How FinTech Facilitates MSME Access to Financing

HOW FINTECH FACILITATES MSME ACCESS TO FINANCING Guideline Note No. 46 June 2021

GUIDELINE NOTE

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GUIDELINE NOTE: HOW FINTECH FACILITATES MSME ACCESS TO FINANCING

CONTENTS 1

EXECUTIVE SUMMARY

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INTRODUCTION

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FINTECH USE CASES AND BUSINESS MODELS FOR MSME ACCESS TO FINANCE

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Crowdfunding Regulatory Framework

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POLICY GUIDELINES: REGULATORY FRAMEWORK FOR FINTECH AND DIGITAL CREDIT

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Regulatory Oversight on FinTech or Digital Credit

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Sandbox for Emerging FinTech Regulatory Frameworks

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Market Conduct Enforcement on Digital Credit

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Comprehensive and Effective Credit Referencing Systems

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Credit Information Sharing

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Data Privacy and Consumer Protection

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Policy Guidance

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POLICY GUIDELINES: FINANCIAL STABILITY

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CONCLUSION

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REFERENCES

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ACKNOWLEDGMENTS This guideline note is a product of the SME Finance Working Group (SMEFWG) and its members.

Contributors: From the AFI Management Unit, Diana Taty Azman (Policy Analyst – Policy Programs and Regional Initiatives), Nik Kamarun Nik Kamil (SME Finance Senior Policy Manager, Alliance for Financial Inclusion) and Dr. Hamid Alavi (independent consultant). This report benefited from key inputs provided by Eliki Boletawa (Head of Policy Programs and Regional Initiatives) and Ghiyazuddin Mohammad (Senior Policy Manager of Digital Financial Services Working Group) The guideline note benefited from the careful review by members of the SME Finance Working Group: Jason Barrantes Rojas (SUGEF Costa Rica), Ellen Joyce Suficiencia (Bangko Sentral Ng Pilipinas), Waleed Samarah (Central Bank of Jordan), Peter Owira (SASRA Kenya), Gul Badshah Safi (Da Afghanistan Bank), Dominic Sikakau (Bank of Papua New Guinea), Lukman Abdulkadir Sale (Central Bank of Nigeria) and Olga Ilyukevich (National Bank of the Republic of Belarus) We would like to thank AFI member institutions, partners, and donors for generously contributing to the development of this publication.

A young customer smiles after paying for goods and services through mobile

© 2021 (June), Alliance for Financial Inclusion. All rights reserved.

money transfer. Kenya. (Photo by Billy Miaron/Shutterstock)

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EXECUTIVE SUMMARY

INTRODUCTION

AFI’s Sochi Accord: FinTech for Financial Inclusion has guided how FinTech can be a means for the closing of the persistent nine percent gender gap in access to finance, management of climate change risks, the inclusion of forcibly displaced persons, reducing the financing gap for MSMEs, lowering costs for cross-border remittances, and the promotion of financial stability and integrity.

The scope and nature of financial institutional risks and activities are rapidly changing requiring current oversight mechanisms to evolve at a similar rate.

The AFI Survey Report on FinTech for MSME Financing, published in 2021, provides the latest insights on the AFI network of financial regulators’ integration of FinTech into products and services offered by financial institutions within the SME Finance Working Group (SMEFWG). The results show that although traditional financial institutions have undergone technological upgrades in operations and money transfers, the unique capabilities of FinTech have the potential to lower entry barriers, elevate the role of sex and age-disaggregated data, and promote new business models in access to finance. This ability comes from their use of alternative data, alternative finance, and functions outside the regulatory requirements of a financial supervisor.

To complement this report, this guideline note was developed in a collaboration involving the AFI SMEFWG and AFI Management Unit to provide practical guidance and share the successful implementation of FinTech to complement the MSME financing landscape. The guideline addresses new regulatory challenges given the risks with respect to cybersecurity, data privacy, money laundering and consumer protection, as well as structural inequalities faced by vulnerable groups such as women, youth and forcibly displaced persons when trying to access these services. It is divided into two parts: > FinTech Use Cases and Business Models for MSMEs Access to Finance > Regulatory Framework for FinTech and Digital Credit.

Image by Andrey Suslov/Shutterstock

FinTech for improved MSME access to financing, may be more disruptive than previous changes in the financial industry. And while its potential benefits are multifold, regulators and supervisors need to be aware of its possible risks and measures that can be taken to mitigate them, to spur sustainable financial inclusion and close the gender gap in access to finance once and for all.

FinTech exists across various functional segments of the financial ecosystem from payments, lending, savings, and insurance. Table 1 illustrates the different uses of FinTech across the financial ecosystem with examples and possible challenges for both consumers and supervisors/regulators. This guideline note will focus specifically on how FinTech is used to provide MSMEs with better access to financing by providing new technologies in credit risk assessments and a new-age form of credit that is available via alternative processes than those of traditional financial institutions.

Digital credit and financing are becoming one of the fastest expanding solutions to narrow the credit gap because of the rapid growth in mobile adoption. While this has been positive in reaching the underbanked or unserved individuals and MSMEs, challenges have arisen which are of particular concern by regulators, such as ensuring an effective legal and regulatory framework, adequacy in supervisory capacity, data protection and data privacy, and an increase in cybersecurity and fraud.

This guideline note will share the different use cases of FinTech to improve access to financing and credit for MSMEs and provide examples of accompanying jurisdictions with regulator monitoring and supervision.

It will then expand further on these challenges, provide guidance on policy aspects for consideration, in addition to relevant examples of policies available within the AFI network.

