Offshore E-money issuers and monetary policy (originally published in October 2001)

Malte Krueger

Abstract


This paper is included in the First Monday Special Issue #3: Internet banking, e-money, and Internet gift economies, published in December 2005. Special Issue editor Mark A. Fox asked authors to submit additional comments regarding their articles.
E-money four years later
In the late 1990s, there was a lively debate about the implications of the newly emerging e-money on the ability of central banks to control monetary aggregates.[1] What caught the imagination of many observers was not so much the fact that new types of money were electronic. Rather, it was the potential that new forms of money were capable to be transferred via the internet without the intervention of a traditional credit institution.
More than anything else, the trial of DigiCash in 1994 with its ‘Cyberbucks’ rang the alarm bells of monetary authorities. It had everything they feared: it was issued by a non-bank, it could be used via the internet, it was P2P capable and it was anonymous.
Against this background, a debate ensued about the merits of the new type of money and its potential to limit the power of central banks. Central banks and international bodies such as the Bank for International Settlements published a large number of reports [2] and academics scrutinised the issues involved. Finally, law makers took to the issue and e-money became subject of regulation in a number of countries. Thus, after long debates, the E-Money Directive of the European Union was passed in 2001 (it is currently reviewed).
By 2001, however, many of the early pioneers such as DigiCash, Cybercash or First Virtual had gone out of business. The whole discussion began losing steam. Moreover, the very concept of ‘e-money’ was slowly changing. Initially, e-money was meant to be a close electronic substitute for cash: a bearer instrument, capable to circulate, anonymous, etc. To some degree, this was achieved by e-purses. However, only to a degree because e-purses do not allow balances to circulate. The recipient has to return balances to financial institutions and the corresponding value will be credited to a bank account. Thus, from the point of view of the payor, e-purses have a lot in common with cash, but not from the point of view of the payee.
On the internet, nothing like the envisioned digital bearer certificates has emerged. Rather, today, what is called ‘e-money’ consists of limited purpose accounts with non-banks. In the EU these non-banks have to obtain an e-money licence. In the U.S. they may be required to hold state money transmitter licences. These accounts have much more in common with bank accounts than with cash. What drives the demand for these products is convenience of use.
Thus, in the end, the internet e-money that exists is not a new type of money at all. And the card based e-money is struggling in many parts of the world. Only recently, one of the first e-purse schemes, the Danish Danmont has been discontinued.
What are the lessons?
1. I think the approach by Alan Greenspan to take a ‘wait and see’ attitude was vindicated. Strict ex ante regulation of new concepts and products make life difficult for small start-ups and thus slows down innovation. Moreover, early regulation may be misguided because it is not known well what to regulate. Thus, the type of e-money regulators had in mind in the late 1990s (digital bearer instruments) never took off.
2. Payments exhibit strong network effects. Therefore, any new instrument that is meant to be more than just a niche product has be firmly connected with the payment backbone: the bank-based retail and wholesale payment system. Therefore, the emergence of a parallel circulation of alternative monies should not worry central bankers. Such schemes are unlikely to grow beyond the already existing scale (in form of barter schemes etc.). Technological innovations are unlikely to change this. This is the point made in my paper and I think it is still valid.
3. The early discussion was very much about technical issues. Innovators that entered the market were technology companies. However, the payment industry also is, to a considerable extent, a service industry. The early newcomers ignored this and paid the price. They all vanished from the market. Today’s successful internet payment providers are much more focussed on service than their predecessors.
4. It seems wise to let non-banks have a share of the payment market. Internet payments, for example, require a mix of technological skills and quality of service that banks may often be unable to provide.
Notes to Special Issue Update
1. Strictly speaking, the term e-money was a misnomer. It implied that traditional monies were non-electronic. But as a matter of fact, bank deposits had been electronic for many years already.
2. Between 1996 and 2001 the BIS published 5 reports on e-money. The ECB (and its predecessor the EMI) published 2 reports (1994 and 1998) and a security framework for e-money issuers (2002). The European Commission passed an E-Money Directive that came into force in 2002. In some countries law makers were much faster. Thus, the German government amended the German banking law in 1997 requiring e-money issuers to become banks.
Technically, it is conceivable that banks (or even non-banks) that are based in offshore centres can issue e-money and distribute it via the Internet all over the world. Therefore, many economists see offshore e-money issuers as a severe threat to the ability of central banks to conduct monetary policy. In this paper, it is argued that offshore issuers will denominate their e-money products in terms of existing currencies. Therefore they will be affected by monetary policy measures in the same way as onshore banks.

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DOI: http://dx.doi.org/10.5210/fm.v0i0.1513



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