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Don't Expand Uninsured Banking — End It

Recent images highlight a dramatic contrast: Michael Corbat of Citi wears a suit and tie, representing hardcore banking—allegedly detested by tens of millions of consumers. Dan Schulman of American Express wears a collarless brown shirt to tout the new Bluebird card. That's "shadow banking," an alternative for what they call the "unhappily banked." People who'll open checking accounts at Walmart.

Of course, appearances aren't everything. There are more substantive differences. Unlike Corbat, Schulman doesn't deliver federal deposit insurance. He defends this, incredibly, as vindicating freedom of choice for Walmart customers!

Carry that a step further. To provide even lower "discount prices," should Walmart rent decaying buildings that don't satisfy local fire laws and building codes—and offer still better deals to consumers? And why should Walmart have to honor the national minimum wage law, any more than Amex honors state banking statutes? With Bluebird, Amex can already violate both the Bank Holding Company Act and many state banking statues.

Schulman says that for Bluebird, Amex has to "set the customers' money aside" somewhere. Like MF Global did?

Or, maybe Amex, unlike Citigroup or Bank of America, just can't run out of money. After all, it can print money (travelers checks). 

Perhaps Amex is one of those nonbank SIFI's conjured up with the Dodd-Frank genie. If so, some council or other should restrain Amex from offering checking accounts (aka "Bluebird") — before they are too numerous to roll back.

Then we have the self-appointed "consumerists" who demand that Congress require federal deposit insurance for prepaid cards. Consider: checking accounts have never been required by federal law to carry this insurance. State-chartered credit unions that are not federally insured can and do offer checking accounts. "Prepaid cards" have converged at warp speed to become functionally indistinguishable from checking accounts, to the point where Amex plans to offer paper checks for Bluebird cardholders beginning early next year. It doesn't make a bit of sense to require the insurance just for prepaid cards.

Schulman irrelevantly asserts that Amex has state money-transmitter licenses. These in no way authorize it to offer checking accounts—or prepaid cards. State laws reserve for chartered institutions such as banks the power to offer demand deposit accounts – in the case of the New York Banking Law, Article 3, Section 131, limiting the power of "receiving deposits." (A spokeswoman for Amex says, "We are confident that we are complying with all state and federal laws and regulations.")

What's the difference between travelers checks and checking accounts, or the deposits that only chartered institutions may receive per state laws?

A demand deposit account, unlike the travelers checks that Amex has sold "for over 100 years," is not a negotiable instrument. Demand deposits don't have a fixed denomination. They are intangibles and are not sold. They enable the owner to order payment in any amount from his own funds, or to add to them by additional deposits. Unlike travelers checks, checking account checks are obligations of the consumer rather than the institution. 

These fundamental differences have persisted for over 100 years, despite changes in regulation and technology. Nonbank money transmitters cannot legally provide banking services. If they're sensible, they don't try.

Confounding these two categories should result in subjecting travelers checks to banking regulation rather than allowing nonbanks to offer checking accounts. Or, just as we no longer have "banks of issue" that can print money and lend it or sell it at a discount, eliminate travelers checks—very little different, and way past their "sell by" date.

The more fundamental question is whether to continue to allow states to authorize and maintain uninsured banks. No. Banking powers, including the power to offer deposit accounts, should be reserved to institutions protected by federal deposit insurance and therefore subject to approval, regulation, examination and closure by a federal authority. Do this not to protect banks, or even consumers, but to protect our financial system. Otherwise we might have an unregulated Facebook or Google of payments, even PayPal, quickly becoming both highly vulnerable and TBTF. (It could actually be run by someone wearing a hoodie, without tie or even white shirt!)

Protecting against this will require federal legislation, which will affect few existing financial service vendors. It won't affect Amex, because what Amex is doing is already prohibited and can't continue. Our present banking institutions may or may not become obsolete. Neither demand deposits nor the need to regulate their providers will become obsolete.

I thank Amex and Walmart for bringing this issue into the crosshairs.

Andrew Kahr is a principal in Credit Builders LLC, a financial product development company, and was the founding chief executive of First Deposit, later known as Providian.



