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The Roadmap Approach to Regulating Digital Financial Services

ITU Workshop on “ Digital Financial Services and Financial Inclusion ” (Geneva, Switzerland, 4 December 2014). The Roadmap Approach to Regulating Digital Financial Services. Jonathan Greenacre Research Fellow, University of New South Wales j.greenacre@unsw.edu.au.

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The Roadmap Approach to Regulating Digital Financial Services

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  1. ITU Workshop on “Digital Financial Services and Financial Inclusion” (Geneva, Switzerland, 4 December 2014) The Roadmap Approach to Regulating Digital Financial Services Jonathan Greenacre Research Fellow, University of New South Wales j.greenacre@unsw.edu.au

  2. The Roadmap Approach to Regulating DFS • Part 1. What is proportionate regulation? • Part 2. The roadmap approach can help us design proportionate regulation • Part 3. Let’s apply the roadmap approach to storage and transfer of e-money • Part 4. Next steps

  3. The Roadmap Approach to Regulating DFS • Part 1. What is proportionate regulation? • Part 2. The roadmap approach can help us design proportionate regulation • Part 3. Let’s apply the roadmap approach to storage and transfer of e-money • Part 4. Next steps

  4. What is proportionate regulation? • Proportionate regulation: The costs of regulation must be proportionate to the benefits and risks of DFS. • We need to understand the relationship between benefits, risks, and regulation.

  5. The Roadmap Approach to Regulating DFS • Part 1. What is proportionate regulation? • Part 2. The roadmap approach can help us design proportionate regulation • Part 3. Let’s apply the roadmap approach to storage and transfer of e-money • Part 4. Next steps

  6. The method behind the roadmap approach • Incremental method: • Start with the most basic model of DFS; • Then examine more complex models, one building block at a time. • For each building block, determine: • Benefits; • Risks that come with those benefits; • Regulation that can deal with those risks.

  7. The Roadmap Approach to Regulating DFS • Part 1. What is proportionate regulation? • Part 2. The roadmap approach can help us design proportionate regulation • Part 3. Let’s apply the roadmap approach to storage and transfer of e-money • Part 4. Next steps

  8. Question: How can a regulator design proportionate regulation for storing customers’ funds? Benefits of storage Access to notes and coins Interest payments Economic growth Risks from storage Operational/technological Liquidity Insolvency Credit risk Bank failure Bond default Regulation Capital requirements Fund isolation Fund safeguarding Insurance for the issuer Insurance for the bank. Let’s use the roadmap to design proportionate regulation for storing customers’ funds Establish relationship Establish relationship Look at lending to establish the relationship between benefits, risks, and regulation.

  9. We set up the roadmap by putting benefits on one axis and risks on the other Benefits Risks

  10. Model 1: Our most basic model of storage Benefits No lending (basic model) Issuer Cash merchant Customer Risks

  11. There is no lending, so the benefits, risks and required regulation are very basic • Basic regulation • Consumer law; • Business conduct. Benefits Access to e-money No lending (basic model) Issuer Cash merchant Customer Risks • Issuer • Telecommunications; • Operational / technological; • Insolvency; • Liquidity.

  12. Model 2: Let’s add a building block: the issuer can invest customers’ funds (e.g. Bolivia, Indonesia, Namibia, Philippines) • Basic regulation • Consumer law; • Business conduct. Benefits Access to e-money Issuer lending Company Bonds No lending (basic model) Government/Central Bank Bonds Issuer Bank Cash merchant Customer Risks • Issuer • Telecommunications; • Operational / technological; • Insolvency; • Liquidity.

  13. Now there is lending, which creates additional benefits, risks, and required regulation • Moderate regulation • Previous regulation; plus • Issuer: prudential-like regulation; • Diversification; • Capital requirements. • Bank: basic prudential regulation. • Basic regulation • Consumer law; • Business conduct. Benefits Access to e-money Issuer lending Company Bonds No lending (basic model) Interest payments to customers Government/Central Bank Bonds Issuer Bank Cash merchant Customer Risks • Issuer • Telecommunications; • Operational / technological; • Insolvency; • Liquidity. • Issuer (previous risks); plus: • Bond default; and • Bank failure.

