Post-Wirecard, the Bank of England has warned it will impose more stringent regulation on the payments sector in order to ensure the safety of the broader financial system.
And, it says, a failure to act could lead to a new ‘Wild West’ era in digital money.
In a speech given remotely to the Brookings Institution, Bank of England governor Andrew Bailey said yesterday that supervisors needed to look beyond technological innovations when regulating digital money.
“Payments regulation should reflect the financial stability risk”
“Payments regulation should reflect the financial stability risk, rather than the legal or technological form, of payment activities,” Bailey said.
“Firms that are systemically important should be subject to standards of operational and financial resilience that reflect the risks they pose, with sufficient data available to monitor emerging risks. These may sound like common sense points, but innovation is increasingly challenging regulators’ ability to ensure they are met.”
Regulators’ scrutiny of the digital money business has intensified since the dramatic June insolvency of German payments firm Wirecard.
The collapse of Wirecard, once valued at twice the market capitalisation of Germany’s largest bank, led to a chain reaction, causing users of dozens of pre-paid debit card services to lose access to their money for several days.
The situation was only rectified after the UK’s Financial Conduct Authority intervened to allow a UK-based Wirecard subsidiary to continue trading.
In his speech, Bailey said regulators needed to explain to clients of electronic money (e-money) and payment services firms, such as the debit card issuers caught up in the Wirecard collapse, that their money was less secure than that held in a bank.
the e-money safeguarding system has not yet been properly stress-tested
According to Bailey, e-money is not state-backed money in the same way as the deposits we hold in a commercial bank. And, he suggested, the money held at e-money firms should be seen as less safe as a result.
State-guaranteed deposit insurance—available for depositors in UK banks—covers the first £85,000 of losses at an insolvent institution.
Under the safeguarding regime, which carries no equivalent insurance, e-money and payments firms are simply supposed to keep client money separate from their own funds.
In a clear warning to payments firms, which constitute the fastest-growing segment of the UK’s fintech sector, Bailey said that the e-money safeguarding system has not yet been properly stress-tested and that clients may be unaware of the risks to which they are exposing themselves.
“We must ensure that users fully understand the difference in protection [between e-money and deposits held at a UK commercial bank], and I suspect at the moment that is not widely the case,” Bailey said.
“The standards are less developed than those for banks, there is no depositor protection scheme, and firms are subject to only limited capital and liquidity requirements. Finally, there is no resolution or administration regime.”
This could put clients’ money at risk, Bailey made clear.
“If [a] firm failed, holders of its ‘money’ would be forced to pursue any recovery through a corporate insolvency procedure, which would neither be quick nor guarantee their funds back,” he said.
In his speech, Bailey defended the current monetary set-up, where a central bank supplies state currency through the banking system.
“Stablecoins could offer some useful benefits”
He contrasted it with a potential monetary future involving stablecoins.
Stablecoins are digital assets backed one-to-one by assets denominated in fiat currency, and are better suited than traditional money for use on the internet and in mobile apps.
Last year, internet giant Facebook said it wanted to introduce a new stablecoin called Libra, for use across the firm’s three huge messaging networks, WhatsApp, Instagram and Messenger.
Facebook’s payment initiatives have so far been blocked by regulators.
In his Brookings speech, the Bank of England governor said stablecoins must have equivalent standards to those in place for other payment types and forms of money.
“Stablecoins could offer some useful benefits,” said Bailey.
“For example, they could further reduce frictions in payments, by potentially increasing the speed and lowering the cost of payments,” he said.
Stablecoins may offer increased convenience, including via integration with other technology, such as social media platforms or retail services.”
“It is these protections that prevent a return to the literal wild-west”
However, Bailey said, stablecoins would have to play by the rules of the conventional financial system, run by central banks.
Payment protections offered by governments and central banks are key in ensuring that consumers’ money will work as intended, Bailey said.
“It is this assurance that stabilises the value of the transfer asset so that all parties in the economy can rely on it,” Bailey said.
If central control is not maintained, Bailey said, we risk a return to the 19th century ‘free banking’ era.
Under the free banking system of the pre-Civil War US, notes issued by different banks traded at different discounts to their par (face) value.
“It is these protections that mean that individual shop owners don’t worry about scrutinising which bank issued your debit card before you tap it to pay,” Bailey said.
“It is these protections that prevent a return to the literal wild-west in which individual banks issued their own private currencies, which were worth different amounts depending on recipient’s assessment of the soundness of the issuing bank.”
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