> Posted by Elisabeth Rhyne, Managing Director, CFI

The following post was originally published last Friday on MasterCard’s Inclusion Hub.

When the Basel Committee speaks, everyone involved in the financial world pays attention. In their new report, it attempts to come to terms with financial inclusion.

As the global regulatory framework for banks, Basel III has no doubt featured in side conversations at Davos. Banking authorities around the world must make shifts to maintain the Committee’s concern with financial system stability, while opening the way for financial inclusion to advance. The new report is called “Guidance on the application of the core principles for effective banking supervision to the regulation and supervision of institutions relevant to financial inclusion.

….If that title grabs you, you might be one of those people who can actually read the document’s carefully worded prose.

In response to the guidance, I would like to share four broad observations, not so much about the specific guidance – which is generally sound – but about the challenges involved in adapting the work of banking authorities to the new world of financial inclusion.

The guidance is uneven in its coverage of new types of financial inclusion providers

The report goes deep on microfinance. It discusses, but has not yet fully explored, digital financial services, big data and new forms of consumer credit.

The implicit assumption throughout the report is that the biggest financial inclusion challenge is credit risk coming from small lenders. This underplays the extent to which financial inclusion also involves large non-financial corporations like telecoms companies and major retail chains. The techniques these players deploy may require supervisory approaches different than those for smaller institutions.

Granted, it may be too soon to have fully formed guidance for all of these emerging areas, but it is important for the Committee to implement distinct efforts to examine each of these new areas, in addition to the attention it pays to the important problem of how to supervise small financial institutions and credit providers that are not fully regulated.

Proportionality is an important principle – but doesn’t yet translate well in actual guidance

The idea behind proportionality is that the rigor of controls should be commensurate with the risks to be mitigated.

Given the small amounts of money involved in financial inclusion – both in terms of individual accounts and smaller financial service providers – proportionate should mean simpler in many cases.

Instead, proportionate seems to be synonymous with “tailored.” The guidance discusses tailored mitigation strategies for specific risks that arise with financial inclusion, but spends much less effort considering how to simplify.

There are two exceptions. For AML/CFT (anti-money laundering, anti-terrorist financing regulation, based on guidance from FATF), the recognition of low risk leads to tolerance of simpler KYC (know-you-customer identification) hurdles for small-value accounts.

For supervision of smaller financial institutions that cater to the poor, like credit unions or microfinance institutions, it allows for more offsite or “auxiliary” supervision: for instance, working with associations to take on some supervision tasks. For the most part, the report advocates quite stringent controls.

This has a big impact on financial inclusion: the small margins involved in accounts for low-income clients mean that tougher controls can lead financial service providers pulling back, reducing access.

Must access come only if new customers and new services have the same degree of protection as those already served? Let’s debate this important question. I can think of good arguments on both sides.

Financial inclusion places an enormous burden on banking authorities to master new skills and activities

Supervisors are asked to take on new roles: for example, more market monitoring, learning about new business models and technologies, collecting demand side data, coordinating across multiple government agencies, and extending their oversight to new entrants previously beyond their mandate.

Many of these roles are not just additional to current activities; they require different competencies. The challenge may overwhelm banking authorities in smaller or less developed countries. Though it would be great if supervisory agencies developed all the recommended competencies, they will need a lot of help to do so.

The institution-by-institution supervision that is the bread and butter of supervisors looks like only one piece of what’s needed for financial inclusion, as the recommended focus shifts towards more market-level surveillance.

Consumer protection gets more attention, but it is still a bit of a foster child

The Basel Committee’s document raises consumer protection issues. It notes that maintaining consumer confidence in the financial system is an important prudential concern that justifies consumer protection regulation.

What remains elusive is clarity about how to divide responsibilities between those responsible for prudential supervision and those responsible for protecting consumers. It’s no wonder, given the great overlap in the span of concern. The prudential section of the guidance covers issues ranging from over-indebtedness in the marketplace and fraud prevention, to the value of analyzing complaints information, data security risks and depositor protection for mobile money.

The guidance states that countries need to have an entity with a direct consumer protection mandate, whether within the prudential regulator or not, and urges cooperation among agencies. Like much of the guidance contained in the new document, this kind of inter-agency coordination is easy to recommend – but hard to do.

Regulators must reinvent themselves for financial inclusion

At the end of the day, I am left with the sense that although this guidance reflects a process still in progress, the Basel Committee has made an urgent effort to come to terms with the changes shaping the financial sector of the future.

Organizations involved with financial inclusion policy and regulation, like the Alliance for Financial Inclusion, the World Bank, and the Global Partnership for Financial Inclusion, must support regulators around the world to reinvent themselves for the tasks ahead.

In fact, everyone involved may now provide their own opinions: the document is open for public comment until March 31, 2016.

Have you read?

South Africa’s Proposed Credit Regulations Irk Credit Providers, Please Customers

What Kinds of Regulation Promote the Development of Microfinance Markets?

Financial Inclusion and the World Economic Forum at Davos