The Game-Changing Potential of a Regulatory Sandbox: Why Creating a Safe Space for Digital Innovation Is a Necessity for Financial Inclusion in Bangladesh
Bangladesh Bank, the central bank of Bangladesh has recently introduced a regulatory innovation office for fintechs under its Payment Systems Department, to better oversee the financial services providers and tech startups innovating around digital payments and other banking services. This office will enable the central bank to better focus on addressing the regulatory knowledge and awareness gaps of the market actors that are driving innovation in the country. This is also a part of Bangladesh Bank’s institutional strategic plan to attain a better understanding of how technology is impacting financial services markets, appraise the scope and nature of potential regulatory actions, and assess the need for reforms to the regulatory framework for digital financial services.
These moves could help address some of the obstacles facing the country’s financial sector. While Bangladesh has made notable progress in accelerating financial inclusion, challenges remain on both the access and usage fronts. The demand for technological disruption in the sector is all the more acute, given that around 50% of Bangladeshis still remain unbanked.
What’s Holding Back Digital Financial Inclusion in Bangladesh?
Digital financial inclusion has been held back in Bangladesh for a number of reasons, including:
- Lack of innovation in use-cases: The evolution of mobile financial services in the country has not progressed much beyond payments and cash in-cash out. Furthermore, the development of mobile money is also limited by a high percentage of over-the-counter transactions, which prevent the users from conducting self-initiated transactions. (Despite these issues, we admire the early efforts from both bKash and Rocket targeting some use cases in merchant payments over the past few years. Bank Asia, where I serve as a senior vice president, has also made significant efforts to innovate in lending, including through agent outlets targeting rural micro-entrepreneurs.)
- Lack of meaningful partnerships among market actors: There has been an enormous need for cross-industry partnerships among the key actors in the country’s digital financial services (DFS) ecosystem. A number of DFS partnerships among banks, mobile network operators, fintechs and microfinance institutions have failed to bring the expected positive market impacts due to conflicts of interest in the business models of agent network and distribution channel management.
- Lack of an early enabling policy environment: Government policies in Bangladesh play a major role in both encouraging and steering progress in financial inclusion – and holding it back. On one hand, the government’s Digital Bangladesh initiative and digitization programs for government-to-person payments have increased the number of people with financial accounts. For example, the Ministry of Education provided more than 15 million parents with mobile wallets, into which they receive their children’s primary and secondary education stipends. On the other hand, some government policies have been partially responsible for the absence of competition and innovation in the digital financial services space in Bangladesh. For instance, leading mobile financial services players have not been able to diversify their services beyond payments, because existing regulations don’t allow them to offer banking products. More focused policies encouraging digital finance for women and micro, small and medium enterprises need to be implemented.
Despite these challenges, new technology is opening up the financial services industry in Bangladesh. Leading banks and fintech players have jointly started exploring partnerships to offer innovative products such as digital credit and insurance: These products are being conceptualized, and new business models are being rolled out. For instance, the central bank has recently approved the first pilot for a digital nano loan product through a partnership between a private commercial bank and a mobile financial service provider. Emerging fintech players have the potential to bring new ideas to these partnerships with traditional financial services providers, eventually leading to an increase in competition that will benefit customers and the broader ecosystem. This makes a discussion on new regulatory approaches imperative for Bangladesh’s continued progress toward greater financial innovation and inclusion.
Advancing digital financial innovation through a regulatory sandbox
One way the government can respond to this growing need for new financial policy is through a “regulatory sandbox” approach. A regulatory sandbox provides a safe harbour for businesses to test inventive products, services and business models which aren’t protected within existing regulatory frameworks or supervised by regulatory institutions. It enables this testing to occur in a live market environment, while guaranteeing that appropriate safeguards are in place. It gives potential players access to regulatory knowledge, and provides regulators with a set of tools to facilitate the testing of innovative ideas on a small scale. Regulatory sandboxes are becoming popular in developed and developing countries around the world. Malaysia, Indonesia, Singapore, Thailand, Hong Kong, Kuwait, the United Kingdom, Australia and Canada all have introduced regulatory sandboxes. Regulators in more than 45 countries are working with sandboxes in their jurisdictions.
The objective of a sandbox is to start the discussion between innovators and regulators early on, bringing emerging innovations into the purview of regulators at an early enough stage that potential mishaps can be prevented. Currently, there is no national-level platform in Bangladesh where new ideas and innovations for financial inclusion can be tested or prototyped, to help both regulators and providers understand their probable impacts. A sandbox approach would create an environment where these innovations can be tested. This is especially important for Bangladesh’s emerging digital finance market, as it would allow financial organizations to develop innovations around areas like biometric ID, alternative credit scoring, electronic know-your-customer solutions, blockchain-based insurances or remittances, and new business models serving low-income populations. All these technologies can catalyze financial inclusion.
