Markets Wired

I. Introduction

Good afternoon and thank you to the Federal Reserve Bank of Chicago for hosting this event and inviting me to speak.  Two years ago, Treasury published a report called The Future of Money and Payments in light of the changing landscape of money and payments.^[i]  Since then, we have continued to evaluate the potential benefits and risks of new technologies, both fast payment systems and tokenization, and new use cases, including cross-border payments initiatives.^[ii]  Today, I would like to focus on another aspect of the report – the recommendation to develop a federal regulatory framework for domestic payments.

In the past few years, we have seen rapid growth in digital payments and development of new payments infrastructure.  We have also seen growth in electronic money, or e-money, by nonbank payment service providers.  Relative to a payment app, e-money issuers may also hold customer balances outside of the traditional system of regulated banks and the central bank.  But an essential and necessary quality of money is trust in its value.  As I will explain, our current state-based regulatory framework has not kept pace with the growth in new kinds of money and payments, raising risks for the integrity of the payment systems and trust in money.  The state-level framework with varying requirements also raises barriers to entry, limiting competition and innovation.  

I will then propose the key foundational elements, including financial resources, risk management, and activities restrictions, that are needed in a modern regulatory framework for nonbank payment service providers, principally for issuers of e-money.  This framework builds on existing rules at the federal level for anti-money laundering and countering the financing of terrorism (or AML/CFT) and for consumer protection.  Of course, setting guidelines and regulations requires the consideration of many factors.  My hope today is to invite a broader discussion.  Through this discussion, we can work towards building a more comprehensive, consistent, and calibrated framework for regulating payments in the United States.

II. What’s changing?

Changes in payments are happening along several dimensions.

First, consumers are increasingly choosing to make payments electronically rather than with cash.^[iii]  This trend predates the COVID-19 pandemic but accelerated during the pandemic as consumers looked for more contactless means of payment.  In the United States, the share of cash payments fell from 31 percent to 16 percent between 2017 and 2023, while the share of payments with credit and debit cards rose from 49 percent to 62 percent.^[iv]  For payments made between individuals, the decline in the use of cash over this same period is more stark, falling from 75 percent to 42 percent, and the use of payment apps rose from 12 percent to 50 percent.^[v]  Relatedly, we are also seeing changes in the types of companies that offer payment services.  For example, nonbank payment service providers that offer user-friendly peer-to-peer payment apps have grown quickly in recent years. 

Second, the infrastructure for payments is advancing and raising the potential for a faster and more efficient payments system.  Adoption of real-time payment systems like FedNow and RTP in the U.S. is increasing, though still relatively limited.  Globally, 119 jurisdictions now have real-time payment systems, and some have seen widespread adoption.^[vi]  At the same time, tokenization based on distributed ledger technologies has emerged as a more ambitious and potentially more transformative alternative to legacy payment systems.  Broadly speaking, these projects aim to reduce frictions and delay in payment and settlement in legacy systems by storing information more centrally, such as on a shared ledger.  A wide range of tokenization projects are being pursued by both the public and private sector, including some joint efforts.^[vii] 

Third, new kinds of private money or money-like instruments are growing.  By “money,” I mean instruments that are designed to have a stable value and can be used for exchange.  In the U.S., like in most countries, money can be either public, like a Federal Reserve note, or privately issued, like a commercial bank deposit.  Funds held at nonbank payment service providers and stablecoins also serve some of the functions of money.  Like deposits, these balances are claims on the nonbank payment service provider represented in dollars, though not backed by the promise of one-to-one conversion to public money.^[viii]  I’ll refer to these nonbank payment service providers as “e-money issuers,” which, as I mentioned earlier, have been growing rapidly.^[ix] 

Relatedly, we have also seen growth in payment apps offered by nonbank firms.  Some may rely on bank partners or are linked to credit cards, but others may offer the ability to hold e-money balances.  Adoption of payment apps – including Venmo, Apple Pay, Google Pay, or CashApp – now rivals adoption of credit cards.  Today, more than three-quarters of U.S. adults have used a payment app.^[x]  While we know that customers are holding balances in e-money, we have relatively little insight into how much e-money is issued in aggregate or how long customers hold balances.^[xi]  We do know that consumers, particularly younger consumers, are increasingly turning to nonbank payment apps and fintechs as their primary banking service.^[xii]

