Banking's infatuation with technology is reminiscent of the hula hoop fad 35 years ago. Getting past this stage will require a long-term commitment to working through the costs, benefits, gimmicks, product failures, and fickleness of consumers, and reaching a stage where the electronic products of the future become more clearly defined. Certainly this is true of the various forms of electronic money that are among the most intriguing of the new products. They may lead to a new concept of pocket money, give birth to a new commercial payment system for the Internet, change the way governments pay out benefits electronically, and revolutionize the movement of value over telephone lines and airwaves. In short, the business of financial intermediation may be heading for the most comprehensive overhaul of products and delivery systems this century. At the same time, a battle is brewing between regulated financial institutions and other companies that, because they are not regulated, may be more nimble in responding to the development and implementation of financial technology. Unlike in the past, when banks could simply purchase, lease, or license the technology they needed from companies eager to profit from such a relationship, the new technological giants may be positioning themselves for a much different role. Instead of being content to profit by helping banks serve their customers better, the nonbanks realize that technology may allow them to take banks' customers away, product by product. The electronic money products currently fall into several different formats. Some electronic money systems create new forms of value that are captured on a smart card or stored-value card. Others benefit from new methods of transmitting electronic instructions to financial institutions to move money in any one of a number of electronic media. Prominent examples are the Mondex system that National Westminster Bank and Midland Bank are currently demonstrating in Swindon, England; Digicash's E-cash, being offered by Mark Twain Bank in St. Louis; and the recently announced New York stored-value test by Chase Manhattan Bank, Citibank, MasterCard, and Visa. The programs' designers have carefully thought through a wide range of consumer, technology, business, and legal issues. However, beyond the initial questions about consumer acceptance, the most quietly contemplated issue is when and how governments and regulators will assume a role in the development of these products. Having had the occasion to evaluate some of these electronic money products and analyze the legal issues that will accompany their introduction into consumer markets, I believe they boil down to one fundamental question: Where is the money? The ramifications of this question are far more complex than they sound. Before any government entity or regulator can begin to construct and apply a set of laws and rules to the different forms of electronic money under development, it must determine whether the product actually creates a new currency with inherent value, or simply identifies a new form of electronic obligation that may be traded among a group of participants that agree to accept what it purports to represent. For example, if the "money" truly resides on a smart card that a consumer carries in his or her pocket, and it is not backed by any account or funds in a financial institution or other type of issuer, the consumer must logically bear the risk of loss. If the "money" continues to reside with the issuing bank or company until the consumer has transmitted payment instructions and settlement has occurred, then the consumer must have an account somewhere, and it may be one that is insured by the FDIC. Whichever the case, issuers and users will have to grapple with questions ranging from the public policy implications of creating a new "currency," to the practical repercussions of the failure of an issuing financial institution or nondepository company. Consider the smart card that acts much like conventional money. Consumer A gives $100 to an issuer, Bank A, which translates that $100 into electronic value on the card. On the card, Consumer A has an encrypted message representing $100, but the issuer has Consumer A's $100 of cash. If Consumer A "locks" his smart card with a personal identification number and then loses the card, assuming that his agreement with Bank A was that he would bear the risk of loss, Consumer A has $0, but the issuer still has Consumer A's $100 of cash. Must the issuer establish a ledger account representing the $100 it received from Consumer A, and for how long? Must Bank A hold a reserve against the value issued on Consumer A's smart card? Does Bank A get a $100 windfall from Consumer A's loss, or do state escheat laws control the future of that $100? These questions will be decided by three factors: contractual agreements between electronic-money issuers and consumers; common law principles of law and equity; and new laws enacted by federal and state legislatures. In this regard, public policy interests will guide the actions of governmental entities. Those interests include monetary control and the creation of currency, consumer protection, law enforcement, especially money laundering, and systemic safety and security. To underscore the importance of understanding where the money is, let us consider several fundamental questions closely associated with new technology-driven banking products and the laws that may currently apply. Every new electronic money system will have to consider whether at various points it may involve the receipt of a "deposit." Even more fundamental is the question of whether the receipt, issuance, collection, retention, or transmission of electronic money puts the proponent of the system in the business of banking or some other business that has special licensing requirements.
While several definitions of deposit litter the federal statutory landscape, perhaps no meaning is more problematic than that in the Glass- Steagall Act. It prohibits as a felony any receiving of "deposits subject to check or to repayment upon presentation of a passbook, certificate of deposit, or other evidence of debt" unless it is authorized by federal or state governments. If an electronic money system is not carefully crafted to avoid the creation of a "deposit" residing outside a bank, savings institution, or credit union, it may be subject to challenge.
Most countries have laws that control the issuance and movement of currencies. Not surprisingly, most governments want to be the sole entities in the business of creating currencies in their countries. Systems that may look like they create a new supply of money will have to satisfy the terms and limitations of laws, such as the U.S. Stamp Payments Act of 1862, which prohibits the creation, issuance, circulation, or payment of any note, check, memorandum, token, or other obligation by any private entity for a sum less than $1 if it is intended to circulate as money. This law could be dusted off and used in ways its authors never imagined. Electronic money innovators may take solace from the fact that among the handful of modern cases reported under the Stamp Payments Act, it has not restricted the use of any form of payment, whether electronic, paper, or commodity-based. The location of money at any particular moment will also be critical to the determination of whether federal deposit insurance attaches to it - an issue of great importance to the consumer. This, too, may turn on the question of whether electronic or digital payment systems allow funds to remain in the traditional banking system until a final transfer or settlement, or whether they go outside the parameters of an insured deposit account. Should, or will, deposit insurance cover the value of electronic cash stored on a personal computer? We know electronic systems that move money pursuant to instructions transmitted over the Internet may be constructed so as to retain the benefits of deposit insurance. The FDIC has issued an opinion on this question. The agency also recently weighed in about when it will consider a nonbanking company that offers a payment system over the Internet to be a deposit broker. While these opinions are not in themselves groundbreaking, they were the FDIC's attempt to begin to address electronic commerce issues as they might apply to deposit insurance. Proponents of electronic money will appreciate the FDIC's discreet and lighthanded approach and will surely build upon it as products and technology evolve. There is perhaps no more immediate question than whether and how the Electronic Funds Transfer Act and its associated Regulation E will apply to smart cards and other forms of electronic cash. Indeed, the application of Reg E's current requirements and limitations could stifle the growth of electronic products that were not contemplated at the time the law and its regulations were drafted. Once again, applicability will hinge on where the money is, or more accurately, whether the stored value can be independently communicated. Amendments proposed by the Federal Reserve Board on March 20 would authorize electronic disclosures and distinguish Reg E's applicability based on whether transactions are on-line or off-line, and whether they are accountable to a central data base. In addition to exempting stored values of less than $100, the amendments reflected the Fed's view that but for initial disclosures, which may be provided electronically, smart cards generally should be exempt from Reg E's requirements and limitations. To conclude, banks, technology companies, and other financial service providers will find themselves on a challenging new frontier as they begin the inevitable process of redefining money and its uses. There will be false starts, and there are likely to be new technological developments that even today are unimaginable.
Government agencies are sure to begin articulating policies that will influence the products that electronic money innovators bring to market. As this process unfolds, they will continually have to be asking where the money is. Mr. Vartanian is managing partner of the Washington office of the New York law firm Fried, Frank, Harris, Shriver & Jacobson, and head of its financial institutions transactions practice.
