Lagos Business School Financial Inclusion Series

Regulatory Experimentation Can Boost Financial Inclusion in Nigeria, but is the Apex Bank Ready to Innovate?

With an impending deadline, the country’s apex bank will have to

FinTech startups are on the rise and challenging current regulatory frameworks.

By their nature, most tech startups (FinTechs in this particular context) are high risk endeavours, defined by uncertainty. They fail fast and often, making quick changes to their product and service offerings, always iterating and improving. It’s not strange to see a FinTech roll out 3 new products and updates all in the space of days or weeks (as against months or years). And the successful ones usually set out to solve a major pain point or problem in the community. Hence, FinTech products and services are reaching “the parts other beers cannot reach” or the parts traditional providers have failed to address!

FinTechs, like other technology disruptions, also have the potential to disrupt an existing market thereby taking customers from existing companies or creating a new market altogether. The increased interest in the cryptocurrency – Bitcoin – is one such example.

Regulators face a Catch-22 scenario. On the one hand, they want to maintain ecosystem stability, ensuring the integrity and survival of the financial services ecosystem. This demands firm regulations and enforcement on all players in the industry. On the other hand, they do not want to stifle innovation and development of the same ecosystem. A tightly regulated ecosystem could deter potential entrants (such as FinTechs) and probably kill off others.

So it is easy to understand how the nature of FinTechs and their rapid influx into markets would pose a serious headache for regulators. As much as regulators want to maintain the stability of their respective ecosystems, they also do not want to stifle innovation in the sector, especially from startups.

If the Central Bank of Nigeria is going to make significant strides in financial inclusion, if it is going to achieve its strategic financial system objectives such as the National Financial Inclusion Strategy (NFIS) as well as the Payment System Vision 2020, and if they are all going to be achieved within the proposed deadlines, then the role of FinTechs with their agile, experimentative business models and short turnaround times should obviously not to be ignored.

With the rise of FinTechs disrupting retail banking, payments, lending and savings using diverse technology infrastructure, financial inclusion can and should be enhanced. However, in spite of the technological advancements, these new entrants are still being limited by regulatory uncertainty, fear of disintermediation by incumbent financial institutions and obsolete identity management protocols.

The regulatory uncertainty facing FinTechs are as a result of their business models. These agile and primarily technology entities are seeking to reduce friction in financial services products by providing innovative technological solutions. In most cases, they offer financial services, but don’t fit conventional definitions of licensed financial services providers. How then can financial services regulators invigorate the industry through innovative products and services? How do they support the entry of such new entrants in a manner that does not put the entire financial system at risk? How do they regulate such institutions without prior knowledge of their impact (positive and negative)? How do these FinTechs continue to invest and develop products and services without the fear of reprisal or being shut down, especially when some have received private equity or venture capital?

Enter Regulatory sandboxes.

According to the U.K. Financial Conduct Authority (FCA), regulatory sandboxes involve temporary relaxations or adjustments of regulatory requirements (regulatory forbearance) to provide a “safe space” for startups and established companies to test new technology-based financial services in a live environment for a limited time, without having to undergo a full authorization and licensing process.

These sandboxes promote experimentation, they are not open-ended and have predefined restrictions including but not limited to:

  1. testing under regulatory supervision or in a controlled environment,
  2. client population or transaction limitations (sample size),

iii. limited test periods (time limit), etc.

As a new regulatory instrument, regulatory sandboxes could also support controlled experimentation of policy initiatives (like the 2012 cashless policy for example), providing some degree of regulatory forbearance over a period of time while evaluating the impact on market-specific challenges. So in essence, regulatory sandboxes are innovations used to manage other innovations (very meta, we know). A regulatory sandbox will allow trailblazers test their products and business models in a live environment with minimal regulatory requirements.

The concept of sandboxing FinTech innovations was first introduced in October 2014 in the United Kingdom. The U.K. process requires pre-authorisation approval from the Financial Conduct Authority (FCA). If approved, each FinTech is granted a customized authorization, including individual guidance and potentially including waivers to regulations if necessary. The FinTech is then permitted to test their service with real customers, as long as it stays within the authorized parameters. Active monitoring during the sandbox period ensures regulators are abreast of all issues and are involved in identifying solutions or possible regulatory or policy amendments.

The U.K. uses a “cohort” approach similar to what is obtainable in technology accelerators, initially accepting two batches of applications per year. The FCA assesses applications based on criteria including their innovativeness, benefit to customers, and readiness for live testing. So far, many of the successful applicants have been startups, though some established banks and other organizations have also made it into the cohort.

Since its introduction in the U.K., regulatory sandboxes have been utilised by a myriad of regulators in other countries to encourage and support innovations with minimal risk to the financial system. Over the past couple of years, several Central Banks across the world (in the USA, Malaysia, Australia and Singapore to name a few) have initiated regulatory sandboxes to open the door for growth in their financial sectors.

We believe that by adopting the use of regulatory sandboxes, government can take a more progressive and proactive approach toward FinTech innovation and realise their strategic goals. Sandboxes can be help provide the much-needed regulatory clarity to support FinTech innovations, minimise uncertainty levels, improve access to investments and also improve collaboration and cooperation between stakeholders and regulators. Where such sandboxes lead to regulatory or policy amendments, these amendments will attract even more innovators and investors in Nigeria’s emerging FinTech startup ecosystem.

For the regulators, the close interactions with FinTechs in the sandbox application and implementation process also provides a bridge to address knowledge gaps.

Win-win scenario.


Author Bio: Olayinka David-West & Ibukun Taiwo are members of the Sustainable and Inclusive Digital Financial Services Initiative at the Lagos Business School