E-Money License vs Banking License. Difference explained.
We bet you want to understand the difference between e-money license vs banking license. It is unsurprising, as such terms like “neobank”, “challenger bank”, “digital bank”, “mobile bank” attributed to payment service providers which should not be called banks.
Banks have dominated the financial markets for at least five centuries. Although their strategies, the services they offer, and the regulations applicable to them have changed throughout this time, the concept of “banks” remains similar to those that were first introduced. Banks are deposit-taking institutions, providing lending and payment intermediation services. Electronic Money Institutions (EMIs) on the other hand, are representative of the digitalisation of financial services. They are a relatively novel participant in the financial market and most commonly are characterised by the issuance of e-money and payment intermediation. Therefore, the question of how electronic money license stands vis-á-vis banking license is of due importance.
In the EU, EMIs were brought into regulation by the EU Electronic Money Directive (EMD) which was aimed to allow non-bank entities to compete with banks. This directive was repealed in 2011 with the EMD2, which expanded the scope of services that could be undertaken by EMIs. EMD2 was implemented at a national level in the UK with the entry of the Electronic Money Regulations 2011 (EMR). The lastly mentioned piece of legislation currently sits alongside the Payment Services Regulations 2017 (PSR) that together form a framework for the operation of EMIs. Whereas banks are currently regulated under the Financial Services and Markets Act 2000 (FSMA).
For a common user of the financial services, the difference between companies with electronic money license in the UK and banks can appear blurred. Therefore, this article will focus on the differences between e-money license vs banking license. While pursuing this aim it will clarify how banks and EMIs are regulated and operate. Thus adding valuable insights even to financial service professionals.
What is a bank?
There is no exhaustive definition of a bank under the common law, which is a legal system of the UK. Nevertheless, there is a landmark English case of the 1960s that sheds light on the common law understanding of the term. The Court of Appeals decision in United Dominions Trust Ltd v Kirkwood listed the below characteristics of banks:
(i) The maintenance of current accounts;
(ii) The payment of cheques drawn on bankers; as well as
(iii) The collection of cheques for clients.
In this case, it was held that in the business of banking, it is essential that a banker accepts money from customers to conduct the customer’s current account from which sums of money are paid by the customer or withdrawn by the bank from time to time. Judge Denning MR clarified that a list of characteristics is not equal to a definition. Stability, soundness, and probity were also deemed by the judge as defining features of banks. Nevertheless, it was accepted that banks are easier to recognise than to define.
Nowadays, our understanding of traditional banking activities covers the acceptance of deposits from the public as well as loan-giving. According to the Bank of England, commercial banks can be understood as financial institutions that look after your money, help you pay for things, and provide loans. It is important to note that in the UK there is only one activity that defines what it is to be a bank and that is deposit-taking. As such, the PRA defines a bank as a firm with an FSMA 2000 Part 4A Permission to carry on the regulated activity of accepting deposits and is a credit institution but not a credit union, building society or friendly society. Under Financial Services and Markets Act 2000 (Regulated Activities) Order 2001/544 deposit-taking is a regulated activity if (a) money received by way of deposit is lent to others; or (b) any other activity of the person accepting the deposit is financed wholly, or to a material extent, out of the capital of or interest on money received by way of deposit. The deposit itself means a sum of money, other than one excluded by article 6 of the aforementioned order, which is paid on terms (a) under which it will be repaid, with or without interest or premium, and either on demand or at a time or in circumstances agreed by or on behalf of the person making the payment and the person receiving it; and (b) which are not referable to the provision of property (other than currency) or services or the giving of security. Plainly speaking, a deposit involves the creation of a debtor-creditor relationship under which the person who accepts the deposit stores value for eventual return. Besides deposits and loans, banks can offer several other services, including the issuance of e-money. In fact, banks can issue e-money without the need for an additional authorisation by the FCA. They only need 4A Part Permission under the FSMA 2000.
Aside from traditional banks, the UK is experiencing a rise in “Challenger banks” and “Neobanks” which are often branchless and offer “online-only” services. Although the term “bank” is used for both, neobank is sometimes referred to as a financial services firm which is entirely cloud or online-based offering a lot of the services that a traditional bank does but that does not, however, have Part 4A Permission to take deposits. Challenger banks on the other hand do have Part 4A Permission under the FSMA to take deposits. Examples of challenger banks are Monzo and Starling Bank, while those of neobanks are Monese and Revolut. Notably, the FCA recognises the issues that can arise from this confusion and in their communication dated 18 May 2021 stated that e-money firms and payment institutions should omit using the word “bank” in their financial promotions and communications with the clients. Below you may see a table that illustrates which of the hottest FinTechs are neobanks and which are challenger banks.
What is an Electronic Money Institution?
Under regulation 2(1) of the EMR, EMI is defined as an entity authorised by the Financial Conduct Authority (FCA) as an e-money institution. This definition appears not very helpful in a vacuum. Hence, we must consider what services EMI may provide in order to understand what is the importance of this authorisation. The core service that EMI may provide is e-money issuance and redemption. E-money is understood as meaning monetary value stored in electronic or magnetic form. For a more detailed discussion on the topic of e-money, you can read our article dedicated to it here.
