Comparing apples with apples. How safe is your money in today’s financial landscape?
Mark Follows, Chief Compliance Officer, Glint Pay & Tim Hoskins, Global Operations and Commercial Officer, Glint Pay
Consumers have more choice when it comes to banking and managing household finances than they have ever had and all options available are set within a regulated mature framework.
In the heady days of the 80’s and 90’s the banks grew and grew and the industry consolidated. For example, banks acquired building societies and their customer base. Building societies were ideally placed to serve personal customers but the large banks soon realised that servicing retail/personal customers was not profitable and services suffered. At this time, the UK and Europe saw a growth in the new eCommerce driven by the evolution of the Internet.
As a response, the EU Payment Services Directive (“PSD”) was implemented to create a new account provider under a competitive regulatory framework. The PSD led to the creation of non-bank Payment Service Providers, which include Authorised Electronic Money Institutions (“e-money firms”). E-money as a new way of managing money via digital wallets was a direct result of regulatory change.
The PSD sought to promote consumer protection whilst creating a framework of rights and obligations for payment providers and users. Key to this was the security of safeguarding client funds.
Non-bank financial institutions, electronic money institutions and payment institutions have evolved to rightly be amongst the financial institutions vying for customer attention. The market has matured and we now have a growing and highly regulated market. With that has come failures which has placed the security of client money in the spotlight.
One of the most important messages to still communicate is therefore one of safety. What does the safety of customer money mean in today’s financial landscape?
The “safety net” for retail customers using traditional banks in the UK is the Financial Services Compensation Scheme (“FSCS”) which was set up by parliament and funded by the financial services industry.
If your bank or building society fails and cannot pay back your money, it’s the FSCS that you turn to. It automatically pays you compensation up to £85,000 per eligible person, per bank, building society or credit union and £75,000 for joint accounts. The FSCS also protects temporary high balances caused by certain life events (e.g. inheritance, real estate transactions and insurance policy payouts) of up to £1 million for up to six months.
However, let’s consider a few factors. Traditional banks, just like e-money firms, can fail. In 2008, five financial institutions collapsed affecting over 4 million retail bank accounts including the well known high street name, Bradford & Bingley. According to the FSCS: “if you have money in multiple accounts with banks that are part of the same banking group (and share a banking licence) we have to treat them as one bank. This means that our compensation limit applies to the total amount you hold across all these accounts, not to each separate account.”
In the scenario of an individual holding £200,000 across two banks sharing a licence, that individual would receive a 42.5% return in the event of a collapse. Remember that percentage as it becomes important when we look at regulation in the e-money sector. We are not arguing that non-banks do not carry risk. Risk can come from a reliance on investment funding until the firm reaches profitability. However, purely under the safeguarding regime — if managed properly — e-money firms are equally if not safer for individual consumers than much larger banks.
What is Safeguarding?
E-money firms are required by UK and EU-wide regulation to adhere to a safeguarding regime. Regulations ensure that relevant customer funds are legally protected in the event of an insolvency. These client funds are segregated from company funds. Safeguarding normally works by e-money firms creating a segregated asset pool of customer relevant funds which must be reconciled daily and not have any company funds mixed in. The asset pool exists to pay customers back in priority to other creditors if an e-money firm collapses.
What is interesting is that safeguarding works on a “total holding” basis with no fixed ceiling on a return unlike the FSCS. In the scenario of an individual holding £200,000 in an e-money firm, that individual receives 100% of that money back in the event of a collapse.
In the event that an e-money firm does not have enough corporate funds to safely distribute the asset pool then the cost of distribution can be drawn from customer funds. However, this is an area yet to be tested in the real world but conceptually, the cost of administering the return of client money would arguably not equate to a loss greater than 10% of the total asset pool. (Practically, it doesn’t take long to process payments and only requires a small number of staff).
This effectively means that the individual with a holding of £200,000 would still see a better return than what is offered under the FSCS.
Despite the protections offered by the e-money safeguarding requirements, the FSCS is held to be the higher standard because consumers are more aware of the scheme, regulators promote it and the banks themselves wear on their sleeve as a badge of honour and trust.
However, if we directly compare the e-money safeguarding requirements with FSCS there is a clear discrepancy. Banks are heavily regulated, and must carry capital adequacy, yet they cap the amount that can be repaid to a customer. Conversely, highly regulated e-money firms do not cap the amount. In short, e-money firms offer a higher level of protection.
Forums are full of public opinion on e-money firms and how not having FSCS protection is a bad thing. There is a widespread lack of education around the cornerstone of nonbank regulation which is the safeguarding regime.
In its recent publication “Sector Views 2020” the FCA calls out e-money firms and FSCS concerns when it says “Regulatory changes have enabled many new payment firms to enter the sector and quickly grow their customer base. But consumers can suffer harm if they use products without regulatory protections or these firms fail to comply with regulations…..consumers could suffer harm because they do not understand whether Section 75 or Financial Services Compensation Scheme (FSCS) protections apply to such products. “
The FCA draws attention to “limited protections” in the event that “firms are not properly safeguarding customers’ funds.” Whilst it is understandable to have concern for firms who are young and starting out compared to well-funded and established firms, we are talking about a regulatory regime that has close and appropriate regulatory oversight (including annual FCA reporting, a 2019 in-depth multi-firm review followed by a Dear CEO letter as well as continued scrutiny of e-money firms and safeguarding requirements).
The raison d’être for creating non-banks in the first place was to foster innovation and competition. The e-money sector works hard to protect client money and it deserves support when it comes to both promoting the advantages of e-money as well as educating the average person on the safety of their money in the event of failings at a firm level.
We have seen traditional retail banking offer customers poor value and at times, very poor service. In fact, only recently were overdrafts a point of focus for the FCA due to consumer detriment.
The FSCS is a good level protection but it is important that consumers are aware of all the protections available to them when it comes to making a choice. A smart person always spreads the risk. We hope that more people will choose non-banks alongside what was once traditional when it comes to diversifying household risk, especially in these uncertain times.