Stablecoins are another new money-like instrument.  Like other forms of private money, a stablecoin typically claims it can be redeemed 1 for 1 in U.S. dollars.^[xiii]  Today, stablecoins are used mostly for payments and trading within the crypto ecosystem, but some proponents believe that stablecoins could become used more widely to pay for real goods and services, such as in situations where people may lack access to other stable assets.  There is some evidence that this is already happening.^[xiv]  Stablecoins have also grown rapidly in the last five years, and now have a market capitalization of $172 billion.^[xv]  And because stablecoins serve as a money substitute in some markets, including increasingly by illicit actors, this market capitalization supports a much larger transaction volume.  Some estimate that Tether supports $190 billion of transaction volume daily.^[xvi]

These changes to how we make payments may offer significant efficiency gains, advance financial equity, and even facilitate new kinds of transactions.^[xvii]  However, they may also present some risks if not appropriately managed, including risks to consumers and financial stability.  

I will turn next to the existing regulatory framework for certain intermediaries in payments – specifically, issuers of e-money – to make the case for a modernized federal framework.  

 

III. The Case for a Federal Payments Regulatory Framework

In the United States, banks are the dominant intermediaries that both issue money and make payments.  They are subject to a comprehensive prudential regulatory framework at the federal level, which reflects that banks also hold longer-term loans and securities, and have direct access to the Fed’s payment rails and federal backstops.^[xviii]

Other intermediaries, like e-money issuers, are overseen primarily at the state level as money transmitters.  The regulatory framework for money transmitters was developed for retail customers to send physical cash, often to family in a different state or country.  Money transmitters with this business model hold customer funds only for the short time period required to send them.  This meant that the customer’s exposure to the money transmitter was limited.  It also meant that money transmitters were prevented from engaging in significant maturity transformation. 

The current regulatory framework for e-money issuers reflects this limited business model.  First, money transmitters are subject to minimum net worth or surety bond requirements, but these financial requirements are generally not tied to the riskiness of their assets.  This means that an e-money issuer that processed 25 billion transactions in 2023 could meet minimum financial requirements with retained earnings of six one thousandths of one percent of its total assets.^[xix]  Money transmitters also may be subject to limits on what they can invest customer funds in.  These investment limits are what maintains 1 for 1 value with the dollar.  But even the most stringent of these requirements permit a relatively wide range of assets.^[xx] 

Second, the requirements vary widely between states.  Some states do not require any minimum financial resources.  Some place a cap on financial resources.^[xxi]  Some states limit investments to only certain kinds of assets.  Others place no restrictions on permissible investments.

Third, and partly as a result of the current state-based regulatory and supervisory framework, e-money issuers do not have direct access to federal payment rails like FedACH or FedNow.^[xxii]

The result is a growing segment of payments that has duplicative and overlapping regulations, but that doesn’t address important risks.  E-money issuers must navigate dozens of state-level licenses with varying requirements, increasing compliance costs and raising barriers to entry.  But there are some types of risks that are difficult for a state regulator to address because they originate outside that state’s borders, create stress in other parts of the financial system, or require coordinated intervention in crisis.  Our conversations with stakeholders highlight both kinds of concerns.  The existing regulatory patchwork is burdensome and inefficient, and at the same time does not adequately address risks to consumers and the financial system or promote competition and innovation by facilitating access to real-time payment systems.

Recognizing these concerns, state regulators have taken steps to improve coordination in supervision and consistency in regulatory requirements.  In 2021, the Conference of State Bank Supervisors released a revised model law after a two-year consultation process.^[xxiii]  Today, about half of states have adopted at least some part of the model law.  States also have recently begun coordinated multi-state exams.  But there are practical challenges to establishing the same standards in every state and limits as to how well those standards can address risks of business models that extend well beyond state borders.  

