Regulatory Handbook: The Enabling Regulation of Digital Financial Services

Regulatory Handbook:The Enabling Regulation of Digital Financial Services, December 2015

UNSW Law Research Paper No. 2016-05

125 Pages Posted: 15 Jan 2016

See all articles by Louise Malady

Louise Malady

University of New South Wales (UNSW) - Faculty of Law

Ross P. Buckley

University of New South Wales (UNSW) - Faculty of Law

Cheng-Yun Tsang

College of Law, National Chengchi University

Date Written: December 1, 2015

Abstract

Financial inclusion is now a significant international policy goal. In developing countries, over one billion people are currently excluded from the financial system. Digital financial services (DFS) offer an effective means to include these people in the formal financial system and to thereby improve standards of living and reduce poverty.

In order for DFS to promote financial inclusion, regulation must be enabling and supportive of innovation and highly cost-effective. This involves taking a proportionate, risk-based approach tailored to the local environment – not simply applying existing regulatory frameworks to DFS.

DFS are essentially retail payment systems. Payment services are critical to financial inclusion; for without payment services financial services cannot be delivered. In the design of legal and regulatory frameworks, regulators must now consider financial inclusion objectives alongside safety and efficiency objectives.

The successful regulation of DFS requires a fresh approach from central banks and regulators. In addition to developing enabling, risk-based DFS regulations, regulators should promote financial literacy, and work with DFS providers to create new products that are directly responsive to market need in their countries. This calls for a major reassessment of the role of central banks, requiring them, for instance, to understand the detailed needs and demand of consumers in their country for DFS.

Regulators need to understand the risks inherent in different DFS models. DFS transactions are unique in that they usually involve agents and collaboration among a bank and telecommunications company. Unlike traditional banking, customer funds in DFS are not typically deposits and are not safeguarded by prudential regulation or deposit insurance. DFS models can subject customer funds to a range of risks, including insolvency, liquidity and operational risks of the provider but also the agent. Understanding these risks is essential to developing effective and enabling regulation for DFS.

DFS ecosystems will not thrive unless consumers are well-treated and trust the service and system, so consumer protection regulation is essential for a thriving DFS ecosystem. It is important that regulators view DFS from the consumers’ perspective and understand how the consumer interacts with each participant involved in the typical DFS value chain.

In addition, as DFS delivery requires the use of agents, regulators need to develop an appropriate legal framework that clearly and effectively allocates agent liability. Without a clear liability chain, customer funds will not be adequately protected, and customers won’t know where to seek redress when they need it. Regulators need to understand the factors that shape the liability chain and then determine which liability rules to adopt to effectively allocate liabilities among principal, agent and customer.

The fear of failing to comply with international anti-money laundering and counter-terror financing (AML/CFT) rules has deterred most countries from taking advantage of the flexible Customer Due Diligence (CDD) requirements advocated by Financial Action Task Force (FATF) in 2013. DFS regulation should embrace tiered CDD requirements and flexible approaches to verification of customer identity suited to national conditions. National biometric identification initiatives will permit DFS to simply and cheaply achieve the CDD required to comply with AML/CFT requirements, and should be pursued by national governments.

This handbook has been designed to assist those responsible for regulating and supervising the use of DFS in emerging markets. A conservative one-size-fits-all regulatory approach is not appropriate for DFS because it is likely to stifle innovation, discourage new market entrants and inhibit the use of DFS to improve financial inclusion. By analysing the nature, risks and regulatory issues associated with different DFS models this handbook aims to equip regulators with the understanding necessary to develop effective and appropriate DFS regulation in their particular local context.

Keywords: Financial inclusion, digital financial services, regulation, poverty reduction, FATF, AML/TF, customer due diligence

Suggested Citation

Malady, Louise and Buckley, Ross P. and Tsang, Cheng-Yun, Regulatory Handbook: The Enabling Regulation of Digital Financial Services (December 1, 2015). Regulatory Handbook:The Enabling Regulation of Digital Financial Services, December 2015; UNSW Law Research Paper No. 2016-05. Available at SSRN: https://ssrn.com/abstract=2715350

Louise Malady

University of New South Wales (UNSW) - Faculty of Law ( email )

Kensington, New South Wales 2052
Australia

Ross P. Buckley (Contact Author)

University of New South Wales (UNSW) - Faculty of Law ( email )

Sydney, New South Wales 2052
Australia

Cheng-Yun Tsang

College of Law, National Chengchi University ( email )

Taipei, 116
Taiwan

HOME PAGE: http://www.law.nccu.edu.tw/people/bio.php?PID=267

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