Overview of UNSW DFS Research Project

There are a multitude of challenges in providing reliable digital financial services (DFS) to poor people in developing countries. To name just a few - these include a lack of reliable infrastructure, poor financial literacy, inappropriate product development and unduly burdensome or complicated regulation. There is no silver bullet to address these challenges - combined efforts are required. Our research focuses on the regulatory challenge of how to strike the right balance in regulating DFS in developing countries.

Laneway in Thamel - Kathmandu, Nepal. Photograph by Louise Malady

The developing country central bank that wants to regulate this area needs to think carefully. Less is more, most often, when it comes to DFS. The DFS Research Team at UNSW Sydney has done a lot of work to support local central banks in doing less, and doing it well. We have produced a Regulatory Handbook to address the questions developing country regulators have, and support them in thinking through the issues. We have also produced a Regulatory Diagnostic Toolkit to assist central banks to identify barriers and gaps in their regulatory regimes.

Typically, there are only three areas that initially call for regulation - the protection of the funds and of consumers, as these are essential to the viability of the ecosystem, and Anti-Money Laundering/Counter-Terror Financing (AML/CTF) regulation, as this is mandated by international agreements.

The traditional way to protect the funds is to require the provider to keep an amount equal to the amount of issued e-money on trust in an account with a commercial bank, and we have analysed how to do this. In civil law systems, which lack the legal institution of a trust, the task is more complex but the risks can be resolved in analogous ways, see our work here. We have also proposed that existing legislation which grants resolution powers in respect of financial institutions be expanded to cover any entity which provides e‑money because of the real risks posed by the collapse or uncertain viability of a significant e-money provider. This would mean a resolution authority would have the same tools available, and follow the same processes, if a provider was to experience financial difficulties as it would for a bank or financial institution.

The protection of consumers should enhance trust in the system but needs to be kept simple, and provide effective redress mechanisms. Sophisticated consumer protection rules are useless if a consumer, who has lost their money, cannot make a free call to a number that is answered reasonably promptly by someone who can fix the problem. Central banks need to focus as much on the redress mechanism’s effectiveness, by, among other things pretending to be distressed customers, as on the rules; as we have suggested. The other step that can serve to protect consumers is a simple provision that makes telcos liable for their agents’ actions. The money-in/money-out functions for e-money are typically provided by the same local storekeepers who sell airtime for the telcos. Some telcos insist these agents are independent contractors and the customer’s recourse ends, formally at least, with the agent. This is undesirable and this misleading allocation of responsibility should be prohibited, as we have explained here.

BNU Agents in Dilli, Timor Leste. Photograph by Louise Malady

In poor counties, AML/CTF regulations often cause more problems than they address, especially by dissuading banks from providing the accounts that low-cost money transfer operators need to provide affordable remittance services. The behavior of banks in closing these accounts is termed ‘de-risking’, but while it lowers the banks’ risks, it raises system-wide risks as it forces these essential remittances into informal, non-transparent channels. We have analysed how local regulators need more support in implementing proportional, risk-based, AML/CTF rules.   

Apart from expanding resolution powers and introducing “light-touch” regulations to protect the funds and consumers, and prevent money laundering and terrorist financing, our advice to regulators is to leave the sector alone in terms of rules and regulations. Let the sector flourish. Nurture it with central bank support, but don’t burden it with regulations suited to a bank that can generate serious risks. Regulators need to encourage providers to develop products suited to the local market, including encouraging products which earn interest or are fee free. Both telco product development teams and central bankers need to get out of the capital city and spend time in the villages talking to customer focus groups; for it is from meeting customer needs, understanding the customer journey, and providing an enabling, “light-touch” and nuanced regulatory regime, that a flourishing digital financial ecosystem will grow, to the benefit of the poor, especially those living outside the major cities.  

Swayambhunath, Kathmandu, Nepal. Photograph by Louise Malady

This project overview was prepared by Ross Buckley, King & Wood Mallesons Professor of International Finance Law, UNSW Sydney, and Louise Malady, Senior Research Fellow, UNSW Sydney.

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