To Advance Financial Inclusion, Regulators Return to First Principles

> Posted by Elisabeth Rhyne, Managing Director, CFI

thumb_1EE16B47E5C149BC98E69E29C9CD8D11As regulators navigate the changes involved in financial inclusion, they must hold fast to first principles. The arrival of new technologies and new players, and in many countries, new mandates for financial inclusion and consumer protection, demand responses in regulation and supervision. Many of these responses are major departures from past practice. However, while the details of regulations and supervision may change significantly, familiar fundamental tenets remain to guide the way.

A task force of distinguished experts convened by the Center for Global Development under the joint leadership of Liliana Rojas-Suarez and Stijn Claessens puts forward three key tenets. First, if it quacks like a duck, treat it like a duck; second, let risk be your guide; and third, strike a balance between anticipation and reaction. (Of course, in regulator-speak these tenets sound different: functional similarity; proportionality; and a balance between ex-ante and ex-post regulation.)

The first principle suggests that regulators should look across providers of all types who are carrying out similar activities, whether banks, telcos, or small financial institutions, and ensure that one provider is not disadvantaged relative to another. This principle is especially important for regulators in determining whether mobile money should be telco or bank-led. It guides regulators towards a response that is agnostic about institutional form and focuses instead on understanding risks inherent in activities.

The second principle, on proportional risk, is especially important for ensuring that small value accounts and transactions are not burdened with restrictions that make them unprofitable, such as Know Your Customer requirements that are prohibitive for low income clients or that make signing up for electronic accounts too cumbersome. It is important also in determining standards for small financial institutions that serve the poor. India’s payment bank regulatory figure is an appropriate application of this principle. It allows institutions primarily involved in payments but not in deposit-taking and credit to operate without heavy supervision.

The third principle addresses the need to set out rules while allowing for experimentation and innovation. For example, while interoperability is a highly important feature for a financially inclusive marketplace, the task force recommends ensuring that technologies do not preclude interoperability, while at the same time allowing the participants in the market to move toward interoperability on their own terms.

Application of these principles should lead to the nirvana of an orderly yet competitive marketplace in which innovation takes place without jeopardizing stability.

There are a number of catches, of course. Nirvana is unattainable in this world.

One major catch is that regulators and especially supervisors who apply these principles must be deeply wise, very knowledgeable, and relatively free from political pressures (whether from industry or government).  Setting aside wisdom and political independence, which are desirable for any regulatory task, financial inclusion brings with it many changes in the specific knowledge and skills involved in supervision, as outlined in our post from Daniel Schydlowsky, former Superintendent of Banks and Insurance of Peru, commenting on the Basel Committee guidance on financial inclusion. Dr. Schydlowsky points out that the skill mix required to support financial inclusion with requires significant re-tooling. If regulators and supervisors do not understand the business models involved in financial inclusion they will have a hard time designing a level playing field and assessing risk proportionally. If they lack techniques for monitoring markets and spotting irregularities, they will have trouble balancing between ex-ante and ex-post. In either case, recognizing the limits of regulatory and supervisory capacity, a prudent regulator may respond by establishing a risk-averse regulatory regime, thus hampering the advances that could support financial inclusion. This challenge is especially great for small countries and poorer countries, as Dr. Schydlowsky points out.

In addition to general principles, the CGD task force report, launched on March 24, provides 26 specific recommendations, particularly regarding the regulation of digital payments. But perhaps its biggest message is that all financial inclusion players have a major stake in the capacity of the regulators and supervisors in whose hands these decisions lie. There can be no more important investment to advance financial inclusion than investment in wise, knowledgeable, and highly qualified regulators and supervisors.

Image credit: Accion

Have you read?

Basel Committee Guidance on Financial Inclusion: Views from a Supervisor

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