Answering the simple question of “what is a deposit?” is getting to be more difficult as innovations with digital financial services continue and unserved and underserved customers use products in new ways. The appearance of electronic wallets, prepaid debit or virtual cards, online transaction accounts and other “savings” instruments is making it harder for authorities, providers and consumers to clearly identify what products are or should be considered deposits – and which only look like deposits. That apparently simple question impacts what products can be covered by deposit insurance, who needs to be licensed or prudentially regulated, and which providers of deposit-like products could have access to central bank facilities.
Defining an insured deposit (and consequently what deposits are not insured) is a fundamental starting point for determining whether deposit insurance is available for a particular product. The definition potentially drives the scope of deposits to be insured and the types of institutions that will be within the deposit insurance protection offered or might be brought within coverage. The definition also affects the size of the deposit insurance fund and potentially even the basis used to charge insurance premiums. This first blog post of a three-part series on deposit insurance and digital financial inclusion focuses on the basic, but not easy question, of how to define a “deposit.”
We find that at present policymakers are asking three key questions when determining whether a new product is a deposit and eligible for deposit insurance:
1. Is it redeemable for at least face value?
Unlike an investment product which may appreciate or depreciate, conventional deposits all over the world are redeemable for at least face value in nominal terms, or more if interest is offered (and assuming the institution is still operating). Although a response to this question seems quite straightforward, this is not always the case. For example, cash collateral or compulsory savings often required by traditional microfinance providers, can generally only be redeemable by the customer after the related credit is paid back and, even at that time, the amount can be netted from outstanding customer credit. Similarly, in the case of cooperative member shares, which may be redeemable upon a member’s exit from the organization, the cooperative may have a right to refuse redemption, or redemption could be fully or partially prohibited by the cooperative charter or by the legal or regulatory framework; these member shares are not considered deposits but loss-absorbing equity instruments. These seemingly “deposit-like” transactions, therefore, fail the “redeemable for at least face value” test.
2. Is it redeemable for cash?
Deposits are a liability of the organization holding the funds and are redeemable in cash, not shares in a company or as a product or service. An implication is that the definition of a “deposit” would not include closed-loop payment cards that can store value which is only redeemable for products, services and/or airtime, etc. (and often the products and services of the issuer).
3. What is the key functionality of the product?
For some products an affirmative response to the first two questions would not be enough to clarify if it is a deposit or if it just looks like a deposit. The functionality of the product must also be considered. This has a big impact on customers’ expectations, which are important in the deposit insurance context. Authorities in different jurisdictions may look at similar products and categorize them differently depending on what functionality they consider more important, who is offering them and the legal framework of the country (particularly its regulation of the financial system, including the deposit insurance scheme, assuming there is one). If the product is seen as a means of payment or transfer that temporarily stores value in a more secure place than the customer’s pocket or wallet, or serves as an entry platform to access a wider array of financial products (perhaps sometime after the value in question is stored), then it would be unlikely to be considered a deposit but rather would be treated as a payment instrument. The functionality would often be accompanied by certain restrictions on providers for prudential reasons, for example limits on permitted investments or any intermediation of customers’ funds by the provider. Some examples of products considered to be payment instruments and not deposits include e-money in the Philippines and Peru, non-reloadable prepaid debit cards in the US, and goal-linked electronic savings in Mexico.
If authorities consider that the main function of the product is value storage, then it is more likely that the product would be considered a deposit. Higher emphasis on value storage functionality would recognize that even low amounts of money may represent most (or all) a customer can actually save, or that apparent temporary storage time may be longer than the time customers would otherwise keep their money if they were merely holding funds between payments. In these cases, authorities might perceive a higher potential for systemic consequences of rapid growth in the uptake of these stored value products, especially by unserved and underserved customers (to name just a factor that might drive decision-making in favor of, or against, treating these products as insurable deposits).
An angle that has thus far not been much considered is whether there are different customer attitudes toward a deposit or a payment product, which would likely be influenced by previous local experiences. In countries with recent pyramid and Ponzi scheme experiences, consumers may be more prone to distrusting any product that look just like a deposit but is not treated as such for regulatory purposes. Also, countries where consumers have suffered losses due to recent failures of non-bank institutions where their deposits had lower insurance coverage than bank deposits may have consumers afraid of putting their money in products that are not bank deposits even if they are offered by formal financial institutions.
In all cases policy makers, and deposit insurers in particular, are working to determine the new rules of the road tailored specifically for the structure of their markets. This is true especially in the large and growing number of countries where authorities are trying explicitly to balance increased financial inclusion with their core role as promoters of financial sector stability. In our next blog post we will explore the implications for policymakers of how they define a “deposit” for innovative digital deposit-like products and how the decision affects protection of customer funds.