Furthermore, thanks to the PSR, besides issuing and redeeming e-money, EMIs can also potentially engage in the payment services, cash withdrawal and deposit services, payment executions services, remittance services, direct debit or credit transfers, account information services and payment initiation services. This list of “complementary” services into which the EMI can potentially engage strongly depends on the type of the authorisation as certain activities may be restricted. For instance, by default, all EMIs are prohibited from providing account information and payment initiation services. In order for them to have the possibility to provide such services authorisation for such specific activity must be sought.
Paramount difference for customers- protection of funds
To outline one of the core differences of e-money license vs banking license we need to consider customer protection afforded by both types of institutions. When a customer deposits money with a traditional bank, the customer is taking credit risk. The reason for that is the fact that the banking business model works in such a way that the bank will use the deposited money to lend it to someone else. In turn, the ability of the entity to which the bank is lending the money to pay back this amount is referred to as credit risk. So does it mean that in case that bank defaults the customer’s funds are lost? It was a case prior to the introduction of the Financial Services Compensation Scheme (FSCS) but not anymore. The FSCS can pay compensation to customers of a PRA-authorised bank if the bank fails or is unable to pay claims against it. To that effect, in the UK the deposit protection limit is:
- Up to GBP 85,000 per eligible person across all accounts held by the person in the person’s name or where the person is a beneficial owner;
- Up to GBP 85,000 per account holder in a joint account, regardless of the number of the account holders;
- Up to GBP 85,000 for sole traders across all personal and business accounts since sole traders are not considered separate entities;
- Up to GBP 85,000 for companies in the form of limited companies or LLPs, in addition to the GBP 85,000 per eligible person for personal accounts.
The manner of customer protection is completely different with EMIs and they are not subject to protection afforded by the FSCS. Rather, EMIs are subject to safeguarding requirements under Regulation 20 of the EMRs 2011. Accordingly, they can employ one of two options for safeguarding- (1) depositing them into a segregated client’s funds account with an authorised credit institution or (2) procuring an insurance or comparable guarantee that will cover the risks associated with the client’s funds. You can learn more on the topic of safeguarding here.
Sharing similar goals as the FSCS, safeguarding requirements purport to protect customer funds in the event that the EMI becomes insolvent. They also apply to customer’s funds when EMIs are engaged in unrelated payment services as set forth in Regulation 23 of the PSRs 2017. Customer funds in this instance entail funds provided by customers in exchange for the issuance of e-money and funds for the execution of the payment operations.
E-money license vs Banking License application
Strictly speaking, there is not really such a thing as a banking license. A bank will have Part 4A permission as per the relevant provisions of the FSMA to carry on the regulated activity of accepting deposits. It is this permission that is often termed as a banking licence. The final decision on whether an entity is authorised as a bank is taken by the Prudential Regulation Authority (PRA). Nevertheless, the FCA’s consent is necessary as well.
The application timeline is divided into the pre-application phase during which the firm introduces its business plan and evidences its readiness to set up banking operations while the PRA and the FCA provide feedback and challenge the firm in terms of its readiness to support banking activities. Hence it is important for the applying firm to have a concise business plan, operational procedures, business continuity measures, data protection measures, AML/CTF framework, outsourcing agreements, etc. It is essential for the firm to complete the development of operational capacities before it applies. The application review phase consists of the PRA and FCA assessment of the business viability, policies and procedures, governance and implementation, IT & outsourcing, resolvability, key governance appointments, liquidity as well as capital requirements.
When it comes to EMIs, authorisation is required solely from the FCA, which acts as a sole regulator. Although there is no need to get a separate authorisation to provide payment services, the FCA must be notified regarding the types of payment services EMI intends to provide. The UK also offers the “small EMI UK” route, where the activities of the firm are restricted solely to the UK and are limited by the monthly payments volume and average outstanding electronic money, 3,000,000 EUR and 500,000 EUR respectively.
When it comes to getting an EMI licence, the application must substantiate the firm’s readiness to issue e-money and provide other payment services. As such, it should contain information on the programme of operations and business plan, initial capital requirements, safeguarding measures, governance arrangements and internal controls, the company’s policies and procedures, business continuity measures, data protection measures, measures for compliance with AML/CTF obligations, as well as information on shareholders and outsourcing agreements. If you want to know more in detail about how to become EMIs, check our EMI authorisation service providing a detailed overview of this topic.
E-money license vs Banking License timeline and fees
For EMI applications, the licensing timeline is 3 months when the application is complete, and 12 months if the FCA requires additional information from the applicant. The application fee for an authorised EMI is GBP 5,000 while for a small EMI it is GBP 1,000. For a banking license, the licensing timeline for completed applications is 6 months, otherwise, when additional documentation is required or necessary, 12 months. In comparison to EMIs, the application fee is much higher for a banking license, standing at GBP 25,000.
How can PSP Lab help you?
We sincerely hope that this article added valuable knowledge and allowed you to understand the key differences of electronic money license vs banking license. Furthermore, if you need help with assessing your eligibility for becoming a bank or an EMI and if you are interested in pursuing these options, do not hesitate to contact us. Our team’s experience in the realm of financial services will not only help you will assist you in the process of meeting the eligibility and adherence criteria before and after applying to become an EMI or bank. In particular, we can tailor your internal controls policies, your business plan and programme of operations to ensure readiness for such applications.