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TABLE 1 APPLICATION OF FINTECH ACROSS FINANCIAL ECOSYSTEM FINANCIAL PRODUCT AND/OR BUSINESS MODEL

TECHNOLOGY AND/OR PRODUCT

EXAMPLES OF BENEFITS

EXAMPLES OF CHALLENGES AND RISKS

Payments 1. Mobile money – P2P transfers

• Mobile/Internet • Cloud Computing • Blockchain

• User friendly • Easily accessible • Cost-effective • Efficient processing time

• Risk of fraud from agents • Lacks interoperability with existing traditional FSPs • Not widely used by individuals of MSMEs

2. Digital Payments

• Mobile/Internet • Cloud Computing • Blockchain

• Better transparency • Better data privacy terms • Efficient processing time • Travel cost-savings

• Risks to data protection and data privacy

Lending/Financing/Investment 3. Credit risk assessment

• Mobile/Internet • Cloud computing • AI, Big data

• Access to alternative data for credit risk assessment • Increased chance to access FSP by unbanked or underbanked

• May create income inequality • Data correlations do not have a longstanding reputation

4. Alternative lending/P2P lending

• Mobile/Internet • Cloud computing • AI, Big data • Blockchain

• Access to alternative finance by non-bank sources • Increased chance to access FSP by unbanked or underbanked • Faster and more efficient

• Higher borrowing costs than traditional FSPs • Risk of over-indebtedness

• Mobile/Internet

• Lower cost of operations

• Cloud computing

• Lower risk of theft

• AI, Big data

• Higher transparency

• Customer financial knowledge and skills required

Saving and Insurance 5. Digital savings

• Increased liquidity

6. Digital Insurance

• Mobile/Internet • Cloud computing • AI, Big data • Blockchain • Internet of Things

• Lower costs, increased liquidity, and higher transparency • Faster and more efficient

• Significant customer financial capability required

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FINTECH USE CASES AND BUSINESS MODELS FOR MSME ACCESS TO FINANCE

TABLE 2 APPLICATION OF FINTECH ACROSS FINANCIAL ECOSYSTEM

Crowdfunding involves the use of small amounts of capital, from many individuals, to finance a new business venture.

This form of financing makes use of the easy accessibility of vast networks of people through social media and crowdfunding websites that function as a consolidated platform for new lenders (non-traditional financial institution) while bringing together investors and borrowers. By increasing the investor pool beyond traditional banks to now individuals or businesses, it allows a larger pool of financing/credit available for MSME borrowers. It is also important to note the gender considerations, as seed crowdfunding campaigns led by women consistently outperform those led by men1.

Innovations have arisen to form new credit sources via different models of crowdfunding that benefit MSMEs as illustrated in AFI’s Special Report on FinTech for Financial Inclusion: A Framework For Digital Financial Transformation.

Some definitions of FinTech services that have now become more popularly available to consumers in developing nations are as follows:

Equity-based crowdfunding

Involves the exchange of shares within MSMEs for capital funding. The buyer or investor will not only be able to have a share of the profits of MSMEs but also a share of its ownership.

Peer-to-peer lending (P2P)

Individuals (or peers) lend money to MSMEs with the understanding that the money will be repaid with interest once the MSMEs are profitable. This is like traditional borrowing from a bank, except that you borrow from lots of investors.

Lending based crowdfunding

Lending-based crowdfunding allows MSMEs to acquire loans by raising funds. Lending campaigns require a shorter time and work well for entrepreneurs or micro-businesses that do not want to immediately give up equity in their startup.

Credit risk assessment

Involves using alternative data sources (utility payment data, e-commerce purchase data, social media data) for the credit risk assessment process instead of the traditional method of only assessing formal credit borrowing performance. Using alternative data for credit risk assessments provides MSMEs, which would otherwise not have sufficient formal collateral, a chance at borrowing credit.

Digital Credit

Involves the delivery of small loans through digital means. Includes small value loans and a shorter loan tenure, while the source of funding can be outside the formal financial ecosystem (i.e., crowdfunded, or P2P). Uses alternative forms of credit assessments.

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1 PriceWaterhouseCoopers, July 2017, “Women unbound: Unleashing female entrepreneurial potential.”

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Digital credit is becoming a more popular solution to narrow the credit gap stemming from the increased mobile adoption rate in the region and these products can be revolutionary for women MSMEs, to increase their revenue.2 In Africa, this form of financing has matured and evolved into different hybrid models to suit the requirements of their landscape. AFI’s Scoping and Assessment Report on Responsible Digital Credit in Africa discusses these at length, and notable models are summarized below: TABLE 3 DIGITAL CREDIT PROVIDERS/MODELS Mobile nano lending vendors

Provide micro loans using credit scoring models which incorporate credit and mobile transaction history, mobile e-money usage, location data and text data. A large number of mobile-based lenders rely on data from apps operating on smartphones that upload SMS, emails, metadata from voice calls, and track geolocation data of the user. As women are 20 percent less likely to own a smartphone compared to men3, they may be structurally excluded from accessing this model.

Digital bank models

Include direct mobile lending models, partnerships between banks and mobile network operators (MNOs), and third-party providers. While several of these models are like the mobile nano lending providers above, they also offer access to a broader range of banking services, such as savings. In addition, banks that often use the analytical technology provided by third-party providers can better analyze banking and other payment transaction histories to enrich credit scoring models.

Digital payday lenders

Include salary-based lenders that have shifted to online (mostly mobile) platform delivery models.

As is the case with traditional payday lenders, digital payday lenders focus primarily on salary workers but also make use of alternative data for credit scoring purposes. The speed and ease of digital lending, along with digital push marketing techniques, have increased concerns of over indebtedness, especially for low-income salary workers who have become dependent on this category of a digital lender in some markets.

Techbased lenders

Include subsidiaries of e-commerce, search, payment and social networking technology companies that are leveraging their large user base and access to client data, either directly or via partnerships, to offer digital credit.

