Scaling up digital financial services: digital financial services are helping to lift millions out of poverty, but regulatory frameworks must improve if they are to expand.

Author:Polverini, Sacha

With 2bn people still unbanked globally, digital financial services (DFS) are providing millions of low-income people with the opportunity to access basic and affordable financial services. A functioning DFS ecosystem requires some key elements, including business models that can profitably handle low-value transactions, an accurate understanding of consumer needs, behaviour and drivers, and a regulatory framework that promotes a healthy and competitive marketplace.

However, regulating DFS in developing countries has proven challenging. DFS is a fast evolving industry with a host of new players such as telecommunications, retailers and alternative payment service providers that until now have not been part of the core financial services mix. Many of the current rules and definitions were developed for an industry that has gone through some major transformations as a result of the financial crisis and technical innovation. New players require different regulatory approaches. To build the right framework and guidelines, regulators need to first develop a proper understanding of the various risks involved, for both the financial system and end-users.

To properly identify and assess risks, data and experience are essential. With access to the right statistics, regulators can be far more specific about the size and frequency of risk and create more refined risk models. Finding the right balance is critical. Over-regulation could stifle innovation and kill any industry before it has the chance to develop and mature whereas underregulation can lead to abuses and excessive risk taking. The right data then needs to be combined with initiatives aimed at building local capacity so that policymakers can leverage past experience and ensure the safety of the financial system.

However, much of the data that helps assess risk, such as size and frequency of fraud, the recurrence of system breakdowns, the number of DFS-related consumer disputes or how often customers' funds are lost, is largely unavailable to regulators. There are no common global definitions, methodologies or even standards that local regulators can use to start collecting this data in a consistent and systemic manner.

International standard setting bodies have the ability, remit and reach to draw on international best practice and experience. They...

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