by Dr. Alfred Hannig

Emerging financial technology companies — FinTechs — are radically innovating the finance industry. Disruptive innovations such as artificial intelligence, machine learning, blockchain technology, biometric identification, cloud computing, and the use of big data are revolutionizing the collection and processing of financial information, the way we save and borrow, how we intermediate financial resources, the channels we use to pay for goods and services, and how we engage in money transfers between wallets and accounts, domestically and across borders. FinTechs are offering technology-enabled solutions that can better address customer needs and preferences by offering enhanced accessibility, convenience and tailored products. This will disrupt the traditional financial institutions’ business processes, necessitating developed economies financial industry renovation to keep abreast with the dynamic digital industry.

At the same time, digitization is also challenging the conventional roles of central banks. Virtual currencies running on blockchain technology, yet still considered to be volatile, risky, and energy intensive allow for peer-to-peer transactions without the clearing house role traditionally provided by central banks.

Meanwhile, we have been witnessing the beginning of a slowdown of the FinTech boom in the United States and Europe where startups are increasingly facing uncertainties in venture capital funding. Collaboration among FinTechs and traditional financial institutions especially in digital payments, money transfer and lending are now becoming the norm rather than the exception. Large investments have started to move to the new centers of FinTech innovation in Asia, reaching new record highs.

Does the pace of digital innovation and the impressive success of the FinTechs in breaking the dominance of established financial institutions also hold a promise for financial inclusion in developing and emerging economies? And what are the risks emanating from the delivery of technology-enabled services by new players and through new channels?

FinTech for Financial Inclusion: The role of regulators and collaboration as a norm

By the nature of their mandate and role, financial regulators are traditionally not directly exposed or closely connected to technological innovations that are emerging in all corners of financial markets. They are equipped to oversee well-defined players, but the speed of the digitized financial activities moving forward in highly complex ecosystems can be overwhelming and trigger cautious initial reactions to financial technology. Learning is key. Regulatory bodies in developed economies, e.g. the Monetary Authority of Singapore (MAS) or the UK Financial Conduct Authority (FCA), as well as an increasing number of central banks and other financial regulators from emerging economies such as Malaysia, Mexico, and Thailand have established regulatory sandbox environments that allow for mutual learning among regulators and the industry. Such sandboxes build on the traditional ‘test and learn’ approaches of regulators from the Philippines and Kenya to facilitate the growth of mobile money over the last decade. The experimental approach also enables isolated and risk-neutral pilot-testing of regulatory responses to FinTech innovations.

At the same time, there is a strong appetite from Central Banks and financial regulators to explore how technological innovations can be employed for their own advantage through developing faster, more interoperable national payment systems, setting up blockchain, issuing digital currency study groups and research projects, and deploying RegTech solutions to enhance efficiency and risk management in their own regulatory and supervisory functions.

As Christine Lagarde, the IMF Managing Director, pointed out at a Bank of England conference a few months ago, to make things smoother, dialogue is needed, dialogue between experienced regulators and ones who are just at the beginning of the FinTech learning curve. This dialogue should also include investors, policymakers and FinTechs, and should take place between countries as well. If we want to reap the benefits of FinTech, cooperation is key. No one can do it alone.

FinTech for Financial Inclusion: Transformative model for delivery of financial services

In order to further structure our understanding of the complexities of the fast-moving digital revolution, it may make sense to go back a decade in time to the works of a group of researchers who analyzed the challenge of expanding access to appropriate financial services through mobile banking and other forms of branchless banking. These reports from the early days of mobile and branchless banking distinguished between additive and transformative models of technology-enabled financial service delivery.

Additive solutions were defined as those in which the mobile phone acts merely as another channel to an existing bank account. Transformational models were conceived as those in which the financial product provided through the mobile channel is targeted at the unbanked, who are predominantly low-income populations.

Lots of FinTech innovations that trigger our immediate interest are additive in the sense characterized above as they are enhancing the convenience for banked or underbanked populations. At AFI, we go further and ask: out of the growing number of apps and tools offered by FinTechs in markets around the globe, which innovations can be transformative and successfully address access to and usage for the two billion people who are still completely left out of the formal financial system? In other words, what is in it for financial inclusion?

FinTech for Financial Inclusion has to be transformative and not just additive. When we start building our knowledge base on FinTechs we should therefore, concentrate our immediate efforts on storing relevant experience on technological innovations that hold a promise to include the unbanked, close the gender gap of financial inclusion, help us manage climate change risks, mitigate the challenges of de-risking, and bring down the costs of cross-border remittances.

