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This is a personal blog. Although the authors are affiliated with Coda Payments, the views expressed here are their own.


Entries in Regulation (9)


Central Banks aren’t accountable—by design

One of the risks that banks and non-bank financial institutions alike must manage is the untrammeled power that financial regulators have to make or break their businesses. Of course, plenty of other sectors are heavily regulated; but central banks are unusually muscular, independent regulators.

It turns out there’s a good reason for this. The original function of central banks, and their most important role even today, is managing the stability of the national currency. By creating money or taking it out of circulation (achieved these days by manipulating interest rates), central banks defend against inflation. It turns out that this is highly susceptible to meddling from politicians, whose calculus is short term and who often seek to interfere with decision-making at central banks in an effort to goose the economy and, at the same time, their own popularity. In the long run this kind of interference is disastrous, because it can lead to dangerous levels of inflation. For this reason, it has become customary to charter central banks with a very high degree of autonomy, and central bankers jealously protect this independence to preserve their credibility in the eyes of the markets.

Over time, the mandate of many central banks around the world has been expanded to include regulatory responsibilities created by legislation (for example, supervising banks) and in many cases to financial policymaking. This evolution was natural: central banks were and are well positioned to understand the inner workings of the financial system given their interest in the role that financial intermediaries play in money creation.

But a problem has emerged. In democratic societies, we expect that policymakers will be accountable to the will and interests of voters. Normally, when governments delegate policymaking (rather than embedding it directly into law) they do so by bestowing such authority on government agencies. While this insulates the policymaking process from seedy business of legislative horse-trading, it still leaves technocratic policymakers exposed to the pressures of democratic politics, since they are situated within bodies that are ultimately headed by politicians or political appointees.

When financial regulation emanates from an independent central bank, no such pressure is brought to bear. And this is something to worry about. There are too many countries where important innovations are being kept from consumers by financial regulators. To take just one obvious example, the governor of the central bank in Nigeria has decided that he doesn't think that mobile operators should be allowed to offer payment services. Given the power vested in his office, he has been able to bar them from doing so without giving much thought to whether ordinary Nigerians want or approve of this policy.

In cases like this, I can’t help but wonder if outcomes would be better if consumers’ voices were heard a bit more loudly in the policymaking process.


Joint ventures and misadventures, regulatory edition

Today in my Twitter feed I saw a number of links to a story indicating that the “Uganda Communications Commission (UCC) is partnering with Bank of Uganda to set new rules that will govern the Mobile Money trade.” The article doesn’t give specifics about how this is going to work, but it is emblematic of an emerging trend in which telco and financial regulators set out to regulate mobile money together.

Unfortunately, this is bad news, for a few reasons.

  1. In general, the only thing harder than getting a regulator to move quickly is getting two regulators to move quickly, together. This will be especially true given that, in every country I’ve worked in, these two regulators have radically different styles and approaches.
  2. Mobile money services are payment services, which financial regulators are competent to regulate. There is virtually no useful role for the telco regulator in such tie-ups, expect perhaps to help their colleagues understand a bit better how mobile networks operate (which of course they could do informally).
  3. The likely outcome of a collaboration between these two regulators is regulation that pertains specifically to mobile money. This is a mistake, because it means the financial regulator will have missed out on an opportunity to put in place more comprehensive payment system regulation that would support not just mobile money, but also other payment services, such as those that are card-based or offered by non-banks other than mobile operators.

Imagine for a moment (you will have to use your imagination, because I don’t think this has ever happened) that a bank decides it wants to get into mobile telecommunications, either by becoming an MNO or an MVNO. Would a special collaboration between regulators needed in order to oversee this novel arrangement? Of course not. The bank would need to apply for a license from, abide by the rules set out by, and submit itself to oversight from the telco regulator, in addition to its pre-existing obligations to the banking supervisor.

A less hypothetical example is Starbucks in the UK. When Starbucks wanted to get into payments, did the FSA need to draft special regulations in collaboration with the coffee-shop regulator? Of course not. Starbucks simply applied for an e-money license from the FSA.

I could go on, because this is kind of fun (what if a pharmaceutical company wanted to offer insurance? What if a cigarette company wanted to start drilling for oil?), but I think the point is clear. Mobile money is just another payment service. That it is offered by a company that is in another regulated business is not a good enough reason for create a cumbersome regulatory superstructure to oversee it. 


