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The CGD Podcast
No Trade-Off Between Financial Inclusion and Stability – Liliana Rojas-Suarez
00:21:14
While exciting new technologies for mobile money transfer deservedly make the headlines, there's a drier aspect of financial inclusion that doesn’t get as much attention: regulation. Liliana Rojas-Suarez visits the CGD Podcast to explain how...
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- [00:00]
A
Foreign.
- [00:07]
B
Thanks very much for joining me for this edition of the CGD podcast. Now, financial inclusion, it's such a buzzword right now, and rightly so. Bringing more people into the financial system empowers them, helps them make and receive payments safely, maybe even helps them save it helps them become more financially secure and that's good for development. But how does financial inclusion work? What's needed? Well, often we hear about great new schemes or technologies that enable money transfer, or sometimes we hear about the problems of money transfer. In fact, CGD's report last year on the unintended consequences of anti terrorism laws looks at exactly that issue. But today we're going to focus on a really important aspect of financial inclusion that perhaps doesn't get much attention, and that's regulation. How is the industry in the country set up and managed in order to grow that market securely and bring more people into the financial system? Well, CGD senior Fellow Liliana Rojas Suarez led a high level task force asking the question, how can financial regulation improve financial inclusion? The report is out and it gives more than 20 concrete recommendations for policymakers. And Liliana joins me today. Hi Liliana, lovely to see you.
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A
Hi Rakesh. Thank you for having me.
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B
Now, let's start from your perspective as a macroeconomist. Let's take this bird's eye view. Why is regulation important for financial inclusion?
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A
You know, Raquel, there are so many obstacles for financial inclusion, but regulation needs to be given a very high priority because there is no innovation that actually comes to life without the rules that determine how it's going to operate. In many countries, just simple instruments such as electronic money are not allowed to function. There is not a rule that actually lets the innovation work. And so you need the regulation that actually let it happen. But in addition to that, when you talk to regulators, they are usually very conservative in their mandates, as they should. They are concerned about the stability of the financial system, the integrity of the financial system, and to protect consumers. And then you want to tell them, well, you should also worry about financial inclusion. But the first question that is going to come to their mind is, yes, but if I have new rules for financial inclusion, how are they going to be aligned or not with my major objectives?
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The ones that are stability, security and protecting customers.
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Correct? Correct. So in this report, that's what we had in mind to try to respect. Not only respect, but elevate the mandates of the regulators and see how we can decide additional or complementary regulations that also permit to reconcile their objective, traditional objectives with the Goal of financial inclusion.
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B
So are they compatible? Can you have a system that is faithful to the traditional mandate? So protecting the integrity of the financial system, the stability of the financial system, protecting customers from fraud, as well as allowing or improving financial inclusion. What's your report say on that?
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A
Absolutely. Not only they are compatible, but they are necessary. You know, there is no way that you are going to get financial inclusion because if you have an unstable financial system, imagine a country that is passing through a huge hyperinflation situation. Well, nobody is going to be willing to put their savings in any financial institutions or trust their money, their funds to any institution because they just don't trust in the system. So to have financial stability is essential for having financial inclusion. At the same time, the more financial inclusion you have, actually that also contributes to stability because you are moving the funds that people are dealing with from the informal to the formal system. Because when one talks about financial inclusion, it's not that there is not financial dealings among the poor, it's that usually they take place in the informal sector at rates that are much beyond, you know, well above those that are in the market situation.
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B
You're talking about some money lenders now.
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I'm talking about money lenders. And what you are trying to do is actually move that into the formal economy, which actually complements the role, not only of stability, but of course, integrity.
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So, I mean, a lot of people would say that, you know, if you don't have a lot of money, if you have very little money and you then are connected to the financial system, some people might feel like they're losing control of their money a little bit. They might feel like it's safer with them. I'm assuming you don't agree.
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Absolutely don't agree at all with that. Actually, having cash is the most dangerous thing that you can do because you can lose it quickly. There's no records of funds. The moment you move to the different alternative of financial system, which, which could be through a traditional bank or could be through the services offered through electronic money by mobile network operators, there is a legitimate and official record of funds. Your money, where you have it, is recorded, so you have the right to it. And it's well established, when you have cash, it can actually disappear. You can lose it. There can be theft, it can be stolen.
- [05:41]
B
And so when you talk about mobile networks, I mean, the thing that springs to mind, the example obviously, is the very famous Kenyan M Pesa example, which is one of the things that you looked at in the report. But it's not Just about mobile networks as well. I mean, you looked at traditional institutions, banks as well, didn't you?
