• Part A: Introduction, Summary and Policy Conclusions
• Introduction
• Summary of Analysis
• Policy Conclusions
• Part B: Analysis
• Chapter 1 - A New Payment Instrument: The Electronic Purse
• 1.1. The scope of the study
• 1.2. Incentives for the use of the electronic purse
• Chapter 2. Consequences of the Electronic Purse for Central Banks
• 2.1. Implications for the oversight of r)avment systems
• 2.2. Implications for monetary policy
• 2.3. Consequences of a reduced use of banknotes
• Chapter 3: Proposals for Central Bank Action
• 3.1. Five scenarios for central bank action
• 3.2. Evaluation of the scenarios
• Part C: Conclusion and Follow-up to the Report
• Annex: The Members of the Working Group on EU Payment Systems

Part A: Introduction, Summary and Policy Conclusions

Introduction

1. Recently a new payment instrument has emerged: the multipurpose prepaid card or "electronic purse". It is a plastic card which contains real purchasing power, for which the customer has paid in advance. Although developments in the field of electronic purses are only at an early stage, the possibility of proliferation of such cards is a real one. In the future, if electronic purses were used in a great number of retail outlets, they would become a direct competitor not only to cashless payment instruments already in existence, but also to notes and coins issued by central banks and national authorities.

2. Given the potential of electronic purse schemes to attain widespread acceptance,, central banks need to formulate their views on the issues raised by this payment instrument. Once such schemes have been introduced and are widely used, redressing undesired situations might be much more difficult. Furthermore, some of the schemes already in preparation provide for the use of electronic purses in several currencies and countries. Therefore, in the context of the Single Market and of the responsibilities of the future European System of Central Banks in relation to the functioning of payment systems, the Committee of Governors of the EC central banks requested, in February 1993, the Working Group on EC Payment Systems to study the issues involved.

3. This report aims at improving central banks' understanding of the functioning of this instrument and at assessing the consequences that its wide spread use may have for their activities and their statutory duties. The report is being published now, as a way of informing interested parties of EU central banks policy conclusions and as a contribution to private sector discussions of this new payment instrument.

Summary of Analysis

4. Prepaid cards have developed first as a single-purpose payment instrument for which the card issuer and the goods or service provider have been one and the same (e.g. telephone cards). Such cards have not raised central bank concerns because the value embedded in them did not have a wide rance of uses and, therefore, did not have the characteristics of money. Drawing on the experience of single-purpose prepaid cards, and on recent technical developments (in particular the invention of the chip card), a new payment instrument is under development in many countries: the multi-purpose prepaid card, also known as the "electronic purse".

5. For all parties involved, the use of electronic purses may theoretically have advantages: consumers would need to carry less loose changc; shopkeepers would have fewer cash handling activities and would have the assurance that their payment claims would not be dishonoured for the card holder's lack of funds (they might also use the chip card for promotional activities), and issuers would benefit from the float involved. Nevertheless, the development of electronic purses is still embryonic and the extent to which they will develop is not easily predictable. Their acceptability as a payment instrument by the general public will depend on the distribution of costs and benefits between the parties involved (i.e. consumers, shopkeepers, and issuers). Although their primary purpose is to provide an alternative to notes and coins, electronic purses also have the potential to be developed further and to be used for retail payments of areater amounts. In such a case, they would also compete with bank deposits and with instruments that are used to transfer them (such as cheques, credit cards and debit cards).

6. The possible development of electronic purses merits special attention from central banks for at least three reasons. First, central banks are concerned that the introduction of the new payment instrument should have no adverse effect on public confidence in the payment system and payment media. This preoccupation would increase if non-regulated institutions were allowed to issue electronic purses, or if the latter were designed in such a way that counterfeiting would be both easy to achieve and difficult to detect.

7. Second, although the substitution of "prepaid card money" for other forms of money should not theoretically hamper central banks' ability to control the money supply, it might, however, have practical implications, at least in the longer run, which need to be carefully examined. This concerns in particular the use of existing monetary policy instruments and the availability of the necessary statistics.

8. Third, because electronic purses may be used for payments of very small value, they have the potential, more than any other cashless instrument, to take over the role of notes and coins in the economy and, therefore, have implications for central banks' activities and revenues. Moreover. although electronic purses are not, in legal terms, infringing on the banknote monopoly, their general use may reduce the use of legal tender to a fairly large extent.

9. The purchasing power loaded in a multipurpose prepaid card represents, for the issuer, a source of funds equivalent in their economic effect to deposit-taking. Therefore the rignt to issue electronic purses needs to be restricted to credit institutions * in order to: 1) protect the integrity of the retail payment system; 2) protect consumers against the consequence of the failure of the issuers, 3) facilitate the conduct of monetary policy; and 4) ensure fair competition between issuing institutions.

* A limited exception to this principle is mentioned in paragraph 32 .

10. Whilst no EU central bank envisages issuing prepaid cards for the moment, the degree of their involvement in the development of electronic purses is different: some of them consider that it is exclusively a matter for private operators; others may wish to be involved in interbank settlements, if appropriate; some, but not all, EU central banks may also wish to encourage market participants to develop a common technical infrastructure with a view to promoting the inter-operability of competing card schemes.

11. EU central banks feel that, at least in the short run, the introduction of the electronic purse as a new payment instrument does not pose insurmountable problems and that, since it could contribute to making payment systems more efficient, they will not unduly hamper its development. They should be alert, however, to the possible problems which may arise in the future and they should continue to monitor carefully such developments at the national level, and also in co-operation with other central banks, in the EU and elsewhere.

Policy Conclusions

12.

• Only credit institutions should be allowed to issue electronic purses * .
• EU central banks should continue to monitor developments in the field of prepaid cards, possibly in co-operation with other central banks outside the EU.
• In this context, EU central banks should be kept informed, if possible at an early stage, of any major prepaid cards schemes involving more than one good or service provider, and decide whether they should be considered as "limited-purpose" or as "multi-purpose"; in the latter case, the provisions of this report will apply.
• Central banks may wish to examine carefully the security features of proposed prepaid cards schemes. In some cases, they may wish to discourage some initiatives in order to protect the integrity of the retail payment system.

