Which is best: Using an FBO Account or becoming a Money Transmitter
Payment facilitators and other PSPs who wish to become part of the funds flow to their merchant clients (in other words, become responsible for moving settlement funds to merchants) must decide how to do so in a compliant fashion. Taking possession of and transmitting funds that belong to another party is regulated by various government authorities and the activity itself must be licensed on a state or provincial level. Payment companies therefore must obtain the necessary licenses and become a Money Transmitter or leverage their sponsor bank’s license through use of an FBO (For Benefit Of) account structure.
Choosing between an FBO model and obtaining a money transmission license depends on your business model, the level of regulatory compliance you're prepared to handle, and your long-term goals. Let’s break down each of these options to help you decide.
1. FBO Account
What It Is: An FBO account is a custodial account where funds are held by a bank for the benefit of another party. In this context, funds that represent consumer purchases are first settled by a processor to an FBO account and then dispersed from the FBO to each merchant’s depository account. The PSP does not touch or handle the money directly.
The beneficial owners of the funds in the FBO account are the merchants of the PSP. Ownership of the account itself can either be ascribed to the bank’s EIN (tax ID) or the name of the company holding the account.
Key Benefits:
o Simplified Regulatory Compliance: By using an FBO account, you avoid the need to obtain money transmission licenses because the bank holding the account is licensed and directly handling the funds.
o Faster Setup: Since you're leveraging an existing bank’s infrastructure, getting started can be quicker and less costly.
o Lower Costs: Avoiding the need for licensing can save significant legal, administrative, and operational costs.
Considerations:
o Limited Control: Relying on the bank’s infrastructure might limit flexibility in how you manage funds.
o Jurisdictional Limits: Some states or countries may still require a money transmission license even if you use an FBO account, depending on your business model. Most Payment Facilitators are able to use an FBO structure effectively but it is always prudent to discuss this with the sponsor bank.
o Interest earned: Any interest accumulated belongs to the owner of the account which is typically the bank.
o Instructional Funding: While the PSP does not own the account or the funds, the PSP will generally be responsible for instructing the disbursement of funds to merchants’ accounts. This is done through an instructional file transmission from the PSP to the owner of the FBO account.
2. Money Transmission License
What It Is: A money transmission license is a regulatory requirement for businesses that want to engage in activities such as transferring money between parties, issuing payment instruments, or handling stored value (like prepaid cards). When a company has obtained the requisite licenses for their business, they are a Money Service Business.
Key Benefits:
o Full Control: With MTLs, one has direct control over the handling and transmission of funds, which can provide more operational flexibility.
o Credibility and Trust: Being a licensed money transmitter can enhance your business’s credibility, potentially making it easier to establish partnerships and gain customer trust.
Considerations:
o High Costs and Complexity: Obtaining money transmission licenses is a time-consuming and expensive process, requiring legal assistance and significant compliance efforts.
o Ongoing Compliance: Maintaining a license requires ongoing compliance with regulatory requirements, which can include regular audits, reporting, and maintaining sufficient capital reserves.
o State-by-State Regulation: In the U.S., you'll need to comply with each state's specific regulations, which can be cumbersome if you plan to operate nationwide.
Companies desiring to become payment facilitators, digital wallet providers, or other types of payment service providers must determine if their model requires direct oversight and handling of funds designated for their customers. If so, and if one is prepared to handle the cost and complexity of the licensing process and ongoing compliance, obtaining MTLs is a good choice that offers flexibility, control, and the ability to retain earned interest.
If a company is starting out and needs to lower upfront costs and minimize complexity, the FBO account is likely the right choice. Banks that sponsor payment facilitators generally offer some form of FBO structure for this reason, since most PSPs do not have a requirement to handle their merchants’ funds directly.
At RPY Innovations, we're passionate about helping businesses uncover and leverage their hidden payments potential. In a world where every company is potentially a fintech company, are you ready to explore your payments identity?