Supply chain platforms

Focus on the pre- and post-shipment process in support of MSME financing. The digitization of documents and transactions and application of data analytics by cloud-based digital supply chain platforms to make credit decisions contribute to valuable insights into complex trade flows.

Crowdfunding Regulatory Framework Normative guidance is needed to ensure the quality of a crowdfunding regulatory framework so it advances financial inclusion while complying with supervision on consumer protection, data protection and data privacy, market integration, and ensuring financial stability.

Beyond the legal and regulatory framework, the development of a crowdfunding industry is influenced by the social, political, and economic environment.

Policymakers can change or influence these factors through education, tax policy, or other such means as may be relevant.23

FIGURE 1: UNITED KINGDOM ENCOURAGES CROWDFUNDING VIA TAX

The UK government has been instrumental in creating the foundations of a crowdfunding industry. In 2016, tax incentives were introduced to savers to invest in crowdfunding platforms that loan small amounts and earn returns through interest payments from borrowers. Any gains from peer-to-peer loans made through an Innovative Finance Individual Savings Account (ISA) would be eligible for tax advantages. The government-owned British Business Bank has separately invested in a variety of crowdfunding platforms.

Source: Government of the United Kingdom (https://www. gov.uk/government/publications/income-tax-crowdfundingand-individual-savings-accounts/income-tax-crowdfundingand-individual-savings-accounts)

2 GPFI, July 2020, “Advancing Women’s Digital Financial Inclusion.”

3 GSMA, March 2020, “The Mobile Gender Gap Report.”

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FIGURE 2: MALAYSIA PROMOTES CROWDFUNDING FOR MSME FUNDING

FIGURE 3: MEXICO FINTECH LAW REGULATES CROWDFUNDING

In November 2020, the Malaysian Government tabled its national budget which placed an emphasis on creating a digital economy receptive to alternative financing, including equity crowdfunding (ECF) and P2P financing. The government allocated MYR50 million (USD13 million) to the My Co-Investment Fund (MyCIF) while an additional MYR10 million (USD2.5 million) was earmarked exclusively to raising funds for social enterprises through P2P financing platforms, marking the second occasion that MYR50 million (USD13 million) has been dedicated for co-investment at a 1:4 ratio for ECF and P2P financing platforms.

In 2018, Mexico enacted the Mexico FinTech Law becoming the first country in Latin America to introduce a legislative framework covering a wide scope of FinTech activities. The law was driven by the rapid growth of these activities in recent years.

Between 2015 and 2016, alternative finance activity, such as crowdfunding, increased more than sevenfold, while P2P consumer lending market volumes expanded by 90 percent in 2017.

Additionally, individuals who invest in equity crowdfunding from January 2021 – December 2021 will be eligible for a tax exemption of their aggregate income for a sum equal to 50 percent of the amount invested.

These efforts will increase public awareness on both ECF and P2P financing, while helping to fund financially responsible MSMEs. The government’s increased recognition of the valuable role played

by FinTech in society has been well-received by the public and private sectors, with expectations of further FinTech-friendly policies.

Source: FinTech News Malaysia (https://FinTechnews. my/25429/various/budget-2021-FinTech)

The law allows non-banks to enter the sector with more legal clarity, encouraging new products and links between banks, telcos and FinTech providers. The law also supports innovative FinTech activities by giving legal recognition to and setting supervisory frameworks for financial technology institutions (FTIs), which can perform the following activities: crowdfunding (debt, equity, co-ownership, or royalties) and e-money (including e-wallets).

The FinTech Law gives the Comisión Nacional Bancaria y de Valores (CNBV) and other financial authorities the power to supervise FTIs and innovative model institutions. New organizational structures within the CNBV have also been established to support the supervision of the new sector. The CNBV now houses a FinTech Supervision Department to oversee crowdfunding and e-money, and a Sandbox Team that works with both regulated and non-regulated entities seeking to test new innovations.

Source: AFI Creating Enabling FinTech Ecosystem (https:// www.afi-global.org/publications/creating-enabling-fintechecosystems-the-role-of-regulators)

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POLICY GUIDELINES: REGULATORY FRAMEWORK FOR FINTECH AND DIGITAL CREDIT Credit provision has traditionally suffered from problems of information asymmetry, with banks specializing in credit risk analysis — a costly and resource-intensive process that makes it commercially unviable to assess many individuals and MSMEs. More often in developing nations, credit bureaus are established to aggregate credit data from various sources of financial information.

The use of FinTech in credit risk assessments involves using alternative data sources (utility payment data, e-commerce purchasing data, social media for behavioral data) instead of traditional financial data for the credit risk assessment process. This can allow formal financial institutions to gain a more holistic view of a potential borrower’s creditworthiness and allow MSMEs without sufficient formal collateral to become eligible to access formal credit and reduce their reliance on informal lenders. These constraints are more pronounced for women who face less opportunities to own traditional forms of collateral or use formal financial services and products to build their credit history.

The use of new types of alternative customer data for financial information through FinTech for credit risk assessments raises significant data protection and privacy concerns. These concerns include allowing third party access to information without consent, and security risks that include fraud and identity theft.

There are also growing concerns around potential algorithm bias in the credit assessment model and the lack of mechanisms to detect and mitigate such biases. This increased vulnerability to discriminatory lending decisions, fraud and disruption could negatively impact MSMEs access to financial services and further marginalize the traditionally underserved segments such as women-owned MSMEs and women entrepreneurs in the future.

The use of digital credit comes with consumer protection risks. The lack of opportunity to gain high levels of digital literacy and capability, and access to timely and reliable information, especially among the underserved segments such as women-owned MSMEs and women entrepreneurs, further exacerbates these risks. To increase usage, digital credit lenders use big data to reach new customers to increase applications to their small-sized and short-termed loans. Key details, such as interest and late-payment fees, are often not communicated among other terms and conditions, posing a risk of delinquency and the further financial exclusion of borrowers.