* A limited exception to this principle is mentioned in paragraph 32 .

Part B: Analysis

Chapter 1: A New Payment Instrument: The Electronic Purse

1.1. The scope of the study

13. The awareness of central banks of their overall responsibility for the functioning of payment systems leads them to consider the planned introduction of the multi-purpose prepaid card, as a new cashless payment instrument in the years to come, and to take an explicit decision on the role they want to play in this respect.

14. This report focuses only on prepaid cards which can be used for a very wide range of purposes. i.e. multi-purpose prepaid cards, which have the potential to be implemented on a national scale but may sometimes be restricted to a certain area. Single-purpose cards where the card issuer and service provider are identical, like those for use in public teieptiones, remain outside the scope of the investigation. However, in real life the distinction between multi and single-purpose cards is not always fully clear, as cards already exist which, though not universally accepted, offer access to more than one application and/or involve separate legal entitles as card issuers and service providers. Whenever these cards can be used in a small number of well identified points of sale within a well identified location (a building, a corporation, a university ... ) they can be considered as "limited purpose" prepaid cards which also remain outside the scope of this study. If necessary, EU central banks should decide whether a specific scheme should be considered as "limited-purpose" or "multi- purpose".

15. Multi-purpose cards where the funds are provided by a credit line aranged by the card issuer to the cardholder are, in effect. pre-authorised rather than pre-paid, and are more closely analogous to conventional credit and charge cards. They are not included in the scope of this study. From now on, the report will only consider cards which, strictly speaking, are pre-paid and multi- purpose; they will be often referred to as "electronic purses".

16. Electronic purses differ from other cashless payment instruments in that they are supplied in advance with generally accepted purchasing power. Tney can be loaded at bank counters, through Automated Teller Machines (ATMs) or through specifically equipped telephones, against a debit entry in a credit institution account, or against banknotes and coins. The embedded purchasing power is drawn down at the point of sale by an electronic device that can suitably adjust the information on the card.

17. Electronic purses are new cashless payment instruments which will be used primarily to settle face to face transactions. Their potential to reduce significantly the use of notes and coins is even greater than that of other debit instruments since they are the first cashless instrument which would be used for very small amounts. Their potential to replace other cashless instruments will depend: 1) on the level of fees and other costs levied by the issuer on those who use or accept these new instruments; 2) on the technical possibility, and the issuer's willingness, to remunerate the purchasing power embedded in electronic purses; and 3) on solutions adopted to compensate users in case of the loss, theft or malfunction of the card.

1.2. Incentives for the use of the electronic purse

18. Over the years, payment with cards has become common practice in most EU countries, as a method of gaining access to funds held in a bank account or to an agreed credit line. For security reasons, on-line systems are now often used for authorisation of the transaction and, sometimes, on- line transaction processing also takes place. Usually the information that is needed to enable the transactons to be made is contained in a magnetic stripe on the back of the cards.

19. Technological developments have enabled further improvements in the use of plastic cards. In this respect the introduction of the chip or "smart" card was an important development. A chip card contains a microcomputer, consisting of a processor and a memory component, which is embedded in the card, thereby allowing remote verification and, accordingly purchases at a local level which previously could only be executed, for security reasons, after on-line reference to a central computer. Apart from offering the advantage of independence of on-line data communications, with their attendant costs, this microcomputer also allows for multi-purpose applications. This means that the use of such a card need not be restricted to payment transactions, but could be extended to, for instance, the registering of retailers' promotional activities or even to totally unrelated functions like the storage of medical information. In such a way the typically higher initial cost of the chip card could be share between several market participants. Many of the features that chip cards offer are optional. In particular, while it is possible to install PIN (Personal Identification Number) authorisation for payment transactions, such a facility need not be implemented in systems developed for off-line low-value applications.

20. Protection against counterfeiting will be a very important element on which the future of electronic purses depend. Forgery will probably be more difficult to detect with this instrument, particularly if the card can be used anonymously, and is not personalised in any way. By virtue of their higher degree of built-in security, chip cards have a far greater potential than traditional cashless payment technologies and, although it is not the only option available, recent experience suggests that the chip card seems to be the most probable choice in this context; for security reasons, an electronic purse system implemented on the basis of cards containing magnetic stripes does not seem very realistic. There is no certainty however, that chip cards will provide an absolute protection against forgeries.

Market developments

21. For electronic purses to become a success, a distinct business case must exist for cardbolders, for shopkeepers and for issuers. Electronic purses can have various advantages for cardholders. The most important aspect. relates to convenience as there would be less need to carry loose change for low-value transactions. An additional advantage might be that, compared with notes and coins, the risk of robbery might diminish if the use of the electronic purses included a security feature such as a PIN code. Furthermore, prepaid cards would have the advantage that non- cash payment transactions could be made without necessarily being linked to a bank account. On the other band, there are disadvantages as well: first, transaction costs may apply, and second, the electronic purse has to be supplied with value in advance, which may give rise to a transfer of float income from consumers to card issuers.

22. Some - but not all - prepaid card schemes envisage to offer the possibility for cardholders to transfer purchasing power from one electronic purse to another; such payment transactions would eliminate the need for clearing procedures and would further increase the possibility for electronic purse money to substitute for notes and coins.

23. For suppliers of goods and services the use of electronic purses could have the advantage of reducing cash handling costs and, possibly, some financial benefits as a result of a lower need for till money. Also, an important characteristic vis-a-vis other face to face cashless instruments would be that, as the card would be supplied with value in advance, there would be no risk of payment being refused for the cardbolder's lack of funds. On the other hand, additional costs might arise if several non-compatib;e electronic purse systems were to evolve and also if the the terminals for electronic purse systems were not compatible with those in use for other card schemes. In addition, potential financial benefits might be smaller than expected if the card-providing institutions were to introduce additional fees for electronic purse transactions. Nevertheless, surveys conducted in a number of countries indicate that some categories of shopkeepers are in favour of electronic purses and want to encourage their introduction, not just for their payments functionality but also, and perhaps even more important, for the additional opportunities for promotional activities based on the memory capacity of these cards.