- [05:57]
A
Correct. You know, we, in the report, something that we have been very clear about is that we remain agnostic, we welcome different innovations, we welcome traditional and non traditional. We know that countries differ significantly among each other. We are not trying to say one way is going to be the panacea and that's going to be the dominant or one way is better than the other. What we are saying facilitate the operation of multiple systems and let the best go ahead and move forward. Financial inclusion.
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B
Your report has sort of three guiding principles which led you to come up with recommendations in different areas. So let's just talk about those three guiding principles. First of all, tell us, how did you approach this?
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A
Yes. When thinking about how to design the report, we went into the mind of the regulators to see what is the framework that they are used to, that they are comfortable with and that actually allows us to build a solution, solid framework for regulation. And there are three principles. The first one is that regulators agree that for the same function being provided, the regulatory burden should be the same. But that doesn't mean that all functions need to be regulated the same because some are riskier than others. And then the second principle hits, which is a risk based approach. The riskier the activity, the risk, the higher the regulatory burden. So those two principles are very common in the financial system. In the rest of the industries that are non financial. There is a third principle that is widely used and is balancing ex ante versus exposed regulations.
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B
Explain that.
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Yes, ex anti regulation is the set of rules that are already pre designed, preconceived, pre announced and you operate under those rules that never change. Exposed regulation is. I have a minimal set of ex antive regulation and then I give myself as a regulator the prerogative to intervene if I see that the market evolves in ways that are not desirable for society.
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B
Now I just want to sort of go back a couple of steps here because you know, here at CGD we try to get institutions and policy makers to think differently, do things in new and better ways. But you have used the guiding principles that regulators are comfortable with as the approach to this report. And I'm interested to understand what's the reason for that. Is it just the idea of being realistic about what's therefore likely to get adopted?
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A
Yes, in part. But I think there's a little more fundamental than that. You know, the risk based approach, believe it or not, is not that old. It's relatively new and was developed after major financial crisis in the world after the 2008 crisis. No, it was designed before that, but was enhanced after the global financial crisis. Even the functional approach, this way of thinking is relatively new and it responds to the over and over and over repetition of crisis around the world. So we actually agree with those principles. Without stability in the financial system, we don't think we can move ahead into any of recommendations. So because we are in agreement with that is the major reason why we take them. What many regulators in the financial system may not agree is that with ex ante exposed, the ex ante exposed, they are used to the exante regulations. They set up the rules that and this is the way banks are going to operate. The ability to intervene farther and give more freedom to markets and then let's see how operates and that's what we call it. Balancing is relatively new in the financial system and that's not widely adopted. It's widely adopted in other industries, but not in the financial system industry.
- [10:04]
B
So okay, given those guiding principles, then your report. There are quite a lot of recommendations here. 25, 25 recommendations. Concrete. I mean it's two or three pages worth of solid recommendations. But you've grouped those recommendations into three specific areas to help people follow them better and because those are areas that you want people to highlight and focus on. So tell us about those areas and why they're important.
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Right. We basically focus our recommendations on the area of competition, on the area of level playing field and on the area of know your customer.
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So let's unpick those. Let's start with competition. Your starting point, I'm assuming because this is all based around the idea of private sector involvement.
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Yes.
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Your starting point is that competition is good.
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Correct.
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So what should regulators do about it then? How do they increase competition?
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Right, right. The whole aim of the recommendations in the report in that area is to allow new entry entrance into the market with new players that bring new innovations. But pay attention, be careful that they do not create instability into the market.
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So are there examples of countries that do this well or examples of countries that don't do it so well?
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In terms of competition, there is no perfect example. Even countries like Kenya for example, that you mentioned that have actually had a hands off and allowed competition to flourish as much as possible. Still there are dominant players and you don't have what is called interoperability, meaning the capability of networks to interconnect between each other. So if you are a user of one network, you don't have the capacity to actually Send, transfer, say money to a user that is using another network. So even in those systems which are free, more free, like oriented, there is no perfect competition. So there's not a perfect example. There are many countries that in different ways are moving into that direction, but not the perfect example yet.
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B
What are the couple of countries that you studied or one country that you studied for the report? Give us a kind of case study.
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Well, Tanzania is in a very interesting situation and again, let me use the example of interoperability because actually it brings about something that here at the center for Global Development we care a lot, which is the role of the multilateral organizations and advanced economies. In Tanzania. The IFC, the International Finance Corporation here in Washington D.C. actually played a very interesting role. They acted as an honest broker in the discussions between the different providers of mobile digital financial services. And when it wouldn't come on their own, the IFC came as a mediator. This was a very interesting case because it actually freed the Central bank of Tanzania to having to take position favoring one side versus another. So the honest brokers were there to intermediate and interoperability emerged as a market based solution. To me that is an example that deserves more attention, including the capacity to see whether it can be replicated in other countries.
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Okay, so that's competition policy, one area of your recommendations. The next area, leveling the playing field. Explain a little bit about this.
