A Hidden Driver of Financial Inclusion: Why Enabling Regulation is Essential to Fintech Success in Emerging Markets
In emerging markets the world over, fintech innovation is jumpstarting financial inclusion for unbanked consumers and small businesses. In the process, the fintech sector has become a key focus of both traditional and impact-focused investors. At the core of all this progress is enabling regulation – i.e., a regulatory process that enables innovators to experiment with new approaches, with the aim of increasing access to and usage of financial services.
For U.S.-centric investors, the goals of most regulatory oversight of basic financial services may seem cut-and-dried, even obvious: protect consumers, stop scammers, prevent egregious fee structures that unfairly impact customers who can’t afford them, and so on.
But for emerging markets in Latin America, Asia and Africa/MENA—where Quona Capital invests—the work of regulators isn’t so clear-cut. Indeed, their efforts are often muddied by political interests, regime changes and a lack of true autonomy – and in countries without easily accessible legacy banking systems, they essentially have to start from scratch. For many of these markets, that has sometimes led to an “anything goes” approach to regulation, in which no one is looking out for the interests of consumers – but this has started to change.
Early regulatory reforms in India and Brazil’s financial sectors
In 2015, when we launched Quona Capital – a venture firm focused on fintech in emerging markets – the green shoots of regulatory reform had already started to appear in some key markets, indicating the huge opportunity that was on the horizon. For instance, the National Payments Corporation of India, a division of the Reserve Bank of India, developed the Unified Payments Interface (UPI) in 2016, creating a set of standards that enable a single mobile application to access different bank accounts and move money immediately from anywhere, at any time. These efforts built upon the work of the Unique Identification Authority of India – led by digital visionary and Infosys co-founder Nandan Nilekani – to provide each Indian with a 12-digit “Aadhaar” identification number, similar to a Social Security number in the U.S. These initiatives have enabled a broader ecosystem for enrollment, updates and authentication services in the banking sector that can drive fintech products forward. Recently, many countries outside of India have begun to accept UPI to reinforce digital payments, including the UAE, Nepal, Bhutan, Singapore and, most recently, France.
Ten thousand miles away from India, in Brazil, the national government is creating regulatory frameworks to boost financial inclusion by bringing more competition to the country’s financial services market. Like many emerging markets, the top five incumbent banks in Brazil have historically controlled a large share of the market – in Brazil’s case, they account for almost 90% of all banking assets. The result? Bank fees in the country are extraordinarily high, and interest rates are amongst the highest in the world. Recognizing that this traditional model is not working, the Central Bank of Brazil decided to enable new regulations to fuel innovation and promote competition. Among the first steps they took was the deregulation of the merchant acquiring space – which consists of the financial institutions that enable retailers and other companies to accept credit card payments. This had previously been entirely controlled by just two companies, Visa and Mastercard. By breaking that system open, regulators allowed more players to emerge in this space, reducing costs dramatically, and making it possible for merchants of all sizes to accept debit and credit card payments. These measures are bearing fruit—the president of the Central Bank recently announced that concentration in the banking sector fell 10% in the past decade due to competition from new fintech entrants.
In both India and Brazil, these regulatory reforms are ongoing. The next step in India’s efforts will focus on cardless cash withdrawal. In May 2022, the Reserve Bank asked banks in India to enable the option of cardless withdrawal, so that anyone can get cash at an ATM by just inputting their UPI details for authentication. Such a move promises to improve convenience and security across India, as it can eliminate cards entirely—as well as the risks posed by card cloning and other frauds. This initiative could soon pave the way for cardless cash withdrawal among semi-urban and rural customers using the Aadhaar Enabled Payment System (which authenticates customers’ biometrics to allow merchants to accept payment from customers of any bank). Card usage is generally low among these customers, so these efforts could potentially increase financial access across the country. And India’s small and medium-sized businesses (SMBs) won’t be left behind, either: The Ministry of Micro, Small and Medium Enterprises also recently put out a draft policy outlining ways to transform the country’s SMBs with technology, regulatory improvements and more financing options.
Similarly, in Brazil, regulators have created a sequence of reforms across all areas of financial services. These reforms are creating new classes of payments and lending licenses to fuel innovation in credit and enable new types of digital payments, and allowing insurance providers to reinvent traditional products. And in 2020, the Central Bank of Brazil launched Pix, an instant payments network that, like UPI in India, is managed autonomously by the Central Bank, and that all financial institutions in the country are required to adopt.