Be careful what you advocate for

There is a little back-and-forth in the comments of a recent post by Elisabeth Rhyne on the Center for Financial Inclusion’s blog that exposes one of the most interesting fissures in the financial inclusion community today. As John Gitau frames it, “The whole inclusion space is divided into two—the apologists of the need to design products and services for the BOP at their terrain and as per their needs and those who advocate for inclusion to entail bringing the low income into the light, the light meaning formal financial services.”

Although tendentiously put, the tension is real. The emergence of M-PESA has prompted a rethink what financial inclusion really is, and not everyone has come to the same conclusion. I once wrote on the MMU blog that M-PESA “opened the eyes of many of us to the fact that payments are an important financial need” that could be met by nonbanks. But others have reacted more warily, coming to view payment services as a dangerous detour from the pathway to high-quality financial inclusion, which is understood to feature a bank account as its bedrock. (I am not the first to notice the irony in the fact that a number of those in the latter camp were themselves champions of microfinance in the days when it was the nontraditional upstart fighting for legitimacy in the world of financial inclusion.)

That a debate between these camps is taking place is a good thing. The problem is the way the debate is being refracted in policymaking. Unfortunately, it increasingly seems that the debate among financial inclusion specialists about what would be best has unduly influenced the debate among policymakers about what should be allowed. It is one thing to argue that the poor would be better off with one kind of financial service (a deposit account) than with another (an e-money account). But it is quite another to deprive them access to the latter as a way of encouraging them to adopt the former. I feel increasingly certain that, in a number of countries, mobile money is being suppressed not because regulators fear that it is unsafe but because they fear it will become popular—perhaps even used by some as a substitute for deposit accounts.

This is regulatory overreach. Financial regulators have a duty to ensure the stability of the financial system and the safety of services that are offered in it. If there are those in the financial inclusion community who believe that payment services offered by nonbanks are so dangerous that they fall into the category of products which governments may justifiably prohibit—I am thinking here of assault weapons and (to take a financial example) Ponzi schemes—then by all means let them say so. But if they rather view mobile money is akin to, say, Coca-Cola—not the healthiest choice, but not so damaging that it can justifiably be withheld from customers who want it—then I would encourage them to make themselves more clear on that point, and to be explicit that they do not want policy used as a tool for imposing their preferences on the poor.


What does the appointment of Raghuram Rajan auger for mobile money in India?

India-watchers the world over have been cheered by Prime Minister Manmohan Singh's appointment of Raghu Rajan as India's chief economic advisor. Rajan, a professor at the University of Chicago, might be the most famous economist in the world for having predicted, three years in advance, the 2008 financial crisis and its causes.

Rajan is outspoken about India’s need for reform. In an April graduation speech, he was unsparing in his critique of India's government and governance. "The government does too much of what it should not do, too little of what it should do, even while being capricious and unaware of its limitations." He had this to say about those limitations, and while he wasn't talking about the Reserve Bank of India's approach to payment-system regulation, he might have been:

Our government is often unaware of its limitations. There is a lot we could learn from the rest of the world. China does not feel threatened by new information—it gets the best experts in the world to offer it advice, then it picks what it is persuaded by. Yet Indian administrators, apart from a few open-minded ones, feel threatened by new ideas. India is sui generis they maintain—that is, it is in a category of its own. So it has nothing to learn from the outside, from the Indian diaspora, or even from its own private sector. Whether this is a matter of convenience, allowing administrators to pursue their vested interests, or whether it is intellectual laziness, is unclear. Nevertheless, we keep repeating failed experiment after failed experiment, ignoring what has worked around the world.

Rajan, who calls "improving our financial markets and financial institutions" his "pet interest," has made no secret of his view that the Indian banking sector is sclerotic and subject to insufficient competition. For a sense of his views on what India needs to advance financial inclusion, we can look to a 2008 report by the Committee on Financial Sector Reforms, which Rajan chaired.

We see inclusion… as expanding access to financial services, such as payments services, savings products, insurance products, and inflation-protected pensions…. The focus should be on actually increasing access to [these] services for the poor regardless of the channel or institution that does this—large banks may or may not be the best way to reach the poor.

