt of funds whose value is either stored on a device in the possession of customers or is accessible from customers when it is stored elsewhere (e.g. a computer server or network).1 The functionality thus described, however, is analogous to accessing accounts held at banks, which represent claims on funds that customers may exercise at any time. From this perspective, e-money is nothing but a convenient technology for customers to access these funds, quite akin to online banking, swiping a card at merchant establishments, or making ‘card-not-present’ transactions.
The question is whether e-money is just a service on existing money or whether it can serve as money proper, ultimately replacing cash and deposits. Addressing this question should lead regulators to consider whether and how regulations should evolve to best reflect the true nature of e-money.
Money is what people think money is
Consider further the analogy between e-money and bank deposits. Aren’t the latter, too, a technology to access and mobilise the value stored in them (cash and other funds) on demand? The answer must be framed in an evolutionary context. In the early days of banking, a deposit was understood to be a safe place inside a well-protected vault where customers would keep their cash and withdraw it when needed (Rothbard 2008). As claims on money, however, deposits progressively became substitutes for money, since people found it more convenient to use them instead of cash in the exchange process. Eventually they (largely) replaced cash as payment devices and even central bank money as a settlement instrument.
To the extent that money substitutes start getting accepted in place of the original, they themselves become money. This owes to people increasingly trusting them as capable of storing value (as money does) and growing more comfortable with their acceptance. In the case of e-money, people at first use it as an easier way to access the value stored in it – they use it for small transfers, engage in frequent cash-in and cash-out transactions, and keep it in small amounts (Hanouch and Kumar 2013). In time, they may use it more widely and even hold it instead of cash and deposits (Pulver 2008, Morawczynski and Pickens 2009). In principle, as e-money usage becomes widespread and people no longer cash out, transactions can take place in e-money with only minimal need for cash to change hands or for deposits to move between accounts (Bachas et al. 2016).
But even with substitution achieving scale, a key feature would still differentiate between bank deposits and e-money, at least under existing regulations, and that is through the different monetary regimes underpinning them – fractional reserves for bank deposits and e-money issued by banks, on the one hand, and 100% backing for e-money issued by nonbanks on the other.2 Under the latter regime, e-money issuances must be matched dollar-for-dollar by money in circulation.
An apparent inconsistency
Current e-money regulations are especially concerned with securing two operational objectives: first, enforcing the 100% backing regime; and second, protecting so-called ‘customer funds’.
The first objective ensures that all e-money outstanding is redeemable at all times on customer demand. The second objective raises a critical issue. Regulatory institutions and field experts talk about customer funds when referring to the funds received against e-money issuances. There are in fact two relevant cases here. Take a mobile network operator (MNO) offering mobile money services. In the first case, the MNO’s business is to allow customers to access and mobilise their bank deposits through mobile devices. In the second case, the MNO sells mobile money to customers.
In the first case, the MNO is only a service provider, not an issuer of mobile money – mobile money is a service provided on deposits, not money – and customers own deposit claims on banks, not the funds deposited with banks. In the second case, customers actually purchase monetary value from the MNO (FCA 2014). They buy a form of value (mobile money), whose ownership they acquire, in exchange for another form of value (cash or deposits) whose ownership they relinquish.3 A quid pro quo is involved in the exchange, which implies that the funds received by the MNO against mobile money issuances are no longer customer owned – their ownership transfers from the customers to the MNO.
This is consistent with the earlier analogy between e-money and bank deposits. When customers acquire bank deposit claims, they relinquish funds ownership to the issuing banks. The difference between e-money and deposits rests on their legal basis – deposits are based on lending contracts (Rubin 1975, Harker 2014) while e-money issuances involve sale agreements (Yurtiçiçek 2013), yet they both imply funds ownership transfer.4 The only legal arrangement that would involve transfer of possession while not transferring ownership is bailment (Helmholz 1992). However, no current regulation contemplates bailment as a legal basis for e-money.
There is therefore an apparent inconsistency in treating as customer funds the funds received by e-money issuers against e-money, much as there would be an inconsistency in treating as depositor funds the money received by banks against deposit claims. Whether e-money is simply a service on deposits or true exchange of values, the funds involved are never customer owned.
The implications are important both for the incentives to use e-money and for the allocation of rights and responsibilities among the institutions involved in its origination and circulation.
If e-money is only a service on deposits:
- Once the funds received by the e-money service providers (EMSPs) are deposited with banks (or invested in securities), customers become the owners of the related deposit claims (and securities) and their interest income. The banks (and securities depositories) are entirely responsible for providing both the liquidity necessary to support e-money redeemability and the insurance coverage needed to protect customer deposit claims (and securities) from insolvency.
