In this section of the Project Report, the term “banking” is used in a
generic and functional sense without any relation to the formal designations
and classifications of particular entities under applicable laws. For our purposes, a bank, a savings bank, a
savings and loan association, a trust company, a credit union, a building and
loan society, a small loan company, etc. are all involved in “banking.” Further, securities brokerage firms, mutual
funds, pension plans, credit card issuers, and other entities that are not
traditionally labeled as “banks” are functionally involved in “banking” to the
extent that they take deposits, transfer funds to third parties, and/or make
loans (as they in fact routinely do.)
Nor does this paper exclude functions from the concept of “banking”
because they are performed, in whole or in part, by governmental and
quasi-governmental institutions rather than by private companies, or because
they are performed on a secondary market level rather than a primary market
level. A quasi-governmental entity that
funds loans that are essentially brokered to it through the secondary market by
primary lenders is performing a “banking” function, just as much as a
traditional privately owned bank in the primary market. Indeed, since such a system is quite likely
to be highly automated in developed countries, it is even more directly related
to the issues addressed through this Project.[1] Further, it appears to be a general
phenomenon that governmental and quasi-governmental entities that perform
financial functions will seek to expand the range of their functioning. Whether this drive is based on an innate
bureaucratic imperative, a normal desire of diversification, or other factors
is unimportant. The fact is that they
are significant participants in the banking system.
In general, therefore, the intent of this report is to focus on function,
not on entity, and to try to see beyond the particular regulatory
classifications of particular jurisdictions.
Such a broad conceptual approach is necessary for this discussion. The “stuff” of banking and payment systems is
money. Money is, and always has been, an
element of a shared belief system, a piece of consensus reality. Today, money -- whether it is legal tender or
e-money -- is principally evidenced as a digital file. The technology exists to cause any money to
be evidenced by a digital file. Indeed,
any financial product can be evidenced as a digital file. This commonality of potentially being
evidenced as a digital file underlies every financial product or service --
regardless of the type or location.
Hence, any entity possessing adequate information processing technology
can perform the functions of a “bank” (putting aside the legality of their
doing so). Indeed, it is a fear not
infrequently expressed by traditional depository institutions that their most
potent future “banking” competitors may be software companies.
This opportunity for a broader range of competitors in the area of
financial services creates issues in the areas of jurisdiction law referred to
as “prescriptive” or “regulatory” jurisdiction, the question of which authority
or authorities have the power to prescribe the rules that govern an
activity. The oversight and control of
the financial services systems in a particular state, province, or country has
historically been an important government function. Financial services providers, in whatever
form, have in modern times been subject to comprehensive examination, strict
limitations, and direct oversight by their controlling government
regulator. The extreme consequences of
previous wide-spread failures within the financial services industry have
demonstrated the importance to governments of maintaining a safe and sound
financial services system.
Examples abound of the broad, societal consequences that ensued when
governments failed to provide proper examination and supervision of financial
services functions conducted in their territories. The world wide Depression of the 1930’s, the
Savings and Loan Industry Bailout in the US in the late 1980’s, the related
Canadian crisis with respect to trust companies, and the Asian Financial Crisis
of the late 1990’s, each find among their proximate causes government’s failure
to adopt correct regulatory policies[1] with respect to
their financial institutions and/or to adequately supervise various forms of
providers of financial services.
Given the importance of
government’s role in regulating financial institutions, the jurisdictional
question that arises is when and how may a government regulate financial
institutions that operate within its territory via the Internet. Traditionally, regulatory jurisdiction was
conveyed by a financial institution’s physical geography – if the institution
establishes a branch in a particular territory, the institution must follow the
rules of that territory governing that particular type of institution.
May, and more importantly, how can a government regulate a financial
institution whose only “physical” presence within its sovereignty consists of
electrons flowing through the Internet to that government’s citizens, a
mechanism through which, for all practical purposes, any financial institution can
provide any financial service to any person anywhere in the world?
