From hedge funds like Numerai to personal loan providers like Prosper, financial technology (FinTech) firms are bringing to market new solutions to increase efficiency and inclusiveness in banking and financial services. The potential of FinTech is even greater in emerging markets. Economist Irving Wladawsky-Berger wrote, “For the billions around the world without access to traditional financial services … FinTech could be their ticket to financial inclusiveness and membership in the global digital economy.”
Firms leveraging machine learning, such as Lendable (a debt platform for African alternative lenders) and Destacame (an alternative credit scoring platform), can help developing countries leapfrog over many stages of development in the financial sector. Central bankers are hopeful, but also aware that regulatory barriers can significantly slow down or prevent FinTech innovation. For the last two years, the main policy tool used to support the development of the FinTech sector has been the creation of regulatory “sandboxes.” Similar to sandboxes used in the tech industry, where developers test software in a segregated environment to avoid risks to the wider system, these regulatory sandboxes allow firms to test solutions in a controlled environment for a set duration (typically 6 months) without immediately imposing the usual regulatory costs and approval procedures. This process allows innovators to test their products and understand what regulatory boundaries may eventually apply once they have “graduated” from the sandbox. At the same time, it gives the regulator time to learn before making a decision on how to regulate new products and services.
The regulatory sandbox approach was pioneered in the UK in 2015 with the express purpose of speeding up the FinTech product development and launch cycle. Since then, nearly a dozen other countries, including Australia, Singapore, and the United Arab Emirates, have followed. Sandboxes are at an early stage of development in other countries, including Brazil, India, and Kenya.
Though it is too soon to tell what impact the sandboxes will have on the broader trajectory of financial innovation (most of these companies are still in an early stage of product testing), the first lessons are coming through. In many countries, impact so far appears limited. Singapore currently has just one recruit in its sandbox, while Canada and Australia (which is considering a redesign) have just two reported recruits. In May 2017, both Malaysia and Thailand admitted four companies to their sandboxes, while the United Arab Emirates accepted five. The UK sandbox, however, has gained the most traction. In the first two cohorts, the Financial Conduct Authority (FCA) received 146 applications and admitted 41 to the testing phase. This may be partially due to the UK’s advantageous environment for FinTech, which includes additional regulatory measures that promote FinTech innovation alongside the sandbox, such as tax policy to support business creation (e.g., tax deductions for investors in seed-stage start-ups), training and assistance to startups, conducive business regulation, and strong protection of property rights. However, in October, the FCA reported its first observations from the initiative, which prompted the Financial Times to share doubts about its real benefits.
Going beyond regulatory sandboxes
In most emerging markets, regulatory sandboxes alone will not generate the desired innovation in financial services; FinTech firms and investors consider much more than the availability of a regulatory sandbox when evaluating market and investment opportunities. Therefore, emerging market governments need to take a holistic approach to creating business environments that truly enable FinTech innovation and address the many challenges that can prove fatal to the growth of FinTech firms. To catalyze FinTech innovation, governments and investors should consider these nine interventions:
Support measures for FinTech start-ups
1. Support FinTech directly. Governments can support the local entrepreneur ecosystem through conferences and events, and by supporting FinTech accelerators, incubators, and common workspaces.
2. Adopt FinTech early. Governments should start using FinTech solutions to create business opportunities for FinTech firms, build trust in new technologies and providers, and therefore encourage citizens and businesses to embrace new technology-based solutions.
3. Enact favorable fiscal policies. Policies such as lower tax rates for startups and subsidies for angel investors can encourage investment in new businesses.
Digital and financial infrastructure
4. Improve digital connectivity. Weak connectivity and costly data—likely due to weak infrastructure and/or limited competition—will limit the potential market for FinTech products and services.
5. Support growth of digital financial services in both the telecommunications and financial sectors. Broadening financial inclusion through digital services such as mobile money can unlock new business opportunities for FinTech firms and investors. Interoperability—meaning the ability for customers to transfer money across different providers—would reduce costs and increase the addressable market for FinTech firms by enabling them to reach more customers with a single integration.
6. Encourage open data, payment channel access, and open APIs. Enabling fair access to important telecommunications and payment channels—such as the USSD gateway, bank ATMs, or the more than two million small retailers (agents) where mobile money customers can conduct transactions—can foster FinTech-driven innovation. Governments can also encourage banks and other private-sector players to develop open application programming interfaces (APIs) to make data more accessible. This would allow third-party developers to build next-generation products and reduce their time to market. Governments can lead by example by facilitating access to government databases related to identification (national identity data, for example), business, and property registration, which would help the digital onboarding of clients.
7. Improve ease of doing business. Streamline the process and reduce costs for starting and closing a business. For example, enact flexible labor laws that help FinTech firms attract and retain talent, such as enabling tech skilled workers from Bangalore—the Silicon Valley of India—to work in East Africa.
8. Simplify processing of personal data. The ability to collect, analyze, and share personal data is critical to FinTech innovation. While data protection rules should ensure that individuals’ rights are protected, overly burdensome requirements (such as prohibitions on selling or sharing data even with customer consent) should be avoided.
9. Create an even playing field. Make sure appropriations rules allow FinTech start-ups to bid on public projects and contract with public agencies. Enforce competition regulations to create an even playing field for new competitors.
To create an environment that truly enables FinTech innovation, public-sector stakeholders should strive to understand business barriers, and consider the whole package of incentives from the perspective of FinTech firms and investors, rather than just jumping on the regulatory sandbox bandwagon. Although there are many benefits to sandboxes, creating an ecosystem where FinTech can thrive will require a holistic and multi-dimensional approach.