- EMSPs, on their side, must only preserve the integrity and continuity of service provision. Since they only offer transaction services, and do not own the funds received, they may not be held responsible for the inability of banks (and securities depositories) to support e-money redeemability through liquidity and insurance provision. Also, provided that customer deposit claims (and securities) are not commingled with their assets, their insolvency does not put those claims at risk. Thus, no extra requirements should be imposed on EMSPs beyond those relating to service quality and market conduct.
Thus, if e-money is not money, regulatory frameworks should be simplified and the responsibilities of the relevant actors should be reconsidered. In particular, the funds received by EMSPs should be deposited with banks only, since banks are best positioned to support e-money redeemability and EMSPs have no incentive to trade off liquidity for higher returns by investing the funds in securities. Moreover, with so-called customer funds being, in fact, customer deposit claims on banks (not on the EMSPs), only banks should be responsible for protecting such claims. There would be no e-money liabilities on the EMSP side, e-money would be nothing but a service on bank deposits, and regulations should drop references to ‘customer funds’.
If, on the other hand, e-money represents true monetary value:
- The funds received against e-money issuances should be recorded on the issuers’ balance sheet as assets against e-money liabilities and any interest income earned on them should belong to the issuers, who would retain the right to decide on its use – including by passing it back on to customers to incentivise the use of e-money for both transaction and saving purposes. Regulators should stop using the terminology ‘customer funds’ and substitute it with ‘issuer liabilities’.
- Regulation should require issuers both to guarantee redeemability and to ensure legal protection of their e-money liabilities against their own insolvency.5 Regulations should also require interoperability between e-money schemes, and provide for the transfer of assets and liabilities from insolvent e-money issuers to surviving ones in the event of insolvency, in order to ensure service continuity to customers.
- E-money issuers should be allowed to invest part of their funds in (safe) assets other than bank deposits, thus enabling them to trade-off between liquidity and higher returns, and should be permitted to enter into liquidity and insurance arrangements with banks and other financial institutions with a view to guaranteeing e-money redeemability.
- In addition, and as an alternative, e-money issuers should be allowed to hold their funds in pooled accounts at central banks (Colombia and El Salvador are examples), which could potentially service multiple interoperable e-money schemes. This option would fully protect the e-money liabilities from liquidity and credit risks, and make them closely resemble narrow-bank deposits (Bossone 2001).
- On the other hand, banks offering e-money services to customers should be required to subject the funds received to the same prudential rules applying to deposits, and should be authorised to extend e-money loans to customers by leveraging their fractional reserves regime.
The question of whether e-money is money proper should be approached from an evolutionary perspective, whereby people over time determine the ‘moneyness’ of any given commodity or financial instruments. E-money may at some point become money in people’s perception, and regulations should be designed with that prospect in mind.
The regulatory framework sketched above would offer customers a broader choice of e-money instruments than currently available (from those granting full protection against liquidity and credit risks to those giving access to lending facilities), and would allow e-money to become not only a transaction device but potentially a saving instrument as well (Ehrbeck and Tarazi 2011), with relevant potential financial inclusion implications.
Finally, such a framework would incentivise banks and non-banks to exploit their own comparative advantage, with non-banks possibly competing on the segment of fully protected e-money and banks being able to replicate on the e-money side their power to create money via lending (Bossone and Sarr 2002).
Author’s note: I am particularly grateful to Gynedi Srinivas for bringing to my attention the question that gives the title to this commentary, and for his very helpful remarks and suggestions. I also wish to thank Abdou Sarr for discussing at length the issue of e-money and for offering me his critical views, and Maria Chiara Malaguti for her legal clarifications. Finally, I thank Thomas Lammer for his insights and precious references. Obviously, I am the only one responsible for the opinions expressed.
About the author:
*Biagio Bossone, Chairman, Group of Lecce; Member of the Surveillance Committee, Centre d’Études pour le Financement de Développement Local
Bachas, P, P Gertler, E Seira and S Higgins (2016), “Banking on Trust: How Debit Cards Help the Poor to Save More”, Working Paper, Yale University, 7 April.
Bossone, B (2001), “Should banks be narrowed?”, IMF Working Paper WP/01/159.
Bossone B, and A Sarr (2002), “A new financial system for poverty reduction and growth”, IMF Working Paper, WP/02/178.
CPMI (2015), “Digital currencies”, Report by the Committee on Payment and Financial Market Infrastructures, Bank for International Settlement, Basle, November.
CPSS (2001), “Survey of electronic money developments”, Report by the Committee on Payment and Settlement Systems, Bank for International Settlement, Basle, no. 48.
CPSS (2003), “A glossary of terms used in payments and settlement systems”, Report by the Committee on Payment and Settlement Systems, Bank for International Settlement, Basle.
ECB (2012), Virtual Currency Schemes, European Central Bank, October.
Ehrbeck, T, and M Tarazi (2011), “Putting the Banking in Branchless Banking: Regulation and the Case for Interest-Bearing and Insured E-money Savings Accounts”, World Economic Forum’s Mobile Financial Services Development Report.
