Innovation Sandboxes as a Tool for Driving Financial Inclusion in Nigeria
How regulators can foster innovation without destabilising the entire financial services ecosystem
There is so much potential for innovation in the African financial services sector. PwC and KPMG highlight the presence of global key FinTech trends — entrepreneurial mindset, venture capital and angel funding and technology penetration — that have stimulated the emergence of FinTechs on the continent, albeit at lower maturity levels.
This rise in new entrants has been facilitated by increased mobile phone penetration which in turn has given birth to a myriad of innovative business models, products and services such as mobile money, online peer-to-peer lending, crowdfunding and cryptocurrencies to name a few. These innovations are instrumental in onboarding even more, previously excluded, people into the financial services ecosystem.
However, the rise in FinTech innovations also comes with transformative implications which if not responsibly managed, could disrupt (in a negative way) the stability of the financial services ecosystem. Take a FinTech that provides periodic online savings services. Right now, there is no direct regulatory mechanism to license or manage the activities of such an institution since they don’t fit into conventional licensing regimes, i.e. they are not a deposit money bank (DMB) or a microfinance bank/institution. All this savings platform wants to do is help their customers save money.
Scenarios like these are commonplace in the FinTech space and for financial services industry regulators, this presents a new challenge. On the one hand, they must maintain the stability of financial services institutions and the ecosystem at large. On the other hand, recognising the impact of digital technologies in addressing ecosystem constraints such as financial inclusion and the introduction of innovations in the system, especially those heralded by FinTechs, regulators do not want to stifle innovation in the system.
Hence, sandboxes (yes, like the playground) were deployed to address such uncertainties.
A sandbox is an isolated environment that allows for experimentation and deployment of innovative products and services or business models. The sandbox provides companies appropriate space to “breathe”, to develop and test innovative solutions in a controlled environment and without fear of enforcement action and regulatory fines.
In financial services, the emergence of FinTechs and their innovations warranted a new approach that was introduced in October 2014 with Project Innovate, a programme of the Financial Conduct Authority (FCA) in the United Kingdom. Project Innovate was modelled after the US Consumer Financial Protection Bureau’s Project Catalyst that launched in 2012. While Project Innovate adopted the principles of Project Catalyst (which are evidence based decision-making and pilot testing), the scope covered all FinTech innovations.
The Case for More FinTech Innovations
In Nigeria’s quest to deepen financial services and drive financial inclusion, many first generation FinTechs, such as mobile money operators (MMOs), were licensed. In spite of this, mobile money penetration is still low and Nigeria is yet to make significant strides in financial inclusion due to industry fragmentation as well as other regulatory and consumer constraints. This, in part, has been highlighted by the inability of the newly implemented social intervention programmes (SIPs) launched by the Federal Government such as Government Enterprise and Empowerment Programme (GEEP), Conditional Cash Transfer (CCT) and n-Power, to reach critical mass.
If we are to make significant headway, an enabling environment for trailblazers while simultaneously mitigating any risks to the entire financial services ecosystem, is mandatory.
Which brings us back to the necessity of a sandbox.
Sandboxes can be divided into two broad categories: regulatory or industry/virtual.
Though both regulatory and industry sandboxes seek to provide an environment to test innovative products, services and business models, there are some significant differences.
According to Innovate Finance’s report, a regulatory sandbox creates a “space” where a FinTech and a limited number of real consumers can engage in an “on-market” trial. Some of the regulatory requirements can be amended to create a bespoke framework for the duration of the trial where the normal regulatory consequences do not apply.
On the other hand, an Industry Sandbox aims to create a “space” for FinTechs and industry players to collaborate on new products and proof of concepts in an “off-market” environment without consumers. It is a space for off-market testing, unlike the Regulatory Sandbox, which enables innovative products to go to market in a controlled way. There are no regulatory implications from testing off-market, so creating a bespoke regulatory framework is not necessary. The sandbox environment can be used to simulate consumer behaviour to test and trial application.
While regulatory sandboxes are driven by regulators towards increased adoption of innovations which deliver superior consumer outcomes, industry or virtual sandboxes are supplementary, enabling industry players to self-organise and provide a knowledge-sharing and communication forum, as well as an optional certification facility as part of the regulatory process.
Further differences are summarised in the table below:
In sum, sandboxes can be instrumental in providing 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.
We strongly believe that with consultations to develop a framework of operational and governance structures, acceptance criteria, etc followed by a pilot test, a sandbox would help the government achieve its year 2020 goals.