How Can Governments in Developing Countries Help Manage Fintech Risks?

Pezesha Africa, a Kenyan fintech startup has closed a seven-figure sum in a seed-extending round led by a Nigerian Venture Capitalist firm, Greenhouse Capital Partners.

Sometimes, financial innovation pays off handsomely. It has the potential to make the financial system more accessible to underserved segments of the population and improve people’s quality of life in general. There are also instances where certain innovations can lead to catastrophe – a situation that disproportionately affects those who are poor.

While promoting innovation, governments must find the right balance between risk management and innovation promotion. There is no better time for the world economy to recover from the Covid recession, which has exacerbated inequalities.

The rate of innovation, including some truly groundbreaking ones, has increased, emphasizing the importance of answering this question.

Financial innovations in the early 2000s took the form of new products that ostensibly made it easier for consumers to obtain credit and for investors to generate higher returns while better managing risk.

The arrogant belief that financial engineering could create value on its own, and that the private sector could manage risks adequately on its own, culminating in a spectacular collapse.

The most recent wave of innovation is powered by new technologies encapsulated by the term “fintech.” Banking and other services are being placed in the hands of consumers thanks to advances in fintech. We can now use apps on our mobile phones to make payments, conduct basic banking, and even trade stocks.

Finance could be democratized because of the fintech revolution. Financial intermediation is being transformed by digital banks, robo-advisers, and online platforms that connect savers and borrowers.

They have made savings and credit products easily accessible to low-income households, as well as those living in rural and remote areas while encouraging entrepreneurial activity.

Customers and businesses benefit from digital payments that are inexpensive, fast, and efficient. International payments, which have been costly and time-consuming for a long time, are about to undergo a radical transformation.

Many low-income countries rely substantially on remittances sent by economic migrants to their home countries; therefore, this is a blessing for them. Commerce on both the domestic and international levels will benefit from improved payment systems.

Technology, on the other hand, is not a panacea. Creditworthiness and loan qualification decisions made by computer algorithms should, in theory, decrease overt racial and other forms of bias.

There is still a wide disparity in digital access and financial knowledge in Kenya. After speculative frenzy erupts, naive retail investors are generally the last to join in, and they are left nursing losses when the frenzy ends.

Governments must continue to safeguard investors and promote financial literacy so that investors can comprehend the products on offer and the risks associated with them.

And even the comparatively cheap entry costs into digital marketplaces do not guarantee an easy road for newcomers and fair competition for existing ones. Digital concentration can be exacerbated by network dynamics that benefit incumbents.

Good examples are China’s Alipay and WeChat Pay. The government gave them free rein, which they capitalized on to create innovations that expanded financial access to the masses and helped in the fight against poverty. But the two platforms now dominate the payments landscape and have acquired so much power that the Chinese authorities recently cracked down on them.

In India, the Unified Payments Interface shows how a government can encourage private sector innovation and competition in financial services without actively interfering in this area.

A public digital infrastructure with open access was constructed by the Indian government, allowing payment providers to enter the market with ease, maintaining a level playing field for both established and new players.

Illiterate and vulnerable persons can easily establish their identities via Aadhaar, which facilitates access to the banking system. To give people more control over their data, the government has suggested regulations.

Fintech regulatory “sandboxes” that allow new products and services to be tested in a controlled environment and in a limited scope, can also help balance regulators’ concerns with the inherent riskiness of innovations.

Fintech can play a significant role in democratizing finance in advanced and developing nations, but its dangers should not be underestimated. While the private sector should be allowed to undertake most of the heavy lifting, governments must play a crucial role in securing the benefits and managing the dangers.

Editor’s Note:  This op-ed was originally published by the Financial Times.