(10) Comments



Comments (10)
Thanks to everyone, especially Frank Rauscher, for the lively and intelligent discussion on this post. One point of clarification: Andrew Kahr's argument rests primarily on systemic-risk grounds, not consumer protection grounds. In his words: "We might have an unregulated Facebook or Google ... quickly becoming both highly vulnerable and TBTF."
I fear I may have inadvertently steered readers' thinking in the wrong direction in an email alert to AB subscribers with my question, "Should the remaining forms of uninsured banking be stamped out to protect consumers, or allowed to flourish or fail in the marketplace?"
So let me rephrase it. Should the remaining forms of uninsured banking be stamped out to protect the financial system, or allowed to flourish or fail in the marketplace?
Frank, Judy, Roy, Bob and Jim: Does my re-framing the question this way change your answer at all?
Posted by Marc Hochstein, Editor in Chief, American Banker | Tuesday, November 06 2012 at 5:06PM ET
One of the reasons that the banks are scared is that their PE ratios doubled during the last few decades based on easy profits from expense reductions under bank deregulation, acquisitions, and and oligopoly for the major banks. Today, they have to work for living to justify those high PE's and they have thrown away their moral compass but not their FDIC too big to fail backstop. Lower income folks can obtain basic banking services at low prices but may not have the same "locational convenience" as offered by major banks. Mr. Newton and Donahue are correct that some new thinking is required and it is time to throw the big banks out of their subsidized la-la land. They have lost the trust of the last century and their attitudes will make it difficult to regain it especially with directors that believe the poor should provide them with 1000% ROE.
Posted by frankarauscher | Thursday, November 01 2012 at 12:31PM ET
Bluebird, prepaid cards and payday loans and other alternative financial service (AFS) providers are the leading edge of a 21st century banking model for a growing segment of our society - the underbanked.

30+ years of consulting with banks and, more recently research of AFS providers, has shown to me that the market is working.

Historically, banks provided services to lower income groups through de-facto subsidies by the most profitable customers. The burden of their legacy cost structures and new regulatory constraints have caused banks to look at each product and price them to justify their existence. This has resulted in lower income consumers to search for alternatives. AFS companies are responding to this demand with innovative products and business models.

These companies are much more nimble, especially in the adoption of mobile solutions, and have created products that, for many, are making traditional financial institutions irrelevant.

Yes, it makes sense to watch these developments and consider appropriate regulations to assure outliers do not abuse this growing market. However, these regulations must be rational and not protectionist.

This new competition will force many banks to reconsider their business models if they do not wish to further marginalize the over sixty million consumers who need access to payments and credit.

Michael Flores
Bretton Woods, Inc.
Posted by Michael_Flores | Thursday, November 01 2012 at 10:48AM ET
Funny that no banks cared about stacking transactions.

You can't even cash a check at the Bank it was drawn on without paying a fee these days.

The banks are scared and their paid mouthpieces are being unleashed.
Posted by Jim Jackson | Wednesday, October 31 2012 at 10:07PM ET
This article is 180 degrees in the wrong direction. Deposit insurance, like the other socialist schemes of the FDR administration, is one of the most misguided, counterproductive features of the financial world today. The success of money market funds beginning in the 1970s proved that consumers, given a choice, make rational risk/reward decisions in a free market. What we really need is to phase out all government-sponsored deposit insurance and allow banks, and their customers, to compete on the basis of safety and soundness, or put another way, risk and reward. Free people in free markets will consistently make better decisions than any government regulators could, and more efficiently. Then we can fire thousands of non-productive government employees and lower both taxes and the cost of doing business.
Posted by Bob Newton | Wednesday, October 31 2012 at 9:53PM ET
Again - who cares? Not the Feds - until something bad happens again. Think the Feds know what a check is? In 1981 I had to go to the Fed and force them to enforce the clearing rules for return items developed for "checks" against "drafts" which began looking like checks including micro encoding yet they were clearly labeled drafts drawn against money market funds (before banks could issue money market funds). Surprise - the Feds did not know the difference so they allowed the money funds to return unpaid drafts "whenever" unlike checks which had a very short time limit. If the Fed did not know all the elements of a check, why would an ordinary citizen know anything about what is FDIC insured or not after the chaos of the meltdown.

