As Egypt is moving towards adopting a unified national strategy for financial inclusion, there has been a need to define the legal framework, says Refaat
As published in our July - August 2021 issue and provided by ECSS studies
The world has been undergoing rapid and successive technological developments across almost all sectors, extending to the monetary and financial sectors, giving rise to new and innovative financial products and services.
As Egypt is moving towards adopting a unified national strategy for financial inclusion, expanding the beneficiary base of non-banking financial activities, and enhancing their efficiency and reducing the cost of using them, there has been a need to define the legal framework that govern these innovative financial systems, ensuring protection of investors’ rights, establishing the basis for sound financial transactions, and promoting a favorable investment environment.
Hence, the cabinet’s decision to approve a draft law on “Regulating and Promoting Fintech in Non-banking Financial Sector” with the aim of supporting financial inclusion policy, increasing the number of beneficiaries of the non-banking financial services, and reducing the cost of using those services and activities. This article discusses mechanisms to leverage the benefits and opportunities that FinTech provides for the non-banking financial sector and the management inherent risks.
FinTech can be defined as a set of financial technologies that can be utilized in the delivery of innovative and state-of-the-art financial services or improving the traditional financial services by reducing on cost and promoting fast and easy delivery of those services, ensuring access to financial services to a larger number of users which promote financial inclusion services, drive innovation and entrepreneurship, and boost financial development and economic growth.
Fintech products take many forms including digital currencies, cryptocurrencies, e-payment, mobile payment, and digital financial platforms such as barter platforms, peer to peer lending, and crowdfunding.
Globally, FinTech applications have contributed to facilitating banking and financial services, making lending without commercial banks’ intermediation possible, facilitating and accelerating payments and transfer of funds, developing low-cost investment methods through financing platforms, offering solutions to obstacles in the financial sector, and addressing financial services industry challenges, all of which have contributed to enhancing productive sectors and boosting economic growth rates.
With the spread of COVID-19 and the restrictions imposed on direct interactions, there is a growing reliance on innovative financial services as well as a significant increase in digital and e-transactions which suggests that FinTech will be an integral part of the world’s future.
The non-banking financial sector is recognized as being complementary to the traditional banking sector for its role in the mobilization of savings, generating sources of funding for economic ventures and individuals, enhancing the flow of investments, protecting rights and property, and bolstering investors’ confidence, contributing towards economic development.
Unquestionably, financial innovations have a significant role in maximizing the efficiency of non-banking financial services. For example, looking at the capital market, we find that financial innovations make it more attractive to investors, improve its quality, and help make data available. This, in turn, contributes to increasing the trading volume and reducing concentration of capital, which translates into more capital for companies and causes the trading rates to approach to the securities’ fair value. Thus, market indicators become more of leading indicators of the economic activity, truly reflecting the economic situation, minimizing risks and boosting the economic growth.
Considering the insurance business –which traditionally relies on historical data analysis for assessing risks, predicting the likelihood of those risks occurring in the future, and determining price of insurance policy– there’s a great potential to leverage the advances of financial technology, allowing for big data analyses and capitalizing on blockchain technology to serve the insurance industry.
Turning to micro, small, and medium enterprises, we find they are growing significantly in Egypt and absorb large numbers of employers, yet the banking financing opportunities available for them are way less than those available for large firms. Fintech would help in this as it promotes safe access to financial services by providing financing services through digital platforms such as barter platforms, peer to peer lending, and crowdfunding.
With regard to real estate financing, FinTech provides state-of-the-art tools for reviewing housing loan applications faster, more accurately, and at lower costs, which means low interest rates on loans. In this respect, Google Cloud had announced the launch of a new solution, Lending DocAI, which aims at increasing the operational efficiency of the loan process through the application of artificial intelligence technologies and machine learning modules in processing loan documents which include tax data and income and asset statements.
Overall, FinTech provides modern digital alternatives for analyzing big data, assessing clients’ status based on the historical development of their behavior as well as their financial and non-financial transactions, among other indicators, all of which ultimately reduce time, effort, and cost. Fintech would help catalyze and attract new clients and projects provided that a regulatory framework is set to ensure protection of data privacy and investors’ rights.
The increase in the technology-driven financial transactions and the need to effectively manage them have led countries and governments to put in place laws and regulations that protect rights and prevent manipulation. These regulations came to be known as regulatory technology or “regtech”.
Economists are divided over the importance of regtech in FinTech. For example, George Stiegler and Milton Friedman oppose regtech fearing that it would limit innovation due to bureaucracy besides the possibility of it limiting market efficiency due to government intervention in market mechanisms through regulatory systems.
On the other hand, Christine Lagarde, President of the European Central Bank, and Jaime Dimon, Chief Executive Officer of JPMorgan, underscore the importance of regtech as a means of protecting individuals and financial systems alike. Reconciling these two different views can be achieved by establishing regulatory systems that stimulate innovation, ensure efficiency of the market, and protect individuals and financial institutions
Globally, central banks and financial supervision authorities have launched regulatory sandboxes for financial technology products and services through which innovators can explore new financial solutions and come up with innovative products while granting them (participants will be proposing the financial technology apps) regulatory exemptions, allowing them to directly test their services and determine their efficiency, quality, and readiness for full implementation in the local market under the supervision of the competent supervisory authority. Regulatory sandboxes have been established in a number of Arab countries including the UAE and Oman.
