When Washington regulators asked bankers last year whether deposit insurance rules should be extended to cover funds transferred to stored- value cards, the answer was a resounding "No!"
But some industry insiders now are saying the issue may not be so clear- cut-that consumer-friendly rules for certain types of bank-issued smart cards and digital cash may make people more comfortable with exotic payment mechanisms.
When the Federal Deposit Insurance Corp. held hearings last fall on stored-value cards, banking industry representatives urged regulators to maintain a hands-off approach for at least the near term. They gave three fundamental reasons:
The technology has not yet reached a critical mass, so premature regulation may stifle the growth.
Unregulated nonbanks will have a competitive advantage.
Consumers will perceive smart cards as simply a replacement for coin and currency, not a bank account relationship that requires deposit insurance.
But these arguments do not necessarily preclude banks from designing stored-value cards and other forms of electronic money backed by deposit insurance, industry experts say.
According to an opinion issued last year by the FDIC's general counsel, a stored-value system like Mondex-an entity now controlled by MasterCard International-would not qualify for deposit insurance. This is because value is transferred from a consumer's bank account to a nonbank third party that in turn assigns value to the consumer's "electronic purse."
Thomas P. Vartanian, a partner in Washington at the law firm of Fried, Frank, Harris, Shriver & Jacobson, said the FDIC also determined that banks could develop smart-card systems that would qualify for deposit insurance.
"If there is no third party involved and money stays in the bank and does not move onto a card or a remote location, then it stays insured," he explained.
"You could create a smart card instrument that is only a notational instrument, where it is an indicator of how much you are allowed to spend through this electronic mechanism. But the payment is subject to a settlement process, because the money never leaves the bank."
While nonbank participation in the nascent electronic money business is given as a reason for regulators' maintaining a light touch, access to federal deposit insurance for stored-value systems may actually work in financial institutions' favor, Mr. Vartanian said.
Nonbank participation "is the linchpin issue," he said. "If you let nonbanks into the business of issuing electronic money where there is no implicit government guarantee, and no Treasury or Federal Reserve standing behind it, the question becomes: Can a system that is essentially operated through nonbanking entities weather the storms of a financial crisis or a liquidity crisis?"
Bankers are starting to address this issue, he added. "I think the purveyors of these products want to have the freedom to be able to either have them insured or uninsured."
For example, banks might issue a noninsured smart card for use with vending machines and other small-amount purchases, but a product with a larger amount of value stored on it-such as an electronic equivalent of traveler's checks-could be insured either through the FDIC or a private- sector form of deposit protection.
"The key right now is allowing the (regulatory) system to be flexible enough to accommodate all these different variations of technology and products," Mr. Vartanian said.
Nessa E. Feddis, senior federal counsel at the American Bankers Association, agreed with Mr. Vartanian that banks need to have the widest range of options. "We don't really know what's going to be important to consumers and what the business case is going to be," she said. "Most of the prominent (stored-value card) pilots thus far won't be FDIC insured, but that isn't to say ... some people won't want that."