Squeezing financial inclusion between regulatory pillars
Nov 10, 2014
In a panel in a recent IFC/MasterCard Foundation conference in Johannesburg, Mark Flaming of MicroCred reminded us that there is a tension running deep in all regulatory discussions of digital financial services (DFS) for financial inclusion, and that is between the banking and payments traditions. These are differentiated regulatory pillars that are deeply ingrained institutionally as separate departments within every central bank, and as separate committees within the Basel structure at the top of the global regulatory food chain. The two traditions are increasingly encoded legally, as more developing countries are passing payments systems laws distinct from banking laws. Payment system departments within central banks have an instinctive understanding of network effects, so they tend to be friendly to an inclusion agenda that promises to connect more people to payment networks. Also, their general aspiration is to increase the share of transactions that happen in real time and reduce credit and counterparty risk, so digital financial inclusion platforms are in fact supportive of their system stability objective. Banking supervision departments, on the other hand, tend to take a much more cautious approach. They tend to worry much more about financial depth relative to the volume of economic activity rather than the size of the population. Their supervisory resources are much more overworked given the inherently more complex and untransparent business of banking, and tend to look at technology, service and business model innovation with more suspicion, as things that could potentially get out of hand. The global financial crisis has of course given them ample evidence to support this instinct. They are more focused on protecting what is (risks) than on pushing the frontiers (opportunities). So which side of the regulatory house should own, or at least take the lead on, financial inclusion for the masses in developing countries? Things have moved fastest in countries that have given it to the payments side, which tends to be more in tune with infrastructure-light digital service platforms and more comfortable dealing with a broader range of players. Under a new type of e-money issuer (EMI) license, they are letting non-banks (and in particular mobile operators, but also electronic top-up specialists and independent retailers), offer basic transactional services to those for whom traditional banking services are too costly, inconvenient, or simply unavailable. But this has been the problem: payments people very reasonably worry that this foray into proto-banking risks tipping their side down a regulatory slippery slope that may lead to the kind of burdensome prudential and consumer protection regulation that mires the banking side. One way to avoid this has been to sharpen the differences between electronic money and banking services - so that putting money in an electronic money account is made to feel very different to putting money in an electronic bank account. Accordingly, EMI licenses in many countries carry tough restrictions such as precluding payment of interest on saved balances, imposing lower account caps, banning their marketing as savings accounts or using the term banking at all, banning the bundling of credit offers even if they are funded externally to the EMI, and excluding them from deposit insurance. But this just seems like an overly limited banking option for the poor: financial inclusion ought to be more than payments. This sharp distinction between EMIs and banks has also introduced regulatory arbitrage opportunities between banks and EMIs, insofar as the payments and banking supervision departments set different standards for service functions common to both, such as requirements for account opening, e-channel security, and contracting of retail stores as cash in/out agents. In some countries, this has made it easier for mobile operators rather than banks to offer basic financial services to the (traditionally excluded) mass market. I argue in a new paper that the next round of regulatory reforms for financial inclusion needs to address both these issues. By neglecting savings, the current practice does not serve a full enough vision of financial inclusion. Firstly, EMIs licensed under payments system frameworks need to be unencumbered from unjustified restrictions. In particular, they should be able to offer savings services on the same basis that banks do. For the essence of banking is not the mere act of taking deposits (which is easy to supervise), but rather the reinvestment of those funds in a way that entails credit and liquidity risk (which is not so easy to supervise). Accordingly, EMIs serving the poor should be reinterpreted as narrow banks - institutions that take deposits from the public and manage customer accounts on the same terms as banks do, but that do not intermediate the corresponding funds. Because narrow banks don´t themselves place bets with depositors´ money, they should remain firmly in the payments pillar. Secondly, regulation should aim not only to introduce new types of competitors, but also to create a more level playing field between players licensed under banking and payments pillars when they perform similar functions in similar fashion. Banking regulators need to be much more open to adopting the kinds of regulatory practices that payments regulators employ routinely when real-time technology platforms are used in a way that minimizes credit and counterparty risks. A key element here is cash in-cash out (CICO): it should not be any more difficult for banks to engage third-party CICO outlets than it is for EMIs, provided that all transactions happen securely on the bank´s technology platform in real time. Ignacio Mas is an independent consultant on mobile money and technology-enabled models for financial inclusion. He is also a Senior Research Fellow at the Saïd Business School at the University of Oxford, and a Senior Fellow at the Fletcher School's Centre for Emerging Market Enterprises at Tufts University. Previously, he was Deputy Director of the Financial Services for the Poor program at the Bill & Melinda Gates Foundation, and Global Business Strategy Director at the Vodafone Group.