Likewise, in Egypt, and in line with Egypt’s vision to become a regional hub for FinTech in Africa and the Middle East, the Central Bank of Egypt (CBE) launched what is known as the Regulatory Sandbox for Financial Technology Applications. Singapore, Australia, and the United Kingdom, among others, are examples of countries that launched regulatory sandboxes for testing technological services. Recently, the United States, the European Union, and Hong Kong have participated in a joint sandbox program.
China’s FinTech regulatory sandbox extends to cover the whole country. This environment enables innovators to implement new ideas without having to worry about judicial threats or violating the existing regulatory systems.
This step comes as an attempt to encourage financial technology innovators to relocate to China, being a country that has substantial capabilities for applying new financial technologies. However, China had implemented some regulatory measures, banned cryptocurrencies transactions, blocked websites that trade on cryptocurrencies, and restricted some block-chain based applications.
As regulatory sandboxes came to exist in most countries to provide opportunities for companies to innovate while, at the same time, protect consumers against risks, the forthcoming law on regulation, development, and use of FinTech in non-banking financial activities in Egypt should allow the Financial Regulatory Authority to establish a regulatory sandbox for FinTech applications where FinTech providers (registered or willing to register) can test their innovative FinTech applications under the supervision of the authority, with the authority providing some facilities as to regulatory sandbox eligibility criteria.
In 2018, the International Monetary Fund (IMF) and the World Bank Group launched the Bali Fintech Agenda, “a set of 12 policy elements aimed at helping member countries to harness the benefits and opportunities of rapid advances in financial technology that are transforming the provision of banking services, while at the same time managing the inherent risks.”
These elements drew upon the experience of member countries and are intended to serve as guiding points to inform national authorities when developing their own national FinTech agendas.
The 12 policy elements include requirements for developing regulatory standards for FinTech, including, building a foundational digital and financial infrastructure that enable efficient data collection, processing, and transmission; reinforcing competition and commitment to open, free, and contestable markets to ensure a level playing field and promote high-quality financial services. By the same token, the forthcoming law on regulating FinTech in Egypt should include articles that address risks of market concentration and allow fair-and-transparent access to key infrastructure.
The Bali Fintech Agenda also outlined the importance of adapting the regulatory framework to match the state-of-the-art technologies, ensuring inciting innovation, making use of modern technologies, and protecting the financial systems from the potential risks of exploiting FinTech for money laundering and funding terrorists, in addition to the risks related to cyber-attacks, data protection, cybersecurity threats, operational risks, market concentration risks, and consumer protection.
Thus, formulating the legal frameworks should be in line with national circumstances, and these frameworks shall be reviewed and updated permanently to keep pace with the technological changes and FinTech developments.
Based on global experiences, a number of challenges affecting the safety and stability of the FinTech systems can be identified, and a number of proposed mechanisms can be developed to strengthen confidence in financial services and achieve the goals of promoting investment.
Among these challenges is the risk that limited players control the provision of financial services due to their large databases and artificial intelligence based software.
In China, for example, while the technological growth has been very successful, allowing millions of new entrants to benefit from available financial products, it has also led to two companies controlling more than 90 percent of the mobile payments, which has been described by the IMF as a “unique and systemic challenge to financial stability and efficiency”. Hence, care must be taken not to allow specific players to monopolize the provision of financial services. Controls on the use of data shall be imposed as well.
Another challenge that FinTech imposed was the death of one of the founders of the cryptocurrency trading platforms and the consequent disappearance of huge sums of money. However, in the case of Egypt, the CBE warned against trading of cryptocurrencies. So, for legal consistency, establishing platforms for trading cryptocurrencies hasn’t been allowed.
On the other side, there is the impact of FinTech on central banks. While FinTech can help central banks improve their services, through issuing digital currencies, expanding access to payment services, and increasing flexibility of financial services, it could, however, impede the application of the monetary policy and redefine the role of central banks as lending institutions to be “a render of last resort”, a situation that requires considering coordination between the CBE and the Financial Regulatory Authority roles in this regard.
Peer-to-peer lending offers another challenge in FinTech. In this type of social lending, a person gets a loan from another individual and an interest rate is identified. The higher the interest rate is, the higher the risk. These debts are then bundled into packages and sold to a third party, usually a major investor.
However, some formal adjustments to those packages may be made in accordance with the buyer’s criteria, a sort of a change of realities. This has in fact happened with Lending Club, one of the major U.S. FinTech companies, which led to the resignation of its CEO.
However, the regulatory regimes of peer-to-peer lending differs from one country to another. For example, in Germany and France, peer-to-peer lending comes under the supervisory authority just like banks. In the United States, it is regarded in the same way as securities issuance while Japan prohibits it basically.
In sum, with the many benefits and challenges of FinTech, the Egyptian government has realized the importance of developing a legal framework to regulate the uses of FinTech in non-banking financial activities. However, before issuing the final draft of the law, it is necessary that all the requirements needed to strengthen confidence in the financial system and protect the economy from potential risks be considered, while providing opportunities to promote innovation and benefit from modern technologies.