MICROFINANCE PAPER WRAP-UP: “Policy Framework on the Regulation, Licensing and Supervision of Digital Banks,” Published by Alliance for Financial Inclusion

This report provides a framework for regulators and policymakers seeking to improve the way they govern digital banks, with a focus on increasing financial inclusion. It draws on “in-depth secondary research and extensive consultation with [Alliance for Financial Inclusion] member countries and regulators in other jurisdictions, and other relevant analysis of developments in financial inclusion and DFS [digital financial services].”

Digital banks may offer more robust options for consumers than typical DFS providers while also being a lower-cost alternative to traditional banks. Digital banks can be regulated either through existing frameworks for banks or through separate, targeted sets of regulations. The authors posit using the following determinants when approaching potential regulatory changes: (1) the policy objectives of the regulator; (2) the maturity of the jurisdiction’s financial market; (3) “non-financial enablers,” such as the prevalence of smartphone usage; and (4) the adequacy of existing bank regulations for regulating digital banks. The authors note that all jurisdictions that developed a specific set of regulations for digital banks cite financial inclusion as a driving factor.

Some jurisdictions have used a licensing approach to limit the entry of new digital banks to ensure sufficient monitoring capacity. To establish a licensing regime for digital banks, the authors suggest the following steps: (1) create plans for increasing financial inclusion; (2) ensure strong “technological and financial skills” among management and board members of digital banks; (3) present clearly defined “operational and IT [information technology] risk management strategies,” especially related to services that are outsourced; and (4) build a strong exit plan to reduce harm to customers in case of bank failure.

The authors express concern over large non-financial companies – specifically technology companies – purchasing controlling stakes in digital banks and this leading to “market conduct and consumer protection challenges.” To minimize these risks, there must be a “clear demarcation between the non-financial activities of these shareholders and those of the digital banks” to maximize the extent to which the interests of the digital banks remain aligned with increasing financial inclusion. Other concerns include cybersecurity and data privacy, which can be mitigated partially via digital financial literacy programs. Finally, the authors recognize that supervisory bodies have to make significant changes to adapt to the differing structures of digital banks, including through the use of regulatory technology (regtech) to “gather granular data” and “monitor the social media trends” of digital banks.

This is a summary of a paper published by the Alliance for Financial Inclusion, November 2021, 34 pages, available at https://www.afi-global.org/wp-content/uploads/2021/11/DFSWG-framework_FINAL.pdf

By Bradley Shulman, Research Associate

Additional Resources

Alliance for Financial Inclusion homepage
https://www.afi-global.org/

More MicroCapital paper wrap-ups
https://www.microcapital.org/?s=wrap

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