Goals and Key Elements

A federal framework for nonbank payment service providers may be better able to address these concerns.  Specifically, a federal framework can:

1.  Address risks which are essential to confidence in the money and payments system, like customer runs, payments disruptions, and financial stability risks.  It should better support a degree of confidence in nonbank money instruments.  This would include consistent reserve requirements and being able to intervene immediately in a crisis to ensure trust and continuity of services.  Coordinating an intervention for a nation-wide or global company across dozens of state regulators would not be possible in time.

2.  Promote innovation and fair competition that benefits consumers through a consistent and comprehensive, though calibrated, regulatory framework for bank and nonbank payments providers.  It is not the case today that the same activities and the same risks have the same regulatory requirements.  The introduction of a federal prudential regulatory framework for payments also raises the possibility that e-money issuers could get direct access to some public payment rails, like FedNow.^[xxiv]  Direct access would promote competition and innovation for payment services. 

3.  Support leadership of U.S. financial firms globally.  A clear, robust framework for domestic payments promotes a level playing field internationally.

With these important benefits in mind – trust in money and payments, innovation and competition, and global financial leadership – I will turn next to the key foundational elements of a federal framework and raise some topics for further discussion.  These elements also are consistent with our broader objectives for payment systems operations, including adherence to the standards established by PFMI and FATF, strong governance, and with the approach we’ve suggested for stablecoin issuers.^[xxv]  These elements complement other standards that already exist at the Federal level, like AML/CFT and consumer protection requirements, so I won’t discuss those.^[xxvi] 

I will discuss standards in four categories: (i) financial resources, (ii) risk management, (iii) supervision and enforcement and (iv) affiliation and activities restrictions.

1. Financial Resources.  To function as money, an e-money claim needs to be backed by high-quality and liquid assets so that a claim representing a $1 is worth $1 when redeemed.  E-money issuers also should have some minimum resources to protect against other kinds of loss and reduce the risk of insolvency.  Financial resource requirements thus serve several purposes.  First, they support trust in the value of money.  Second, financial resource requirements ensure that customers are protected if an e-money issuer becomes insolvent.  Finally, financial resource requirements mitigate risk to financial stability from customer runs, which we know can be contagious and destabilizing to the broader financial system.

   Calibrating these requirements raises important questions.  First, these requirements should reflect the products that e-money issuers do and don’t offer.  E-money issuers are not banks.  Instead, they generally offer a more limited range of payment-related services.^[xxvii]  The calibration of financial resource requirements should reflect this more limited product offering while credibly backing customer claims 1 for 1  with high-quality and liquid assets.  The calibration and composition of financial resource requirements may also have broader consequences.  To the extent that deposits flow to e-money issuers from banks, it could reduce credit provision or raise its costs.
     

2. Risk Management.  Risk management standards address a range of concerns.  I will highlight two.

   First, operational risks.  Payment systems need to be resilient and payments need to go to the right place and in the right amount.  Consistent and well-calibrated risk-management standards would help ensure that the system for making payments is accurate, operates under both high and low volumes of payments, at all times during defined operating hours, and is resilient to external threats like cyber-attacks.  This is critical for both users of the system and, potentially, for financial stability.  Failures or delays in some payments could spill over to other parts of the economy and the financial system.

   Second, third-party risk.  Making a payment involves many different intermediaries – from wallets, to banks, to processors, to tech providers and others. 

   I’ll use an example to help illustrate.  Let’s say that you want to buy a cup of coffee here in Chicago with e-money.  If you have funds stored with an e-money issuer and the coffee shop is set up with the same e-money issuer, your digital payment may settle “on the books” of the e-money issuer.  As I’ve just discussed, it is critical that this “on the books” settlement is reliable and resilient.  And, even in this simple case, the transaction may be enabled by technology provided by a third-party, like tap to pay.  Now let’s say instead that you don’t have funds stored with an e-money issuer.  In this case, your digital payment would be funded through a linked credit card or bank account, involving one or more banks, a credit card network, and potentially a mobile wallet.  It might even involve a wholesale settlement system between financial institutions. These interlinkages are usually – and should be! – seamless to the customer.  But for a payment to function smoothly, each of these nodes needs to operate as expected.

