When you hand your hard-earned money over to any kind of financial institution, you want to be confident that it will be kept safe – otherwise you might as well keep it under your mattress. If the institution collapses, you will naturally expect to get your money back.
Traditional UK banks are able to guarantee this because they are covered by the Financial Services Compensation Scheme (FSCS). The FSCS ensures that if the bank were to go bust, you would be refunded all the money in your account up to a maximum of £85,000. In the EU, various deposit guarantee schemes cover customers for up to €100,000.
In the last decade or so, we’ve seen a new generation of payment service providers and electronic money services that offer customers a range of innovative tools and services. However, unlike traditional banks, these companies aren’t protected by the UK’s FSCS or European equivalents.
So, does that mean your money is at risk?
Not really. In fact, these organisations offer protection that is as good if not better than traditional banks through something called ‘safeguarding of funds’. Let’s see what this means.
How payment service providers use safeguarding of funds to keep your money safe
The new generation of payment service providers (PSPs) – think prepaid cards, mobile money services and digital finance accounts – use money you deposit with them in a different way to traditional banks.
- When you deposit your money into a high street bank, they combine your money with their own, and use it to lend out to other customers (for mortgages, business loans etc.). The bank charges interest on these loans and may pay some of that interest back to you to ‘thank you’ for depositing your money on their books. The risk, however, is that if the bank collapses, all your money will disappear – which is why the FSCS was created – it means you will receive up to £85,000 if the bank fails.
- With a PSP, your money is not allowed to be mixed in with the bank’s money – it must be kept in a separate account, just for you. The PSP cannot lend out your money or do anything else with it. They may make money by charging you for transactions or offering special paid-for services.
Because of these differences, traditional banks are much more highly regulated than PSPs and must comply with the FSCS or similar schemes to protect their customers’ money. PSPs are still required to protect their customers’ cash, but they do it in a different way – through safeguarding of funds.
Safeguarding customer funds keeps your money safe
PSPs, which include Payment Institutions and Electronic Money Institutions are required to keep their customers’ money protected. They do this by safeguarding their customers’ funds, which can be done in one of two ways:
If the PSP chooses to go down this route, they must keep all the money you deposit with them in a segregated account that is uniquely yours. This means that even if the company behind the PSP folded, your money wouldn’t go anywhere – it would remain in your account and you’d still be able to withdraw it.
An alternative for PSPs is to insure themselves in case they collapse. This would mean that if the PSP failed, the insurer would be required to pay you back whatever your balance was the day that the PSP closed. At present, this is not very common – most PSPs go down the account segregation route.
Either way, the safeguarding of funds protocol means that a PSP offers just as much protection for your money as a traditional bank. In theory, your money could actually be safer. This is because the FSCS will refund you up to £85,000 if a bank collapses - but that means someone who had £100,000 saved would lose £15,000.
By contrast, if you had £100,000 in an account with a PSP that collapsed, you would retain all your money.
PSPs must prove that they are compliant
This all sounds straightforward in theory, but there are many accounting and technological complications involved. Moving money in and out of thousands of individual accounts and keeping everything in order is complex. And this is why PSPs are frequently audited by the Financial Conduct Authority to ensure they comply. The FCA assesses:
The PSP must follow strict accounting processes to ensure their books are balanced
The PSP is required to put in place a system which records all transactions in and out of customer accounts, including keeping receipts
Every day, the PSP must ensure that the balance on all its customers’ accounts matches up with their internal records
Proof the system works - the collapse of EMI ‘Loot’:
As with any disruptive new technology, start-up companies sometimes fail. This is what happened with UK Electronic Money Institution ‘Loot’ in early 2019. The company, which offered its 200,000 customers a prepayment card and mobile app failed to capture enough funding to pay for its expansion, so the company was dissolved.
Nevertheless, this did not mean its customers lost their money. Quite simply, Loot had followed the rules about segregating accounts, and this meant customers were returned the money they had stored in their accounts. While this would no doubt have been inconvenient, Loot’s customers suffered no financial losses.
Safeguarding of funds means PSPs are a safe alternative
One of the major attractions of PSPs is that they offer you services which are targeted specifically at your needs. At Xace, for instance, we provide accounts that are especially useful for people involved with sectors such as cryptocurrency accounts, gaming accounts and esports accounts – these are niche sectors which most high street banks do not cater for, so it would be a struggle depositing your money with them.
And, because PSPs like Xace comply with the FCA’s safeguarding of funds requirements, you can be confident that your hard-earned money will be just as – if not safer than - it would be in a regular bank account.