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

2. 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. 3 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 The Roadmap Approach to Regulating DFS

4. 4 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. What is proportionate regulation?

5. 5 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 The Roadmap Approach to Regulating DFS

6. 6 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. The method behind the roadmap approach

7. 7 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 The Roadmap Approach to Regulating DFS

8. 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. Establish relationship Look at lending to establish the relationship between benefits, risks, and regulation. Let’s use the roadmap to design proportionate regulation for storing customers’ funds

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

10. Issuer AssetLiability CashCustomer account 1 Customer account 2 Customer account 3 Benefits Risks No lending (basic model) Customer Cash merchant Model 1: Our most basic model of storage

11. Access to e-money Benefits Risks Issuer Telecommunications; Operational / technological; Insolvency; Liquidity. No lending (basic model) Customer Cash merchant Issuer AssetLiability CashCustomer account 1 Customer account 2 Customer account 3 Basic regulation Consumer law; Business conduct. Basic regulation Consumer law; Business conduct. There is no lending, so the benefits, risks and required regulation are very basic

12. Access to e-money Benefits Risks Issuer Telecommunications; Operational / technological; Insolvency; Liquidity. No lending (basic model) Customer Cash merchant Issuer AssetLiability CashCustomer account 1 Customer account 2 Customer account 3 Bank Company Bonds Government/Central Bank Bonds AssetLiability Cash reserves Pooled account Issuer lending Basic regulation Consumer law; Business conduct. Basic regulation Consumer law; Business conduct. (e.g. Bolivia, Indonesia, Namibia, Philippines) Model 2: Let’s add a building block: the issuer can invest customers’ funds

13. Access to e-money Benefits Risks Issuer Telecommunications; Operational / technological; Insolvency; Liquidity. Issuer (previous risks); plus: Bond default; and Bank failure. No lending (basic model) Customer Cash merchant Issuer AssetLiability CashCustomer account 1 Customer account 2 Customer account 3 Bank Company Bonds Government/Central Bank Bonds AssetLiability Cash reserves Pooled account Issuer lending Basic regulation Consumer law; Business conduct. Basic regulation Consumer law; Business conduct. Interest payments to customers Moderate regulation Previous regulation; plus Issuer: prudential-like regulation; Diversification; Capital requirements. Bank: basic prudential regulation. Moderate regulation Previous regulation; plus Issuer: prudential-like regulation; Diversification; Capital requirements. Bank: basic prudential regulation. Now there is lending, which creates additional benefits, risks, and required regulation

14. Interest payments to customers Access to e-money Benefits Risks Issuer Telecommunications; Operational / technological; Insolvency; Liquidity. Issuer (previous risks); plus: Bond default; and Bank failure. No lending (basic model) Customer Cash merchant Issuer AssetLiability CashCustomer account 1 Customer account 2 Customer account 3 Company Bonds Government/ Central Bank Bonds Lending to firms / financial markets Consumer lending Bank Company Bonds Government/Central Bank Bonds AssetLiability Cash reserves Pooled account Issuer lending Basic regulation Consumer law; Business conduct. Basic regulation Consumer law; Business conduct. Bank lending Moderate regulation Previous regulation; plus Issuer: prudential-like regulation; Diversification; Capital requirements. Bank: basic prudential regulation. Moderate regulation Previous regulation; plus Issuer: prudential-like regulation; Diversification; Capital requirements. Bank: basic prudential regulation. Interest payments to customers (Permitted in most countries, although limitations apply in Bolivia) Model 3: Let’s add another building block: the bank can lend out customers’ funds

15. Interest payments to customers Access to e-money Benefits Risks Issuer Telecommunications; Operational / technological; Insolvency; Liquidity. Issuer (previous risks); plus: Bond default; and Bank failure. Previous risks; plus Full bank failure: Exogenous; Endogenous. No lending (basic model) Customer Cash merchant Issuer AssetLiability CashCustomer account 1 Customer account 2 Customer account 3 Company Bonds Government/ Central Bank Bonds Lending to firms / financial markets Consumer lending Bank Company Bonds Government/Central Bank Bonds AssetLiability Cash reserves Pooled account Issuer lending Basic regulation Consumer law; Business conduct. Basic regulation Consumer law; Business conduct. Moderate regulation Previous regulation; plus Issuer: prudential-like regulation; Diversification; Capital requirements. Bank: basic prudential regulation. Moderate regulation Previous regulation; plus Issuer: prudential-like regulation; Diversification; Capital requirements. Bank: basic prudential regulation. Full regulation Previous regulation (for previous risks); Bank: more extensive prudential regulation. Full regulation Previous regulation (for previous risks); Bank: more extensive prudential regulation. Bank lending Economic growth Interest payments to customers There is bank lending, which creates even more benefits, risks, and required regulation