FCA (2013), “The definition of electronic money”, PERG 3A.3, Financial Conduct Authority, Handbook.
Greenacre, J, and R Buckley (2014a), “Mobile Money Knowledge Product: Trust Law Protections for Mobile Money Customers”, Centre for International Finance and Regulation, Working Paper.
Greenacre, J, and R Buckley (2014b), Using Trusts to Protect Mobile Money Customers, UNCDF.
GSMA (2010), “Mobile Money Definitions”, July.
GSMA (2016), “Safeguarding Mobile Money: How providers and regulators can ensure that customer funds are protected”, January.
Hanouch, M, and K Kumar (2013), Mobile Money: 10 Things You Need to Know, CGAP, 30 December.
Harker, T C (2014), “Bailment Ailment: An Analysis of the Legal Status Of Ordinary Demand Deposits in the Shadow of the Financial Crisis of 2008”, Fordham Journal of Corporate & Financial Law 19(3).
Hayes, D G, J F E Gillespie, P H Daly, G Grippo, and P J Johnson (1996), “An Introduction to Electronic Money Issues”, paper prepared for the US Department of Treasury Conference ‘Towards Electronic Money and Banking: The Role of Government’, September.
Helmholz, R H (1992), “Bailment Theories and the Liability of Bailees: The Elusive Uniform Standard of Reasonable Care”, University of Kansas Law Review, 97-135.
IMF (2016), “Virtual Currencies and Beyond: Initial Considerations”, IMF Staff Discussion Note, SDN/16/03.
Morawczynski, O, and M Pickens (2009), “Poor People Using Mobile Financial Services: Observations on Customer Usage and Impact from M-PESA”, CGAP Brief, Washington, D.C., CGAP.
Office of the Comptroller of the Currency (1996), “Stored Value Card Systems”, Opinion to the Chief Executive Officers of all National Banks, OCC Banking Bulletin, No. 96-48.
Pulver, C (2008), “The Performance and Impact of M-PESA: Preliminary Evidence from a Household Survey”, Financial Sector Deepening Kenya.
Ramos, D, J Solana, R P Buckley, and J Greenacre (2015), “Protecting the Funds of Mobile Money Customers in Civil Law Jurisdictions”, GEG Working Paper, University of Oxford.
Roberds, W (1997), “What’s Really New about the New Forms of Retail Payment?”, Federal Reserve Bank of Atlanta Economic Review, 82(1), 32-45.
Rothbard, M N (2008), The Mystery of Banking, 2nd edition, Ludwig von Mises Institute, Auburn, Alabama.
Rubin, M H (1975), “Bailment and Deposit in Louisiana”, Writing Requirements and the Parol Evidence Rule: A Student Symposium, Louisiana Law Review 35(4).
Yurtiçiçek, M S (2013), “The Legal Nature of Electronic Money And The Effects of The EU Regulations Concerning The Electronic Money Market”, Law and Justice Review IV(1): 276-321.
 E-money must not be confused with ‘virtual currencies’, which, as the ECB (2012) notes, “…differ from electronic money schemes insofar as the currency being used as the unit of account has no physical counterpart with legal tender status”. Also, virtual currencies are representations of value typically denominated in their own unit of account (IMF 2016). Differences between e-money and virtual or digital currencies are further discussed in CPMI (2015).
 Existing regulations typically require that 100% of customer funds be isolated from the e-money issuer’s funds and deposited in a separate account held at a credit institution or invested in secure, low-risk assets. As an alternative, EU regulation requires that e-money issuers obtain insurance covering the full value of the funds received.
 The Office of the Comptroller of the Currency (1996) explains that: “The issuing bank sells electronic cash directly to consumers, or contracts the selling function to another firm. When the issuer sells its electronic cash directly to consumers, it is essentially selling bank liabilities to its customers. The issuer takes the proceeds from the sale of electronic cash and invests or holds the proceeds until the electronic cash is presented to the issuer for redemption.” See also Hayes et al. (1996), and Roberds (1997).
 In the case of bank deposits, as banks issue deposit claims to customers they become owners of the money deposited and have the right to decide on their use, subject to applicable regulations. Even if banks are required by regulation to make specific uses of the money received, including, for instance, by being required to hold specific types of assets, they (not the depositors) own the assets and they (not the depositors) are entitled to keep the income earned on the assets.
 For a review of the various forms of protection of ‘customer funds’ adopted worldwide, depending on the type of legal jurisdiction where regulations apply (i.e., civic vs. common law), see GSMA (2016), Ramos et al. (2015), and Greenacre and Buckley (2014a, b).
Enjoy the article?
Did you find this article informative? Please consider contributing to Eurasia Review, as we are truly independent and do not receive financial support from any institution, corporation or organization.