September 14, 2007

Prepaid cards: offering the ECB a deal it cannot refuse

Dave asks over on DigitalMoney, perhaps in wobbly exasperation as he tries to walk the logic of the ECB's level playing field:

One of the ECB's points is that they want to create a level playing field of payments. This is a good idea: so is there a single or simple action that could be taken to do this?

I know we've played out all these arguments in the past, but on the off chance that anyone really wants to know the answer:

Yes, there is:

separate banking from payment systems!

The reason for the silly limits on anonymous prepaid cards is because banks don't issue them; their business is about identifying people for borrowing and lending purposes, so they need to know who you are.

However, issuers of pre-paid products do not want to know who you are, just what you do. What you are buying is fine. For them, a traceable-but-anonymous product works perfectly because it solves their privacy issues, and gives them the marketing data to offer you precise deals that are likely to be a win-win for both parties.

Then, why do the banks care about these products that they don't issue? Simple: a pre-paid card is a payment instrument, and a payment done by the retailer without resort to the bank is a payment lost to the bank. So we can see the lost fees as an issue (ask a bank what proportion of their income comes from payment fees).

That's bad, but it gets worse: the payment is not only a payment (for the customer) it is a loan (for the retailer). One of the inside secrets of pre-paid cards is that on the balance sheet, they appear as ... customer-provided financing! Which means that the retailer has cut out the bank.

Now do we see why the ECB is going loopy trying to fit restrictions on emerging payment instruments into contortions labelled "the level playing field?"

And, if you think that's not good, prepare for double-plus-ungood: consider the *cost* of the financing. On paper, it looks like a zero-percent loan from the customer to the business. That is, the cash put into the pre-paid card this month comes back to the customer at face value when they buy goods. Zero percent!

Can it get worse? Oh, yes. For various reasons to do with abandoned funds and expiry conditions, the actual expected interest rate is less than zero. Because the cards are also losable or inefficient, that's money the retailer never needs to give back.

That's right: the customer gives a negative interest rate loan to the business. The basic result is going to be that the one and only chance of banks surviving this is if the Central Banks declare prepaid cards to be totally illegal. We are talking pure economics here, this is a slam-dunk.

But, the CB cannot simply declare them illegal. Not without asserting some form of jurisdiction over retail processes, and coming up with an argument that will appease the consumer. And that's the rub. As its mission has some semblance of helping the consumer, it is hard to convince the consumer that you are helping them by taking something from them.

The best the CB can currently do is declare them as essential tools for money launderers, etc etc, and put lots of restrictions on them because they are "tools too dangerous to be let loose on the innocent public." That's what Dave talks about and ridicules in his post:

If there is going to be a level playing field, then lightening the regulatory burden on e-cash might be an obvious place to begin. One source of costs is the requirement to verify the identity of e-cash users. There is a simplified due diligence procedure for a limited set of circumstances:

  1. nonrechargeable... no more than 150 euro; or

  2. rechargeable... a limit of 2,500 euro in a calendar year, ...

These limits seem low to me. I think...

Obviously, they are stupidly low, but Dave has yet to consider how much damage Al-Qaeda can do if they get into M&S with a pocketful of these cards.

Will it work? No. Even with these limits in place, it still won't be enough to save banking (again, resort to the economics argument to see why). They can even afford to squeeze the limits lower, and retailers will still be on top. This is part and parcel of why I predict that the next 1-2 decades will see the end of Central Banking as we know it.

I know what I would do if I was one of those players. A bank, or a CB or a retailer. But that's not interesting. What's interesting is to watch how, as negative-interest loans become more "compelling" to the public, how much more wobbly the ECB can make the playing field before people start sliding off.

Posted by iang at September 14, 2007 07:19 AM | TrackBack

A barter system like Bartercard, or the WIR, becomes a monetary system the minute members start granting credit to each other.

At that point they need a "Value Unit" eg Bartercard's "Trade Pound" as a reference point against which members may exchange their "Money's Worth" of goods and services.

All that Banks add in their monopoly position as "Credit Intermediaries" is essentially a Guarantee, backed by as small an amount of Capital as they can get away with under the BIS "Basel" accords.

And what we have seen is how Banks have essentially been outsourcing that guarantee to "investors" through the use of credit derivatives and other related financial "toxic waste".

I am working (with Norwegian government support)on pilot schemes in Scotland and Norway of local "Guarantee Societies" whereby local "peer to peer" "trade" credit is granted subject to mutual guarantees.

These are supported by provisions/payments made into a default fund by the user of the guarantee.

In this disintermediated model, a "Bank" is necessary to manage the system and the default fund, allocate guarantee limits and so on. It's just that they don't need to risk any of their Capital.

ie the Bank is operating as a "service provider"

The key is a partnership-based legal protocol binding the Guarantee Society members in respect of the credit received, and which may be settled with conventional central bank money, or alternatively with "money's worth" of goods and services.

This model may be described as a "Clearing Union".

Posted by: Chris Cook at September 14, 2007 01:37 PM

This is scary. Should I relocate to some friendlier jurisdiction?

Posted by: Daniel A. Nagy at September 15, 2007 08:17 PM

"However, issuers of pre-paid products do not want to know who you are, just what you do. What you are buying is fine. For them, a traceable-but-anonymous product works perfectly because it solves their privacy issues, and gives them the marketing data to offer you precise deals that are likely to be a win-win for both parties."

We prefer not to know either who they are or what they are purchasing.

Dee Lync
Marketing Financial Services

Posted by: Dee Lync at August 14, 2008 02:07 AM
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