24. For issuing institutions, in general, the most important reason to take part in the development of electronic purse schemes is, perhaps, the gain of float income that would otherwise accrue to other parties (private individuals, business enterprises or, in the case of notes, central banks). If issuers were forced by competitive pressures to pay market interest rates on electronic purses. the advantages of issuing electronic purses would of course deline.

25. For credit and financial institutions, the advantage of issuing or promoting electronic purses would be that they could be designed in such a way that they are a relatively cheap, off-line, substitute for other non-cash payment instruments with no risk of overdrawing bank accounts. Furthermore, the substitution of electronic purse payments for notes and coins would reduce cash handling costs and the need to hold non-interest-bearing cost balances. If the issuing institution is also the account holder, an additional incentive to persuade conswners to use electronic purses instead of notes and corn would be the fact that the issuing institution would only lose reserves when the funds embedded in the card are spent and merchants demand payment, whereas, by contrast, when notes and coins are withdrawn by an account holder there is an immediate drain on reserves.

26. Other companies may also try to introduce such instruments, or to upgrade existing forms of prepayment. An example of such upgrading could be the issuance by PTTs of universally applicable cards based on those which are now solely used to operate public telephones.

27. To a certain extent, the advantages of electronic purses for some economic acents are disadvantages for others. Therefore, the overall acceptance of this new payment instrument is as yet uncertain. In any case, a key factor will be its actual acceptance by consumers which will depend on many factors, such as the reliability of the system, its user-friendliness and the financial conditions which will apply in terms of costs and fees.

Chapter 2. Consequences of the Electronic Purse for Central Banks

28. EU central banks are of the opinion that the market, should decide which payment instruments can best serve customer needs. Therefore, they do not wish to interfere unnecessarily in the development of prepaid cards schemes. Moreover they do not feel that, in general, they need to be heavily involved in retail payment systems. Nevertheless, the creation of the electronic purse must be evaluated carefully, because if it develops this payment instrument will affect central banks in the long run: a) as overseers of their countries' payment system; b) as the authorities in charge of monetary policy and c) as issuers of banknotes.

2.1. Implications for the oversight of payment systems

29. All EU central banks are concerned with the integrity, stability and efficiency of their country's payment system. Even if central banks generally concentrate their attention on large-value payment systems, because of the systemic risks involved, they cannot neglect the implications which the inaopropriate functioning of a payment instrument may have for the public confidence in the currency, the retail payment systems and the payment media in general. In this respect, electronic purses raise at least two kinds of problems: one relating to the soundness of the issuer, and the other relating to the soundness of the instrument.

The soundness of the issuer

30. In the schemes which the Working Group on EU Payment Systems has been able to examine, the "issuer" of an electronic purse has three functions: 1) it makes the card available to the customer; 2) it is the beneficiary of the payment made by the card-holder to "load" its card and; 3) it is the institution which has the contractual liability to pay the merchants for goods or services purchased by the card-holder and, possibly, to reimburse the unused funds to the cardholder.

31. In economic terms, it is clear that the money received by the issuer of an electronic purse is a bank deposit. It is indeed a claim which the card-holder (or account holder) has on a third party and which can be used to make cashless payments to a wide range of providers of goods and services. Such deposits contrast with deposits which are payments in advance for which the range of goods or services to be purchased is well defined and limited in scope. Therefore, in economic terms, the reasons which led public authorities to reserve deposit-taking to a specific catecory of institutions should also apply to the issuers of electronic purses. These reasons relate both to the protection of the consumer and to the protection of the money transmission system. If corporations other than credit institutions were to issue electronic purses, banking regulations, which, in the end, seek to protect customers deposits, would not apply. Moreover, deposit guarantee schemes would not apply either. As far as the money transmission system is concerned, its stability could be threatened by the failure of one or several issuers; public confidence in other retail payment instruments (e.g. debit cards) may also be affected. Therefore, it is very imoortant that the liquidity regime which applies to credit institutions serves to ensure that the issuers of prepaid cards are able to meet their liabilities to retailers in the settlement of transactions made with the cards. Moreover, there would be an additional concern for central banks and banking supervisors if banks which were subject to prudential regulations (and in some countries to reserve requirements) were not able to compete on equal terms with other issuers of electronic purses.

32. In some circumstances (e.g. in the case of schemes already in operation before the policy conclusions of this report were drawn up), the local central bank may agree that electronic purse issuers do not have to be fully fledged credit institutions provided that:

1. they provide only domestic payment services;
2. they are subject to appropriate regulations, in particular, with respect to liquidity requirements;
3. they are supervised by the institution which supervises credit institutions.

The soundness of the instrument

33. Irrespective of the issuing institution, EU central banks have an additional concern which relates to the risk of counterfeiting. Other cashless payment instruments are, indeed, already sometimes counterfeited. However, because they are linked to a bank account, the fraud can be usually quickly identified. This may no longer be the case for electronic purses if the proceeds of their use are cleared anonymously, a possibility which is in fact likely to occur if transaction costs for low- value transactions are to be kept at a low level. The risk of someone introducing forged money into the system could increase further in the future if, as already envisaged by some promoters of electronic purse schemes, card holders can by-pass the clearing process and exchange purchasing power directly from one card to another. Central banks may wish to encourage measures which may limit the risk of fraud. These measures may, for example, consist of introducing limits to the amounts loaded on the cards, of setting the maximum size of individual payments, or of monitoring the use of individual cards.

34. EU central banks would be concerned if the security features of any electronic purse scheme did not prove adequate to maintain public confidence in the retail payment system. This danger should not be ruled out, although it is not, of course, likely to materialise in the near future, when the use of electronic purses will still be relatively marginal. Given the potential, however, of a truly multi-purpose prepaid card to be a significant substitute for other payment media in the long run, a potential danger does exist. EU central banks are alert to this problem and they expect the issuers of electronic purses to devote enough resources to it. Should the latter not address the issue in a satisfactory manner in the future, EU central banks will need to reconsider their general appreciation of the problem.

