Don't Expand Uninsured Banking — End It

Recent images highlight a dramatic contrast: Michael Corbat of Citi wears a suit and tie, representing hardcore banking—allegedly detested by tens of millions of consumers. Dan Schulman of American Express wears a collarless brown shirt to tout the new Bluebird card. That's "shadow banking," an alternative for what they call the "unhappily banked." People who'll open checking accounts at Walmart.

Of course, appearances aren't everything. There are more substantive differences. Unlike Corbat, Schulman doesn't deliver federal deposit insurance. He defends this, incredibly, as vindicating freedom of choice for Walmart customers!

Carry that a step further. To provide even lower "discount prices," should Walmart rent decaying buildings that don't satisfy local fire laws and building codes—and offer still better deals to consumers? And why should Walmart have to honor the national minimum wage law, any more than Amex honors state banking statutes? With Bluebird, Amex can already violate both the Bank Holding Company Act and many state banking statues.

Schulman says that for Bluebird, Amex has to "set the customers' money aside" somewhere. Like MF Global did?

Or, maybe Amex, unlike Citigroup or Bank of America, just can't run out of money. After all, it can print money (travelers checks). 

Perhaps Amex is one of those nonbank SIFI's conjured up with the Dodd-Frank genie. If so, some council or other should restrain Amex from offering checking accounts (aka "Bluebird") — before they are too numerous to roll back.

Then we have the self-appointed "consumerists" who demand that Congress require federal deposit insurance for prepaid cards. Consider: checking accounts have never been required by federal law to carry this insurance. State-chartered credit unions that are not federally insured can and do offer checking accounts. "Prepaid cards" have converged at warp speed to become functionally indistinguishable from checking accounts, to the point where Amex plans to offer paper checks for Bluebird cardholders beginning early next year. It doesn't make a bit of sense to require the insurance just for prepaid cards.

Schulman irrelevantly asserts that Amex has state money-transmitter licenses. These in no way authorize it to offer checking accounts—or prepaid cards. State laws reserve for chartered institutions such as banks the power to offer demand deposit accounts – in the case of the New York Banking Law, Article 3, Section 131, limiting the power of "receiving deposits." (A spokeswoman for Amex says, "We are confident that we are complying with all state and federal laws and regulations.")

What's the difference between travelers checks and checking accounts, or the deposits that only chartered institutions may receive per state laws?

A demand deposit account, unlike the travelers checks that Amex has sold "for over 100 years," is not a negotiable instrument. Demand deposits don't have a fixed denomination. They are intangibles and are not sold. They enable the owner to order payment in any amount from his own funds, or to add to them by additional deposits. Unlike travelers checks, checking account checks are obligations of the consumer rather than the institution. 

These fundamental differences have persisted for over 100 years, despite changes in regulation and technology. Nonbank money transmitters cannot legally provide banking services. If they're sensible, they don't try.

Confounding these two categories should result in subjecting travelers checks to banking regulation rather than allowing nonbanks to offer checking accounts. Or, just as we no longer have "banks of issue" that can print money and lend it or sell it at a discount, eliminate travelers checks—very little different, and way past their "sell by" date.

The more fundamental question is whether to continue to allow states to authorize and maintain uninsured banks. No. Banking powers, including the power to offer deposit accounts, should be reserved to institutions protected by federal deposit insurance and therefore subject to approval, regulation, examination and closure by a federal authority. Do this not to protect banks, or even consumers, but to protect our financial system. Otherwise we might have an unregulated Facebook or Google of payments, even PayPal, quickly becoming both highly vulnerable and TBTF. (It could actually be run by someone wearing a hoodie, without tie or even white shirt!)

Protecting against this will require federal legislation, which will affect few existing financial service vendors. It won't affect Amex, because what Amex is doing is already prohibited and can't continue. Our present banking institutions may or may not become obsolete. Neither demand deposits nor the need to regulate their providers will become obsolete.

I thank Amex and Walmart for bringing this issue into the crosshairs.

Andrew Kahr is a principal in Credit Builders LLC, a financial product development company, and was the founding chief executive of First Deposit, later known as Providian.