Nearly a decade after the 2008 global financial crisis, the world has seen a fundamental overhaul and tightening of financial regulations.  The enforcement of stricter rules on liquidity and capital for systemically important financial institutions, combined with comprehensive efforts to enhance the quality of bank supervision, are trends unlikely to be reversed, despite initial efforts by the new U.S. administration to roll back the Dodd-Frank Act.

In the aftermath of the global financial crisis commercial banks sharply scaled back on their provision of financial services, and in many jurisdictions the financial system has become increasingly reliant on non-bank financing, what has been generally understood as “shadow banking.” Moreover, international banks have begun to “de-risk” their business relations by terminating or severely restricting relationships with perceived higher risk customer sectors, e.g. money transfer operators or remittance providers, or even entire jurisdictions. The unintended consequence of this has been changes to risk management and regulatory frameworks, together with tougher compliance and enforcement environments. 

In response to these trends, the international community has repeatedly highlighted the threats from international banks withdrawing from certain markets or lines of business for financial inclusion in emerging and developing economies but also to the overall stability and integrity of the global financial system. At the Alliance for Financial Inclusion (AFI), we have argued that financial stability concerns need to be effectively addressed. However, to control the risks of financial exclusion, we have also supported risk-proportionate regulation for lower-risk, technology-enabled transactions, such as digital financial services for underbanked or unbanked populations, which are reducing the cost of retail banking dramatically and have emerged as a solution to breaking down the barrier between the formal banking sector and the populations with no access to finance. 

Financial stability and financial inclusion are important policy objectives these days, and there is growing consensus that they can be mutually reinforcing and that a coordinated approach, if pursued in a coherent manner, can help policymakers to build a resilient and inclusive financial sector and support economic growth. Consistent with this thinking, the G 20 has encouraged global Standard Setting Bodies (SSBs) to incorporate financial inclusion issues into the international financial regulatory framework. 

Answering this call, SSBs such as the Financial Action Task Force (FATF) and Basel Committee on Banking Supervision (BCBS) have made great strides in the last years in terms of striking the balance between financial stability and financial inclusion and made space for practical implementation of the risk-based approach. A recent example of this is the recently published Global Shadow Banking Monitoring Report 2016, the Financial Stability Board’s (FSB) sixth annual assessment of global trends and risks in the shadow banking system. The FSB suggests that resilient market-based finance, appropriately regulated, provides a valuable alternative to bank funding for the real economy. The findings are consistent with the Moscow Resolution on Financial Inclusion and Shadow Banking adopted by participants to the November 2015 Bank of Russia and AFI conference on “Financial Inclusion and the Transformation of Shadow Banking” which emphasized the necessity to manage systemic risks emanating from certain unregulated shadow banking activities while recognizing the essential role of non-bank financial institutions in driving innovation and promoting financial inclusion.

Despite growing global consensus on the links between financial stability and financial inclusion, important questions have not been fully answered, namely, how the two objectives are connected and how to strike an appropriate balance between the two. Recent IMF and World Bank research has found there can be both policy trade-offs and synergies, for example, driving financial inclusion through rapid or uncontrolled expansion of credit can impair financial stability, especially if the quality of financial supervision is inadequate. On the other hand, advancing financial inclusion through electronic payments, deposits or insurance may be associated with positive effects on financial stability. As the World Bank rightly concludes, ignoring the nexus between the two objectives could result in suboptimal outcomes, namely, costly financial crises or continued financial exclusion. CGAP studies provide some examples of the linkages between financial inclusion, financial stability, financial integrity, and financial consumer protection (collectively, the I-SIP framework) and highlight the importance of policymakers’ understanding of these linkages. From a policy perspective, much can be gained from a better understanding of these interrelationships and coordinated policy approaches. 

Notwithstanding the significant progress that has been made in recognizing financial inclusion as a key policy objective, it seems unlikely that global SSBs will make the development of additional standards or guidance on the appropriate or optimal balance between financial stability and financial inclusion a priority in the near future. This is understandable given the primary mandate of the SSBs, their already packed agendas and the scarce resources available for such an effort. It might also be unrealistic to expect this guidance should originate with the SSBs, as their approach to standard-setting is based primarily on analyzing the systemic risk implications in the formal financial sector of advanced economies.

