Three Ways Financial Inclusion Makes Life Harder for Regulators

> Posted by Elisabeth Rhyne, Managing Director, CFI

I don’t know how they will do it. Bank regulators, that is. How will they cope with the challenges coming their way throughout this decade of rapid financial sector change?

In the good old days, if there were such days, bank regulators operated inside their comfort zones in a world with known risks. A standard set of skills and knowledge saw them through. If I may indulge in stereotype (without being entirely unfair), the profile a bank supervisor needed was: good with numbers, cautious, a stickler for details, dedicated, often courageous, and having a strong sense of right and wrong. These are all wonderful qualities, and for prudential supervision of banks, there was a good fit between the task and this personal profile. Just as important, the bodies of knowledge regulators and supervisors needed was well understood.

Not today. The post-financial crisis world deeply challenges the comfort zone for banking authorities. In specific, I want to focus here on how financial inclusion challenges it. Changes associated with financial inclusion require banking authorities to move beyond their zones and develop a broader range of skills and qualities in at least three ways.

1. Adapting to continual technology change. Regulators around the globe are struggling today to create regulations that will bring the wonders of mobile money into their countries. But mobile money is only the technology du jour. Just as regulators get mobile money squared away, new technologies and business models are bound to appear and render regulations on the previous model outdated. I suspect, for example, that the spread of smartphones will upend SMS-based mobile money models, forcing regulators to shift focus from telecoms operators to cyber-security. Each new technology brings different players, new business models, and its own set of stresses on regulatory boundaries. While there are many with deep technical expertise among bank regulators, the pace of change is daunting, especially for organizations that must work within or seek to change legislative and regulatory constraints.

2. New mandates for consumer protection, especially at the base of the pyramid. Bank regulation is built around a time-honored and economic-theory-backed justification that includes financial system stability, and in many cases depositor protection, but not what we know as consumer protection (transparency, product suitability, fair treatment, recourse). Regulators now need to view consumer protection supervision as an equal and necessary compliment to prudential supervision. But legislative mandates for consumer protection are new and still incomplete, organizational structures are often missing or overlapping, and the body of knowledge that supports consumer protection regulation is still quite young. Prudential supervision is still seen as the “hard science” by numbers-driven supervisors, while consumer protection may be viewed as nice but not really essential. Very few countries currently have consumer protection regimes that are mature and successful enough to serve as models.

3. Perhaps most importantly, financial inclusion is bringing an enormous influx of new customers and providers. Regulators must come to understand these new customers and connect with these new providers. The customers differ significantly from the middle-class consumers who have been banking customers for decades. They are economically vulnerable, with relatively low levels of education, and they may be far more comfortable operating in the informal sector. These customers’ first use of formal financial services often occurs with providers outside the traditional commercial banking sector. In Latin America, for example, store credit is a rapidly growing segment of the consumer credit market, especially for lower income clients. Regulators may lack the tools to monitor and influence this market if their mandate is limited to formally regulated institutions. At a recent CGAP/IDB/ASBA-sponsored gathering of Latin American supervisors on consumer credit, regulators expressed frustration over their lack of tools even for gathering information on non-bank providers. And regulators would generally prefer to focus on a manageable number of larger institutions than a proliferation of small providers.

This changing scene calls for regulators – and regulatory agencies – that can be flexible, creative, and open-minded, in addition to retaining all their old virtues. It calls for new skills to be brought into regulatory agencies (such as how to collect and interpret demand-side information) and new bodies of knowledge to be mastered, from new business models to technologies to client protection. It may require a change of mindset from a preoccupation with squeezing risk out of a system to a recognition that the task is to manage a continually shifting set of risks.

It will take significant investment, by both national and global entities, to equip regulatory authorities for these challenges. Investment is needed in both overall institution-building and in training for regulatory and supervisory personnel. Existing efforts, such as the Alliance for Financial Inclusion, the alliance between CGAP and the Toronto Centre, and others, offer high-quality support. Given the pace and magnitude of change that regulators must come to terms with, these efforts need to be stepped up dramatically.

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