By leveraging innovation in the financial industry to achieve greater inclusion, a regulatory sandbox will help providers and regulators like Bangladesh Bank in the following ways:
- Reducing uncertainty for market players: A sandbox will support fintechs’ innovative projects by eliminating their doubts about the effects of various regulations on their work. It will also provide them with better access to the financial industry, as partnership proposals by local fintechs or IT companies are often declined by banks and similar financial institutions due to a lack of regulatory approval from the Bangladesh Bank. A sandbox will offer providers the power to test their products and services in an environment where the aftermath of failure can be contained, and reasons behind the failure examined.
- Substantially reducing time for seeking approvals: There is a queue of applicants for regulatory designation as payment service providers and mobile financial services subsidiaries at Bangladesh Bank. These applicants include diverse organizations ranging from banks and mobile network operators to local IT companies. Most of them have had to wait for more than a year to get these approvals, due to lack of appropriate harmonization between the central bank and the applicants: Sometimes an applicant fails to demonstrate the actual product or innovation, while other times the regulator doesn’t understand the innovation and its impact. Having a sandbox would not only reduce the time required to get approval for successful innovations, it would also give confidence to the regulator who’s evaluating applications, thus potentially reducing the cost of bringing innovative ideas to the market.
- Providing new perspectives to Bangladesh Bank: A sandbox would provide an opportunity for Bangladesh Bank to learn about emerging innovations and gain some perspective on these products’ various implications for customer protection. As disruptive solutions are tested, the bank might decide to innovate on its own approach, delivering a new dimension on issues such as customer protection and data privacy.
- Offering a better understanding of opportunities and risks: A sandbox would clarify any unforeseen risks or opportunities associated with innovative financial products and services. This could help the central bank craft a regulatory policy that ensures that appropriate guidelines are in place when products are launched.
- Providing an opportunity to test new regulations in a controlled environment and at a small scale: New products aren’t the only thing that could be tested in a sandbox. Regulatory approaches could also be experimented with, potentially involving anti-money laundering and know-your-customer requirements, enhanced safeguards for over-the-counter transactions, and new disclosure mechanisms.
- Promoting collaboration in Bangladesh’s digital finance industry: By encouraging innovations, a regulatory sandbox would allow industry players to start a dialogue with regulators. It would allow them to explore new products, business models and partnerships that likely would never be considered if they had to be treated as production-ready ventures.
What it will take to run a regulatory sandbox in Bangladesh
To establish a sandbox, the following issues would need to be addressed:
- Identifying the right approach: Bangladesh Bank may need to review different possible sandbox models and brainstorm a suitable approach. In the process, it would need to:
- Identify who will be allowed to join the sandbox: Will it be open only to startups, or also to incumbents with ideas for new products?
- Decide if there will be any specific customer target segments: Will the innovations serve the low- and moderate-income segment, higher-income customers, or all of the above?
- Determine which stakeholders will run and promote the regulatory sandbox
- Identify the sandbox’s relevant scope (i.e.: is it only for digital payment products, or will it cover various other forms of digital banking, mobile remittances, etc.), and set up indicators of success
- Developing capacity to manage the sandbox: Bangladesh Bank may need to promote an internal culture of supporting innovation, building its teams’ capacity and knowledge to manage the sandbox. Engaging with international experts who have advised other central banks on regulatory sandboxes would help bring new perspectives. The bank would also need to develop a robust plan to guide the implementation of the sandbox.
- Identifying any limitations on the sandbox: Bangladesh Bank would need to identify any barriers to innovation and competition in the country which a sandbox may not address – for example: the licensing framework for new products, the time taken to grant these licenses, questions about access to payment systems and data, etc.
It is essential to develop an ecosystem that facilitates and encourages innovation, and there are many potential benefits that could result from allowing new financial products and services to be tested for compliance before receiving regulatory approval. There is ample evidence that a regulatory sandbox approach can promote meaningful innovations across the various sectors of a financial system. But a sandbox doesn’t need to be limited to the central bank only. It can also enable an inclusive approach towards multiple sectors – such as insurance development, securities and exchange, microfinance, etc. – which are handled by separate regulators.
If the country moves ahead with the sandbox concept, industry experts believe Bangladesh could generate solid impact by encouraging mutually beneficial collaboration among cross-industry partners, including banks, microfinance institutions, mobile financial service providers and telecom operators. In the process, a regulatory sandbox could move the country towards achieving the Sustainable Development Goals by bringing more inclusivity and innovation into the financial sector, ensuring that its services leave no one behind.
Jakirul Islam is a digital financial services expert and a senior vice president at Bank Asia.
Photo courtesy of WorldFish.