The questions we then must ask ourselves with regard to the perceived standards gap are: first, whether we want additional guidance on standards to be developed; second is how, and third is by whom?  

The first question of whether guidance needs to be developed is perhaps the easiest to answer. Given their ambitious policy priorities and regulatory agendas on financial stability and financial inclusion, policymakers and regulators from developing and emerging economies have repeatedly requested evidence-based guidance, or at least expressed a strong demand for proven knowledge on how these policy objectives can be mutually reinforcing.

The answer to the second question, how effective guidance should be produced, can be approached by looking at AFI’s experience with peer learning platforms, which have uncovered practical knowledge on financial inclusion policy and regulatory frameworks. Peer learning and knowledge sharing methodologies have proven to be a useful and constructive way to enable authorities to learn from each other’s diverse experiences in promoting financial inclusion. Collaboration and positive peer pressure among AFI members has led to strong commitment by countries to implement financial inclusion policy reforms while at the same time preventing or mitigating the threat to financial stability and integrity. 

The third question, who should take the lead in providing guidance, is the most critical. We argue that the best examples of regulatory frameworks that allow both financial stability and appropriate financial inclusion are found in countries that have already been sharing their experiences with peers across the AFI network. Effective guidance should draw on the practical lessons of emerging and developing countries that have successfully pioneered financial innovations and smart policy solutions to promote financial inclusion in a safe, sound and effective manner.

All these questions came to the surface at the 2016 global conference, “Maximizing the Power of Financial Access: Finding an Optimal Balance Between Financial Inclusion and Financial Stability”, co-hosted by Bank Indonesia and AFI in Bali, Indonesia. The outcomes of this conference, which are documented in the Bali Outcome Statement on the Linkages Between Financial Inclusion and Financial Stability, confirm that additional guidance on the links between these two policy objectives is required.

At the conference and in subsequent discussions among AFI members, it was suggested that AFI develop a “set of indicators” for its members that reflect a healthy balance between financial stability and financial inclusion. Another recommendation was for AFI to develop an index that links the two sets of indicators and which countries could use to compare progress. It was also argued that AFI should develop a “standard” based on the indicators or index that members would have to follow.  In addition, there was a recommendation that AFI should proactively guide members to comply with such a given standard. One concrete example referred to the definition of minimum KYC requirements that should apply to low-risk products but should not leave gaps open and not allow activities like money laundering to take place. 

In sum, there was a perception by some members that now may be the time for AFI to come up with minimum standards that members can use as a guide. However, suggestions of top-down guidance were also met with skepticism, as AFI does not have the mandate to issue standards and there are concerns that setting standards may be counterproductive if the costs, benefits and specific country contexts are not taken into account.

A cautious and realistic view of the current standard-setting landscape should guide our efforts to provide additional guidance. AFI is not a compliance-driven standard setting body, but through accumulated experience and expertise the network has earned the right to recommend policy and regulatory “benchmarks” on topics central to its mandate. This means bottom-up surfacing of recommended and proven best practices, not top-down, mandatory standards. This thinking reflects a fundamental shift to the notion of standard setting. On unresolved policy topics such as the optimal balance between financial stability and financial inclusion or the newly established Fintech/Regtech platform AFI offers a space for open and honest dialogue, debate and smart experimentation. AFI also serves as an all-inclusive platform which allows views from a diverse community of partners and stakeholders to be heard. 

The way forward seems to suggest a phased, bottom-up approach. AFI already provides the opportunity to develop case studies, discuss benchmarks and develop indicators through the Working Groups. In the coming years, these efforts should be enhanced to enable the Working Groups to develop benchmarks and identify whether, in select cases, members are complying with or implementing the agreed indicators. Results and recommendations should be discussed with SSBs, the IMF, World Bank and other relevant stakeholders. As a next step, AFI’s governing bodies could agree on the emerging regulatory guidance and whether compliance with the benchmarks is voluntary or mandatory. Consequently, AFI could ensure members’ voluntary or recommended compliance and monitor implementation of the indicators that have been developed by its Working Groups. 

In looking further ahead, AFI may provide benchmarks which are different in nature and character from conventional standards, and based on practical evidence of proportionality in practice. This may also be the first brick to AFI’s future as an architect of self-imposed “standards” which can provide effective guidance and peer pressure to members for observing best practices.