The following sections will provide details on several subsets of FinTech regulations, namely oversight on digital credit, using regulatory sandboxes for FinTech related policies, credit referencing system and operations, market conduct on digital credit, data privacy and consumer protection, and credit information sharing.4 Regulatory Oversight on FinTech or Digital Credit Regulatory frameworks for FinTech credit continue to evolve as this new phenomenon further develops. Several jurisdictions are putting in place new forms of licenses for FinTech platforms. Regulators and supervisors should closely monitor the development of the digital credit players and models and ensure that all credit providers and related third parties are properly licensed, regulated and fall under the financial supervisors’ oversight, to avoid regulatory gaps. Additionally, measures should be in place to ensure that consumers are adequately protected, particularly those from underserved or unserved segments such as women MSMEs and women entrepreneurs, regardless of the provider they use to access digital credit.

Regulators and supervisors are advised to have a robust legal mandate for licensing, regulating and supervising market conduct for the provision of digital credit. The examples below feature different legal classifications of FinTech activities, including digital credit products and services, and how they are regulated in their respective local contexts. Key gender considerations need to be integrated into the policy mandate and regulation at the outset and during any review of existing policies, regulations, and guidelines.

4 Women’s World Banking, 11 November 2020, “Sexist AI? What to do about gender-based algorithmic bias in the financial sector.”

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FIGURE 4: UGANDA'S LEGAL CLASSIFICATION OF FINTECH ACTIVITIES

Crowdfunding activity in Uganda is mainly done via donation platforms, primarily those based in foreign and developed countries leaving little domestic platform activity.

Uganda currently has no legislation that specifically provides for equity or loan-based crowdfunding.

Donation and reward crowdfunding fall outside the jurisdiction of financial regulators. However, there are relevant regulations and applicable legislation that can be leveraged into the crowdfunding industry: 1. The Tier 4 Microfinance Institutions and Money Lenders Act (2016), regulated by the Ugandan Microfinance Regulatory Authority (UMRA), was enacted to legitimize money lenders who are outside the radar of any regulator. It also recognized the importance of informal lending in the promotion of financial inclusion of the unbanked population and attempts to regulate the industry. This act required licensing, record-keeping, and direct oversight by the authority in the hopes of reining in rogue and unscrupulous money lending practices. Crowdfunding platforms and businesses will have to follow the guidelines within the Act. 2. The Anti-Money Laundering Act (2013) and the Financial Institutions (Anti-Money Laundering) Regulations (2010) set out detailed requirements and obligations on accountable persons involved in financial transactions.

Requirements include establishing ‘Know-YourCustomer’ systems and processes, the recording of transactions, and mechanisms for reporting suspicious transactions. Crowdfunding businesses qualify as accountable persons under the AntiMoney Laundering Act and are subject to these guidelines.

Source: Africa Legal Network, 2021. (https://www. africalegalnetwork.com/legal-alert-uganda-new-regulationsmoney-lending/)

FIGURE 5: MALAYSIA'S P2P FINANCING FRAMEWORK

In 2015, Malaysia introduced a regulatory framework to facilitate equity crowdfunding. In 2016, a regulatory framework for P2P was developed by the Securities Commission setting out requirements for the registration of a P2P. Since the introduction of the ECF and P2P regulatory framework in Malaysia in 2016, the Securities Commission has registered 21 platforms to provide regulated crowdfunding options to meet the financing needs of MSMEs. These platforms have attracted strong interest from MSMEs and retail investors. In 2020, more than 2,500 MSMEs raised more than MYR1 billion (roughly USD250 million) through regulated crowdfunding markets of the Malaysian capital market.

The guidelines include roles of P2P operators that cover due diligence, compliance, data and financial transparency, and processes in the case of default or delinquency. Additionally, consumer empowerment and market conduct measures such as disclosure, transparency and dispute resolution were placed on P2P operators.

Source: FAQ on P2P Framework, Press Release “Malaysia’s Regulated Crowdfunding Markets Cross RM 1 billion Mark”

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FIGURE 6: INDIA'S PROPOSAL FOR P2P PLATFORM REGULATION

The Bank of India and Securities and Exchange Board of India (SEBI) specifically focused on equity-based crowdfunding in a 2014 consultation paper. Crowdfunding equity, debt and funds would fall under the purview of the capital markets regulator (SEBI), while P2P lending falls within the domain of the Reserve Bank of India (RBI) which has regulatory jurisdiction on companies or cooperative societies. However, if the P2P platforms are run by individuals, proprietorships, partnerships, or limited liability partnerships, they do not fall under the purview of the RBI. Hence, P2P platforms must adopt a company structure and any other entity rendering such services would be deemed illegal.

P2P lending platforms are registered under the Companies Act. What is being proposed is that by defining P2P platforms as Non-Banking Financial Companies (NBFC) under the RBI Act, P2P lending platforms will come under the purview of the RBI’s regulation. Once notified as NBFCs, the RBI can issue regulations and the supervision of P2P companies will be under its purview.

Source: RBI Consultation Paper on P2P Lending, https:// www.rbi.org.in/scripts/bs_viewcontent.aspx?Id=3164

Sandbox for Emerging FinTech Regulatory Frameworks There are many approaches to developing alternative financing regulations including regulatory technology (RegTech) task forces, regulatory sandboxes and setting up an innovation office, to name a few. In the AFI Survey Report on FinTech for MSME Financing, the majority of SMEFWG members use the regulatory sandbox method to devise a relevant and appropriate legal framework on alternative financing methods, with methods which encompass FinTech and the use of digital credit to finance MSMEs. The AFI Innovative Regulatory Approaches Toolkit defines regulatory sandboxes as formal regulatory initiatives through which firms can experiment with new products, services, or business models in a live environment with safeguards, under the supervision of a regulator. Regulatory sandboxes promote far more regulatory understanding of FinTech products, services, and business models through live-testing functions. By lowering the costs of establishing proof of concept, and streamlining the licensing process, regulators can decrease obstacles to the quick and safe deployment of innovative products and services. Sandboxes allow time and space for both regulators and FinTech companies to understand the main challenges that need to be overcome. In doing so, it may reduce regulatory costs and information asymmetries between regulators and FinTech providers and provide critical insights, including data on underserved segments, such as women-owned MSMEs and women entrepreneurs, which can support the development of evidence and data-based policies and regulations.