2.2. Implications for monetary policy

35. For monetary policy purposes, central banks need to control (or at least know) the amount of money which is available to non-bank economic acents as a means of payment. Since the introduction of prepaid cards involves only a substitution of one form of money for another one, the impact on monetary policy will be limited. However, a more widespread use of prepaid cards in the future is likely to have at least three implications for the conduct of monetary policy.

36. First, the new form of money contained in multi-purpose prepaid cards will have to be included in narrow money aggregates since it will be close to a perfect substitute for notes and coins and, up to a certain extent, for sight deposits. The inclusion of muiti-purpose prepaid card money in monetary statistics is not likely to be particularly difficult since, according to para. 31, it is to be held by credit institutions only.

37. Second, the extent to which the velocity of prepaid card money will be identical to forms of money which already exist will have to be assessed and, if necessary, taken into account by monetary policy experts.

38. Third, the decrease in notes and coins is likely to contract the size of central banks' balance sheets and, therefore, at least in some countries, may diminish their ability to influence rates of interest through their market operations. This effect however is not exclusively linked to the introduction of electronic purses. The progressive substitution of notes and coins for cashless money has had the same result and, over time, it can be expected that central banks that wish to contral the monetary base will be able to find ways of doing so, for example by introducing or increasing the use of required reserves.

2.3. Consequences of a reduced use of banknotes

39. With the introduction of electronic purses, for the first time a viable cashless alternative for small amounts will become available. In the extreme this could mean that the role of central banks as suppliers of banknotes could theoretically disappear. Studies made by the Econometric Research and Special Studies Department of the Nederlandsche Bank sugcest that the coin circulation may be affected much more strongly than the note circulation, the ultimate percentage effect on the coin circulation depending strongly, however, on the degree to which coin is hoarded. In addition, the effect on the note circulation is, according to the study, stronger in terms of numbers than in terms of value.

Legal tender

40. A negative aspect of the large-scale use of electronic purses, in combination with widespread use of debit and credit cards, might be that, in the long run, the use of banknotes could be limited mainly to transactions in the underground economy, for which purposes central banks may wish to avoid providing the means. In any case, money embedded in electronic purses does not have legal tender status. Theoretically, the use of electronic purses could develop up to a point where the ability of customers to pay with notes and coins could be threatened. This would be in contradiction with the legal tender resolutions in some (but not all) EU countries. Before this stage is reached, it will be necessary to assess whether legal tender regulations need to be changed or if the use of this instrument needs to be restricted so that the possibility to pay with notes and coins is maintained.

Central banks' activities and revenues

41. If the widespread use of electronic purses were to lead to a marked reduction in the value of banknotes in circulation, central banks' note printing (for those central banks which print their banknotes), handling and sorting activities could be affected. As these influences (and others resulting from changes in payment behaviour) gradually develop over time, central banks will be able to monitor them and to adjust their banknote printing and handling activities accordingly.

42. Because banknotes represent non-interest bearing liabilities for central banks, any reduction of their use in the economy also affects central banks' revenues. However, maximising profits is not the objective of central banks and, therefore, they will not base their policies with regard to prepaid cards, or to any payment instrument, on their profit expectations.

Chapter 3: Proposals for Central Bank Action

3.1. Five scenarios for central bank action

43. Five scenarios for central bank action have been discussed. They were based upon the fact that current legal opinion in most European countries holds the view that, under existing legislation, the banknote monopoly does not extend to electronic purses. This implies that: 1) the issuance of electronic purses by parties other than central banks is possible; and 2) that central banks' statutory obligations do not create any legal obligation for them to issue electronic purses themselves, thus leaving them the choice as to what extent they wish to be involved. This is all the more so as legal tender will continue to coexist with electronic purses and will thus remain available to those who prefer to use banknotes and coins.

44. The five scenarios are, in order from minimum to maximum central bank involvement:

• a) no central bank intervention at all;
• b) no restriction on the issuing institution but with central banks exercising oversight;
• c) the issuing of electronic purses to be restricted only to credit institutions (as defined by the First and Second Banking Co-ordination Directives) or to institutions covered by paragraph 32 of this report;
• d) central banks issue electronic purses themselves in competition with similar private sector schemes, using the existing banking infrastructure for the distribution of their electronic purses;
• e) central banks decide that the issue of electronic purses is exclusively a central bank activity and create a distribution infrastructure of their own. Under this scenario electronic purses could be given the status of legal tender.

3.2. Evaluation of the scenarios

45. The longer term consequences of electronic purse develooments are such that scenario a) is not compatible with fundamental central bank responsibilities for maintaining the integrity, stability and efficiency of its country's payment system and for the conduct of monetary policy.

46. Scenario d) would be in contradiction with the long term trends which have led central banks to withdraw from competition with the banking sector and to concentrate on the oversight of payment systems and on the provision of interbank services. It could also be argued that central banks would have an unfair advantage over other issuers because of the zero credit risk nature of an electronic purse issued by the central bank.

47. As far as scenario e) is concerned no EU central bank intends to issue such cards for the moment since they feel that the consequences of the introduction of electronic purses may not be so different in nature from the emergence of other cashless instruments in the past. However, in the Iong run, it can not be excluded that circumstances might develop which could lead EU central banks to issue prepaid cards themselves @ .

@ Thus, in Finland, the central bank has decided to issue prepaid cards itself as a way of preventing proliferation of non-compatible systems.

48. For the reasons which have been explained in para. 31, EU central banks are convinced that the funds representing the value of the purchasing power "loaded" in the electronic purses need to be considered as banking deposits which can only be held by credit institutions. As a result, they consider that scenario b) is not adequate, and conclude that scenario c) is the most aopropriate of the five scenarios mentioned in para. 44.

49. The central banks' desire to prevent non-banks issuing prepaid cards primarily relates to the need to preserve the integrity of the retail payment system. Moreover, since information channels between banks and central banks are now well developed, they could also be used to obtain information needed in order to monitor the development of this new payment instrument. In addition, the conduct of monetary policy would be relatively unaffected since the funds associated with prepaid cards would not be fundamentally different from ordinary deposits.

