How safe are European deposits with fintech banks?
EU states such as Belgium, Lithuania and Ireland are offering e-money institution, payments institution or banking licenses to fintechs, which can be passported across Europe, in anticipation of the U.K. losing its ability to do so after Brexit. But there is no cross-border deposit protection for European consumers holding accounts at EU banks with passported licenses.
The Bank of Lithuania is positioning itself as a hub for payments-related fintechs wanting to enter Europe, offering “Lite" bank licenses for challenger banks with a minimum capital requirement of €1 million. As of January 2019, it has granted three special bank licenses, and is considering four more applications.
The three recipients are Revolut; European Merchant UAB, part of London-based payments services provider Akce Group; and Lithuania’s largest credit union Mano Unija. Newly licensed banks could be at risk if there is another banking crisis. If a Lithuanian-licensed neobank signed up 25 million customers across Europe and each deposited $200, that would represent $5 billion — over a tenth of Lithuania’s GDP and a huge sum for Lithuania to cover in the event of default.
Revolut, which provides prepaid accounts offering low-cost foreign transfers and debit cards, wants to expand into consumer and business lending and savings across Europe. European Merchant and Mano Unija plan to focus on the Lithuanian banking market.
In 2008, U.K. savers lost billions when an Icelandic bank offering high interest rates collapsed, and Iceland’s deposit protection scheme refused to cover their losses.
“The question for consumers, after the great financial crash, is, is my money safe?” said Patrick Collinson, The Guardian’s money editor. “It's wrong that we’ve allowed passporting across the EU for banking services without first creating a Pan-EU protection scheme that is centrally financed.”
European deposit guarantee schemes are organized at national level, although minimum scheme standards have been agreed at EU level. Under EU rules, €100,000 per depositor is guaranteed in these schemes. So Revolut Bank customers outside Lithuania would have to rely on Lithuania’s deposit protection scheme.
As Iceland showed, a national deposit scheme could fail to reimburse foreign depositors, if the country experienced financial crisis, leading to downgrading of its sovereign credit rating.
There is no agreement among EU states on the introduction of a European Deposit Insurance Scheme (EDIS), which was proposed by the EC in 2015. A December 2018 EU finance minister meeting postponed discussions on the EDIS to June 2019, without agreeing on the principles or the details of the scheme.
There are also currently no Pan-European rules for e-money institution licenses, which are governed by national rules and conditions.
“In the absence of Pan-European deposit insurance, consumers should read their T&C carefully,” said Patricia Hewitt, principal of PG Research & Advisory Services. “License-friendly countries like Lithuania will continue to attract neobanks, but, until there’s a large-scale failure by one of these entities, there’ll be little impetus for the EC to step in and demand proper and clear disclosures — à la Schumer box — of these risks.”
In December 2018, London-based Revolut obtained a specialized banking license and an e-money institution license from the Bank of Lithuania. The bank license will allow Revolut to offer consumer and business loans as well as full checking and savings accounts, but not investment services.
Initially, Revolut will offer bank accounts in Lithuania, as it will take three to six months to passport its banking license across Europe. It will then offer bank accounts in other countries such as the U.K., France, Germany, Spain and Poland.
Due to Brexit, Revolut plans to apply for a U.K. banking license, as it currently holds only a U.K. e-money license.
“Current U.K. funds with Revolut are safeguarded in accounts with a tier one U.K. bank, as per our obligations under e-money institution regulations,” said Kiran Wylie, Revolut’s U.K. and Ireland PR and communications manager.
Until Revolut gains a U.K. banking license, U.K. depositors’ funds will continue to be protected via U.K. e-money institution legislation. The U.K.’s Financial Services Compensation Scheme only applies to bank deposits.
Lithuania’s fintech cluster includes over 100 licensed firms, the majority of which are engaged in payments, e-money issuance, P2P lending or crowdfunding.
“If a bank licensed in Lithuania failed, the burden of compensating its customers would fall on Lithuania, which has a population of 3 million and GDP of $47.2 billion,” said Sofie Blakstad, CEO of Scandinavian fintech Hiveonline. “I don't know what Lithuania’s deposit guarantee pot looks like, but, if a Lithuanian-registered bank with, say, 25 million customers across Europe failed, the money simply wouldn't be there.”
Currently, Lithuania has an A3 stable rating from Moody’s.
“The risk of Lithuania being unable to cover the insurance for Revolut deposits is very low at this point,” said Ron van Wezel, Aite Group senior analyst. “It hasn’t proven easy for neobanks to attract deposits. People are conservative with their money and tend to keep their core savings with their existing bank. They use neobanks for specific purposes, in the case of Revolut for international payments. While Revolut has many customers, I expect it to remain a relatively small player in the deposit/lending business for the foreseeable future.”
Marius Jurgilas, a member of the Bank of Lithuania’s board and a former Bank of England economist, expressed confidence in Revolut's prospects.
“The Bank of Lithuania scrutinized Revolut Bank’s business plan and growth projections,” Jurgilas said. “We don’t see any systemic risk from its plan, from a Lithuanian perspective. The magnitude and levels of its deposits as indicated to us don’t indicate systemic risks … It’s important to understand that e-money accounts can’t be upgraded to bank accounts without customers’ explicit consent.”
In December 2018, Revolut had 3 million customers, was adding 8,000-10,000 e-money accounts daily, and transacting $4 billion per month in volumes.
"Revolut's restricted bank services — expected to start in the second half of 2019 — will be limited to simple deposit-taking and conservative lending,” said Wylie. “This is due to the specialized license that we obtained and to our pragmatic policy of limiting our overall exposure to failure by providing generic banking services in the first phase. Revolut's banking operations are subject to the same local deposit insurance contributions as all banks operating in Lithuania.”
The EU learned lessons from the financial crisis, Jurgilas said.
“We’ve almost finished creating the European banking union, whose purpose is to ensure the 2007-2008 crisis isn’t repeated,” he said. “The greatest requirement was to break the vicious cycle between banking sector problems and sovereign debt, whereby sovereign risk fed into the banking sector and vice versa. The EU created multiple institutions and layers to ensure this doesn’t happen again. For example, systemically important institutions are required to maintain an additional layer of capital.”
The EU’s Single Supervision Mechanism requires the largest EU banks to be supervised by the ECB as well as their national supervisors. “84% of the EU bank sector in terms of assets are directly supervised by the ECB,” Jurgilas said. “If Revolut became a systemically important bank, it would be directly supervised by the ECB. Also, if we saw any systemic risks from Revolut, there are ways of dealing with that. ”
Jurgilas says the one element needed for complete EU banking union is the EDIS. “I can understand that some EU states which have dealt with the consequences of the financial crisis don’t want to share banking default risks with states that haven’t fully dealt with them,” he said. “But maybe for a bank starting with a clean slate like Revolut, we can find a solution for EDIS deposit cover on a bilateral basis.”