Judy C. is right on target about Walmart caring more about their customers. I meet with their most senior executive about twice a year and they are concerned about their customers having a better life. Unlike Wells Fargo whose lead director just issued a letter on October 26 to shareholders that "Payday Lending" is good! Their interest rates provide a ROE on that product of close to 1000%! You read that correctly. 1000% on the backs of their poorest customers!

Who has any sympathy for a bank like that? Throw US Bank, Regions, and Fifth-Third into that cabal too!

The non-banks do not have to be "sensible" because there is little sense in some of the major banks.
Posted by frankarauscher | Wednesday, October 31 2012 at 7:21PM ET
I think AMEX was approved by Federal Reserve in 2008, converted to a Bank Holding Company and access to Troubled Asset Relief Program. AMEX is no longer obligated under TARP - purchased back 340 million in Treasury Warrants.
Posted by Diane B. | Wednesday, October 31 2012 at 12:57PM ET
Bankers do not have a divine right to their customer's funds, they need to earn it. Unfortunately, the industry tends to hide behind regulation and law and seldom ventures out to create innovative products that fill real customer needs, which Bluebird seems to do. The market will tell us if customers prefer this product.

Mr Kahr's comment, "A demand deposit account, unlike the travelers checks that Amex has sold "for over 100 years," is not a negotiable instrument. Demand deposits don't have a fixed denomination. They are intangibles and are not sold." ignores the fact that demand deposits accounts are most certainly sold by banks and a check written on a demand deposit is a negotiable instrument as is the Traveler Check when signed by the purchaser. What's his real point... promoting protectionism for the banking industry.
Posted by Roy Henderson | Wednesday, October 31 2012 at 11:45AM ET
I agree with Frank Rauscher. Bluebird is a good product that consumers talk about and have asked for - an affordable way to manage money. Walmart has listened to their customers and other consumers by partnering with AMEX. Walmart culture has alwasy been "lowest price" for Consumers. AMex is 3rd largest card provider after VISA. I have confidence AMEx has provided Consumer protection for Consumer funds.
Posted by Diane B. | Wednesday, October 31 2012 at 11:15AM ET
In 1985 I was on the ABA Operations and Automation committee which was involved with transaction accounts; and, I brought up for discussion the opportunity for companies like Exxon and Walmart to use the ACH to receive payroll deposits for credit balances on debit cards and to issue their own debit cards. At the time, Irving Bank had much of the ACH business and thought that they controlled the product. The surface issue was the requirement of issuing paper confirmations of transactions to the consumer if a non-bank card was being used. The sub-surface issue was non-banks doing a better job than the banking industry.
The wisdom of the group was "to punt" and ignore the future. The ABA had no policy on electronic banking. At the time another member and myself were then asked to write one which we did. The thrust was that completion was good, that classic banking had died with de-regulation a few years earlier, and retail electronic transactions really started with Bankamericard two decades earlier and that the banking industry was slow to react and it needed to act quickly.
Today, the industry is again faced with competition; and, the answer is to try to rebuild a moat to protect the non-competitive banks. I agree with Mr. Kahr that some type of consumer protection would be appropriate; but, if banks want non-banks to stay out of their business, then banks should give up using the pre-emption rules of the OCC to enter the realm of the non-banks such as is done by US Bank and Wells Fargo with payday lending to give an example. If Wells and US Bank can abuse customers, why can't non-banks do it with this product? And the regulators continue to allow that abuse even though they are swamped with comment letters on it. Who cares? Not the industry because they are silent or too uneducated to comment. Not the regulators! Perhaps Congress after the bank lobby goes to them if the election changes the administration. Good points for Mr. Kahr as he is wise enough to raise the issue.
Posted by frankarauscher | Tuesday, October 30 2012 at 6:27PM ET
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