A few examples on how FinTech can be truly transformative include the biometric SIM card registration in Pakistan, enabling millions of people to open new mobile accounts in a safe and integrated way. Female bank agents with mobile devices in open-air markets in Nigeria are another FinTech solution with potential to scale up in other markets. In this case, women are enabled through a tiered KYC system to setup accounts without documentation or minimum balance requirements, and to make deposits and withdrawals without having to leave their stalls.

In China, millions of previously unbanked customers have been enabled to track their carbon footprint and carbon offsets through a mobile phone interface. Access to e-wallets can also play an important role in climate-related disasters, such as facilitating emergency cash transfers to populations in remote areas that may be cut off from major urban centres, but are still able to access goods and services in their local community.

Another FinTech for Financial Inclusion example relevant to climate change points to mobile microinsurance solutions in the Pacific region, which protect individuals from climate change risks. Finally, iris recognition solutions designed to assist vulnerable and unbanked Syrian refugees in Jordan with trusted registration, as well as food and cash-based assistance, are one of the recent FinTechs that have caught the attention of the financial inclusion community.

“The pressure to understand the nature of technology-enabled financial services and to grasp the potential of digital innovations is much higher today.”

Reducing the complexities of the current FinTech debate and narrowing down on relevant breakthrough solutions will enable policymakers and regulators to educate themselves about those solutions that make a real difference for the unbanked. However, unlike in 2006, when cash was just moved to electronic value stored by mobile phones in only a few pioneering countries such as Philippines and Kenya, the pressure to understand the nature of technology-enabled financial services and to grasp the potential of digital innovations is much higher today.

The constant penetration of technology-driven applications in nearly every segment of financial services and in many places around the world is indeed something new. And it goes far beyond of what we have experienced in those early days of mobile financial services, in terms of both scale and the level of technological sophistication. The dramatic cases of massive uptake of digital financial services through the disruption in financial technology such as eKYC implementation of AML/CFT measures in India facilitated enrollment of more than 1 billion Indians in the national biometric ID program Aadhaar. Giant P2P platforms enabling digital financial services ecosystems in China exemplify the rapid pace of ubiquitous technological advances, which may also determine tomorrow’s reality of financial inclusion.

Regulatory challenges

We have reasons to believe that innovations will enable emerging and developing countries to leapfrog into this new tech area and that financial inclusion will benefit significantly and positively from the emerging trends. Technology will continue to change financial behavior and consumer profiles, as well as the nature of financial markets and financial infrastructure, and it is already happening in a growing number of places. But if markets and infrastructure change, the regulatory landscape is also likely to change. Collaboration across regulatory domains such as between financial regulators, telco regulators and Ministries for Internal Affairs who are oftentimes in charge of ensuring data security and protection will become the norm rather than the exception. Systematic coordination and collaboration between regulators has indeed become a main feature of emerging and developing countries, which have made major strides in financial inclusion, usually under the framework of a National Financial Inclusion Strategy.

The regulatory task will not only become more complex and challenging in view of the necessary collaboration across regulatory domains. The Financial Stability Board (FSB) published earlier this year a report on the financial stability implications from FinTech highlighting in particular that the rapid pace of change makes it more difficult for authorities to monitor and respond to risks in the financial system.

Leveraging digital financial services and FinTech for Financial Inclusion goals will come with new risks such as those stemming from unfair lending practices, and those related to the analysis of big data or increased systemic vulnerabilities due to threats of cybersecurity. For example, an AFI Digital Financial Services (DFS) Working Group Guideline on Technology Risks emphasizes technology related risks such as cybersecurity, DFS agent fraud, and issues around data privacy and consumer protection, particularly regarding digitally delivered credit as highly relevant compared to the risks, which are usually emanating within the conventional prudential responsibilities of financial regulators tasked to ensure appropriate safety and soundness of financial transactions.

Indeed, with fast-moving FinTechs interlinked with a thriving e-commerce industry, household debt could potentially grow. As a result, the demand side will come even faster into the regulatory focus in both developed and developing economies. However, and according to the view of some AFI members, international activities to resolve demand side issues are still stuck in awareness raising, and we have not seen the cutting-edge solutions to facilitate behavioral changes. The potential of usage of big data by regulators has by far not been exploited due to unresolved data privacy issues. From a financial regulator’s view point, there is therefore, a huge need for transformative FinTech for the demand side.

Overall, if effectively supervised, technology-enabled financial services will strengthen both financial stability and financial integrity. The interests of financial stability are served by broadening the deposit base, and digital financial services provide an important channel for this. Likewise — as has been recognized by the Financial Action Task Force (FATF) — financial inclusion can reduce the volume of unseen transactions taking place in the grey economy, and strengthen monitoring of Money Laundering and Terrorist Financing Risks. Indeed, global Standard Setting Bodies (SSBs) have made space for the implementation of the risk-based approach and have recognized the essential role of non-bank financial institutions in driving innovation and promoting financial inclusion.