50. For clearing and settlement purposes, electronic purse schemes could, probably, make use of already existing infrastructures for cashless retail payment instruments, in which central banks usually are only involved in providing final settlement. Some EU central banks hold the view that they should encourage interbank co-operation in order to increase the efficiency of the competing systems through standardisation and the use of common infrastructures. Other central banks are of the opinion that the efficiency of retail payment systems is a matter for issuers and users of payment instruments. In any case, co-operation at the technical level, should not be used to restrict competition when setting customer conditions.

Part C: Conclusion and Follow-up to the Report

51. Multi-purpose prepaid cards schemes are still at an early stage of develooment. However. E.U central banks should not adopt a "wait and see" approach to this problem because heavy investments are likely to be made in this field, and it would be very difficult in the future to modify developments which were later found to be inappropriate. EU central banks should endeavour to be informed, if possible at in early stare of development, of any scheme being developed in their own country.

52. The most important conclusion of this report concerns the need to restrict the issuance of electronic purses to credit institutions and, by exception, to institutions covered by paragraph 32. The the analysis of the nature of the funds related to electronic purse schemes is straightforward in economic terms, it is not necessarily clear in legal terms, probably because electronic purses did not exist (and were not even envisaged), when existing banking regulations were drawn up. If necessary, EU central banks will address this problem in their own country individually, and possibly at the EU level.

53. Apart from this important policy conclusion, EU central banks feel that, at this early stage of development of prepaid cards schemes, they should remain flexible and leave technology and market forces to play their appropriate roles. They may wish, however, to satisfy themselves that the security features of proposed electronic purse schemes are adequate. If and when this new payment instrument develops, EU central banks will have to reassess its effects on the integrity of the payment system and, they may have to define new policy conclusions, including, if really necessary, that they themselves issue electronic purses. Under the aegis of the EMI, EU central banks will continue to exchange information in this field and to monitor the development of this new payment instrument.

54. Moreover, the development of multi-purpose prepaid cards is not a phenomenon limited to the EU. In a global banking market, it will be beneficial for central banks to endeavour to reach a common position on electronic purse developments on a world wide basis.

    Chairman                              Mr. T. Padoa-Schioppa
    Banque Nationale de Belgique          Mr. R. Reynders
    Danmarks Nationalbank                 Mr. J. Ovi
    Deutsche Bundesbank                   Mr. H.J. Friederich
    Banco de Espana                       Mr. J. Ariztegui
    Bank of Greece                        Mr. Foskolos
    Banque de France                      Mr. D. Bruneei
    Central Bank of lreland               Mr. P. McGowan
    Banca d'ltalia                        Mr. C. Santini
    Institut Mondetaire Luxembourgeois    Mr. P. Beck
    De Nederlandsche Bank                 Mrs H.C.J. van der Wielen
    Banco de Portugal                     Mr. A. Sequiera
    Bank of England                       Mr. B. Quinn
    European Monetary Institute           Mr. J.-M Godeffroy

John Muller is Of Counsel with the law firm of Brobeck, Phleger & Harrison LLP in San Francisco. His practice focuses on bank mergers and acquisitions, new bank powers, electronic commerce, corporate governance and general regulatory advice.

For more information on Brobeck, Phleger & Harrison LLP, please see http://www.brobeck.com .

TWO PRELIMINARY POINTS

LEGAL ISSUES

A. Can Non-banks Issue Electronic Money?

(1) non-banks, being less closely supervised, less familiar with developing secure payment systems, and perhaps having less stake in protecting a valuable existing reputation, may be more likely to develop an e-money product that can be counterfeited or used more than once ("double spending");

(2) non-banks may have an unfair competitive advantage over banks because they are not subject to the costs of extensive government regulation and supervision; and

(3) because non-banks do not report to the central bank, non-bank issuance of e-money creates a greater threat that the central bank will be unable to track the money supply and will lose the ability to set monetary policy.

1. United States . The emerging Federal Reserve view is that the non-bank issuance of e-money should be permitted. The cost of developing and marketing e-money products provides a strong incentive for non-banks to develop secure products. Although non-banks may have some competitive advantages, banks have corresponding advantages in their existing payment systems and merchant relationships (many merchants are unlikely to accept e-money unless they can deposit it into their bank account, and banks can control which issuers' e-money they will accept). Banks also have well-established reputations; consumers are more likely to trust e-money issued by a major local bank than by a newly-formed non-bank.

   The Fed doesn't expect e-money, whether issued by banks or nonbanks, to have a substantial impact on the Fed's ability to track the level of the money supply or to conduct monetary policy: if every person in the United States held $150 of electronic money, which is not likely any time soon, the total amount of electronic money would be less than 10% of U.S. currency currently in circulation. If non-banks become significant issuers of e-money, the Fed will seek to establish a voluntary reporting system, similar to the system in place today under which non-bank issuers of travelers' checks report on the amount of travelers' checks in circulation (which is a component of the M1 monetary aggregate). The Fed will monitor developments closely to ensure that non-bank involvement in e-money issuance does not create unanticipated problems. See:

   http://www.bog.frb.fed.us/BOARDDOCS/SPEECHES/19960618.htm

   http://www.ny.frb.org/pihome/news/speeches/sp961008.html

2. Europe . The European Monetary Institute Working Group on EU Payment Systems in 1994 recommended that only credit institutions or companies supervised by the regulatory body which supervises credit institutions should be permitted to issue e-money. Recent speeches by German and Dutch central bank officials reiterate this conclusion. See:

   http://www.systemics.com/docs/papers/EU_prepaid_cards.html

   http://www.systemics.com/docs/papers/EU_perspective.html

   http://ourworld.compuserve.com/homepages/ckuner/meister.html

3. U.S. Banking Industry Efforts . In 1995, the American Bankers Association Payments System Task Force issued a report concluding that only depository institutions should have direct access to the existing payment system (see http://www.aba.com/payment.htm for the executive summary of the Task Force report). This conclusion does not mean that non-banks could not issue electronic money, only that a non-bank issuer would have to use a bank or banks to settle transactions through the existing payment systems. The ABA has recently changed the Payments System Task Force into an ongoing Payments System Steering Committee.