The report goes on to speak approvingly of the emergence of mobile money in Kenya and the Philippines, and explicitly poses the question of whether nonbanks should be permitted to offer payment services.

The Committee recommends that the regulator actively explore the channels by which non-traditional entities with extensive low cost networks (e.g., post offices), regular contact with the underserved (e.g., kirana shops, cell phone companies) or with some leverage over potential borrowers (e.g., buyers of produce, sellers of inputs such as fertilizers) could be used to provide financial services in a viable manner. While the business correspondent model will be one way these entities can link up to the formal financial system, the larger question, however, will be whether some non-traditional entities can directly and independently provide regulated financial services. For instance, should cell phone companies be able to offer account-to-account transfers without going through bank deposit accounts? The answer to these questions should be based on what is the most efficient way to provide services while imposing tolerable levels of systemic risk. Some of the new non-traditional players may be large and well capitalized (e.g., cell phone companies), and may therefore add less risk to the system than the existing reliance on some financial entities.

Why delve so deeply into the views of a man who, while no doubt influential, is taking up an advisory role in a country where so much of policymaking is shaped by the vagaries of politics? For one simple reason: the New York Times calls Rajan the leading candidate to replace Duvvuri Subbarao as head of the RBI when his term expires next year. Governor Subbarao has been an intractable opponent of allowing nonbanks to offer robust payment services in India, despite the mounting evidence that mobile operators in particular are uniquely well positioned to offer compelling payment services to the poor. To borrow words from Rajan, "whether this is a matter of convenience, allowing administrators to pursue their vested interests, or whether it is intellectual laziness, is unclear." But what is clear is that Rajan would bring a radically different approach to RBI. And that, in turn, would auger well for access to financial services for India's poor.


What lies between closed-loop and open-loop payment systems?

Around the world we see two very different kinds of payment systems that permit the storage of value in accounts other than traditional bank accounts. One is a so-called closed-loop system, in which customers are able to spend value they’ve deposited into their account only for goods and services offered by the provider of that payment system; usually, it is impossible to redeem this value for cash or transfer it to someone else’s account. Gift cards, transit (e.g. Oyster) cards, Starbucks cards, and so on fall into this category. Schemes like this tend to be very lightly, if at all, regulated, since it is hard to exploit them for money laundering or terrorist financing; they pose few systemic risks; and, since customers are unlikely to store large sums in them, scant attention is given to the question of whether customers will be able to get their money out of the system in the event that the provider becomes insolvent.

Open-loop payment systems, on the other hand, allow customers to spend value deposited into them at multiple merchants, transfer it to someone else, and/or withdraw it as cash later. Mobile money, pre-paid debit, and other e-money-based systems fall into this category. They are more heavily regulated, because these systems can be used to launder money; they can (if they grow large) pose systemic risks; and policymakers often feel that, if customers are told that they will be able to withdraw their money, then safeguards should be put into place to ensure that they will always be able to do so.

But although these two kinds of systems are regulated as discrete models, they are in fact situated on a continuum, and there are many interesting hybrids in between. Many supposedly closed-loop systems are not so closed in practice, and indeed there are strong commercial pressures on the providers of closed-loop services to open up by incrementally expanding the range of functionality they offer customers. A classic example of this evolution is the Octopus card, which was introduced as a way to pay for mass transit but can now be used to make purchases at retailers all over Hong Kong.

This is in part because it is easier for a lightly-regulated closed-loop system to incrementally add functionality that edges them along the spectrum toward openness rather than it is to seek regulatory approval to transform into fully-fledged open-loop service provider or to start a new such system from scratch. By adding the ability for customers to send airtime to each other on their networks, for example, mobile operators in a number of countries inadvertently created an unofficial domestic remittance system that has never become formally regulated as such.

This poses challenges for policy makers, who can either block these new hybrid models and the enhanced functionality they offer customers or find ways of coping with their emergence. RBI has drafted a framework for regulating “semi-closed” and “semi-open” payment systems, but rather than using these categories as a way to accommodate emerging service models, it has instead offered them as rigid prescriptions for what functionality may be offered to customers by systems that are regulated in each category. As such, it does little to foster the emergence of useful new open characteristics of closed-loop systems, which, after all, can benefit consumers, including the financially excluded, in interesting ways.