The Consumer Financial Protection Bureau’s (CFPB) recent Consumer Alert was certainly well intentioned. Many consumers (including the authors) who hold funds in payment apps (such as Venmo and Paypal) should be made aware that the funds are usually NOT held in an FDIC-insured bank. But that doesn’t mean the funds are necessarily unprotected.
The alert states:
Unlike traditional bank and credit union accounts which have deposit insurance, funds stored in these nonbank payment companies may be unprotected.
In recent months, many Americans were reminded that funds deposited with banks and credit unions enjoy the safety afforded by federal deposit insurance through the FDIC or NCUA. Americans witnessed the failure of large systemically important banks such as Silicon Valley Bank, Signature Bank, and First Republic Bank. These banks experienced a run, but insured depositors could have confidence their money was safe. However, similar protection would not be guaranteed to customers that store money on nonbank payment apps.
The important fact omitted from the CFPB’s alert is that most non-bank payment apps like Venmo and Paypal (which are affiliates) are regulated not as FDIC-insured banks, but as state licensed money transmitters. For example, if you check the Venmo or Paypal websites, scroll down to the bottom of the page for the link to “Legal,” you will find links to the list of their state licenses. It is these licenses, not FDIC insurance, which protect consumer funds. [https://www.paypal.com/us/webapps/mpp/licenses?locale.x=en_US ].
Under these state licenses, funds are protected by requiring bonds to be posted and more importantly, by requiring each licensed money transmitter to hold reserves (often called “permissible investments”) equal to the amount of consumer funds they are holding. Unlike banks, which can take in deposits and then turn around and use the deposits to fund loans, licensed money transmitters cannot. They are required to hold those funds in cash, bank accounts or highly rated investments. That is why you hear about “runs” on banks – but you don’t hear about “runs” on licensed money transmitters.
It’s also worth noting that under FDIC General Counsel’s Opinion No. 8, many non-bank apps hold customer funds in pooled “for benefit of” (FBO) accounts at FDIC insured banks; by doing so, those customer funds can also obtain the benefit of pass-through FDIC insurance.
Like any industry, there of course could be some non-compliant companies. Consumers should check their payment app website to make sure that the company holding their funds is licensed as a money transmitter (or a similar category) in their state. If not, the consumer may want to inquire with the company to determine if there’s a legitimate reason—such as a partnership with a bank—that removes the licensing obligation. Consumers may also consider moving their funds to a bank account, and/or moving their payment app to provider that is licensed.
In our view, to suggest that all balances held in payment apps should be automatically swept into bank accounts, where fees are often higher, where payments are slower, and where the bank itself could have a “run” on deposits – – is wrong-headed.