ith the ever-emerging technological disruptions in the financial services sector, financial regulation faces unprecedented uncertainties. These technological disruptions are an opportunity to the financial services sector as they promote financial inclusion, make it easier to iterate and deploy new financial services broadly, and increase disintermediation in the financial services sector.
FinTechs also enable different industries like telecommunications, traditional finance, and technology to converge and collaborate in providing efficient financial services and products. This creates borderless platforms and greater scalability hence enabling the availability of financial services that were once expensive or scarce.
FinTech Innovations in Uganda
Just like the rest of the world, Uganda is experiencing a surge in technology innovations in financial services. These innovations are creating new models and products of financial services and have greatly created new models of how payments and remittances are delivered; and are disrupting the banking intermediation space.
Banks are now utilizing distributed network of computer terminals and internet connectivity to extend services beyond brick and mortar branches, with internet banking over personal computers and using Automated Teller Machines. On 20th April 2018, an Automated Clearing House was put in place through which cheques and high-volume electronic funds transfers (EFTs) are cleared.
Mobile money payments infrastructure that is largely dominated and primarily operated by mobile network operators (MNOs) which are not conventional financial services providers has redefined the payments and remittances domain. This has been enabled by the proliferation and access to mobile telephones. Mobile money technology continues to accelerate innovation in conventional financial institutions.
Banks are now developing systems and applications to link their customers’ bank accounts with their mobile money accounts, enabling remote and convenient access to transact with their banks through their mobile phones. The Credit Finance Bureau uses algorithms to assess the creditworthiness of borrowers summarised in credit scores and accordingly inform risk management by credit providers.
Reacting to the Disruptions
The disruptions that have come with FinTechs are now straining the regulatory framework which has justified the need for regulation to ensure systemic stability, consumer protections and investor protections. The evolution of FinTechs in Uganda can be greatly associated with the emergence of mobile money which saw the Bank of Uganda issue the Bank of Uganda Mobile Money Guidelines, 2013 to regulate the mobile money industry since there was a regulatory gap on how the mobile money ecosystem could operate.
Another form of compliance requirement that is playing catch-up is the license for the provision of Digital Financial Services that is acquired from the Uganda Communications Commission. The existing regulatory structures are mere guidelines which do not have the force of the law and moreover do not encompass all aspects of the FinTech industry.
Regulatory Response to the emergence of FinTech in Uganda
In response to the regulatory gap, the Parliament of Uganda on 28th March 2020 passed the National Payment Systems Bill, 2019 which is awaiting the President’s assent to become law. The object of the bill is to regulate payment systems; to provide for the safety and efficiency of payment systems; to provide functions of the central bank in relation to payment systems; to provide for financial collateral arrangements; to regulate payment service providers; to regulate issuance of electronic money and provide for the oversight of payment instruments.
The Bill comes at the right timing where online activity and increased adoption of technological services is taking centre stage in the way financial services are delivered. FinTech Start-ups have the potential of creating disruptive innovative financial solutions and products that will compete with traditional models of finance. The lack of proactiveness in providing guidelines for FinTech is a sign that regulators are taking a wait and see approach. Going forward regulators need to focus on engagement of the stakeholders in the FinTech industry and have collaborative efforts.
Bank of Uganda as a primary regulator per the National Payment Systems Bill needs to look at regulation as a means for fostering innovation and promoting competition in financial services for the good of consumers. The bottom line is that the regulators need to strike a balance between promoting financial innovation and not creating barriers to innovation while ensuring financial stability and be accommodative to innovations that improve efficiency in financial markets.
Towards a Regulatory frameworks that supports FinTechs
In the FinTech ecosystem it is important for the regulator to understand that FinTech start-ups develop technology solutions to improve a particular financial service or product therefore a one-size-fits-all regulatory approach cannot be appropriate to create a good regulatory environment for growth.
A case in point are the issues and risks posed by the different technologies like mobile money which faces risks of different forms of fraud like identity theft through SIM swaps, fake currency deposits and social engineering scams; P2P lending platforms and crowd funding that have risks of fraud, consumer protection, authentication and identity issues that are posed by digital currencies and digital payment systems.
The National Payment Systems Bill 2019 under its clause 9 captures several eligibility requirements for acquiring a license to operate a payment system which puts into consideration the diverse abilities of the different FinTech products. As much as the Bill puts into consideration the diverse nature of different FinTech products, a further regulatory policy informed by the evaluation of the merits of each technology and which financial activity it is being applied to will be required.
Principles- Based Regulation and Self-Regulation
In an ever-changing world of technology, the regulator needs to be a principles-based regulator. Under Principles- based regulation the regulator is focused more on the out-comes and allows for flexibility in delivering services consistent with the outcomes the technology employed wants to achieve. In a world of technological innovations, it must be appreciated that a one-size fits all will likely stifle innovation as different FinTech products seeks to improve or disrupt a financial service.
With a principle-based regulator it would mean that programs that allow FinTech start-ups to roll out new services on a limited test basis for purposes of experimenting would be flexible to accommodate different Fintech products. The Financial Conduct Authority (FCA) of the United Kingdom is a principles-based regulator and its successes in the regulation of FinTechs can be manifested through the revolutionary regulatory sandboxes.