   The Bankers Roundtable has formed a Banking Industry Technology Secretariat (BITS) to address cyberbanking issues. BITS has recently issued a Request for Information with respect to the potential design, development and implementation of real-time payment systems for electronic transactions. See:

   http://www.bankersround.org/public/phot.html

B. Does the Receipt of Funds from a Consumer by an Electronic Money Issuer Create a "Deposit?"

1. Non-banks . For non-banks, the importance of the "deposit" issue arises not because of deposit insurance (non-banks are not eligible for FDIC deposit insurance² ) but because deposit treatment would give federal and state regulators a legal "hook" to prevent non-banks from issuing electronic money if the regulators were so inclined. The Glass-Steagall Act provides that an entity may not engage "in the business of receiving deposits subject to ... repayment upon presentation of a pass book, certificate of deposit or other evidence of debt, or upon request of the depositor" unless the entity is incorporated in the U.S., permitted to engage in such business by the jurisdiction where the business is carried on, subject to examination by the banking authority of such jurisdiction, and publishes periodic reports of condition. 12 U.S.C. §378(a)(2). U.S. v. Jenkins, 943 F.2d 167 (2nd Cir. 1991), suggests that this statute is applicable only to individuals or entities that purport to be a bank or representatives of a bank.

   Many states have comparable laws. California law: "no person which has not received a certificate ... authorizing it to engage in the banking business shall solicit or receive deposits, issue certificates of deposit with or without provision for interest, make payments on check, or transact business in the way or manner of a commercial bank or trust company." Cal. Financial Code §3390.

   A conclusion that the funds a non-bank e-money issuer takes in from its customers in exchange for electronic value are "deposits" would also subject the non-bank to Federal Trade Commission ("FTC") jurisdiction. If the FTC determines that a non-bank is engaged in the business of receiving deposits and could reasonably be mistaken for a depository institution by the entity's customers, the non-bank may not use the mails or other forms of interstate commerce to receive or facilitate receiving deposits unless the non-bank's state supervisor has determined that the institution would be eligible for FDIC insurance if it were a bank. 12 U.S.C.A. §1831t(e).

   In addition, if non-banks both accept "deposits" that can be withdrawn by check or similar means for payment to third parties and make commercial loans, they will be treated as banks for purposes of the Bank Holding Company Act, subjecting their parent companies to signficant activities restrictions and Fed supervision. 12 U.S.C.A. §1841(c)(1).

   The existence of these laws restricting non-bank acceptance of "deposits" has not kept non-banks from taking in consumer funds in return for transmitting money or issuing travelers' checks or money orders; federal and state regulators have viewed these activities as not involving any deposit. These activities, however, are regulated by the states (see Part E below). Similar state level regulation may be the price for non-banks that wish to issue electronic money.

2. Banks . For electronic money systems which limit the amount of value that can be stored to a fairly small amount (limits often mentioned for stored value cards are $100 and $300), deposit insurance is unlikely to offer any competitive advantage over non-insured products. In other words, consumers are likely to be more concerned about the security of the system, privacy of their information, and widespread acceptance by merchants than whether the bank holding their funds will remain solvent. Deposit insurance would carry the potential burden of deposit insurance premiums (currently zero for most banks). Nonetheless, if deposit insurance is a desirable feature, the FDIC has published a legal opinion by its General Counsel indicating how a stored value card system can be structured to meet the statutory definition of "deposit" and therefore be covered by federal deposit insurance. See:

   http://www. fdic.gov/consumer/svc/storedvc.html

   The FDIC General Counsel's opinion divides stored value cards into four separate categories: Bank Primary-Customer Account Systems (funds remain in the customer's bank account until the electronic value is transferred to a merchant or other payee), Bank Primary-Reserve Systems (when value is downloaded onto the customer's card, funds are transferred from the customer's account to a reserve or general liability account held at the institution to pay merchants and other payees); Bank Secondary-Advance Systems (the issuer of the card is a third party, which provides electronic value to banks to make available to their customers; the customers then pay the third party for the stored value out of their bank accounts); and Bank Secondary-Pre-Acquisition Systems (the issuer of the card is a third party; banks pay the third party for the electronic value and subsequently resell that value to bank customers).

   The opinion concludes that:

   1. funds underlying Bank Primary-Customer Account Systems are "deposits" of the customer;

   2. funds held by a bank in Bank Secondary-Advance Systems for the (presumably brief) period prior to their transfer to the issuer are "deposits" of the issuer; and

   3. funds underlying the other two types of systems are not deposits under the statutory definition.

   The opinion also states that the FDIC expects that institutions will clearly disclose to their customers the insured or non-insured status of their stored value products.

   The FDIC also has regulatory authority to treat bank obligations relating to stored value cards and other electronic payment systems as deposits even if such obligations do not fall within the statutory definition of "deposit." The FDIC held public hearings on September 12 and 13, 1996 to take comments on deposit insurance issues related to electronic payment systems. See:

   http://www.fdic. gov/publish/valucard.html

3. Hybrid Institutions: Non-insured Banks. U.S. federal banking law also creates the possibility that an institution can be both a bank and not insured by the FDIC. Such an institution must be authorized by state law. However, following the failure of Maryland and Ohio state deposit insurance funds in the 1980s, many states changed their laws to require that all banks be FDIC-insured. Therefore, it is not clear whether any state today would charter a non FDIC-insured bank to issue e-money.

   If such an institution does come into being, it must receive written acknowledgement from its depositors that they understand the institution is not federally insured and, if it fails, the government will not guarantee the return of the depositors' money. The institution must also include the same disclosure in all of its advertisements and on every instrument evidencing a deposit. 12 U.S.C.A. §1831t(b).

