Financial institutions and banking services play a crucial role in society. Services are being paid and payments are received at a bank account. Until recently, commercial banks had a monopoly position to use internationally accepted payment systems. At the peak of the Dot.com era, PayPal Holdings Inc. initiated a first disruption of the traditional bank payment systems. These days, online payment systems provide upgraded services that are common practice. However, there are crucial differences between traditional banks that are considered credit institutions, and Neobank and FinTech firms that are designated electronic money institutions.
Credit institutions receive deposits and grant credit. Traditional banking activities, fractional reserve lending and financial risk management require distinct methods for capital maintenance and adequacy. As a consequence, banks are subject to strict regulatory control. Electronic money institutions on the other hand provide a service. This service may include access to the IBAN customer identification system that allows for monetary transactions. Since electronic money institutions are not considered banks, there are several limitations to their activities.
Banking touches different isolated legal doctrines and frameworks. Due to the international and cross border nature of many transactions, regulation may overlap or trigger arbitrage. Yet, sovereign countries under the umbrella of the European community may impose limitations to market entry for as long as these apply to both foreign and domestic market participants. As such, entrepreneurs and international businesses can benefit from the European single market and its borderless society. However, they must comply with home state, host state, as well as the comprehensive EU codes. The advantage of collaboration within the political and economic European Union allows the European Court of Justice to challenge domestic actions in member states against community law.
The financial system is built upon trust. There are measures to ensure the stability of the banking system and avoid panic in times of economic turmoil. Banks are required to hold capital cushions, participate in local deposit protection schemes, and depending on their size may be rescued with tax-payer input. The latter, where financial institutions are rescued by local governments is undesirable since it may trigger moral hazard.
A bank and its customer enter into an agreement that is subject to contract law. Mandatory codes of conduct, best practices and other rules for consumer protection further the environment for financial institutions. As a consequence, financial institutions have duties and responsibilities towards their customers. Good governance can be enforced and may justify civil action. However, civil actions come at the expense of the claimant and are subject to formal verdicts by the designated courts.
Financial institutions are regulated in a domestic as well as international framework. Globalization and the extensive scope and nature of international payments triggered a quest for uniformity. The global financial system is vulnerable for abuse by illicit actors. Abuse may lead to a decline in confidence and thus could lead to a disruption of economies. Therefore, issues as money laundering are defined on a cross-country level. This approach instantly opens the doors for compliance with different regimes in various jurisdictions. Something to consider when opening a bank account for a company that operates internationally.