It is also important for regulators in developing FinTech ecosystems like Uganda to be in close contact with national FinTech associations. These associations are formed by a coalition of stakeholders in the FinTech ecosystem, such as financial institutions, start-ups, and venture capitalists. They collaborate to promote cross-industry cooperation and work to form cross-border strategies and regional integration. Uganda has such an association; the Financial Technology Service Providers’ Association (FITSPA).
Therefore, in an evolving regulatory environment like Uganda’s, the central bank should collaborate with FITSPA to enable it evolve towards becoming a self-regulatory organisation for players in the FinTech ecosystem while collaborating with the central bank. This will help in protecting the interests of the industry, develop regulatory approaches that foster innovation and establish codes of conduct that efficiently promote consumer protection and financial stability.
The Financial Technology Service Providers Association (FITSPA) partnered with Financial Sector Deepening Uganda (FSDU) to develop an industry code of conduct for all service providers in the FinTech industry. The code of conduct is mandatory and applies to all members and start-up members of FITSPA who are in the business of providing financial services. The code will among other things cover the following service providers: digital and mobile payment providers, payment gateways, e-money, cross-border payment providers, digital credit or savings, InsureTech, blockchain-based finance and crypto-assets, digital microfinance, digital pension and savings platforms, P2P lenders, and crowdfunding platforms.
The private sector is already showing potential towards self regulation hence Bank of Uganda needs to compliment and support these efforts towards an effective regulatory environment. In Indonesia, the P2P Lending Working Group, an offshoot of the Indonesian FinTech Association has matured to become a self-regulatory organisation – the Indonesian FinTech Lenders Association. The Indonesian FinTech Lenders Association provides public education campaigns, risk management certifications and a compulsory code of conduct for P2P lending. The Indonesian FinTech Lenders Association houses an online list of registered lenders and a consumer complaint center through which complaints can be sent via email or a toll-free hotline; the association also monitors credit growth and interest rates from online lending to prevent over indebtedness for its borrowers.
The association then reports any misconduct to the Indonesian FinTech Lenders Association. All this response was informed by the rapidly growing P2P lending market in Indonesia that accounts for 30 percent of all licensed Fintech companies in Indonesia. The Indonesian FinTech Lenders Association issued Regulation No. 77/2016 for P2P lenders that has shaped all these developments.
The program for experimenting is commonly referred to as a “Regulatory Sandbox” which is provided for under Clause 16 of the National Payment Systems Bill 2019. The clause gives the Central bank the mandate to establish a regulatory sandbox framework for purposes of governing the manner in which a person may obtain limited access to the payment system ecosystem to test innovative financial products or services and the framework shall prescribe the criteria and minimum requirements for operation a sand box and the manner in which to conduct the sand box.
The regulatory sandbox framework established by the central bank shall then be the basis for eligibility and approval for any person who wishes to operate a sandbox. Sandbox approaches are intended to help regulators better understand new technologies and work collaboratively with industry players to develop appropriate rules and regulations for emerging products, services, and business models.
How the Regulatory Sandbox has shaped the growth of FinTechs in United Kingdom
The Financial Conduct Authority of the United Kingdom as part of its broader Project Finance launched the first FinTech regulatory sandbox in June 2016. This allows FinTech start-ups to test innovative products and services in a safe, live environment with consumer safe-guards and when appropriate exempt from some regulatory requirements.
In the first year of the operation of the sandbox, 90 percent of firms that completed testing in its first cohort were continuing towards a wider market launch, and more than 40 percent received investment during or following their sandbox tests.
The essence of the Sandbox is to have Fintech solutions experimented in an environment where actual products or services are provided to customers but within a well-defined space and duration where the consequences of failure can be contained hence the impact of any failure on consumers and on financial stability can be limited and contained.
As regulatory sandboxes continue prove to be an appropriate mechanism for Fintech regulation that is supportive and accomodating innovation, the greatest potential for the sandbox tool is in experimenting and testing of the evolving RegTech approaches to re-conceptualize the future of financial regulation.
RegTech refers to the use of technology in the context of regulatory monitoring and compliance. RegTech automates processes which allow efficient risk identification and regulatory compliance. The advantage of RegTech to the regulator is that it provides real time insights and continuous monitoring capacity through deep learning and Artificial Intelligence filters which identify problems in advance rather than enabling enforcement action after the fact. This is a great transformation in the approach to both finance and its regulation.
Regulators therefore need to use technology to address challenges of monitoring and enforcing new regulatory requirements in a rapidly growing sector of FinTechs that is facilitating the development of cross-border markets and disrupting traditional models of financial services. Therefore, to ensure financial stability and limit risks to consumers, regulators are bound to adapt to the use of RegTech.
RegTech adds value to regulators by assisting them understand innovative products and complex transactions, market manipulation, internal fraud, and risks in real time. Therefore since regulators are going to have to deal with large volumes of data and information reported to them, it is essential that regulators develop systems to appropriately monitor and analyse these data sets using technology such as artificial intelligence and deep learning which has the potential to automate supervision, prudential regulation and consumer protection.
Therefore going forward the regulator needs to create principles-based regulatory environment that is flexible to support and accommodate innovations as well collaborating with the stakeholders in the industry to come up with efficient sandboxes and develop RegTech to improve the efficiency of the regulator while ensuring consumer protection and prudential regulation.