Financial Inclusion: What's Next for Regulators? (The Economist article)

9 June, 2016

Original source: The Economist

Tilman Ehrbeck, former CEO of CGAP and currently partner at the philanthropic investment firm Omidyar Network, discusses innovative ways to expand financial inclusion.

During last month’s International Monetary Fund (IMF) and World Bank Spring Meetings, IMF managing director Christine Lagarde emerged as a powerful supporter of financial inclusion. In her opening remarks on a panel, Lagarde cited IMF research showing that greater financial inclusion tangibly benefits economies on a macro level, in areas such as GDP growth or reduced income inequality.

Lagarde was adding her voice to a growing consensus that financial inclusion should join financial stability, financial system’s integrity (or the ethically and legally sound and independent nature of a financial system), and consumer protection as a national and international financial policy objective.

To advance financial inclusion experts propose several strategies. Firstly, so that financial regulations are not overly costly or cumbersome, they should be proportional to the underlying risks associated with specific products or transactions. Pakistan and Mexico’s tiered ‘Know Your Customer’ (KYC) rules (which require more data about a customer as the amount of the transaction increases) are but one example of this approach.

Secondly, better timing the creation of new rules over budding products and services can help expand financial inclusion because overregulating too early can stifle innovation, while doing so too late leaves consumers unprotected. A good example of this appropriate timing of regulations principle is patent protection in the pharmaceuticals industry. It grants pharmaceutical innovators sufficient time to recoup high research investments followed by broader access to life-saving drugs through lower-priced generic versions of these medicines later.

Recommendations like these make sound sense at a global, conceptual level. The challenge, however, lies in finding pragmatic approaches and cost-reducing, technology-based tools that can help regulators and financial services providers expand financial inclusion.

Here are some potential next steps: 

1. Institute Regulatory Coordination Across Silos

Historically, the global financial policy architecture has separated standards-setting bodies by function, such as payments, deposit-taking, or securities trade—a structure often replicated at the national level. However, such silos do not reflect how consumers today think about money – or how new digital financial products are built.

For example, mobile money in emerging markets meets a short-term low-income household cash flow need in the informal economy, through quick cash transfers crossing traditional regulatory borders between payments and short-term credit.

In Kenya, for example, the Commercial Bank of Africa cooperates with cellular network operator Safaricom to instantly offer access to savings and, over time, credit, to M-Pesa mobile money users. The new service –called M-Shwari—is so popular that it is now one of Kenya’s largest retail banks by number of accounts, just two years after inception.

As more of these M-Shwari-type services proliferate globally, financial regulators will need to monitor and oversee innovative offerings like these not only across traditional financial product silos but also with other bodies, such as telecommunications regulators. 

2. Establish a New Dialogue with the Industry

Financial services providers need clarity and certainty about financial regulations before investing heavily in new technology-driven offerings and channels. Regulators, in parallel, are understandably reticent to judge and rule over these offerings before understanding their opportunities and risks.

To overcome this chicken-and-egg dilemma, UK financial regulators are changing how they engage with the private sector by evaluating the potential of  – and the required oversight over – new financial products in “sandboxes”, the virtual testing environments often used for new technology-based products.

This allows experimentation with these new financial products with some regulatory oversight, ranging from limited field-testing to government-backed guarantees that existing financial services rules will not apply before products are commercially launched. Regulators can thus monitor new innovations and step in when needed. 

3. Leverage Technology to Strengthen Supervisory Capacity

Many recent advancements such as cellular technology or the Internet show that, broadly speaking, technological innovation emerges before industry is fully prepared to exploit it; industry’s embrace of novel products and services precedes regulatory understanding of the full potential and consumer threats; and regulations precede an institution’s capacity to develop and enforce rules.

In this chain, mobile money is perhaps the most recent example of delays and disconnects from invention to oversight, both of which will likely increase given the rapid digitization of many aspects of our lives. This limits the reach of these innovations to those who would most benefit.

To compress this period and expand the scope and scale of new financial inclusion innovations, the very same technologies that sparked progress and disruption can help accelerate understanding of, and oversight over, these innovations.  

Around the globe, interest in regulatory technology, or RegTech, is growing. Innovations in this area might include ways to accelerate oversight of key financial services metrics from static and time-delayed to dynamic and real-time through intelligent algorithms. Or new approaches to update KYC requirements, which were conceived before the smartphones, biometrics, and big data analytics that permeate our lives today.

In Switzerland, for example, the KYC Exchange service has created a cloud-based secure communication platform that allows financial institutions to share KYC and Customer Due Diligence (CDD) data amongst themselves, helping banks to comply with money laundering laws in a more efficient and affordable way.  New technologies like these help fortify regulatory requirements at lower costs for both providers and consumers.

Policymakers have embraced financial inclusion because it benefits families, small businesses and the economy as a whole, particularly in developing countries with large informal sectors. Technology-led innovations are creating new opportunities to bring formal financial services to more people at lower costs. For these efforts to succeed, regulatory mindsets and approaches must evolve in parallel.

To read the original article, including further information about Tilman Ehrbeck, click here.

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