  14. Model 3: Let’s add another building block: the bank can lend out customers’ funds (Permitted in most countries, although limitations apply in Bolivia) • Moderate regulation • Previous regulation; plus • Issuer: prudential-like regulation; • Diversification; • Capital requirements. • Bank: basic prudential regulation. • Basic regulation • Consumer law; • Business conduct. Benefits Bank lending Interest payments to customers Access to e-money Lending to firms / financial markets Issuer lending Company Bonds No lending (basic model) Interest payments to customers Consumer lending Government/Central Bank Bonds Issuer Company Bonds Bank Government/ Central Bank Bonds Cash merchant Customer Risks • Issuer • Telecommunications; • Operational / technological; • Insolvency; • Liquidity. • Issuer (previous risks); plus: • Bond default; and • Bank failure.

  15. There is bank lending, which creates even more benefits, risks, and required regulation • Full regulation • Previous regulation (for previous risks); • Bank: more extensive prudential regulation. • Moderate regulation • Previous regulation; plus • Issuer: prudential-like regulation; • Diversification; • Capital requirements. • Bank: basic prudential regulation. • Basic regulation • Consumer law; • Business conduct. Benefits Bank lending Economic growth Interest payments to customers Access to e-money Lending to firms / financial markets Issuer lending Company Bonds No lending (basic model) Interest payments to customers Consumer lending Government/Central Bank Bonds Issuer Company Bonds Bank Government/ Central Bank Bonds Cash merchant Customer Risks • Issuer • Telecommunications; • Operational / technological; • Insolvency; • Liquidity. • Issuer (previous risks); plus: • Bond default; and • Bank failure. • Previous risks; plus • Full bank failure: • Exogenous; • Endogenous.

  16. Benefit 1 of the roadmap: groups our research into benefits, risks and regulation and shows the relationship between them • Full regulation • Previous regulation (for previous risks); • Bank: more extensive prudential regulation. • Moderate regulation • Previous regulation; plus • Issuer: prudential-like regulation; • Diversification; • Capital requirements. • Bank: basic prudential regulation. • Basic regulation • Consumer law; • Business conduct. Benefits Bank lending Economic growth Interest payments to customers Access to e-money Lending to firms / financial markets Issuer lending Company Bonds No lending (basic model) Interest payments to customers Consumer lending Government/Central Bank Bonds Issuer Company Bonds Bank Government/ Central Bank Bonds Cash merchant Customer Risks • Issuer • Telecommunications; • Operational / technological; • Insolvency; • Liquidity. • Issuer (previous risks); plus: • Bond default; and • Bank failure. • Previous risks; plus • Full bank failure: • Exogenous; • Endogenous.

  17. Benefit 2 of the roadmap: we can design proportionate regulation • Full regulation • Previous regulation (for previous risks); • Bank: more extensive prudential regulation. • Moderate regulation • Previous regulation; plus • Issuer: prudential-like regulation: • Diversification; • Capital requirements. • Bank: basic prudential regulation. • Basic regulation • Consumer law; • Business conduct. Benefits Bank lending Economic growth Interest payments to customers Access to e-money Lending to firms / financial markets Issuer lending I can use this regulation to deal with those risks Company Bonds No lending (basic model) Interest payments to customers Consumer lending Government/Central Bank Bonds Issuer Company Bonds Bank Government/ Central Bank Bonds Cash merchant Customer Risks • Issuer • Telecommunications; • Operational / technological; • Insolvency; • Liquidity. • Issuer (previous risks); plus: • Bond default; and • Bank failure. I want DFS to provide these benefits • Previous risks; plus • Full bank failure: • Exogenous; • Endogenous. This means I must deal with these risks