C. For Banks, is Participation in the Issuance of Electronic Money a Permissible Banking Activity?

1. National Banks . The Office of the Comptroller of the Currency ("OCC"), rather than the Fed, has jurisdiction over the powers of national banks; the Fed's jurisdiction extends only to bank holding companies and their non-bank subsidiaries. The OCC has approved national bank participation in Mondex USA: "national banks may under 12 U.S.C. §24 (Seventh) engage in the business of developing and operating a stored value system". See:

   http://www.occ.treas.gov/interp/nov/conda220.htm

   According to the OCC approval, Mondex USA will operate through two limited liability companies ("LLCs"), which will be respectively the issuer of electronic value and the servicer of the Mondex USA system. The LLCs will be owned by a group of four national banks and three non-banks. See:

   http://www.mondexusa.com

   The OCC's approval is subject to several conditions, including:

   (a) the performance of services by the LLCs for national banks, including sale and redemption of stored value, will be subject to OCC regulation, supervision and examination;

   (b) the LLCs must stipulate that they are "institution affiliated parties" with respect to their national bank investors, giving the OCC enforcement jurisdiction; and

   (c) the LLCs must obtain OCC approval of any material changes to the LLC Operating Agreements.

2. Bank Holding Companies . The Federal Reserve Board has not yet squarely addressed whether the issuance of electronic money is sufficiently "closely related to banking" as to be a permissible activity for bank holding companies and their non-bank subsidiaries. However, related approvals indicate that the Fed is likely to find that the issuance of electronic money is a permissible activity. The Fed has authorized bank holding company-owned ATM networks to provide services for the operation of stored value card systems. See Banc One Corporation et al., 79 Fed. Res. Bull. 1158 (Dec. 1993) (MAC network); The Bank of New  York Company, Inc. et al., 80 Fed. Res. Bull. 1107 (Dec. 1994) (NYCE network). In addition, the Fed has determined that the issuance and sale of travelers' checks, money orders and similar consumer-type payment instruments, and the transmission of money both inside the U.S. and abroad, are closely related to banking. 62 Fed. Reg. 9338 (February 28, 1997) (to be codified at 12 C.F.R. §225.28(b)(13); 81 Fed. Res. Bull. 1130 (1995).

3. Safety and Soundness Issues . The OCC and FDIC have described the safety and soundness concerns they will expect banks to address before commencing operation of,or participation in, an electronic money payment system. See:

   http://www.occ.treas.gov/ftp/bulletin/96-48.txt

   http://www.fdic.gov/elecbank.pdf

   The OCC Bulletin analyzes safety and soundness issues by identifying the various functions that banks may perform with respect to a stored value card system: investment in a company operating a stored value system, issuance of stored value, distribution of stored value cards for third party issuers, transaction authorization for systems that involve authorization prior to merchant acceptance, redemption of stored value held by merchants and consumers, clearing and settling, and transaction archiving. Banks must understand the different risks associated with each of these roles, as well as the need to ensure consumer understanding of the product.

   The OCC suggests several specific items which banks should disclose to their stored value card customers: the identity of the issuer/obligor of the stored value, how to use the card, how and where the customer can load value on the card, whether the stored value earns interest or any kind of return, where it can be redeemed, any fees imposed on the customer, protection for lost or stolen cards, the availability of FDIC insurance, whether and under what circumstances information on transactions may be available to third parties, who is liable for transactions that are not completed properly, what happens to stored value that is not used for lengthy periods, and what dispute resolution mechanisms are available.

   The FDIC examination procedures identify six specific areas of concern: planning and deployment (has senior management been involved in making decisions, and have cost and strategic implications been thoroughly considered), operating policies and procedures, auditability, legal risk (e.g., risk of unenforceability of electronic contracts, uncertainty regarding liability for errors, uncertainty regarding which jurisdictions may seek to regulate electronic transactions), administration and system operations (is the bank's security adequate? is the bank prepared to administer multiple standards and protocols?) and outsourcing (can the bank adequately monitor and control vendor performance?).

D. For Banks, Are Accounts that Hold Funds out of Which Electronic Money is Redeemed Subject to Reserve Requirements?

1. Non-banks are not subject to reserve requirements.

2. The bank accounts subject to reserve requirements are "transaction accounts" and "nonpersonal time deposits" (the reserve percentage for nonpersonal time deposits is currently zero).

3. The term "transaction account" is defined to include, among other items, any account (other than a savings deposit) from which the account holder may make third party payments at an ATM, remote service unit or other electronic device. 12 C.F.R. §204.2(e).

4. The definition of "savings deposit" creates opportunities for banks to structure accounts with third-party payment features that avoid reserve requirements. The definition includes accounts in which the bank reserves the right to require at least seven days' advance notice of withdrawals, and accounts from which the depositor can make up to six transfers and withdrawals (no more than three third-party payments) per statement cycle. 12 C.F.R. §204.2(d).

   Numerous banks have also instituted arrangements which regularly sweep funds from a transaction account into a money market account that qualifies as a savings deposit. The Fed is "monitoring closely" the effect of such arrangements in lowering system-wide reserves and thereby influencing the implementation of monetary policy. 61 Fed. Reg. 69023 (Dec. 31, 1996).

   The Fed, or at least some Fed staffers, are also beginning to consider a future in which monetary policy is conducted through means other than the manipulation of bank reserves maintained at the Fed. See

E. For Non-bank Issuers, will States Attempt to Regulate Using Money Transmitter or Travelers' Check Statutes?

1. Almost all of the states require licensing of non-bank transmitters of money (e.g., Western Union) and issuers of travelers' checks. See, e.g., California Financial Code §§1800-1827, §§1853-1894.

2. Intentional operation of a money transmitting business without a license in a state where such a license is required is a federal crime. Money transmitting includes "transferring funds on behalf of the public by any and all means. . ." 18 U.S.C. §960. Section 407 of the Money Laundering Suppression Act of 1994 directs the Treasury Department to study the progress of the states in enacting a model statute for regulation of money transmitters, and report to the Congress by September 1997.

3. Money transmitter/traveler check statutes generally impose capitalization and reserve requirements much higher than bank requirements, designed to ensure that the issuer has sufficient funds on hand to make good on its commitments. If applicable to e-money issuers, these statutes may limit the use of funds received by the issuer in payment for the stored value and/or the ability of non-bank issuers to lend of electronic value.