16. Moderate regulation Previous regulation; plus Issuer: prudential-like regulation; Diversification; Capital requirements. Bank: basic prudential regulation. Moderate regulation Previous regulation; plus Issuer: prudential-like regulation; Diversification; Capital requirements. Bank: basic prudential regulation. Full regulation Previous regulation (for previous risks); Bank: more extensive prudential regulation. Full regulation Previous regulation (for previous risks); Bank: more extensive prudential regulation. Economic growth Interest payments to customers Access to e-money Benefits Risks Issuer Telecommunications; Operational / technological; Insolvency; Liquidity. Issuer (previous risks); plus: Bond default; and Bank failure. Previous risks; plus Full bank failure: Exogenous; Endogenous. No lending (basic model) Customer Cash merchant Issuer AssetLiability CashCustomer account 1 Customer account 2 Customer account 3 Company Bonds Government/ Central Bank Bonds Lending to firms / financial markets Consumer lending Bank Company Bonds Government/Central Bank Bonds AssetLiability Cash reserves Pooled account Issuer lending Basic regulation Consumer law; Business conduct. Basic regulation Consumer law; Business conduct. Bank lending Benefit 1 of the roadmap: groups our research into benefits, risks and regulation and shows the relationship between them Interest payments to customers

17. Moderate regulation Previous regulation; plus Issuer: prudential-like regulation: Diversification; Capital requirements. Bank: basic prudential regulation. Moderate regulation Previous regulation; plus Issuer: prudential-like regulation: Diversification; Capital requirements. Bank: basic prudential regulation. Full regulation Previous regulation (for previous risks); Bank: more extensive prudential regulation. Full regulation Previous regulation (for previous risks); Bank: more extensive prudential regulation. Economic growth Interest payments to customers Access to e-money Benefits Risks Issuer Telecommunications; Operational / technological; Insolvency; Liquidity. Issuer (previous risks); plus: Bond default; and Bank failure. Previous risks; plus Full bank failure: Exogenous; Endogenous. No lending (basic model) Customer Cash merchant Issuer AssetLiability CashCustomer account 1 Customer account 2 Customer account 3 Company Bonds Government/ Central Bank Bonds Lending to firms / financial markets Consumer lending Bank Company Bonds Government/Central Bank Bonds AssetLiability Cash reserves Pooled account Issuer lending Basic regulation Consumer law; Business conduct. Basic regulation Consumer law; Business conduct. Bank lending I want DFS to provide these benefits This means I must deal with these risks I can use this regulation to deal with those risks Interest payments to customers Benefit 2 of the roadmap: we can design proportionate regulation

18. Moderate regulation Previous regulation; plus Issuer: prudential-like regulation; Diversification; Capital requirements. Bank: basic prudential regulation. Moderate regulation Previous regulation; plus Issuer: prudential-like regulation; Diversification; Capital requirements. Bank: basic prudential regulation. Full regulation Previous regulation (for previous risks); Bank: more extensive prudential regulation. Form of deposit insurance. Full regulation Previous regulation (for previous risks); Bank: more extensive prudential regulation. Form of deposit insurance. Economic growth Interest payments to customers Access to e-money Benefits Risks Issuer Telecommunications; Operational / technological; Insolvency; Liquidity. Issuer (previous risks); plus: Bond default; and Bank failure. Previous risks; plus Full bank failure: Exogenous; Endogenous. No lending (basic model) Customer Cash merchant Issuer AssetLiability CashCustomer account 1 Customer account 2 Customer account 3 Company Bonds Government/ Central Bank Bonds Lending to firms / financial markets Consumer lending Bank Company Bonds Government/Central Bank Bonds AssetLiability Cash reserves Pooled account Issuer lending Basic regulation Consumer law; Business conduct. Civil law Basic regulation Consumer law; Business conduct. Civil law Bank lending Benefit 3 of the roadmap: we can identify unclear areas of law and research (in red) to customers

19. Regulation Encryption Guarantees Identification Capital requirements Anti-money laundering Liability rules Issuer: Capital adequacy Liquidity Bank: Capital adequacy rules Liquidity. Risks Settlement Systemic ML/TF Inflation 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? Answer: look at the size and type of participants to establish the relationships between benefits, risks, and regulation. Establish relationship Now let’s use the roadmap to design proportionate regulation for transferring e-money between customers

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

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

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

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

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

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

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

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

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

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

30. 30 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 The Roadmap Approach to Regulating DFS

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

32. Jonathan Greenacre Email: j.greenacre@unsw.edu.auj.greenacre@unsw.edu.au Phone: +61 468 929445 Geneva, Switzerland, 4 December 2014 32 Discussion