Michael Tarazi works on policy and technology issues at CGAP and this is his very first blog post. Michael joined CGAP in 2008 as a Senior Policy Specialist. He is our Government and Policy Team’s lead person for the Maldives Mobile Phone Banking Project with the World Bank and the Maldives Monetary Authority. As with any blog post, the views here are his own. –Jim

E-money accounts should pay interest. There – I said it.

It took me some time to build up the nerve to say it so directly. I toyed with the usual limp and backside-saving formulations: “perhaps we should consider,” “more thought should be given to . .”, “more studies are needed to explore . . ”.  But I feel pretty confident about this one.

E-money is commonly defined as (i) monetary value as represented by claim on an issuer, (ii) stored on an electronic device, (iii) prepaid, and (iv) accepted by third parties other than the issuer.

E-money can be issued by nonbanks to customers who “deposit” funds.  But wait - accepting public “deposits” is usually an activity undertaken only by licensed banks. And licensed banks are subject to the vast array of prudential regulations, with accounting standards and ratios of the sort that are way beyond my comprehension (and apparently beyond the comprehension of even those who devised them if the current crisis is any indication).

So bank regulators go out of their way to restrict e-money to “payment” services and to strip e-money accounts of any characteristic that might make them look a little too much like bank accounts. For example, and quite legitimately, the prepaid cash backing up e-value cannot be intermediated and must be deposited in a prudentially regulated institution or invested in certain “lower-risk” securities (such as government bonds with short term maturity).

In their effort to distinguish e-money accounts from bank accounts, regulators also typically impose any combination of limitations on (i) the amount of money that can be stored, (ii) the amount of money that can be transferred on a daily, weekly or monthly basis, and (iii) the number of payments that can be effected over a certain period of time.

They even – and this is the part that really irks me – prohibit interest to be paid on such e-money accounts. I am particularly bothered by this because pre-paid e-money funds are typically pooled and held in a prudentially regulated institution –where of course, they earn interest. But the interest isn’t paid out to the customers. This strikes me as unfair. And maybe even a little mean.

Passing on earned interest to the customer should be encouraged (I almost wrote “mandatory” but felt it prudent to appear less authoritarian).

It would move e-money schemes beyond just funds transfer to include savings.  Now I have discovered that what some people mean by “savings” is simply “safe storage”. I fully recognize that security of funds can be a major concern for low-income people as it is for even not-so-poor people. (My mother would walk around shopping with wads of bills stored in her bra. “If somebody gets to this stash” she would say, “they’ll be talking to the judge about a lot more than just theft.”)

But those of us advocating access to finance can do better than just promote savings as safe storage – we can promote savings as interest bearing accounts which put more money into the hands of poor customers and which teach such customers the time value of money. The extra benefit of interest may even encourage greater consumer uptake of e-money – bringing financial services to even more unbanked people. And it would also increase competition by allowing nonbanks to compete with bank sponsored e-money schemes that often do in fact pay interest.

There are nevertheless objections, though I find none particularly convincing:

1.    The interest on such small sums is negligible. True, especially these days. However, because e-money issuers pool their client funds, they can pass on higher rates of interest to poor customers than would otherwise be earned by low-value individual accounts in conventional banks. And interest on the float (unofficial estimates put the floats as high as 1% of the money supply) is not so negligible. One successful e-money issuer wouldn’t give the exact amount of its interest earnings, but stated that it was “quite a nice little sum.” Imagine how much nicer that sum would be in the hands of the people whose underlying funds actually earned the interest.
2.    E-money issuers rely on the interest to make their business models viable. I doubt it. M-PESA for example can’t even use the interest due to its trust structure. I’d be willing to bet that most business models rely on transaction fees – not interest.
3.    The paying of interest invites scams. This is perhaps the most valid objection. The argument is that paying interest will attract more customers depositing larger amounts, thereby inviting scams. But any financial service invites scams (does the name Bernie Madoff sound familiar?). Consumer protections are of course needed. But to prohibit interest on these grounds is effectively to tell customers “you aren’t getting your interest money for your own protection.” (You should be going “hmmmmmm” right now.)

Nonbank e-money issuers should effectively function as “limited services” banks – charging on a per transaction basis to fill the gap for poor people where commercial banks won’t downscale. As long as deposits are held in a prudentially licensed institution and isolated from the issuer’s creditors, regulators should be pressed hard to justify other limitations.

At the very least, they should pass the earned interest on to their customers. And while they’re at it, why not provide deposit insurance too?