Financial Inclusion and Disruptive Innovation: Regulatory Implications

Executive Summary 

Innovations in digital financial services (DFS) have driven strong advances in financial inclusion in emerging markets and developing economies (EMDEs). Past growth in DFS has benefited from basic regulatory enablers such as nonbanks gaining permission to issue electronic money (e-money), the use of agents as delivery channels, risk-based customer due diligence (CDD), and financial consumer protection tailored to the digital context.

The current wave of innovative business models, products and services, and technologies further disrupts financial services and creates new opportunities to meet the needs of underserved and low-income customers. Increasingly novel and complex innovations bring new risks and challenges for regulators and supervisors.

Global standard-setting bodies (SSBs) and other experts are building a good foundation of literature and guidance on regulating new innovations. However, it mainly focuses on issues of stability and integrity, giving less attention to consumer risks and financial inclusion opportunities. It also tends to look at specific innovations in isolation rather than through a holistic approach that considers whether the legal framework, institutional structures, supervisory approach, and organizational culture are adequate and flexible enough to accommodate a range of current and future disruptive innovations, and counts financial inclusion among its primary policy objectives.

To help fill this gap, CGAP explored the latest wave of disruptive financial services innovations to better understand the regulatory changes that allow EMDEs to harness their financial inclusion potential while containing consumer and financial sector risk. For our review, we segmented these innovations into three dimensions:

1. Business model innovations such as digital banking, fintech activities, and platform-based finance.
2. Product and service innovations, including digital credit, crowdfunding, crypto assets, and central bank digital currencies (CBDCs).
3. Innovative technologies that underpin these models and products, such as distributed ledger technology (DLT), artificial intelligence (AI), application programming interfaces (APIs), cloud computing, and biometrics.

Choices on how to regulate and supervise these innovations have important implications for financial inclusion. CGAP’s initial research found three cross-cutting themes to be most relevant: defining the financial sector regulatory perimeter, managing relationships between different types of authorities, and balancing different policy objectives. This paper provides a synthesis of disruptive innovations in digital financial services and their regulatory implications for financial inclusion. Further, it recommends using these themes to frame a basic stocktaking exercise to identify areas for regulatory action.

The paper’s intent is to encourage regulators to consider a more holistic approach in response to disruptive innovation, as opposed to one focused on individual innovations. Moreover, this working paper lays the foundation for ongoing CGAP work on recommendations for regulators on how to best harness innovation for inclusive finance.