The rapid evolution of the financial technology ( fintech) arena has presented a dilemma to regulators across the world. The industry is emerging as one of the most vibrant segments of the wider financial services sector, and in 2015 collected over $22bn in investment, according to the Central Bank of Bahrain (CBB), a figure that is expected to grow exponentially over the coming years. The disruptive power of new products and services has heightened competition and compelled financial institutions to improve their offerings, a trend that has enhanced the consumer experience and helped to drive sector growth.
Regulators have generally adopted a welcoming stance to the fintech industry. However, their enthusiasm has been tempered by a number of concerns, ranging from questions of market stability to consumer protection. Regulating for fintech is complex, and keeping up with an ever-expanding frontier of cutting-edge technology is challenging.
Protecting the general public and the wider financial system from technological misadventures is a primary regulatory responsibility, yet a rigid framework makes financial innovation difficult. The dilemma facing regulators, therefore, is how to encourage industry growth, while ensuring it does not damage the surrounding economic environment.
NEW SOLUTION: Increasingly, the answer for most regulators is found in the regulatory sandbox, which is an entity, endorsed or operated by the regulator, that allows for limited-scale testing of new products for a fixed period. To enable this, standard regulatory requirements may be relaxed or lifted entirely for the duration of the trial. For example, a fintech firm might be granted permission to test a mobile payment platform on 5000 customers for three months, after which time the regulator will assess its performance according to an agreed set of metrics. The regulator is then able to make a risk-based decision regarding the merits of the new product and rule accordingly.
The sandbox concept is a relatively new one. Pioneered by the UK’s Financial Conduct Authority in 2015, the first fintech companies to make use of the platform began trials as recently as 2016. Participants included established banks and other large institutions, and a large number of start-ups.
Of the 69 products that made up the first batch of candidates, 24 received approval for a wider rollout. These included cross-border and domestic payment solutions based on blockchain technology, consumer-oriented mobile applications, securities management platforms and new lending products.
The success of this experiment did not go unnoticed, and the subsequent spread of the sandbox concept throughout the financial world has been rapid. By the beginning of 2017 there were sandboxes at various stages of development in the US, Singapore, Hong Kong, Malaysia, Thailand, Switzerland and the UAE. The European Banking Federation has also proposed that a Europe-wide fintech sandbox be created, a development that would enable companies to trial their products on a cross-border basis.
REGIONAL LEADER: Bahrain unveiled its new regulatory sandbox in June 2017, with the CBB announcing in an accompanying statement that the move would strengthen the country’s position as a financial services hub in the GCC. In being one of the first countries in the region to adopt the concept, Bahrain is aligning itself with some of the most progressive financial jurisdictions in the world.
The sandbox is offered to local and international firms with existing solutions that have already been tested in a lab environment, as well as ideas that have yet to be developed and tested. Bahrain has historically thrived on its openness to foreign investment, so it is no surprise that the entry to the sandbox is not limited to domestic companies.
The companies that the CBB hopes will take advantage of its new platform include financial sector firms, technology and telecoms companies, professional service firms and any other type of applicant deemed acceptable by the regulator.
The framework establishes a nine-month period for testing new products, which may be extended by up to three months. Candidates can use volunteer customers or their own staff for the sample pool, but the decision regarding the total number of test subjects remains in the hands of the CBB, and will be determined on a case-by-case basis.
As with other sandbox initiatives, the CBB has attempted to ensure that only technologies that will make a significant and positive contribution to the financial services sector are included in the programme. Consequently, successful candidates can only propose products that are truly innovative or significantly different from existing offerings. These products should be of direct or indirect benefit to customers, for example, by improving security, customer experience, efficiency, quality of product, lower prices or a combination of these qualities.
LOOKING AHEAD: The adoption of the sandbox concept by Bahrain enables the country to maintain regulatory control over the most dynamic corner of the financial services sector, while allowing for rapid, evidence-based product innovation. This means that Manama can keep pace with the fast-moving technological curve, which the test-and-learn approach adopted by numerous jurisdictions around the world has accelerated. Looking ahead, there are still questions that need to be answered. Perhaps the most crucial regarding the ability of the CBB to attract sandbox candidates from foreign jurisdictions, a task that will become more challenging as the development of sandboxes in nearby locations, such as the UAE and India, gains momentum. The regulatory fintech framework in the kingdom will play a central role in this regard, and is currently a work in progress.
In March 2017 the Bahrain Economic Development Board established a partnership with fintech incubator and ecosystem builder Singapore Fintech Consortium to establish a comprehensive fintech ecosystem and regulatory framework. Other potential initiatives include the construction of a dedicated fintech hub, an incubator accelerator platform and a fintech-focused venture capital portal. These developments, if realised, will help to build Bahrain’s credentials in an increasingly competitive sandbox market.
Perhaps the biggest challenge facing the regulator, however, concerns achieving a balance between granting fintech companies the freedom to pursue technological opportunities and safeguarding the interests of consumers. This concern is likely to be a factor in the consideration of every application to the kingdom’s new platform. The challenge is an old one – regulators have been struggling for years with their dual role of restricting and enabling financial practices. Bahrain’s new sandbox, it is hoped, will provide a way for the CBB to productively reconcile these competing regulatory interests in the future.
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