Regulatory Handbook: The Enabling Regulation of Digital Financial Services

Abstract

Financial inclusion is now a significant international policy goal. In developing countries, over one billion people are currently excluded from the financial system. Digital financial services (DFS) offer an effective means to include these people in the formal financial system and to thereby improve standards of living and reduce poverty. In order for DFS to promote financial inclusion, regulation must be enabling and supportive of innovation and highly cost-effective. This involves taking a proportionate, risk-based approach tailored to the local environment – not simply applying existing regulatory frameworks to DFS. DFS are essentially retail payment systems. Payment services are critical to financial inclusion; for without payment services financial services cannot be delivered. In the design of legal and regulatory frameworks, regulators must now consider financial inclusion objectives alongside safety and efficiency objectives. The successful regulation of DFS requires a fresh approach from central banks and regulators. In addition to developing enabling, risk-based DFS regulations, regulators should promote financial literacy, and work with DFS providers to create new products that are directly responsive to market need in their countries. This calls for a major reassessment of the role of central banks, requiring them, for instance, to understand the detailed needs and demand of consumers in their country for DFS. Regulators need to understand the risks inherent in different DFS models. DFS transactions are unique in that they usually involve agents and collaboration among a bank and telecommunications company. Unlike traditional banking, customer funds in DFS are not typically deposits and are not safeguarded by prudential regulation or deposit insurance. DFS models can subject customer funds to a range of risks, including insolvency, liquidity and operational risks of the provider but also the agent. Understanding these risks is essential to developing effective and enabling regulation for DFS.