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If there’s a lesson that FinTechs must learn from Silicon Valley Bank’s (SVB) collapse, it’s the need to diversify their banking partners to include electronic money institutions (EMI), says Anthony Oduu, co-founder and CTO at business-to-business (B2B) cross-border payments provider Verto.
According to Oduu, unlike FDIC-insured financial institutions (FIs) that can use clients’ deposits to generate revenue, thereby exposing clients to the possible loss of funds in the case of an insolvency, EMIs like Verto have a mandate to protect customer funds — a method known as “safeguarding.”
As a result, customer funds are kept separate from the institution’s, and EMIs are only permitted to access those funds when executing clients’ instructions regarding a payment service or the issuance of e-money.
“Safeguarding is a mandate within the license that prevents EMIs from touching a client’s funds until we are instructed to do so,” Oduu told PYMNTS in an interview, adding that funds are held in a safeguarding account that an EMI establishes with a partner bank.
Moreover, there is no limit as to how much can be recovered in the case of a financial crisis — a key benefit that Oduu said would have given SVB customers, many of whom had millions deposited in their accounts, a huge reprieve.
In fact, in the wake of SVB’s collapse, U.S. customers with deposits at SVB couldn’t count on recovering more than $250,000, the maximum covered by Federal Deposit Insurance Corp. (FDIC) insurance.
And in the U.K. where The Bank of England put SVB UK in its insolvency procedure before selling the subsidiary to HSBC, eligible depositors could recover much less from the country’s Financial Services Compensation Scheme (FSCS) — up to £85,000 (about $102,600) per firm or up to £170,000 (about $205,000) for joint accounts.
With safeguarding, however, those limits are removed. “Unlike the FDIC and the FSCS, which are insurance solutions, there’s no limit as to how much can be reimbursed with a safeguarding account,” Oduu pointed out.
Diversifying Banking Partners
According to Oduu, “safeguarding” is not a solution EMIs are pioneering today. In fact, several startups and FinTech unicorns in Africa use it as a strategy to mitigate risk, including to manage foreign exchange (FX) volatility.
For example, a U.S.-based startup that needs to make monthly payments to employees, vendors and suppliers in 20 different currencies can hedge against FX volatility by leaving funds in their fundable account from which they can make those payments at the end of the month. “Not only are we segregating funds in U.S. dollars, we also segregate funds in every currency that the client uses Verto for,” he noted.
But Oduu acknowledged that there is a general lack of awareness about “safeguarding,” especially among small tech firms which have been conditioned by default to rely on traditional banks to manage their funds.
“The idea that a Fintech can manage your funds for you is not something that is well informed in the community of tech founders,” Oduu remarked, adding that that lack of information is why some founders will deposit millions of dollars in a high street bank even if they’ll only get $250,000 reimbursed.
So, what is the best practice moving forward? Oduu said firms should have multiple bank accounts to make the most of the $250,000 insurance the FDIC offers. And one of those accounts should be with an EMI-licensed FinTech like Verto, which is where firms should keep at least six-months’ worth of operational money to cover payroll and vendor payments should anything happen to the FIs they bank with.
As Oduu said, “You cannot rely on one bank because the fact that they have the right to use your money to make money creates a lot of risk. And even if they increase the FDIC limit to $2 million or $10 million, you’ll always have that risk of your money getting lost if something happens to that bank.”
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