Thanks to Open Banking, creators and consumers of financial services are now faced with an exciting, and at times confusing, array of choice when it comes to payment service providers.
In addition to the traditional high-street banks, there are now the likes of Currencycloud, Modulr, Cashplus, Fire, Tuxedo Money Solutions and Contis, which provide innovative, user-friendly and cost-effective bank-alternatives for consumers and businesses in areas such as payment transfers, digital accounts, currencies and collections.
With so many new providers offering businesses alternatives to banks, it is not always clear who does what and how they' re regulated.
In conjunction with the Emerging Payments Association’s (EPA) Project Regulator team, which Modulr is a member of, we take a look at who the new players are, how they differ from traditional banks and how they're regulated.
Most of the new payment service providers that have emerged in recent years are the result of European Union (EU) regulations (namely the first and Second Payment Services Directive, otherwise known as PSD1 and PSD2).
In an effort to foster greater innovation and competition in payments, the directives created a new type of non-bank payment service provider.
To give customers confidence in these new players, the directives require that they be authorised or registered as payment service providers, or PSPs, and obliges them to protect customers’ rights — for example, the right to information before and after a payment has been made and fair treatment when something goes wrong.
To enable new providers to flourish, the cost to become authorised or registered is much less than it would be to become a bank. And the capital these new payment service providers must hold is also considerably less than banks.
Who are the new players?
New non-bank payment service providers can be authorised or registered either as payment institutions (PIs) or e-money institutions (EMIs) by the UK’s financial services regulator, the Financial Conduct Authority (FCA).
So, what are the main differences between banks, EMIs and PIs?
Banks take deposits
Out of the three providers, only banks are authorised to accept customer deposits. Banks can lend and earn money from customers' funds. But with this benefit comes greater responsibility and regulatory burden. For example, banks are subject to higher capital requirements than EMIs and PIs, which means they have to prove to their regulator that they hold sufficient financial resources to meet their obligations if their business doesn’t go as well as expected.
Payment institutions and e-money institutions provide payment services
With a payment institution or e-money institution license, PIs and EMIs are allowed to provide payment services (such as credit transfers, direct debits, electronic credit card transactions, money transfer) and even payment accounts. However, a PI is not allowed to hold funds on account without a payment instruction.
E-money institutions make payments and provide ‘digital accounts’
Like payment institutions, EMIs can make payments, but they also provide customers with digital accounts for ‘electronic money’ (e-money), which is the “digital equivalent of cash” stored on a mobile phone or e-wallet, or remotely on a server.
As an authorised e-money institution, Modulr can provide businesses with an unlimited number of digital accounts with their own account numbers and sort codes. Businesses can use these accounts to pay in and pay out, reconcile and receive real-time notifications about the movement of money into and out of these accounts. Setting up these accounts is also a lot quicker and easier than it would be with a traditional bank.
How safe is my money?
Now we know who does what, how are customers of EMIs and PIs protected if the business goes bust?
The funds received by EMIs and PIs are not protected under the FSCS. Instead, these firms must ‘safeguard’ customer’s funds by placing them either in a separate dedicated account, or having them covered by insurance or a guarantee, in the event that they become insolvent.
What if something goes wrong?
Payment service providers have to respond within 15 business days if a complaint is about a breach of a customers' rights under the payment services or e-money legislation. In exceptional cases, the payment service provider may need more time to investigate and respond to the complaint, in which case they can take up to 35 days.
If the payment service user is an individual or a small business, trust or charity under a certain size and they are not satisfied with the response they’ve received, they can take their complaint to the Financial Ombudsman Service. The Ombudsman is an independent watchdog with responsibility for judging complaints and has the power to award compensation.
KEY DIFFERENCES BETWEEN BANKS, E-MONEY AND PAYMENT INSTITUTIONS
What they can do: Accept deposits, pay interest, lend money, make investments, issue e-money (digital wallets and cards)
What they can't do: They must only carry on the regulated activities for which they have permission, which includes all usual banking services, as well as those services offered by EMIs and PIs
Forms of customer protection: Financial Services Compensation Scheme to guarantee customer deposits up to a specified limit
Examples: Barclays, Lloyds, Metro Bank, Arkea Banking Services
What they can do: Provide payment services, issue e-money (digital wallets and cards) and accounts for making and receiving payments
What they can't do: Cannot accept deposits or lend from payment services funds, make risky investments or pay interest on e-money they issue
Forms of customer protection: Must safeguard funds they receive in exchange for e-money under the Electronic Money Regulations
What they can do: Provide payment services (credit transfers, direct debits, electronic credit card transactions, money transfer)
What they can't do: Cannot issue e-money, accept deposits, make risky investments. Client funds cannot be mixed with the institution's own money and must be held in a separate account
Forms of customer protection: Safeguard funds (either received from a service user or payment service provider for the execution of a payment transaction) in accordance with the Payment Service Regulations. Safeguarding of customer monies can be carried out either through segregating those funds or covering them with an insurance policy/guarantee