It’s funny. A few months ago, bankers were fretting that fintechs and crypto startups were “too risky”. After the sudden implosion of Credit Suisse, Silicon Valley Bank (SVB), Silvergate and Signature the boot is on the other foot: fintechs now see banks as too perilous.

Silvergate and Signature were primary banking institutions for cryptocurrency companies, and nearly half of all US venture-backed startups kept cash with SVB. One crypto company is said to have had over $3 billion with SVB. 

But the crisis is not just about lost deposits. Banks are also used by their customers to make payments. The Silvergate Exchange Network (SEN) and Signature’s Signet were real-time payment platforms that crypto customers relied on to stay in business. They allowed commercial clients to make payments 24/7 through their respective instant settlement services. As I write, many crypto startups not only in the US but in Europe too are seeking new payment partnerships.

The extent of the crisis tells us there is a real problem that needs solving here. For organisations that just need payment solutions for their customers and payroll obligations, what is the low- or zero-risk option?

The bank risk dilemma

Amid all the finger pointing, the search is on for long-term solutions. The Harvard Business Review has already weighed in with an article that looks specifically at the issue of private-sector payrolls, which demand $9 trillion in payment flows annually in the US alone. 

When SVB began to tumble on March 9, it was unclear what the total payroll impact on missed wages would have been for that month. But just one payroll provider, Patriot Software, with 55,000 US customers, had over $100 million in payroll and payroll taxes with SVB on the day federal regulators closed it down, according to the Patriot Software CEO in a blog post.

The issue, as analysed by the HBR authors, is that businesses, like Patriot, require large sums of money on hand to meet monthly expenses. They keep that money in licensed banks with access to the payment infrastructure necessary to send funds wherever they are needed. Those banks operate on a commercial model of taking in funds at a low interest rate and investing them to achieve a higher return. In other words, they speculate with customers’ money, within a range of allowable risk defined by the relevant central bank. It’s not impossible - as SVB discovered - that banks get their risk calculations badly wrong. 

The sums involved for many businesses making use of these banking payment services usually far exceed deposit insurance schemes, which in the US was capped at $250,000. When SVB ran into difficulties, the US Federal Reserve decided it had to step in and guarantee all deposits - ignoring the $250,000 cap - to ensure that the bank’s customers could meet their payment commitments, including payroll. 

So, here’s the rub according to the HBR article: “The problem of uninsured depositors is really the problem of accessing the payment system — a system monopolized by central banks and then delegated to banks. The payroll problem is a notable example of this problem as payroll funds necessarily must get parked in banks, where they are exposed to the risks mentioned above.” 

Solutions, not problems

The HBR authors’ preferred solution is a new class of “payment bank” that would exist solely for the purposes of making payments. They would have no latitude for speculation. Any funds deposited to meet payment liabilities would remain available on a 1:1 basis. 

Another option already exists, of course. These are Electronic Money Institutions. EMIs are non-bank payment service providers that offer an alternative to traditional banks. They are regulated entities that are authorised to issue electronic money and provide payment services, such as online accounts or wallets, prepaid cards, and money transfer services. They tend to have lower fees and more flexible account opening requirements than traditional banks. 

Once perceived as higher risk than banks, many business customers are now realising that the opposite is true.  Even before the current crisis, a 2022  report by Oliver Wyman found that EMIs are growing faster than traditional banks, with their share of the European payments market expected to grow to 15% by 2025. In light of the current situation with SVB, it is possible that there may be a greater influx of funds moving from traditional banks to EMI institutions.

One reason for previous caution about EMIs is that they do not participate in the deposit insurance schemes that cover licensed banks such as the $250,000 deposit insurance scheme in the US and the Financial Services Compensation Scheme (FSCS) in the UK that covers deposits up to £85,000. However, EMIs keep clients' funds at a 1:1 ratio in a regulated process known as ‘safeguarding’. Safeguarding involves segregating customer funds from the EMI’s own funds and holding them in a separate account with a credit institution or investing them in secure, liquid assets. 

EMIs are not perfect either and customers need to be diligent about their regulation, safeguarding, and risk management procedures. The biggest potential weakness is where the safeguarding funds are themselves deposited. If that’s in a traditional bank, then the owners of deposits in safeguarding receive a higher priority than other customers, but there is still some degree of risk.  If it’s with a central bank, then your money is as safe as it’s going to get. 

A role model example here is Lithuanian EMIs, which are required to keep funds in safeguarded accounts in a bank within the EEA. Most keep the majority of funds at the central bank - the Bank of Lithuania - and several keep 100% of customers’ funds there. Even in the case of an EMI failure, those deposits would still be there, safely waiting for owners, without the need for any bailout from authorities.

Due diligence

Ultimately, the balance of risk between EMIs and licensed banks depends on individual circumstances and business preferences. It is important for customers to carefully evaluate the risks and benefits of using different types of financial institutions before making a decision.

Over many years in the banking industry, one thing has become very apparent to me: it all comes down to the safety of funds. No matter how sophisticated products or investment opportunities there are - if one cannot provide a basic safety mechanism, clients will suffer sooner or later.