  18. Benefit 3 of the roadmap: we can identify unclear areas of law and research (in red) • Full regulation • Previous regulation (for previous risks); • Bank: more extensive prudential regulation. • Form of deposit insurance. • Moderate regulation • Previous regulation; plus • Issuer: prudential-like regulation; • Diversification; • Capital requirements. • Bank: basic prudential regulation. • Basic regulation • Consumer law; • Business conduct. • Civil law Benefits Bank lending Economic growth Interest payments to customers Access to e-money Lending to firms / financial markets Issuer lending Company Bonds No lending (basic model) to customers Consumer lending Government/Central Bank Bonds Issuer Company Bonds Bank Government/ Central Bank Bonds Cash merchant Customer Risks • Issuer • Telecommunications; • Operational / technological; • Insolvency; • Liquidity. • Issuer (previous risks); plus: • Bond default; and • Bank failure. • Previous risks; plus • Full bank failure: • Exogenous; • Endogenous.

  19. Now let’s use the roadmap to design proportionate regulation for transferring e-money between customers • Benefits • Transfer funds in small network (non-interoperable) • Transfer funds in a wide network (interoperable) • Transfer funds in the banking system How can a regulator design proportionate regulation for transferring customers’ funds? Establish relationship • Risks • Settlement • Systemic • ML/TF • Inflation Answer: look at thesize and type of participants to establish the relationships between benefits, risks, and regulation. Establish relationship • Regulation • Encryption • Guarantees • Identification • Capital requirements • Anti-money laundering • Liability rules • Issuer: • Capital adequacy • Liquidity • Bank: • Capital adequacy rules • Liquidity.

  20. Again, we put benefits on one axis and risks on the other Benefits Risks

  21. Model 1: Our most basic transfer model (Kenya) Benefits Non-interoperable (basic model) Issuer Customer Customer Risks

  22. Funds can only be transferred within a scheme, which means the benefits, risks, and required regulation are very basic Benefits Access to transfers within a scheme • Basic regulation • Business conduct • AML/CFT • Macro-economic policy. Non-interoperable (basic model) Issuer Customer Customer Risks • Settlement risk: • ML/TF; • Inflationary.

  23. Model 2: Let’s add a building block: funds can be transferred across mobile money schemes (Indonesia, Tanzania) Benefits Access to transfers within a scheme • Basic regulation • Business conduct • AML/CFT • Macro-economic policy. Interoperable Issuer Non-interoperable (basic model) Issuer Issuer Customer Customer Risks • Settlement risk: • ML/TF; • Inflationary.

  24. Now we have a system which increases benefits, risks, and requires more extensive regulation Benefits • Moderate regulation • Previous regulation (stronger application) plus • Issuer: interconnection • Capital/liquidity requirements Access to transfers within a scheme • Basic regulation • Business conduct • AML/CFT • Macro-economic policy. Access to mm transfer system   Interoperable Issuer Non-interoperable (basic model) Issuer Issuer Customer Customer Risks • Settlement risk: • ML/TF; • Inflationary. • Previous risks (made stronger); • Interconnection.

  25. Model 3: Let’s add another building block: funds can be transferred between mobile money and the banking system (Malawi, Tanzania) Benefits • Moderate regulation • Previous regulation (stronger application) plus • Issuer: interconnection • Capital/liquidity requirements Access to mm transfer system   Access to transfers within a scheme • Basic regulation • Business conduct • AML/CFT • Macro-economic policy. Interoperable with banking system Access to mm transfer system   Interoperable Bank Issuer Banking Clearing System Bank Non-interoperable (basic model) Bank Issuer Issuer Customer Customer Risks • Settlement risk: • ML/TF; • Inflationary. • Previous risks (made stronger); • Interconnection.