   This means that e-money issuers, like banks, must manage the risks associated with these third-party relationships.  The bankruptcy of Synapse – though not a bank or e-money issuer – illustrates the importance of managing risk in relationships among payments service providers.  And by applying a prudential regulatory framework to e-money issuers, we might also hope to facilitate bank partnerships with e-money issuers.  We may also consider whether other service providers – like some critical technology or network providers – should be subject to more supervision more directly.  This does not mean that these firms should be subject to the same kinds of standards as e-money issuers or banks.  Issuing money, as I’ve just discussed, presents special kinds of public policy considerations.  At the same time, the operational resilience of related intermediaries is critical to many payment arrangements.  
    

3. Supervision and Enforcement. A regulatory framework is only as effective as its oversight and enforcement.  A federal framework should have a federal supervisor with the authority and resources necessary to examine e-money issuers and be able to act if standards are not being met.
   
4. Activities and Affiliation.
   Payment activities. To ensure a level competitive playing field, and to better calibrate requirements for e-money issuers, the regulatory framework needs to restrict e-money issuers to payments-related activities.  To the extent they instead extend credit and engage in significant maturity transformation, they would resemble banks and should be subject to bank-like rules.
   Affiliation and separation of banking and commerce.  In addition, we may consider whether an e-money issuer’s affiliates should be subject to limitations on their activities.  In the United States, there generally are restrictions to support the separation of banking and commerce, based on competitive concerns and the potential for risks from one part of the business to spill into another.  The combination of a commercial or technology platform and payments presents some of these same themes of banking and commerce but is also distinguishable in some ways.  Some old solutions, like antitrust law or limiting the ability of a non-financial company to own or control payments provider can mitigate anti-competitive behavior.^[xxviii] And some of these requirements already apply.  Some new solutions, like interoperability standards and restrictions on use of customer data, could also be needed.

V. Conclusion

A federal payments framework that includes the key foundational standards discussed above can both simplify our domestic regulatory patchwork and make the regulatory framework more robust.  We can promote innovation and competition, while better protecting consumers, the payment system, and the financial system.  We can create a more level playing field domestically and also support U.S. global financial leadership. 

These goals and solutions I have offered for e-money issuers are similar to points that the Secretary, the President’s Working Group on Financial Markets, the Financial Stability Oversight Council, and I have made regarding a federal regulatory framework for stablecoins.^[xxix]  We have long identified stablecoins as presenting payments and run risks like those presented today by e-money issuers.  At the same time, stablecoins present some unique risks because they rely on distributed ledger technology and thus may involve a different set of intermediaries and can be transferred peer-to-peer.  We continue to support efforts in Congress to establish such a framework.  

My remarks today were informed by our conversations with many stakeholders – consumer groups, payment providers, fintechs, banks, academics, and others — with a wide range of interests.  They have been invaluable in identifying key questions to consider.  I would like to conclude with an invitation to stakeholders to continue this conversation.  

Thank you.

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_[i] U.S. Department of the Treasury, “The Future of Money and Payments: Report Pursuant to Section 4(b) of Executive Order 14067,” September 2022.

_[ii]See e.g., Remarks by Under Secretary for Domestic Finance Nellie Liang “Modernizing U.S. Money and Payments: Technological and Regulatory Considerations” at the Peterson Institute for International Economics | U.S. Department of the Treasury, April 17, 2024; Remarks by Under Secretary for International Affairs Jay Shambaugh on New Technologies and Cross-border Payments, October 17, 2023.

_[iii]Individual consumers have different preferences for and access to payment methods.  See e.g., Berhan Bayeh, Emily Cubides, and Shaun O’Brien 2024 Findings from the Diary of Consumer Payment Choice.

_[iv] Bayeh, Cubides, and O’Brien, 2024.  Measured as total share of payments.

_[v] Id.

_[vi]Frost, Jon, Priscilla Koo Wilkens, Anneke Kosse, Vatsala Shreeti and Carolina Velásquez, 2024.  “Fast Payment Systems: Design and Adoption,” BIS Quarterly Review, Bank for International Settlements, March 4, 2024.