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FIGURE 7: MALAYSIA'S FINTECH REGULATORY SANDBOX FRAMEWORK

Realizing that FinTech calls for a balanced approach that carefully considers the potential benefits and risks brought about by these developments, Bank Negara Malaysia (BNM) established a Financial Technology Regulatory Sandbox Framework in 2016. The establishment of this framework also allows the regulator to monitor emerging risks as digital innovation becomes a more prominent feature in our financial system.

The sandbox has achieved multiple benefits so far: allowing BNM to standardize its policies using an evidencebased approach; helping participating FinTech companies validate and improve the benefits of their offerings; benefiting customers through solutions that are more affordable, efficient, and readily available – leading to more widespread use of digital financial services.

In 2017, Bank Negara Malaysia established the Financial Technology Enabler Group (FTEG), a unit responsible for formulating and enhancing regulatory policies to facilitate the adoption of technological innovations in the Malaysian financial services industry.

Source: Focus Malaysia, 2020. “Fintech sandbox to stay as new solutions testing channel says BNM”. Bank Negara Malaysia, 2017. “FTEG launches call for participation on Fintech Hacks”.

Fintech services are regulated by different authorities depending on the business activity undertaken Regulatory mandates of different regulators

Online remittance Insurance aggregator Digital bank Currency exchange Financial market: Banking / Insurance / payment / money service business

Machine learning Biometric KYC

Equity/Property crowdfunding P2P lending

Blockchain / DLT

INvestment aggregator

Robo-advisor

Invoice trading marketplace

Falls under both purview depending on the specific use(s) of such technology

Lending activities

Capital market: Exchange / clearing house / asset management

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FIGURE 8: BRAZIL COLLABORATIVE SANDBOX MODEL

The Central Bank of Brazil (BCB) and the National Federation of the Central Bank Employees Association created a multi-jurisdictional sandbox model, with features to accelerate innovation through collaboration.

The Laboratory of Financial and Technological Innovation (LIFT), which launched in 2018, is a “sectoral sandbox” that fosters innovative technological solution prototypes for the Brazilian financial market. LIFT is based on an open architecture platform where FinTech, technology companies and financial institutions can collaborate on new products and services in an experimental environment without consumers. According to the creators of LIFT, “The intention is to create a continuous process of proposition, appreciation and development of ideas to strengthen the innovation ecosystem in the financial system.”

Source: Banco Central Do Brazil, 2021. (https://www.bcb.gov. br/en/financialstability/regulatorysandbox)

Market Conduct Enforcement on Digital Credit Digital credit may bring new risks requiring specific rules and oversight of digital credit models. AFI’s Policy Guidance Note on Digitally Delivered Credit provides a summary of experiences of central banks and financial regulators in regulating risks via oversight mechanisms.

These risks for policymakers include: 1. Different levels of oversight, as well as different requirements for product approval and reporting across digital credit providers. The mix of regulated and unregulated providers in digital credit markets means that firms offering similar products to similar consumer segments will have different compliance requirements, which may give unregulated lenders an advantage.

2. Unequal application of consumer protection rules across provider types. Since many jurisdictions have incomplete consumer protection rules in place, digital credit users may not always receive the same level of consumer protection in areas such as disclosure of costs and key terms, protection of personal and account-level data, and rights to recourse and redress. This is particularly important when relating to vulnerable population segments as they have less opportunity to gain high levels of financial capability and are more exposed to risk.

3. Lack of competition in the digital credit market.

This can include insufficient sharing of consumer data and loan performance by incumbent providers, higher costs to access mobile money and MNO channels or even restricting access for new lenders.

These are concerns when MNOs and MMOs in a telecommunications or mobile money market form exclusive partnerships with only a few lenders and offer them access to their customer base and data while restricting access to other lenders.

4. Risk of over-indebtedness. An easy and automatic enrollment process, compelling marketing strategies that include unsolicited loan offers, and misleading disclosure of terms, can all encourage borrowers to take on loans without considering whether they need the loan and how they will repay it. This is a particular risk for those population groups at the bottom of the pyramid.

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5. Risk of market saturation due to fast-scaling products. The use of algorithms for digital creditscoring models and digital delivery channels makes it possible to provide millions of loans instantly and simultaneously. This introduces potential prudential risks for providers if their scoring models are not well-designed and they expand their loan portfolio too quickly. There is precedent in examples such as microfinance in Nicaragua and payroll lending in South Africa, where mass-market consumer credit products have led to the failure of financial institutions. Better monitoring of digital credit models and loan portfolios will be necessary to avoid market saturation and prudential risks.

There is also a risk of algorithmic bias which can structurally exclude certain population groups increasing their costs.

FIGURE 9: KENYA ENFORCES DISCLOSURE REQUIREMENTS FOR DIGITAL CREDIT

The Competition Authority of Kenya (CAK) in 2016 issued an order to all digital financial services providers to provide the full price of DFS transactions on a customer’s mobile handset before completing the transaction. This order was issued in response to poor price disclosure practices in the Kenyan DFS market where many providers, including digital credit providers, did not disclose the cost of their product or transaction before the consumer accepted the transaction on their mobile device.

