The Key Role of Regulators for Digital Financial Inclusion
Executive Education / 5 July 2022
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Ricardo has been the tutor for the Certified Expert in Financial Inclusion Policy course at Frankfurt School for a number of years. He also works with the financial regulation institution in his home country Guatemala, where his responsibilities relate to international standards, prudential regulations and financial inclusion projects, among other regulatory topics. In such a capacity, he led the development and implementation of the country’s first National Financial Inclusion Strategy.

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The COVID-19 pandemic and the unfolding shock to commodity prices and household income, among other macroeconomic variables, represents a massive setback in global efforts on poverty reduction. This commotion has had key implications for the engagement of the population at the base of the pyramid by financial institutions, and hence with the work to advance financial inclusion.

Frankfurt School’s upcoming Summer Academy 2022 and our online course Certified Expert in Financial Inclusion Policy (CEFI) aim to support financial market participants, both practitioners and policymakers, in addressing future challenges and thriving from new opportunities.

The World Bank and CGAP just announced the forthcoming release of the data on global financial inclusion in the latest edition of the well-known Global Findex Database. Comprehensive financial inclusion measures should help financial institutions to design strategies and regulators to develop policies in both advanced and emerging markets. The last release, made in April 2018, included important FinTech contributions and showed the level of financial inclusion at 68.5% globally, though this rate stood at only 54.4% in Latin America and the Caribbean, at 43.5% in the Middle East & North Africa and at 42.6% in Sub-Saharan Africa. Overall, low-income countries showed a financial inclusion rate of only 34.9%, implying that 2 out of 3 adults lacked access to financial services. Even though the latter is a tough reality to grasp, it’s important to underscore that digital innovations played a key role in widening financial inclusion. Simply put, technological innovation has proven to be the most effective way to advance financial inclusion, making it easier to provide financial services to those that need them the most.

Digital Financial Inclusion

Digital financial inclusion (DFI) can be defined as the use of digital financial services (DFS) to support financial inclusion. DFS are basically the broad range of financial services accessed and delivered through digital technology, including e-money, payments, credit, savings, remittances and insurance. The concept is considered broader than FinTech since it incorporates both a larger set of financial activities and a wider set of providers, including traditional financial institutions. In that sense, FinTech refers to the use of technology and innovative business models to provide financial services with new instruments, channels, and systems.

Most central bankers in emerging markets would argue that DFI is still a work in progress, including in countries with high financial inclusion levels. One of the main reasons is the need to narrow the ‘digital gap’, which in the case of DFI, includes raising financial and digital literacy, addressing infrastructure issues, such as broadband and Wi-Fi availability, and also overcoming challenges in the ‘last mile’ of the delivery of financial products and services.

Regulatory Approaches

According to the Payment Aspects of Financial Inclusion framework developed by the World Bank and the CPMI (2016), the legal and regulatory framework is one of the three foundations and critical enablers to drive access and usage to transaction accounts, along with financial and ICT infrastructures and the public and private sector commitment.

A recent (2022) empirical study done at the IMF showed an important impact of achieving higher levels of financial inclusion when policies succeed in extending financial services to a broader segment of the population in an efficient and sustainable manner. The data showed that a greater use of FinTech narrows the class (rich-poor) divide and the rural divide, however it is not sufficient to close all gaps. FinTech deployments need to be complemented with targeted policy initiatives and hence innovation-oriented regulations have a key role to play in achieving effective DFI. According to the study, the ‘dark side’ of FinTech could indeed lead to the exclusion of certain vulnerable groups because of unintentional algorithm biases and predatory lending practices.

DFI developments are, by their nature, new and possibly not fully tested and therefore present challenges that need to be identified and addressed by regulators. The main potential risks resulting relate to: cyber resilience; consumer protection and data privacy; market concentration; and digital exclusion. These risks raise the importance of effective regulatory and supervision frameworks.

Some innovative, noteworthy efforts by regulators to stay abreast of DFI challenges have come in the form of dedicated Innovation Offices, greater use of technologies (known as ‘RegTech’ and ‘SupTech’) and Regulatory Sandboxes. All of these approaches can foster the effective development of the DFI ecosystem as long as policies are technically sound, timely and inclusive.

The Pressing Need to Develop Skills

The pandemic reminded the world of the paramount need to be prepared in all contexts and quoting Stephen Mwaura, a well-known Kenyan DFS expert, capacity building is the most important priority for policymakers addressing DFI. Combining expertise in digital finance and financial inclusion, the courses at the Frankfurt School Sustainable World Academy play their part in this effort.