  26. Now the network includes the banking system, creating even more benefits, risks, and regulation to the previous two models • High levels of regulation • Previous regulation; plus • Banking risks • Issuer / bank: interconnection. Benefits • Moderate regulation • Previous regulation (stronger application) plus • Issuer: interconnection • Capital/liquidity requirements Access to mm transfer system   Access to transfers within a scheme Access to mm-bank transfer system • Basic regulation • Business conduct • AML/CFT • Macro-economic policy. Interoperable with banking system Access to mm transfer system   Interoperable Bank Issuer Banking Clearing System Bank Non-interoperable (basic model) Bank Issuer Issuer Customer Customer Risks • Issuers: previous risks (made stronger); • Banking risks; • Issuers – banks: interconnection. • Settlement risk: • ML/TF; • Inflationary. • Previous risks (made stronger); • Interconnection.

  27. Benefit 1 of the roadmap: groups our research into benefits, risks and regulation and shows the relationship between them • High levels of regulation • Previous regulation; plus • Banking risks • Issuer / bank: interconnection. Benefits • Moderate regulation • Previous regulation (stronger application) plus • Issuer: interconnection • Capital/liquidity requirements Access to mm transfer system   Access to transfers within a scheme Access to mm-bank transfer system • Basic regulation • Business conduct • AML/CFT • Macro-economic policy. Interoperable with banking system Access to mm transfer system   Interoperable Bank Issuer Banking Clearing System Bank Non-interoperable (basic model) Bank Issuer Issuer Customer Customer Risks • Issuers: previous risks (made stronger); • Banking risks; • Issuers – banks: interconnection. • Settlement risk: • ML/TF; • Inflationary. • Previous risks (made stronger); • Interconnection.

  28. Benefit 2 of the roadmap: helps us design proportionate representation I can use this regulation to deal with those risks • High levels of regulation • Previous regulation; plus • Banking risks • Issuer / bank: interconnection. Benefits • Moderate regulation • Previous regulation (stronger application) plus • Issuer: interconnection • Capital/liquidity requirements Access to mm transfer system   Access to transfers within a scheme Access to mm-bank transfer system • Basic regulation • Business conduct • AML/CFT • Macro-economic policy. Interoperable with banking system Access to mm transfer system   Interoperable Bank Issuer Banking Clearing System Bank Non-interoperable (basic model) Bank Issuer Issuer Customer Customer I want DFS to provide these benefits Risks • Settlement risk: • ML/TF; • Inflationary. • Issuers: previous risks (made stronger); • Banking risks; • Issuers – banks: interconnection. • Previous risks (made stronger); • Interconnection. This means I must deal with these risks

  29. Benefit 3 of the roadmap: we can identify unclear areas of law and research (in red) • High levels of regulation • Previous regulation; plus • Banking risks • Issuer / bank: interconnection. Benefits • Moderate regulation • Previous regulation (stronger application) plus • Issuer: interconnection • Capital/liquidity requirements Access to mm transfer system   Access to transfers within a scheme Access to mm-bank transfer system • Basic regulation • Business conduct • AML/CFT • Macro-economic policy. Interoperable with banking system Access to mm transfer system   Interoperable Bank Issuer Banking Clearing System Bank Non-interoperable (basic model) Bank Issuer Issuer Customer Customer Risks • Issuers: previous risks (made stronger); • Banking risks; • Issuers – banks: interconnection. • Settlement risk: • ML/TF; • Inflationary. • Previous risks (made stronger); • Interconnection.

  30. The Roadmap Approach to Regulating DFS • Part 1. What is proportionate regulation? • Part 2. The roadmap approach can help us design proportionate regulation • Part 3. Let’s apply the roadmap approach to storage and transfer of e-money • Part 4. Next steps

  31. We can use the regulatory roadmap approach for other areas of DFS No. of building blocks Etc Our aim: proportionate regulation of each of these financial services Insurance Loans Savings Real-time payments Mas and Almazán (2014)

  32. Discussion • Jonathan Greenacre • Email: j.greenacre@unsw.edu.au • Phone: +61 468 929445

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