In the case of digital credit, this means that, unlike rules enforced by central banks, CAK’s order indisputably applied to all digital credit providers, regardless of whether they are a regulated bank, app-based lender, or any other type of firm.

Source: CGAP, 2018. “Kenya’s Rules on Mobile Money Price Transparency Are Paying Off“. (https://www.cgap.org/blog/ kenyas-rules-mobile-money-price-transparency-are-paying_)

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FIGURE 10: TANZANIA'S ARRANGEMENTS FOR EMERGING DIGITAL CREDIT

The Fair Competition Commission has a broad mandate to promote and protect competition, as well as prevent unfair and misleading market conduct. In pursuit of this mandate, the Commission issued Standard Form (Consumer Contracts) Regulations, 2014 to govern business contracts and prevent unfair market terms in the contracts. The regulations provide a basis for reviewing the terms and conditions of contracts, including digital credit products. Section 36 of the Fair Competition Act requires all terms and conditions governing consumer transactions to be registered with the Commission. However, the Commission has limited capacity to enforce market conduct across all sectors.

The operations of banking, payments systems and financial cooperatives are governed by separate laws that contain some elements of financial consumer protection. For example, section 49 of the Banking and Financial Institutions Act, 2006 deals with fair lending in terms of loan repayment, changes in the terms of lending and indexing of interest rates. Disclosure of the terms and conditions of bank credit products is governed

by Banking and Financial Institutions (Disclosure) Regulations, 2014. The Bank of Tanzania also has a Complaint Handling Desk.

However, the disclosure regulations and the consumer recourse mechanism cater to bank credit products, while all payment services providers are licensed and regulated by the Bank of Tanzania under the National Payments Systems Act, 2015.

In this regard, MNOs are required to set up a legal entity for the provision of mobile money. The Act, together with the respective regulations, has provisions dealing with consumer protection requirements for payment services.

The range of financial services in the market and the multiple agencies involved in licensing, regulation and supervision, necessitates interagency cooperation in the enforcement of fair market conduct, with complaints handling therefore becoming critical. To this end, the Fair Competition Commission is working on arrangements for collaboration with financial services regulators through the Memorandum of Understanding mechanism. The Ministry of Industry

and Trade, which is responsible for the licensing of non-deposit-taking credit providers, is also covered in the envisaged collaborative arrangements. The MoUs will also address potential conflicts among regulators in the enforcement of market conduct regulations.

Source: Tanzania Fair Competition Commission, 2014. (https://www.competition.or.tz/)

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Comprehensive and Effective Credit Referencing Systems It is important that authorities create a gender-sensitive and enabling regulatory environment that supports comprehensive coverage of the credit referencing system, as this will enhance the ability of service providers to effectively offer credit in the market.

Expansion of credit information, including incorporating alternative credit referencing, will also contribute to greater financial inclusion for unserved and underserved consumers.

Authorities should implement comprehensive and effective credit referencing systems that incorporate a wide range of sourcing information, including non-bank financial services providers. A specific focus should be on the different types of information available about men and women and ensuring that a wide enough pool of indicators are included so there is no gender bias.

AFI’s Policy Framework for Responsible Digital Credit provides minimum regulatory and supervisory requirements for developing a responsible digital credit regime. Specific to credit referencing systems, good regulation should: 1. Expand the role and capacity of credit reference systems to ensure all financial services providers, including non-bank digital lenders, submit data to the credit reference bureau. Credit reference systems should also facilitate real-time information sharing to meet customer needs.

Credit Information Sharing FinTech lenders, by their legal definition, are not required to report financial information about their MSMEs borrowers’ and loan performance to credit bureaus or similar authorities. It is not in their favor to report such data as there is a high possibility it was acquired through expensive proprietary lending models.

However, the benefits of reporting credit information such as the volume of applications, borrowing and repayment performance, and account closure data, outweigh the concerns of FinTech lenders as it would feed into the credit assessment framework of regulators and, ultimately, benefit the unbanked and underbanked.

This information becomes particularly useful when fully disaggregated by indicators such as sex and age.

The policy issues of sharing and col¬lecting alternative data pose questions for the sustainabil¬ity of the traditional role and business model of the credit reporting industry itself.5 When consumers provide consent to access their digital database in exchange for access to credit lending services, it is prudent to explore new approaches and tools for aggregating, analyzing, and using the data. In essence, mar¬ket alternatives to traditional credit reporting services will be needed in an environ-ment where everyone can contribute nontraditional credit data (such as e-commerce, mobile, social media, trade, etc.), and many types of entities can use this data (not just banks or traditional non-bank lenders).

2. Define rules and procedures that enable a range of consumer financial data to be included in the credit reference system, including data generated through digital financial services.

3. Ensure there are fair, transparent, and clear criteria for digital credit providers to access and use alternative data (e.g. utility bill payments data, and mobile phone usage data).

5 World Bank & CGAP, 2018, “Data Protection and Privacy for Alternative Data.”

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GUIDELINE NOTE: HOW FINTECH FACILITATES MSME ACCESS TO FINANCING

FIGURE 11: PHILIPPINES CREDIT INFORMATION SHARING ENFORCEMENT VIA INDUSTRY PLAYERS

FIGURE 12: CREDOLAB'S FINTECH SOLUTION FOR CREDIT SCORING WITH ALTERNATIVE DATA

In 2019, FinTech players (FintechAlliance.PH) established a Code of Conduct to promote transparency and protect customers from any possible malpractice and unethical action by FinTech players. The code upholds higher standards of behavior and steers players away from attempts to exploit the FinTech industry for money laundering, terrorist financing, fraud, and invasion of privacy.

