Imagine Roberto Campos Neto, Maxwell Opoku-Afari, and Ravi Menon walk into a bar to discuss the regulation of innovation. This could be the beginning of a bad joke or a great conversation. The three leaders in innovation regulation – from Brazil, Ghana, and Singapore, respectively – represent distinct examples of regulators leveraging innovation to promote competition, advance financial inclusion, and build a globally recognized innovation hub. In a forthcoming report, CGAP features the stories of these leaders, their teams, and the organizations they work for, and how they exemplify what we call ‘vision-guided regulation’ – a regulatory approach characteristic of modern-day financial sector regulators that revolves around five elements of (i) vision, (ii) tone at the top, (iii) innovation culture, (iv) industry engagement, and (v) mandate. These elements are new strands in the regulatory DNA, making regulators better equipped for the world of fast-paced innovation and sophisticated technology. But what are the ways in which regulators harness innovation?
Tracks for harnessing innovation
There are two distinct ways in which regulators harness innovation that sometimes overlap and inform each other. Regulators create regulations that set the rules for the deployment of innovation in the market by a new entrant or incumbent. Let’s call it ‘the policy track’. They also build infrastructure that uses innovation and/or enables innovation – ‘the infrastructure track’.
The infrastructure track responds to the gaps in infrastructure that pose obstacles to achieving policy objectives (notably economic development and competition). The role of the regulator is to build or contribute to building the infrastructure needed or enable financial service providers (FSPs), including nonbanks, to access and benefit from existing infrastructure. In recent years, the focus of this track has been on digital public infrastructure (DPI). Under the infrastructure track, policymakers harness innovation to solve an existing problem (i.e., biometric IDs) or to create a new market opportunity (i.e., customer data sharing via open finance). This could involve deploying new technology to build a piece of infrastructure or upgrading the existing one. Examples of the infrastructure track include CBDCs (Brazil, Ghana, Nigeria), IDs (India, Indonesia), instant payments, and open finance (Brazil, Chile, India, UK).
The policy track may advance policy objectives such as financial inclusion and competition, and as such, have market-making or market-promoting elements (e.g., introduction of bespoke digital banking licenses in Hong Kong, Korea, and Pakistan). Or, it may be a response to the needs of the industry (or customers) expressed either through market developments (e.g., an innovation gaining traction among customers) or voiced needs (e.g., demands for regulatory certainty, applications for a license, industry associations’ lobby). Under the policy track, the role of the regulator is to come up with an adequate regulatory response – amending or re-interpreting existing rules, adopting new rules, addressing uncertainty through guidance (e.g., mobile money regulation over a decade ago in Kenya and Ghana, or more recently, bespoke regulation of virtual assets in Hong Kong, Turkey, and elsewhere).
In both the policy and the infrastructure tracks, the private sector plays a role to a varying degree. For instance, private sector players can build infrastructure such as ID solutions, data exchanges, and credit bureaus. New types of providers may self-regulate in the absence of regulation imposed by the public sector agencies. Whether and how much the private sector is involved in either track depends on local factors. And the level of involvement oscillates from very low to very high.
Supporting functions
In addition to the policy and infrastructure tracks, there is also an inward-looking track (‘SupTech’) focused on harnessing innovation to enhance regulators’ operations either by supporting (e.g., receiving regulatory returns digitally), enhancing (e.g., automated filing system), or overhauling (e.g., pulling regulatory data from FSPs through APIs instead of receiving traditional regulatory returns) existing solutions or by adding new solutions (e.g., social media sentiment analysis).
Besides these tracks, regulators should also establish two supporting functions informing the tracks: (i) ‘steering’, and (ii) ‘screening’. Steering is a function performed at the top management level of the regulatory authority with the objective of aligning regulatory activities with the broader national policies (where they exist and matter) and ensuring appropriate prioritization and coordination across the tracks. The steering function often manifests through a vision/strategy document or statements, and implementation roadmaps.
The screening function provides input into both the policy and the infrastructure tracks, identifying existing market demand and/or opportunities for policy interventions. The screening function can be exercised through multiple instruments from various market monitoring tools (market scan, license applications, queries from varied stakeholders, industry consultations, surveys, regulatory reporting, economic analysis), specialized units (innovation hub, regulatory sandbox), peer learning (exchanges, workshops, conferences), and capacity building (individual training, technical assistance).
The two functions are indispensable in the current era, but they require well-developed systems for triage (prioritization) and information sharing across the regulatory authority and beyond. The former ensures that the limited regulatory resources are spent strategically and in the most efficient and effective manner. The latter ensures timely collaboration among various units within the organization and across regulatory agencies.
Bringing it all together - strands and tracks
The new DNA strands and tracks for harnessing innovation are key enablers of success for regulators in ensuring innovation helps advance financial inclusion, and simply to succeed in navigating the fast-changing world of finance. In the forthcoming report, we dive deeper into the five elements of vision-guided regulation and lessons learned that can be useful to regulators anywhere in the world.
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