Regulatory Sandboxes: Potential for Financial Inclusion?
Many regulators need to address innovations that could advance financial inclusion without incurring major risks. Regulatory sandboxes have emerged as a tool that has potential. A regulatory sandbox is a framework set up by a regulator that allows FinTech startups and other innovators to conduct live experiments in a controlled environment under a regulator’s supervision. Regulatory sandboxes are gaining popularity, mostly in developed financial markets. With a few exceptions, the countries with regulatory sandboxes designed them to accommodate or even spur FinTech innovations; typically, they are not designed to focus explicitly on financial inclusion. This raises the question: Could regulatory sandboxes be useful in emerging markets and developing economies (EMDEs) to advance FinTech innovations designed to benefit unserved and underserved customers?
This question has piqued the interest of the financial inclusion community. For instance, a report that complements the G20 High-Level Principles for Digital Financial Inclusion refers to regulatory sandboxes as a means to balance innovation and risk in favor of financial inclusion. For now, evidence for the effectiveness of regulatory sandboxes is weak. The newness, variability and lack of performance data on sandboxes make it difficult (if not impossible) to measure their impact on financial markets, let alone on financial inclusion. However, our working hypothesis is that regulatory sandboxes can enable innovations that are likely to benefit excluded customers, regardless of whether inclusion is a key objective. FinTech innovations can lead to more affordable products and services, new distribution channels that reach excluded groups, operational efficiencies that make it possible to serve low-margin customers profitably and compliance and risk-management approaches (e.g., simplified customer due diligence and alternative credit scoring).
Three of the 18 countries where regulatory sandboxes have been or are being established — Bahrain, India and Malaysia — have explicitly listed financial inclusion among their key objectives. Other countries may follow suit depending on their policy goals, mandates and priorities. Policy makers who decide to make financial inclusion an integral part of their sandboxes could do so in several ways. For instance, they could favor pro-inclusion innovators with a more streamlined admissions process, licensing fee waivers, or performance indicators that measure innovations' impact on financial inclusion. By favoring pro-inclusion innovators, regulators could use sandboxes to measure innovations' potential impact on financial inclusion and tailor policy interventions to increase the benefits and mitigate the risks.
While there are good reasons to explore regulatory sandboxes, policy makers should be prepared to face challenges. Most importantly, operating a regulatory sandbox requires adequate human and financial resources to select proposals, provide guidance, oversee experiments and evaluate innovations. Regulators may lack these resources in many EMDE countries. Therefore, policy makers need to pay attention to details and carefully consider their options. These may include various sandbox designs and other pro-innovation approaches that have been used successfully. For example, the test-and-learn approach enables a regulator to craft an ad hoc framework within which an innovator tests a new idea in a live environment, with safeguards and key performance indicators in place. A wait-and-see approach allows a regulator to observe how an innovation evolves before intervening (e.g., person-to-person lending in China).
Regulatory sandboxes are too new to be fully understood and evaluated. In the absence of hard, long-term data on successful testing, their risks and benefits are speculative, but they deserve further attention. CGAP has conducted a comprehensive mapping of regulatory sandboxes to gain insights into their actual and potential role in EMDEs, particularly regarding financial inclusion. With our findings, we offer a compass for policy makers to navigate through this complex new landscape.
Apart from the positive benefits of a Regulatory Sandbox on Innovation(s), which might lead to Financial Inclusion/deepening as well, reduction of regulatory and reputation risks for Fintechs and established FIs would be a major reward. Due to the higher frequency of emergence of innovative products and services Regulators cannot simply wait for them to significantly grow to introduce regulations. By ensuring regulator's visibility and oversight over the emerging product/services during its testing in a live environment, Regulatory sandboxes will eliminate the risks to future innovations in case of major market failures, if any. Regulatory sandbox as a service may also be explored through Public Private Partnerships as the Regulator has the specific skill set and the overall industry would be the beneficiary. Regulatory surgeries by Regulatory experts or through the regulator for a developing idea might also be beneficial.
Dear Fahad Niazi, thank you for these important observations. In the upcoming paper, we will address some of these issues.