CredoLab develops credit scores based on mobile and web-behavioral data to make loans accessible to those who would otherwise be left out by traditional banking processes. Their technology works by transforming the credit decision-making process and creating a path for creditworthy individuals to access mainstream financial services. By using customer behavioral data, CredoLab empowers businesses to underwrite applications from unbanked, new-to-bank and new-to-credit (NTC) customers (e.g. self-employed, millennials, thin files, etc.).

The move was made in response to the violation of the Data Privacy Act of 2012 by online lenders that failed to use professional and non-abusive practices in coordinating with borrowers who are unable to pay on time. BSP together with other regulators, such as the Securities and Exchange Commission (SEC), Anti-Money Laundering Council (AMLC), Bureau of Internal Revenue (BIR), Department of Trade and Industry (DTI), and the Insurance Commission (IC) expressed support for the code.

Further, outsourcing regulations are also in place to provide a framework on the appropriate processes, procedures and information system that can adequately identify, monitor, and mitigate operational risks arising from the outsourced activities. Key risk areas are assessed before entering outsourcing contracts with technology providers, including the risk of confidentiality and integrity of data.

Generating Credit Information from a Smartphone CredoLab developed an app that accesses and collects anonymized data regarding call history, contacts, SMS history, calendars, and storage.

Examples of anonymous data collected are information about incoming and outgoing phone calls, SMS and e-mail messages, data on the use of the internet browser and the geographic position of the mobile device, information about the list of applications installed on the mobile device and calendar data. The app analyzes the smartphone footprint only after the users have granted the required operating system's permissions and given their data privacy consent. Once the less than the one-minute process is complete, a credit score is then sent to your respective bank for further assessment on the user’s application.

This app was created as a solution to the low approval rate of micro-businesses. These applicants often do not have credit data with the credit bureau, and often do not get access to financing by banks and other non-bank financial institutions.

This time-saving and safe technology provides data solutions to both consumers and lenders, allowing increased financing for MSMEs.

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GUIDELINE NOTE: HOW FINTECH FACILITATES MSME ACCESS TO FINANCING

Data Privacy and Consumer Protection Consumer data protection is critical in ensuring that customers are confident that their data is private and used appropriately when borrowing digital credit. It is widely acknowledged that women are at greater risk of abuse in the financial system and more prone to financial fraud and scams, due to their unequal access to resources and information and power imbalances at the household and community levels. Consumer information should not be shared without the customer’s consent, unless required by law, as it would otherwise defy practices of fair market conduct and expose the consumer to risks. Regional cross-border initiatives should be considered, together with opportunities to share best practices of data privacy regulation between policymakers, and the adoption of tools that assist with non-compliance detection.

Non-compliance risks may increase with the development of big data that is commonly used by FinTech. AFI’s Policy Framework for Responsible Digital Credit provides minimum regulatory and supervisory requirements for developing a responsible digital credit regime. Specific to data protection and privacy, good regulation should: 1. Issue and enforce rules for consumer data protection, data privacy and usage rights.

2. Enforce risk mitigation measures to protect the security, integrity, and confidentiality of customers’ information. At minimum, data privacy rules should include restricted access to consumer data, consent to use and process the data, fair and transparent use and processing of data, and ensure confidentiality of customer data.

3. Require operators to obtain consent for customers prior to sharing their data with third-party entities.

4. Enforce rules that stipulate exceptions to the use of consumer data without consumer consent, which may include compliance with laws or court orders.

5. Encourage regional data privacy initiatives based on common principles, support interregional data flows and interoperable capabilities with existing national approaches.

6. Put in place a framework for all financial service provid¬ers to implement transparent, user-friendly, gender-sensitive and effective recourse mechanisms and dispute resolution mechanisms to address any claims and complaints from MSMEs, while taking into consideration the differential consumer protection needs for women and men.

Such a framework should define a process for deleting information to be shared without consent, set a data retention period, establish channels for enquiries and complaints, and establish options for redress by consumer protection and complaint agencies within the financial regulator or other appropriate government departments.

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GUIDELINE NOTE: HOW FINTECH FACILITATES MSME ACCESS TO FINANCING

FIGURE 13: PHILIPPINES CONSUMER PROTECTION EDUCATION

The central bank (Bangko Sentral Ng Pilipinas or BSP) is in a partnership with the Department of Trade and Industry (DTI) and two networks of Microfinance Non-Governmental Organizations (MFNGOs) to facilitate information sharing and greater access to finance for MSMEs served by DTI Negosyo Centers — a one-stop-shop where MSMEs can seek support such as processing of permits, linkage to financial institutions, and capacity building.

Policy Guidance The examples above provide useful guidance on measures and directions that regulators in AFI member countries have taken to promote crowdfunding while safeguarding privacy concerns that protect investors.

The promotion of new technologies for financing MSMEs has advantages, but a careful understanding and consideration of risks is necessary to ensure that investors and consumers (entrepreneurs or MSMEs) are protected. Policy recommendations for the regulation of lending-based and investment-based crowdfunding platforms are as follows:6

One of BSP’s tasks under this partnership is to help enable Negosyo Centers deliver financial education sessions as part of the broader capacity building program for MSMEs. Technical discussions on the content of modules and tools resulted in agreements focused on topics related to DFS, in line with DTI’s banner programs promoting e-commerce. Module and tools development is ongoing and expected to be rolled out to more than 1,000 Negosyo Centers around the country to benefit their MSME clients.

The BSP continues to enhance the financial literacy of its country residents, with a focus on expanding strategic and multi-sectoral partnerships to reach priority sectors such as MSMEs. While the financial literacy programs are not fintech-specific, there is an emphasis on the importance of personal finance, maximizing the benefits of the use of digital financial products and services, and consumer protection, among others.

The BSP is also implementing a Digital Literacy Program as part of its financial education advocacy and while this program is not MSME-specific, it targets the public and MSMEs can also benefit.

