The Shadow Payment System
43 Journal of Corporation Law, Forthcoming
41 Pages Posted: 27 Sep 2016 Last revised: 29 May 2018
Date Written: April 21, 2017
Banking, derivatives, and structured finance may attract the lion’s share of accolades and approbation in global finance—but payment systems are where the money is. Historically, payment systems in most jurisdictions have been legally and operationally intertwined with the conventional banking system. The stability of these systems has thus benefited from the unique prudential regulatory regimes imposed on deposit-taking banks. These regimes include deposit guarantee schemes, emergence liquidity assistance or ‘lender of last resort’ facilities, and special bankruptcy or ‘resolution’ processes for failing banks. These regimes have the practical effect of relaxing the strict application of corporate bankruptcy law, thereby enabling banks—and the payment systems embedded within them—to continue to perform their core payment and other functions under conditions of severe institutional stress.
Recent years have witnessed the emergence of a vibrant, diverse, and rapidly growing shadow payment system. This system includes peer-to-peer payment systems such as PayPal, mobile money platforms such as M-Pesa, and crypto-currency exchanges such as Mt. Gox. The defining feature of this shadow payment system is that the financial institutions that populate it perform the same core payment functions as banks, but without benefiting from the prudential regulatory regimes that ensure bank-based payment systems can continue to function during periods of institutional stress free from the substantive and procedural constraints imposed by general corporate bankruptcy law. This paper examines the risks that the legal treatment of the shadow payment system poses to both customers and broader financial and economic stability, along with the likely effectiveness of various strategies that might be employed to address these risks.
Keywords: Fintech, shadow payment system, payment system, bank regulation, financial regulation, peer-to-peer payment system, PayPal, mobile money, M-Pesa, crypto-currency exchange, Bitcoin, Mt Gox, bankruptcy law
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