Spot The Difference: E-Money vs. Banking Institutions
Revolut recently announced that the PRA (UK Banking Regulator) has granted it a banking licence, with restrictions. They’ve come a long way from being a multi-currency travel card and the firm needs a ‘bigger’ licence for them to continue growing its client base and product lines. But hang on, why do they even need a banking licence in the first place? And what’s the difference between an E-Money Institution (EMI) and an actual bank?
The Basics: They are different from a regulatory and compliance lens
Banks are deposit-taking institutions that are governed by two regulators in the UK, the PRA mentioned earlier, and the FCA. In comparison, EMIs are regulated by the FCA only. As a result, banks naturally have more compliance and regulatory burdens since they are dealing with two regulators instead of one (at least in the UK). There are more rules around liquidity and capital governed by Basel III for banks, and, depending on the products they offer, they would be subject to more rules like MiFID and lending regulations. As such, compliance and risk teams in banks are also usually bigger than that of EMIs. However, technology can streamline and automate numerous compliance and regulatory reporting workflows, so the number of employees in such departments should not be the only factor in determining the effectiveness of a team!
Trust: Client monies are both safe but protected differently
Arguably the biggest draw for financial institutions wanting to be a bank is the ability to offer insured customer deposits. In the UK, the FSCS would insure retail deposits and investments up to £85,000 while in the US, the FDIC could $250,000. Aside from protecting customers and giving them their money back when shit hits the fan, being a bank and offering deposit insurance is an automatic way to gain more trust from the public. Although safeguarded customer funds in EMIs are also relatively safe and scrutinised to high standards by the FCA, the average retail customer would still prefer the assurance of a deposit insurance scheme.
This is extremely useful for a growing scale-up like Revolut. To get more retail customers from incumbent banks like Barclays, Santander and HSBC to move onto the Revolut platform, they need to gain their trust, not just offer a sexy signup deal. Rational customers will have multiple accounts to maximise the utility of the financial services that they are getting. Becoming a bank could be the push that Revolut needs to get customers to use and move their main financial activities onto their financial platform.
Growth: Banks have more freedom in offering financial products
As more existing and new customers can start trusting Revolut, it’s time to roll out new financial products. EMIs can be pretty limited in terms of what they can offer. There are strict rules around offering ‘interest’ on customer funds for EMIs, and they aren’t allowed to use customer funds to generate investment returns either (because of safeguarding). Combined with fee compression that’s occurring throughout the industry, it is relatively difficult for EMIs to become profitable as a result.
Becoming a bank would change all that, as Revolut could start offering products they already rolled out in Europe (because they are a licenced bank in the EU!) such as loans and mortgages. In today’s higher interest rate environment, this could be another big revenue driver for one of their main markets, the UK.
Efficiency: Banks don’t need to work with other institutions to make products work
Besides the ability to offer more types of financial products, this ultimately means that Revolut could start offering financial services themselves. It does sound very obvious but this is a huge sigh of relief for their operational teams. First of all, they don’t need to safeguard their customer funds anymore (this is more annoying than you think, operationally!). Most EMIs would have to partner with banks or investment firms to offer payments, FX and stock trading for example. Having a banking licence would allow Revolut to pursue these initiatives internally instead. This could be expensive and difficult without the right knowledge/systems, but it would be a good long-term investment to save costs and have more pinpoint control over how their financial products are designed/offered.
An example would be FX and payments EMIs like Ebury or CurrencyCloud. They can’t offer FX or payments themselves, so they might partner with banks like JPMorgan or Goldman Sachs and use their transactional banking services. Ebury or CurrencyCloud customers may find it frustrating when their payments get stopped by the banks’ compliance teams. Because there are now two layers of communication between the end customer and the banks, the EMIs would be caught in the middle trying to rectify problems that are out of their control.
Conclusion: Same same, but different
To most customers, Revolut, Wise and Monese might feel and look the same as banks. However, EMIs are a completely different type of financial institution and could be seen as ‘inferior’ to banks in terms of permissions. Getting a banking licence is likely to be pivotal for Revolut’s growth strategy and it would be interesting to learn how they’ve managed to convince the PRA on this!