Once again, we argue that SSBs would find it difficult to provide comprehensive and systematic standards for the practical implementation of a risk-based approach for FinTech for Financial Inclusion given their already busy agendas and in view of the rapid and massive changes financial technology will bring on the global level.

However, policymakers and regulators in the developing world who are increasingly conceiving financial inclusion as a key pillar under their core mandate of financial stability, are facing resource constraints and limited absorptive capacities in view of the complex learning agendas especially generated by FinTech innovations.

Defining balancing regulation for FinTech for Financial Inclusion

The financial inclusion space has changed in the past decade, and FinTech is accelerating these changes. To use our own example, when AFI was created, financial inclusion was a relatively neglected topic in the global agenda. Today, as financial inclusion has entered the mainstream debate and gained prominence (e.g. in the G20 initiatives), there is far greater acceptance, ambition and interest regarding these issues. With more actors and increased complexity, there is also more proliferation of roles competencies and appropriate funding — among in-country implementers, development partners, agencies and projects, industry groupings, private sector players, consulting companies, research institutions, and funders.

Multiple support activities and offerings to address the needs of policymakers and regulators in creating enabling and conducive regulatory frameworks, and supervisory mechanisms for FinTechs are available from many sides in an increasingly overcrowded financial inclusion space. Amidst all of this, who does what in the future has become more contested and more competitive than before. The additional resources and inputs are in principle welcome. Equally important are rationalization and coordination of support activities to preserve the neutrality of regulatory approaches and to avoid confusion of potential beneficiaries of external support, duplication of efforts and overlapping work streams.

Against the background of it all, financial regulators want to master the balancing act of taking on their prudential responsibilities and facilitating competitive non-monopolistic market development. At the same time, they want to enable transformative FinTech innovation, improve access and usage of financial services, deepen use cases and improve the quality of financial services.

Few key elements of a strategic approach towards balancing innovation and regulatory oversight for FinTech for Financial Inclusion are emerging:

1. Creating opportunities to systematically build a FinTech for Financial Inclusion knowledge repository for financial regulators, which stores relevant material on technological innovations that are transformative and therefore relevant for Financial Inclusion, including the closing of the gender gap, the management of climate change risks, the mitigation of the challenges of de-risking, and lowering the costs for cross-border remittances.
2. Enabling test-and-learn approaches on FinTech for Financial Inclusion on the country level such as Regulatory Sandboxes, Innovation Hubs or RegLabs. These should also support the application of approaches such as tiered KYC, eKYC (including digital identification) and RegTech, as well as include capacity building activities for staff of regulatory bodies such as practical exposure to FinTech innovations in pioneering countries and training for regulators in collaboration with technical partners (e.g. the IMF or FATF-style regional bodies, Asian Development Bank (ADB), World Bank Group) on relevant topics such as cybersecurity and AML/CFT issues.
3. In collaboration with global SSBs and experts in the field, providing additional regulatory guidance originating from practical examples on risk proportionality and peer learning efforts among regulators which will lead to better policies for financial inclusion.
4. Facilitating peer learning knowledge sharing and capacity building among regulators to upscale what pioneers and champions in the regulatory space already have learned by implementing key policy enablers to reinforce digital financial services. Including sharing lessons on effective approaches for balancing financial innovations with other key public policy of financial stability and financial inclusion.
5. Incorporating FinTech into National Financial Inclusion Strategies by publicly sharing financial inclusion targets and facilitating collaboration and coordination across regulatory domains as well as cooperation along the financial inclusion value chain.
6. Enhancing Public Private Dialogue (PPD) and global dialogue with the private sector, technology companies, researchers, development partners, and regulators from developed and developing economies to enhance the mutual understanding of the FinTech innovations’ risk profiles, their role in financial inclusion, contribution to solutions to enhance compliance to International Standards (e.g. de-risking) etc.

This preliminary agenda does neither claim to be exhaustive nor does it intend to offer the unique vertical solution, which is applicable everywhere. It can be seen as one way to reduce complexity and make FinTech for Financial Inclusion truly transformative, yet more tangible for financial regulators who see financial inclusion as part of their financial stability mandate. This should be in everyone’s interest, just as reaching the next billion of the financially excluded remains at the core of our ambitions.

References:

The FinTech effect and the disruption of financial services

Smart Data: 3 Reasons It’s the Future of Fintech

Central Banking and Fintech—A Brave New World?

Year in data 2016: There are signs that the fintech boom is slowing

Regulating Transformational Branchless Banking: Mobile Phones and Other Technology to Increase

The Enabling Environment for Mobile Banking in Africa

Can ‘fintech’ innovations impact financial inclusion in developing countries?

Mobile Financial Services Technology Risks

Financial Stability Board 2017