_[vii]A notable effort is Project Agora with joint participation from seven central banks and a consortium of private financial firms to develop and test a cross-border platform for cross-border payments.  See https://www.bis.org/about/bisih/topics/fmis/agora.htm

_[viii]While these new forms of money share a key similarity with deposits and other forms of money, they are not subject to the same regulatory framework or protected by deposit insurance. 

_[ix]See Bayeh, Cubides, and O’Brien, 2024; Consumer Reports, “Peer-to-Peer Payment Services,” January 10, 2023.

_[x] Consumer Reports, “Peer-to-Peer Payment Services,” January 10, 2023.  Similarly, the Federal Reserve Bank of Atlanta’s 2023 Survey and Diary of Consumer Payment Choice found that 72% of customers adopted online or mobile payment accounts like PayPal, Zelle, Venmo and Cash App in 2023, a statistically significant increase from 2022.

_[xi] One recent survey suggested that, on average, customers held about $300 in balances.  See, Erin El Issa, “Most Americans Go Mobile With Payment Apps — Here’s How They Roll – NerdWallet,” February 26, 2020. A 2022 Consumer Report Survey indicates that one in ten consumers hold balances in their payment account.  CFPB estimates customer balances in the “billions” but notes that precise figures are not known.  Consumer Financial Protection Bureau, “Issue Spotlight: Analysis of Deposit Insurance Coverage on Funds Stored Through Payment Apps | Consumer Financial Protection Bureau (consumerfinance.gov),” June 1, 2023.

_[xii]See e.g., Ron Shevlin, The Checking Account War is Over and the Fintechs Have Won, FORBES (July 5, 2023).

_[xiii] This type of stablecoins is distinct from a smaller subset of stablecoin arrangements that use other means to attempt to stabilize the price of the instrument (sometimes referred to as “synthetic” or “algorithmic” stablecoins) or are convertible for other assets.  Because of their more widespread adoption, this discussion focuses on stablecoins that represent a claim on the issuer and can be redeemed for dollars.

_[xiv] Angus Berwick, September 10, 2024, The Shadow Dollar That’s Fueling the Financial Underworld, Wall Street Journal.

_[xv] CoinMarketCap as of October 10, 2024.

_[xvi] Angus Berwick, September 10, 2024.

_[xvii]Nellie Liang, April 17, 2023.

_[xviii] See e.g., E. Gerald Gorrigan, Are Banks Special? Annual Report of the Federal Reserve Bank of Minneapolis, December 31, 1982.

_[xix] See PayPal, Global Payment Processing | PayPal US; Dan Awrey, “Bad Money,” Cornell Law Review, February 5, 2020. Estimating that PayPal’s capital was .0006%.

_[xx] In addition, even high-quality assets can fluctuate in value and may be difficult to monetize in stress.

_[xxi] Dan Awrey, 2020.

_[xxii] 87 Fed. Reg. 51099 (August 19, 2022). A prudential regulatory framework is one consideration used by Reserve Banks in evaluating requests for accounts and services. 

_[xxiii] Conference of State Banking Supervisors, “CSBS Money Transmission Modernization Act,” April 22, 2024, available at https://www.csbs.org/csbs-money-transmission-modernization-act-mtma   

_[xxiv]87 Fed. Reg. 51099 (August 19, 2022). A prudential regulatory framework is one consideration used by Reserve Banks in evaluating requests for accounts and services. 

_[xxv] President’s Working Group on Financial Markets, the Federal Deposit Insurance Corporation, and the

Office of the Comptroller of the Currency, Report on Stablecoins (Nov. 2021).

 

_[xxvii]Restrictions on the activities of the issuer – for example, to prohibit lending activities – would ensure that this remains true.  See Activities and Affiliation discussion.

_[xxviii] For example, banks are subject to anti-tying laws and activities limitations.  See 12 U.S.C. 1972(1); 12 U.S.C. 1464(q); 12 U.S.C. 24(seventh).  Parent companies are also subject to restrictions on their activities.  See 12 U.S.C. 1841 et seq.;12 U.S.C. 1467a.

_[xxix]PWG Report on Stablecoins; Financial Stability Oversight Council, Report on Digital Asset Financial Stability Risks and Regulation, 2022.