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Yes, levelling the playing field is a set of recommendations that basically try to avoid the regulators themselves to actually distort or favor one provider versus another. Regulation should not be favoring one player versus another. So the basic idea is that if you provide the same function, the regulation should be the same unless there are differences in risk. Because here's where we are combining the two approaches. The functional approach and the risk based approach.
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B
Give me an example.
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Tell us about it. Yes, another case study is the case of the newly founded, newly created payment banks in India. The payment banks in India basically is a very simple bank format in which the only activity of the bank is to collect deposits but cannot lend. That's why it's called payments Bank. So they collect deposits and use the deposit for only one function, to buy government paper. What does this mean? At the end of the day? That means that they're making the deposit hundred percent safe. Okay, so this is a store of value, a deposit that is actually completely backed up by safe assets. And so.
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So it's not risky.
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It's not risky at all. You have eliminated the risk component of it. All Right, so now compare A different situation. Suppose now that you have other providers that are offering an electronic store of value, but that you do not regulate the way in which the funds from that electronic value are going to be used.
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So when you mean electronic store of.
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Value, for example, an E wallet.
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An E wallet, for example.
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Right. So if there is no regulation about what happens with those funds, well, the consumer could be at risk, right? I mean, the funds could not be secured with a safe asset backing it up.
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So some smart new technology firm that only exists online says, we're a store of money, you can come and deposit your money here.
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Right? Right.
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But it's not. What are they using that money for?
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If I don't know about that, then. Well, I raise questions, right? Because if I'm comparing the the same store of value, both are, one is called a deposit, the other one is an electronic wallet, but both are used for me to be able to save both same functionality. But in one case I'm confident that it's going to be safe. In the other case, I have doubts about it. Well, if you don't tell me what you're going to be doing with this instrument, then the regulatory birthing cannot be the same. Then you are not leveling the playing field. You are telling me, okay, you are riskless and then you can go ahead. I need to define what the funds are going to be used on.
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So even though the payment bank and the E Wallet, the technology company, are offering the same service, which is come and deposit your money with us because the payment bank is buying government securities, that's safe.
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Correct.
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Government's not going to default on those money is safe. But the E Wallet people, you don't know what they're spending that money on. So it's riskier.
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Correct. In the example I gave you. Because the truth of the matter is that I can also make an electronic wallet very safe, as safe as the payments bank, for example, I can require, and here's where the regulation comes to level the playing field. I can require that. That the funds that are being collected are being placed in a deposit in a pool account that is also protected by the deposit insurance. So I can make it as safe. And many countries are actually following that route.
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So actually, rather than seeing it as an extra burden on riskier players, it's an incentive for them to become less risky.
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Correct. It's because consumer protection, as I said, is one of the major mandates and, and one that we strongly agree.
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Competition policy, leveling the playing field. And the third area of recommendations is another really important aspect of financial systems and that's know your customer, whoever is dealing with whoever, they need to know who they are, to put it bluntly and not very plainly.
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Exactly, exactly. And you would think that this is an obvious one. However, it's not because most countries in the world don't have secure ID systems. So you actually don't know who you are dealing with. Now I'm going to say what does that do to financial inclusion? And the truth is, well, the regulators get very concerned about seeing all these illegal money moving and so they require lot of regulations for knowing your customer. Right. Well, what do you do if you are a bank and you have many customers and that you have these little customers that don't have their low income and therefore they're not going to bring large profits to your institution. They don't have a record of employment. They might not even have a record of formal address. They may not even have a birth certificate. So, you know, it's too difficult to meet the requirements of the regulator in terms of know your customer and, and at the same time serve these customers. So as a financial institution, what you tend to do is to ignore them. So our recommendations try to say no, hold on. You can achieve both goals at the same time and the way to do it is first recognize that risk matters as throughout the whole report. So if you're dealing with more customers, and I really constrain the amount of transactions to very low amounts and I tell you the balance that you can have in the account is X and it's a very small amount, you know, you would have to do an enormous amount of transactions to actually make a dent. So in that case, when you create what is called say a basic account, then the requirements on know your customers for these people could be much lower than for regular accounts in which you can demand more requiring it.
- [20:28]
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So we've covered the three basic areas of the recommendations in the report. Competition, policy, leveling the playing field, and knowing your customer. There are 25 recommendations. We can't go through them all, otherwise we would be here for a very long time. So I urge people listening to check out the report on our website, www.cgdev.org. all right, Liliana Rojas Suarez, great to talk with you on the podcast. Thank you very much for joining me.
- [20:54]
A
Thank you.
- [20:55]
B
I said it already. The website address for all our work is cgdev.org Please join me, Rajesh Merchant Dhani for the next podcast from the center for Global Development.