Risk-Based Supervision in the Digital Financial Inclusion Era
In recent years, supervisory agencies have seen their responsibilities expanding substantially and their capacity and resources lagging behind, while the international community has not developed enough guidance on ways to improve supervisory effectiveness. This is especially true in emerging and developing economies where digital financial inclusion is advancing. Supervisors once responsible only for prudential supervision of a few banks now may also find themselves supervising microfinance institutions and issuers of electronic money, may have seen financial consumer protection, financial education and financial inclusion added to their mandates, and must in any event keep abreast of fast-paced technological innovations (including a proliferation of FinTech companies).
The G20 Global Partnership for Financial Inclusion’s (GPFI’s) recently published white paper identifies lack of supervisory capacity (in terms of resources, staff, expertise and tools) as one of the key challenges facing financial sector supervisors in emerging markets, among other institutional and operational challenges. The white paper recommends several ways to address these challenges. One of the recommendations in particular strikes a chord: the development of more specific guidance on risk-based supervision of financial providers targeting excluded and underserved consumers. As Christine Lagarde (Managing Director of the International Monetary Fund) recently noted, effective supervision is key to the success of financial inclusion efforts.
A risk-based approach to supervision, familiar to many prudential supervisors, helps supervisors to strategically allocate and use their scarce resources, as well as prioritize and adjust interventions according to identified and properly assessed risks. In addition, financial sector standard-setting bodies have already incorporated this in high-level guidance. Even so, there is still an urgent need to provide a more practical guidance on how to implement a risk-based approach in markets with low supervisory capacity, high numbers of unserved and underserved populations, and dynamic changes triggered by digital financial inclusion.
Supervisors could implement the approach to balance various supervisory and policy objectives—safety and soundness of individual institutions, and overall financial stability, integrity, consumer protection and inclusion—while targeting the most imminent and/or relevant risks. Among these four objectives, consumer protection deserves special attention. According to the GPFI white paper, the increasing challenges to effective consumer protection posed by digital financial inclusion and emerging consumer risks further support the need for specific guidance on risk-based consumer protection supervision.
The effectiveness of risk-based supervision, regardless of its focus, depends heavily on high-quality data, which low-capacity supervisors often find lacking. Practical approaches to effective data collection and analysis in the course of market monitoring and individual firm assessment (offsite and onsite supervision) may help supervisors overcome their capacity challenges. For example, supervisors would benefit from recommendations on what data to collect, what sources to use, in what form and through what channel data could be more effectively collected, how to verify data consistency and accuracy, or how best to analyze data. Discussion on the advantages and challenges of alternative types and sources of data would also be useful in the present context where supervisors are starting to explore sources such as complaints databases, social media, and customer surveys, whereas financial service providers are using technological innovations that facilitate not only delivery of financial services (FinTech) but also compliance with financial regulations (RegTech). Supervisors would also benefit from recommendations on how to establish effective cooperation among the multiple supervisors typically involved with digital financial inclusion and among other supervisors, public authorities and private sector actors.
Supervisors would also benefit from learning more about new supervisory tools, which could help them effectively implement a comprehensive risk-based supervisory framework. In addition to traditional techniques and tools, more work is needed to develop and promote new supervisory tools influenced by developments in digital financial services, including consumer-centric instruments (e.g., mystery shopping, consumer testing, focus groups), and technological innovations that hold great promise to directly improve supervision, including new technology such as distributed ledger and geospatial analysis.
Implementing a risk-based approach to supervision is a complex process that requires time and resources and may not be accomplished all at once but rather in stages. Sequencing may be needed to accommodate not only the supervisor’s capacity, but also the capacity of supervised entities to fine-tune their IT systems, reporting protocols, compliance processes and the like. In any case, training, knowledge-sharing and knowledge-exchange efforts will be important to help supervisors strengthen their capacity and deal with challenges brought about by digital finance.
As the GPFI white paper points out, multiple actors ranging from local to multilateral organizations and standard setters can play a unique role in improving supervisory capacity; this is especially true vis-à-vis the implementation of a comprehensive risk-based approach. All these efforts focused on risk-based supervision may be the key for supervisors to effectively promote stability, integrity, protection and inclusiveness in a fast-evolving digital finance universe using new techniques and technologies.