Leaving money lying around in a checking account isn't a great idea. It's safe enough but you're not earning interest on the money. Even worse is leaving funds sitting idle in a payment app like Venmo or PayPal.
Why? Because money stored in those apps may not be covered by the FDIC (Federal Deposit Insurance Corp.) The apps aren't bank accounts, after all, and generally speaking the FDIC only covers bank deposits.
"Popular digital payment apps are increasingly used as substitutes for a traditional bank or credit union account but lack the same protections to ensure that funds are safe,” said Rohit Chopra, director of the Consumer Federal Protection Bureau (CFPB).
“As tech companies expand into banking and payments, the CFPB is sharpening its focus on those that sidestep the safeguards that local banks and credit unions have long adhered to," Chopra said in a news release.
The payment apps are certainly handy. They save the hassle of writing and mailing a check and the payment is virtually instant. But as Chopra points out, they're not banks and don't offer all the protections of regular bank accounts.
The recent failures of Silicon Valley Bank, Signature Bank and First Republic Bank have been a reminder that even though banks can fail, depositors' funds are safe up to the limits for each account. If a payment app had uninsured funds deposited in those banks, the losses would not have been covered and could have been passed on to consumers.
The CFPB outlines the risks in a issue spotlight:
- More than three quarters of adults in the United States have used a payment app. Younger customers’ use of these payment app services is especially prevalent. Approximately 85 percent of consumers aged 18 to 29 have used such a service. Transaction volume across all service providers in 2022 was estimated at approximately $893 billion, and is projected to reach approximately $1.6 trillion by 2027.
- Nonbanks can earn money when users store funds on their platforms. When users of these digital apps receive payments, the funds are not usually swept automatically to the recipient’s linked bank or credit union account. Instead, companies hold and invest the funds. These activities are not typically subjected to the same oversight that an insured bank or credit union faces. Apps also earn money through fees on merchants and other ancillary services, like selling crypto-assets and offering affiliated financial products.
- Funds sitting in payment app accounts often lack deposit insurance. When users receive payments, through these apps, these funds are not automatically swept into their linked bank or credit union account. In addition, payment app companies do not necessarily store customer funds in an insured account through a business arrangement with a bank or credit union. The company’s investments carry risk and if it were to fail, customers could lose their funds.
- User agreements often lack specific information. User agreements for digital payment apps often lack information on where funds are being held or invested, whether and under what conditions they may be insured, and what would happen if the company or the entity holding the funds were to fail.
Many states are enacting policies to ensure that these digital payment apps are able to meet their obligations, including a new law recently enacted in Texas. State laws, however, generally do not require that customer funds be stored in or automatically swept into insured accounts.