After many false starts in recent years, the advent of electronic money appears to have arrived. New and more innovative ways of transferring funds are rapidly being made available to us. Electronic money as most consumers know it consists of credit cards, automated teller machine cards, debit cards, and prepaid cards used for public telephones, buses, subways, highway tolls, and other necessities. The newest entrant on the scene is the first generation of computer chip-based stored-value cards.
These advances in electronic funds transfers pose a significant challenge to financial institution regulators for, as our economy shifts from a paper-based system of moving funds to an electronic-based system, technology threatens to outpace existing laws and regulations. Stored-value cards offer an instructive example of some of the issues this new technology poses for regulators.
Entities such as Mondex, Visa International, and MasterCard International, among others, are currently experimenting with stored value cards. One method of loading value to the cards could be to insert cash into a machine which is designed for that purpose. Another would be to electronically transfer funds to a stored value card from a checking or savings account.
The latter transaction could be done by physically visiting a bank, by using an ATM, or by using a home computer. Use of the Internet to facilitate these transactions is promised.
While technology currently exists to facilitate the transfer of funds to a card which has the characteristics of cash, the impact of such a transfer on the balance sheet of a financial institution is unclear. What happens when $100 is transferred from a deposit account to a stored-value card?
Is the $100 treated like a cash withdrawal, reducing the amount of the customer's insured deposit, and likewise the amount of deposit insurance premiums the bank has to pay?
Or, is the transfer counted as an insured deposit until the funds on the stored-value card are used with a third-party vendor, who in turn collects the funds from the depositor's bank, similar to a debit card operation?
The status of the funds transferred to the stored-value card is important under current deposit insurance regulations. What happens to the transferred funds if the bank should fail? Are they insured, or does the holder of the stored-value card become a general creditor of the bank?
The status of the transferred funds also affects the premium a bank would pay on its assessed deposit base. Similarly, if the funds have been transferred to the stored-value card, but not yet spent, are they subject to the reserve requirements of the Federal Reserve?
When funds are transferred from a deposit account to a stored-value card, typically, a bank will create a reserve to pay third parties. If the bank should fail, can this reserve be considered a custodial account for the benefit of stored-value card holders and/or third-party vendors?
The FDIC is given broad authority to determine whether or not an account is federally insured. If the deposit records are clear and unambiguous, then they are binding on the depositor, and no other records are used to determine the ownership of an account. If the records are less than clear, the FDIC can look at other evidence to determine the owner of an account and whether or not an account exists, but it is the final arbiter and is charged with using its "sole discretion" in making a decision.
More important than determining the ownership of an account, however, is determining the actual amount of funds in an insured deposit account. To do this, the FDIC will look at the balance of the principal and interest unconditionally credited to the account. If cash is withdrawn, the account is debited for the specific amount. But with a debit card, the funds remain in an insured account until transferred to a third party's collecting bank. If funds are transferred from an account to a stored-value card, however, should the bank account be debited at that point or subsequently when the stored-value card is used?
The possibility of a lost stored-value card further demonstrates the regulatory uncertainty. If a stored-value card had electronic identifiers enabling a bank to replace the unused value of the lost card, then the stored-value card would be something more than a cash equivalent, and would start to have characteristics of a debit card. Clearly a bank would not replace actual cash one of its depositors might lose.
This new technology also has potentially significant ramifications for the Federal Reserve. All depository institutions are required to keep reserves based on the amount of "net transaction accounts" on their balance sheets.
The regulations issued by the Fed contain pages devoted to this issue, but generally things like debit cards and travelers checks that are primary obligations of a depository institution are subject to the Fed's reserve requirements.
Reserves, however, are not required to be held against cash withdrawn from an account. Accordingly, the treatment of stored-value cards will affect whether or not their value will be subject to the Fed's reserve requirements.
The impact of new technology has changed and will continue to change the way in which financial institutions offer products and services to their customers. Products such as stored-value cards are touted as being safer and more secure than cash and other forms of payment currently in use. But there are many unanswered questions regarding how these new products will fit into the current scheme of laws, regulations, and policies.
It is critical that if these new products are to provide the benefits that are promised, coordination must continue among the hardware and software producers, the telecommunications industry that will provide the link to these transactions, and the depository and non-depository financial services entities that will offer these products.
It is equally important that these products be allowed to develop in a legislative and regulatory environment that does not discourage creativity and inventiveness, while at the same time ensuring that the federal safety net for our insured depository institution system is not endangered.
Mr. Brooks, who has served the FDIC and Senate Banking Committee as general counsel, heads Vedder, Price, Kaufman & Kammholz's financial institutions practice as a partner in the Washington office.
