Regulation and Supervision
An enabling regulatory and supervisory environment strongly affects both the viability of the business proposition for providers of formal financial services at the base of the pyramid, as well as the value proposition for poor consumers that might induce them to choose formal financial services over informal options. When CGAP began its work on regulation and supervision to promote financial inclusion in the early 2000s, topics such as a flexible and risk-based approach to preventing money-laundering and terrorist financing and clear permission to do business through agents were not even on our radar screen. The same is true, with limited exceptions, of basic issues in financial consumer protection and market conduct of providers of financial services to the poor.
While our work has always focused on the question of what approaches to regulation and supervision promote an enabling environment for bringing poor customers into the world of formal finance, numerous forces have helped to drive a significant evolution in the range and type of issues considered in working to improve the enabling environment, including the following:
From microcredit to microfinance: A government’s potential role as the enabler of financially-inclusive business models through regulatory policy began to attract significant attention during the rise of microlending in the 1980s and 1990s. In many countries, governments removed regulatory barriers to nonbank microlending (by measures such as exemptions from interest caps that made such lending otherwise unprofitable, or by adopting regulation explicitly authorizing formation and operation of various types of nonbank microlending institutions where such authority was previously lacking or ambiguous). Although many of these institutions served their customers well and quickly grew beyond donor dependence (attracting interest from a burgeoning range of wholesale suppliers of debt investment), these institutions could not, by definition, offer clients much-needed savings services and those formed as NGOs could not attract equity investment. Increasingly, therefore, policy makers began adjusting regulation to enable new business models combining microlending with authority to accept retail deposits, by lowering minimum capital requirements and otherwise adapting prudential regulation so as to permit nondepository microlending institutions to transform and new ‘greenfield’ depository institutions to be established.
Regulating new actors in innovative financial inclusion: As financial inclusion came increasingly to be understood to include a variety of financial services that poor people want and use, regulators again came up against regulatory barriers that prevent the emergence of cost-lowering business models that could widen access for low-income people. These services, primarily electronic funds storage and transfer, often rely on mobile telephone technology to transmit transaction details, and retail agents as the principal customer interface. As a result, regulators are challenged to define the role of mobile network operators, retail agents, and other actors not previously subject to financial regulation and supervision.
Increasing global emphasis on combating money laundering and terrorist financing: Another force affecting the range of issues considered key to an enabling regulatory and supervisory environment for financial inclusion has been the broadening, in the wake of September 11, 2001, of global anti-money laundering (AML) and combating financing of terrorism (CFT) efforts. AML/CFT has been broadened to encompass all types of actors through whom money can be laundered or terrorist financing accumulated and transferred (not just the obvious mainstream financial service providers such as global banks). At the country level, policy makers’ desire to appear tough on these issues (and avoid their country’s blacklisting as “noncompliant”) has led to the adoption of some AML/CFT regimes that perpetuate financial exclusion. In recent years, recognition has grown that this is a bad result from a policy perspective, and that bringing poor customers into the electronically traceable world of formal finance serves both financial inclusion and financial integrity goals. This shift has been accompanied by increasing emphasis on identifying proportionate, risk-based approaches to rule making on AML/CFT.
Growing distinction between responsible and irresponsible financial inclusion: The heightened attention to financial consumer protection and market conduct triggered by the 2008-2009 global financial crisis—and simultaneous delinquency and over-indebtedness crises in the Indian state of Andhra Pradesh and some other microcredit markets around the world—have combined to underscore the important point that not all financial inclusion is healthy—or even in poor clients’ best interest. As a result, it is now more widely understood that policy and regulation must create the right “rules of the game” that will reinforce responsible practices and products from suppliers, in part so that poor people will trust them enough to choose formal financial services over informal. However, the specific approaches to regulation and supervision that will best promote responsible finance are still very much emerging topics of study and debate.
Global shapers of financial regulation and supervision embrace financial inclusion and endorse a proportionate approach: Perhaps the most fundamental force in the evolution of thinking about what approaches to regulation and supervision will best promote an enabling environment for financial inclusion—and in elevating the prominence of the subject—has been the increasing involvement of the G20 and global financial sector standard-setting bodies (SSBs). The G20 Leaders’ decision to include financial inclusion as one pillar of that influential body’s multi-year global development agenda, and to include among the elements of the G20’s Financial Inclusion Action Plan ongoing engagement with the principal SSBs to improve treatment of financial inclusion in their standards and guidance and financial sector assessments, has had a particularly important effect. Of the five SSBs that have been the focus of the G20’s financial inclusion work, three—the Basel Committee on Banking Supervision, the Financial Action Task Force (AML/CFT), and the International Association of Insurance Supervisors—have all recently revised their highest level normative standards to strengthen the proportionality principle: i.e., the balancing of risks and benefits against costs of regulation and supervision. While small transaction sizes don’t necessarily translate into low risk, a proportionate, risk-sensitive approach to regulation and supervision can lead to big gains for financial inclusion. And though work is still needed to develop guidance on how to apply proportionality in designing enabling regulatory and supervisory frameworks to promote responsible financial inclusion at the country level, the validation by the SSBs that “one size doesn’t fit all” is already significant progress because it has expanded the nature of the discussion of global financial standard-setting to consider the realities of low-access markets.
Even as the forgoing forces (and others) have driven significant change in the types of questions considered important in developing enabling regulatory and supervisory environments for financial inclusion, two essential considerations remain unchanged:
- First, the most enabling of regulatory and supervisory regimes cannot make a viable market for base-of-the-pyramid finance by themselves. There must also be providers who see a business opportunity and products that offer a superior value proposition that causes customers to choose them over informal options. Several countries have invested heavily in regulatory reform only to find no significant change because these factors were not considered.
- Second, investment in enabling regulation without investment in adequate supervision may also yield disappointing—or even counterproductive—results. Moreover, supervision of base-of-pyramid providers can raise many specific challenges, such as dealing with large numbers of small and often remote retail outlets in the case of financial cooperatives, or unbundling and rebundling of the financial service value chain in the case of branchless banking, with new actors such as mobile network operators and retail agents joining the picture and redistributing risk among them.
Topic Contact: Tim Lyman
- Financial Inclusion Guide: A Practitioner’s Resource for Navigating the Financial Inclusion Legal Environment, a collaboration between the Boston University Center for Finance, Law and Policy, and CGAP