Without a huge amount of buy-in from the governments of both countries, this level of adoption and innovation simply wouldn’t be possible. These successes show that progress requires not just a framework for regulatory reform, but the will and skill of local central banks to put reforms and resources into place. In other words, it’s a combination of vision and an ability to execute that makes for meaningful progress.
The opportunities and challenges of creating enabling regulations for fintech innovation
As these examples in Brazil and India demonstrate, an enabling regulatory framework is critical to fostering the kind of technological and business model innovation required to expand financial access and improve the quality of financial services. And other countries are increasingly seeking to emulate this approach. For instance, in the past three years, the Central Bank of Egypt has undertaken a concerted effort to accelerate the country’s modernization by digitizing the economy – taking a page from similarly ambitious initiatives in Brazil and India. In 2019, an electronic payments system called Meeza – supported by the Egyptian government (and quickly used to replace Egyptian state employees’ payroll cards) – was launched to help promote a cashless digital economy. In 2022, Egypt launched InstaPay, a national system for digital payments that lets people complete financial transactions instantly online across all of the country’s main banks. And earlier this year, Egypt’s largest national banks announced the launch of Nclude, a bank-backed venture fund focused on fintech for the masses.
But while regulators in emerging markets across the world are seeking effective ways to enable responsible fintech innovation, they haven’t all experienced the same level of success. Unlike Brazil — where fintech innovation has developed at pace with enabling regulation — progress has not been as smooth in much of the rest of Latin America, even in countries that have embraced the rhetoric of financial inclusion. The reason? Regulators in many countries across the region often lack the requisite independence and funding to enact reforms – in contrast to their peers in Brazil. In many cases, these countries’ actual reforms have either been mishandled or have failed to live up to the hype.
Take Mexico, for example. Though the Mexican executive branch released the Fintech Law in 2018 to help address regulatory gaps faced by the fintech sector, progress has been slow, with implementation of the law turning out to be more complicated than expected. Since the law’s passage, more than 50 companies have been approved or provisionally approved for payment licenses, while not a single new retail banking license has been issued: This is slowing innovation, as fintech innovators still need to link their accounts to licensed banks.
In other countries, we also see clear areas of fintech innovation that have not gained as much traction as they could have due to the regulatory limitations tied to them. For example, decentralized finance and cryptocurrencies have been particularly challenging to adapt in emerging markets because of a lack of regulatory understanding. Even in India, crypto and digital banking regulations still need more clarity, and as a result, the scaling of blockchain-based solutions has not made meaningful headway. By contrast, in the Philippines, the Central Bank has been more progressive with crypto and decentralized finance regulations, embracing feedback from the industry to drive changes within the regulatory system.
Challenges can also arise when companies try to implement new regulations. As if building a fintech company weren’t already challenging enough, fintechs must be careful not to get too far ahead of government mandates, lest they cause negative reactions. For example, Telda, an Egypt-based digital banking startup facilitating peer-to-peer payments, made premature claims in the media that it had been awarded a digital banking license, which appeared to have the effect of slowing down the consideration of other fintechs for this coveted classification throughout the country.
Education is often the first step in avoiding these sorts of issues and successfully putting new regulatory advances into practice. In Asia, several of Quona’s portfolio companies have been leaders in forming industry associations like the Digital Lenders Association of India, and in leading initiatives like the Indonesia Fintech Association, aimed at educating regulators on new technological innovations and working collaboratively to bring them to market.
Despite the challenges and uneven progress in devising appropriate regulatory approaches to fintech innovation, one thing is clear: Regulations like those driving India’s development of UPI or Egypt’s move to Meeza can boost financial access to the disenfranchised, reduce the cost of micro-transactions and protect consumers at the same time.
Experimentation is key to regulatory progress, and regulators would do well to pivot quickly away from regulations that don’t create the desired effect. Working together, fintechs and regulators can enable innovation to flourish, ultimately benefiting everyone.
Monica Brand Engel, Ganesh Rengaswamy and Jonathan Whittle are co-founders and Managing Partners at Quona Capital, a venture capital firm focused on advancing financial inclusion around the globe, particularly in emerging markets that include Latin America, India and Southeast Asia, Africa and MENA.