Digital technology is going a long way toward making formal financial services more accessible for undeserved customers. The typically lower cost of digital delivery of financial services and products allows customers to transact locally in irregular, tiny amounts, and helps them manage what are often uneven income and expenses. But despite the opportunities digital finance offers, the expansion of these new services presents a number of issues that need to be considered by policymakers. One important question is whether digital financial products will be insured as part of a country’s deposit insurance system. At present, countries with deposit insurance have adopted one of three approaches to digital “deposit-like” products based on their market structure, legal and regulatory frameworks and their assessment of risks associated with the widespread adoption of these products. We have termed these approaches the “exclusion”, “direct,” or “indirect” approach.
The exclusion approach is applied by countries which consider deposit-like products to be primarily instruments of temporary value storage to make payments or transfers. Under this approach, the term “deposit” specifically excludes e-money in any form (for example, in Peru and the Philippines) and e-money is therefore explicitly not covered by the deposit insurance system. However, this approach can still protect customer funds from some of the risks of insolvency of a provider by requiring the “float” (or total value of customer funds) to be held in a trust or other custodial account, which could protect the funds from the claims of general creditors. However, in the absence of strong protections offered by trusts or similar vehicles, in the case of provider insolvency the exclusion approach would leave account holders exposed to the risk of losing funds to other creditors and to a potentially lengthy process for repayment of their funds in the event of a loss.
The direct approach includes digital deposit-like products in the definition of insured deposits, and is applied by countries where the providers of such products are prudentially regulated financial institutions that are direct members of the deposit insurance system. Colombia and Mexico have adopted this approach and have not only permitted banks to offer deposit-like products, but also have created new specialized categories of prudentially regulated financial institutions which are allowed to offer deposit-like products that will be insured.
This approach aims to ensure that customers only have access to deposit-like products offered in a safe and sound manner by supervised financial institutions, although with the possible unintended consequence of stifling financial innovations led by other types of entities.
The indirect approach, the most complex and the least explored to date, allows for deposit insurance coverage to be extended to digital deposit-like products even when the provider of such products is not a member of the deposit insurance system. This approach is being implemented in countries like Kenya and Nigeria, where deposit-like products may be provided by non-financial firms, including mobile network operators and technology companies (although in neither country is this approach fully operational yet). With the indirect approach, the “float” collected by providers is placed in one or more pooled custodial accounts with an insured depository institution. As the float is held in a custodial account, there is no deposit insurance offered directly to the provider of deposit-like products or its customers, but indirectly through the custodial account provider which is a member of the deposit insurance system. An important benefit for customers is that the deposit insurer does not apply the business account coverage limit to the custodial account (a situation where the amount insured would not be enough to cover all customer funds). Instead, under the indirect approach the coverage limit for individual accounts is “passed through” to each owner of the funds making up the float held in the custodial account.
There is no “one-size-fits-all” approach to this topic. The feasibility and effectiveness of each approach, and how each approach may need to be tailored in a given country, will depend on the legal system, the regulatory and supervisory framework, the structure and powers of the deposit insurer and the specific types of providers and products offered in the digital finance arena. Authorities and providers are gaining more knowledge about the opportunities, risks and challenges related to each approach to insuring deposit-like products as they embark upon the design and implementation of these solutions. As new products and providers emerge and as authorities improve their understanding of existing approaches, flexible frameworks will be needed that allow for adjustments.