4. Money transmitters, whether or not they are required to be licensed in the state(s) where they operate, are required to register with the Treasury Department. 31 U.S.C.A. §5330. Money transmitters and issuers of travelers' checks, money orders or similar instruments are subject to the Bank Secrecy Act and required to file reports on transactions of $10,0000 or more. Id. §§5311-5313.

F. ConsumerProtection Issues

1. Regulation E - Congressional Action . Regulation E, which implements the Electronic Fund Transfer Act ("EFTA"), includes restrictions on unsolicited issuance of access devices to consumers, and requirements relating to initial disclosures, advance notice of change in terms, transaction receipts and periodic statements, limitations on consumer liability and error resolution procedures. As a result of controversy over the Fed's proposal regarding the applicability of Regulation E to stored value card systems (see below), Congress has directed the Fed to study whether the Electronic Fund Transfer Act can be applied to stored value products without adversely impacting the cost, development and operation of such products, and whether alternatives to regulation could more efficiently achieve the objectives embodied in that Act. The Fed may not finalize any amendments to Regulation E that would regulate stored value products until the later of (a) three months after the study is submitted to Congress, or (b) June 30, 1997. Pub. L. 104-208, §2601, 110 Stat. 3009.

2. Regulation E - Fed Proposal . On May 2, 1996, the Fed published proposed revisions to Regulation E which would address stored-value card systems by classifying them as either:
   • "on-line" (as with a debit card, transactions by a card holder to use the value associated with the card are authorized through communication with a central data facility, which debits an account held at the card issuer; balance information is not recorded on the card itself but only at the data facility);

   • "off-line accountable" (balances are recorded on the card itself and individual cardholder transactions are not required to be pre-authorized, but data on each transaction is stored and periodically transmitted to a central data facility, so that transactions are traceable to the particular card); or

   • "off-line unaccountable" (transactions are not pre-authorized, and are not traceable to a particular card; the record of the value remaining on the card is maintained only on the card itself).

   Under the Fed's proposal, in all three systems, a transaction in which a stored-value card is "loaded" with value by accessing a consumer's deposit account will be subject to Regulation E and its transaction receipt and dispute resolution requirements. As to transactions in which the value on a card is used to make a payment, however, off-line unaccountable systems would be exempted completely from Regulation E, and off-line accountable and on-line systems would be exempted completely if the maximum value that can be stored is $100 or less. If the maximum value is not limited to $100, off-line accountable systems would be subject only to the Regulation E requirements on initial disclosures, while on-line systems would be subject to all requirements of Regulation E other than periodic statements (as long as an account balance and account history is available on request) and the requirement of advance notice of changes in terms.

   The Fed proposal recognizes that banks and others are developing systems for computer network payment products that operate in a manner similar to stored value cards, i.e., a customer transfers value from the customer's bank account to the network payment product, and then uses that product to purchase goods or services. The Fed has not made any specific proposal, but requested comment on the extent to which the Board should address the applicability of Regulation E to network payment products. 61 Fed. Reg. 19696 (May 2, 1996).

3. Privacy

   Privacy of information is shaping up as perhaps the major item for the widespread consumer acceptance of new electronic money systems. Principal areas to watch:

   (a) the battle between consumer/privacy advocates and retail/direct marketing groups over the conditions under which information about consumers and their transactions can be disclosed; and

   (b) the battle between privacy/commerce advocates and law enforcement over the widespread availability of strong cryptography and the ability to conduct transactions anonymously or pseudonymously. For (a), see:

   http://www.ftc.gov/bcp/conline/pubs/privacy/privacy1.htm

   http://www.ntia.doc.gov/ntiahome/privwhitepaper.html

   For (b), see:

   http://www.jya.com/crypto.htm

   http://www.epic.org

   http://www.treas.gov/treasury/bureaus/fincen

4. Matching Consumer Expectations

   With a number of competing e-money products available, likely the most important element in addressing consumer issues will be communicating clearly the features of the product, against the backdrop of consumers' knowledge of how existing payment systems work, and then ensuring that the product actually works as described. The key issues to be addressed, in addition to privacy, are (a) the identity of the obligor, (b) limits on consumer liability for unauthorized transactions (and on the corresponding payee side, the ability of merchants to obtain comfort that payments will not "bounce" and transactions cannot be repudiated), and (c) the effect of lost value (lost cards or unretrievable information on the consumer's hard drive). See:

   http://www.house.gov/banking_democrats/consumers.html

   http://www.house.gov/castle/banking/brown3.htm

   http://www.oecd.org/daf/ccp/cons/index.htm (OECD Committee on Consumer Policy)

5. Advertising

   As a corollary to #4 above, e-money issuers must take care to avoid inflated claims for their product. Are stored value cards and Internet payment products today as good as cash, given limited acceptance by merchants and limited ability to conduct anonymous transactions? The FDIC and Fed have already informally indicated that e-money issuers should not refer to their products as cash.

G. Commercial Law Issues

The issuance of electronic money will raise numerous commercial law issues of the type that are already settled for checks, Automated Clearing House transactions and wire transfers by the Uniform Commercial Code, Federal Reserve circulars and clearing house rules. Among such issues are when payments become final, liability for authorized payments completed improperly and the ability to pledge electronic value as collateral for a debt. The American Bar Association Section of Business Law has convened a Task Force whose report, A Commercial Lawyer's Take on the Electronic Purse, will be published in the February 1997 Business Lawyer.

Another important element in establishing the commercial viability of electronic commerce and electronic money is the development of rules of contract law and evidence regarding the validity of electronic contracts. In turn, the desire to establish methods for ensuring that electronic signatures are valid and cannot be repudiated creates a need in commerce for "trusted third parties" to verify the link between a person and his or her electronic signature. Because banks are already in the business of marketing their trustworthiness, banks are natural candidates to act as trusted third parties, e.g., as certificate authorities to tie a user to his/her public key in systems that use public key cryptography. For information regarding ongoing efforts to establish the validity of electronic contracts, state digital signature laws and the role of trusted third parties, see: