EMIs vs Traditional Offshore Banks: Which one is right for your business?
What is the difference between EMIs (Electronic Money Institutions) and traditional banks? With the growth of EMIs as a viable alternative for sending and receiving electronic payments internationally, this is a question we are frequently asked here at Offshore Pro Group. Safety of funds and stability of financial insitutions are key concerns for our clients.
Some people incorrectly assume they need a bank account – when in fact an EMI might suit their needs better, by providing faster, cheaper and more efficient services. Others, however, would be better off working with a traditional onshore, offshore or private bank.
Like with most business decisions, the answer comes down to researching and understanding the options. There is no perfect solution, and sometimes you might be better off using more than one provider to cover your banking needs. This article should help you to carry out a simple cost-benefit analysis.
What is an EMI?
The European Union, which of course until recently included the UK, is certainly the leader worldwide in which non-bank payment services have developed. Why? An overriding political goal of the European Union has always been to create a free, cross-border market in which competition thrives. The logic is that just as you can have different telecom, electricity or even railway companies operating on national infrastructure, why shouldn’t newcomers or challengers be allowed access to national payment systems?
With SEPA, the Single European Payments Area, the EU has successfully developed a single market where cross border, intra-EU payments must not cost more than a local or domestic payment.
Hundreds of EMIs have been licensed across the EU in recent years and are competing successfully in this market. The largest and best known include Revolut, Wise (formerly known as TransferWise) and N26. There are also many smaller EMIs focusing on niche business. All European EMIs are granted equal access to the SEPA payment system.
Whether or not your business is located in Europe, you can take advantage of the services of European EMIs if you need to send and receive payments in the SEPA area, or even beyond. Whilst some limit their services to low risk, low margin personal accounts for European residents, others might have a completely different focus – such as higher margin, higher risk business or providing services to offshore and other non-European companies.
Outside Europe, EMIs are less developed. In the USA, for example, they typically work in conjunction with traditional banks, more like retailers of banking services that they buy in wholesale then resell.
European EMIs, meanwhile, must rely on foreign banks if they want to do business in foreign currencies. For example, a European EMI is completely free legally speaking to open accounts in US dollars or Japanese yen, but they won’t be able to use the SEPA system as those currencies are not supported in SEPA. They’ll need to rely on external providers in those countries, to gain access to SWIFT payments, that often will make their services less efficient and competitive. Whereas with the Euro currency, they usually have direct access to the Central Bank’s payment rails without needing to go through traditional banks at all.
The Main Difference Between and EMI and a Bank
With EMIs offering payment services that in many cases are better and cheaper than traditional banks, it is not always clear to all clients what is the main difference between the two.
The most important difference is that a bank is a credit institution. Traditionally banks make money by accepting deposits, paying interest, and lending the funds out again at a higher interest rate. An EMI can do none of these things. EMIs are not allowed to pay interest on deposits, and neither can they make loans. The prohibition on all credit operations also extends to things like credit cards (the traditional type that comes with a monthly spending limit) letters of credit, bank guarantees etc.
Obviously, then, if you or your business think there is any chance in future that you will need to borrow funds – whether an overdraft or corporate credit card to help cash-flow, or export financing, mortgages etc – that would be a good reason to seek to establish a relationship with a traditional bank at the earliest opportunity.
On the other hand, if all you need is an account to send and receive commercial payments, and you don’t care about receiving interest on your surplus funds, then you will likely find an EMI can open an account faster, and provide cheaper and better services – at least for your transfers in EUR. EMIs generally have sophisticated internet banking services (often better than banks) and they can issue debit cards or prepaid credit cards, as well as providing online merchant services for accepting credit cards.
What About Security of Funds?
Since EMIs are a fairly new concept, our clients naturally worry about stability and security. Wouldn’t a traditional bank be safer, they ask?
First off, we should point out that when it comes to the EU and the UK in particular, the EMI sector is very strictly regulated. In our view, there is no particular risk. Since EMIs are prohibited from loaning money, they must keep all their client funds in “safeguarding accounts” at either commercial or national banks in the EU zone. The client funds are completely separate from the company’s own funds, so in the case of insolvency or bankruptcy of the EMI, the clients’ funds are entirely separated.
That said, unlike with EU banks, there is no state guarantee scheme. In a European bank, your deposits are backed by the government up to EUR 100,000. Anything above that, you could theoretically lose if the bank fails. In the case of EMIs, the client funds are 100% segregated so the law effectively guarantees you will get everything back in the event of failure, rather than just EUR 100K. In that respect, then, one could argue that funds are better protected in EMIs than banks.
There are, however, a couple of caveats. Basically there are two main risks to keeping your funds in EMIs:
- The pass-through risk of the counterparty bank. You have no control over which banks an EMI keeps your money in. If the bank where the funds are kept collapses, a big mess could ensue. One would hope that most EMIs would be prudent enough to keep funds across several banks, but that might be difficult operationally. It’s worth pointing out that many EMIs in Lithuania, in particular, keep all their safeguarded funds at the Lithuanian National Bank. This is not technically a Central Bank (the only European Central Bank is in Frankfurt) but it is nonetheless backed by both the Lithuanian state and the ECB. Other safeguarding banks typically include big names like Barclays, ING and HSBC.
- The fraud risk. This is actually a very small risk, in our view. But it cannot be ruled out altogether. What if an EMI’s management siphon off funds by showing a different set of books to the Regulators? In practice, this would be very difficult, since auditing is dome electronically in real time. But the recent collapse of the German bank Wirecard Bank reminds us that even in the best run systems in the most reputable countries, fraud is possible. Wirecard, however, had complex offshore operations in places like Dubai and the Philippines. EMIs would never be allowed to take such risks by their European regulators.
In summary, we believe the risks of using EMIs versus banks for your payments are negligible. But remember, EMIs are not a place to park excess funds. They are strictly designed for money moving. If your volumes justify it, you could sweep funds in and out of your EMI accounts on a daily basis into a traditional bank. If you have lots of funds on deposit, it would not be smart to keep them all in one place – no matter if it’s a bank or an EMI.
Risk Management and Compliance Policies at EMIs
Understanding the compliance requirements and risk tolerance of your chosen financial institution is very important to maintaining a smooth business relationship. This applies equally to banks and EMIs. However, we mention it here because clients are often worried that their EMI accounts might be “blocked.”
Since we operate mainly with offshore, non-mainstream clients, we believe that small and boutique, with personalised service, is much better than volume business. There are banks and EMIs that specialise in low-risk, high volume retail transactions. These include the big-brand banks, and the best known EMIs like Revolut and Wise.
These banks and EMIs run compliance software that scans transactions. For example, we heard the other day about an online retailer who was selling British-made Persian rugs online. Their financial institution flagged them as potentially doing business with Iran, a sanctioned country, because of the “Persian” connection. If you get flagged in this way as a false positive, the systems generally block your account and ask questions later. These questions are, in turn, dealt with by junior staff who are often undertrained and overworked, meaning it can literally take months to resolve such a blockage. Often these under trained staff end up compounding mistakes by misunderstanding your responses, especially because they are typically working out of remote offices in low cost countries that may be culturally very different from where you grew up. Maybe they don’t even speak proper English, never mind other languages. This, unfortunately, is the level of service you can expect from big name banks these days. It is the reason that we rarely recommend them.
Compare that to working with a small, specialist EMI (or an offshore private bank). They will typically have only a few hundred or a few thousand clients, and they know them personally. You as a client will get to know the people there, so they will have a clear understanding of your business. If there is any transaction you think may raise flags, you can call them in advance and discuss the best way to handle it. This open communication means that problems rarely occur – and if they do, they can be quickly and easily resolved. For us, in the offshore business “small is beautiful” when it comes to both offshore banks and EMIs.
We hope this article has given you some better understanding of the risks involved in EMIs and bank accounts. Don’t hesitate to contact us to set up a personal consultation in your individual circumstances, so we can recommend you to the best banks and EMIs, in Europe, the Caribbean and beyond!