Source: Bangko Sentral Ng Pilipinas, 2021. (https:// www.bsp.gov.ph/Pages/InclusiveFinance/ FinEdConsumerProtectionCampaigns.aspx). Philippines Department of Trade and Industry, 2021. (https://www. negosyocenter.gov.ph/negosyocenter)

6 This list is not exhaustive and does not include where we have reached a negative conclusion, i.e., that certain approaches should not be taken.

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TABLE 4 POLICY GUIDANCE FOR COLLECTION, PROTECTION, AND USE OF DATA Accuracy and reliability

Regulatory and supervisory institutions should mandate measures that ensure alternative data collected is compliant with the law, matched to the correct customer, obtained from trustable sources, and updated and relevant to the purpose for what is being used.

Accountability

Operators using alternative data for credit scoring and evaluations of customers must be able to see the data source. Where data is sourced directly from customers, operators should take adequate measures to implement data protection and privacy principles.

Consent

A consumer’s consent must be sought when alternative data is being used for a different purpose than the one specified for the data collection. When data is provided by a third party, mechanisms should be in place to obtain consent from the data owner.

Operators should be required to enter into agreements with their clients governing the main terms of the client-platform relationship.

Consumer’s Rights

Operators should put in place mechanisms that allow consumers access to their data and request the deletion of data. In addition, consumers should also be able to decline the use of their data for certain purposes (i.e. marketing) and should be allowed to transfer their data to another location without affecting its usability.

Data Collection

The collection of big data that involves personal information for credit scoring and evaluation should be collected and processed in accordance with the law. The legal basis could involve the consumer’s consent to collect and process what is necessary, such as, for the performance of a contract to which the data subject is a party.

Security

Operators should conduct periodic cybersecurity risk assessments, develop policies and procedures to effectively respond to cyber incidents, communicate cyber incidents to the appropriate regulator, and devote resources to assess, monitor and mitigate consequences of cyber-incidents.

Transparency

Many operators do not offer standardized pricing policies. This has caused challenges in pricing transparency of lending products and services. These are challenges not addressed by traditional annual percentage rate (APR) rules.

Specific business conduct requirements for a platform should be in place to provide adequate disclosure to investors and borrowers on various elements such as: (i) how the platform operates and earns its revenue, (ii) financial disclosure of offerings that may differ according to the size of offerings, (iii) risks of engaging in offerings.

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GUIDELINE NOTE: HOW FINTECH FACILITATES MSME ACCESS TO FINANCING

CONCLUSION FinTech exists across various functional segments of the financial ecosystem from payments, lending, savings, and insurance.

With its use comes operational risks and challenges for both consumers, and supervisors and regulators.

However, as described in this guideline note, while its benefits to MSMEs are abundant and borderless, policymakers should consider applying these new technologies on a nationwide scale taking a holistic approach to these activities, strengthening oversight mechanisms and providing practical solutions to mitigate these risks - which are even greater for the underserved segments. Special consideration is further needed in light of the gendered implications of these efforts.

Countries looking to develop regulatory frameworks around alternative financing methods such as FinTech and the use of digital credit may consider the following steps: > Understand the different types and business models of digital alternative financing available to MSMEs in the local context as they can be equity-based, lending-based, crowdfunding-based or a hybrid of these models to suit the demand of the local population. > Define the usage of digital credit in your local context. > Take stock of the different risk profiles applicable such as macro financial risks, strategic risks, operational risks, and cyber risks that apply to your local context if FinTech is to be used as an alternative source of financing for MSMEs. > Identify the legal jurisdiction of these digital alternative financing and integrate within a national legal framework either by adoption or by establishing new laws. > Decide on how to approach developing alternative financing regulations either by collaboration on the supply-side (such as a RegTech taskforce), or collaboration by both supply-side and demand-side (such as a regulatory sandbox). > Understand the market conduct of digital credit and implement and enforce proper disclosure regulations and a consumer recourse mechanism.

> Updated credit referencing systems to include alternative credit financing options and consumer financial data collected by these new FinTech platforms. > Note that data privacy and cybersecurity will be an increasing risk with the usage of FinTech for financing. Policies regarding accuracy and reliability, accountability, consent, consumer’s rights, data collection, security, and transparency will need to be explored through a gender lens for an iron-clad policy framework. > Ensure data collection is disaggregated by a wide range of indicators, with gender and age being paramount > Develop a gender lens with which to view activities to ensure structural bias in omitted and positive steps are taken to reduce the gender gap Aside from the country examples provided in this guideline note, other useful references made in this document should be explored if you wish to seek information from emerging markets and developing countries regarding the use of FinTech for financial inclusion and the responsible use of digital credit, and cybersecurity in digital financial services.

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GUIDELINE NOTE: HOW FINTECH FACILITATES MSME ACCESS TO FINANCING

ACRONYMS AND ABBREVIATIONS AML Anti-money Laundering AMLC

Anti-money Laundering Council

API

Application Programming Interfaces

APR

Annual Percentage Rate

BCB

Central Bank of Brazil

BIR

Bureau of Internal Revenue

BNM

Bank Negara Malaysia

BSP

Bangko Sentral ng Pilipinas

CAK

Competition Authority of Kenya

CBRC

China Banking Regulatory Commission

DFS

Digital Financial Services

DTI

Department of Trade and Industry

EBRD

European Bank for Reconstruction and Development

ECF

Equity Crowdfunding

FinTech Financial Technology FSB

Financial Stability Board

FINRA Financial Industry Regulatory Authority FTEG

Financial Technology Enabler Group

FTIs

Financial Technology Institutions

IC Insurance Commission LIFT Laboratory of Financial and Technological

Innovation MFNGOs Microfinance Non-Governmental Organizations MNOs

Mobile Network Operators

MSMEs Micro, Small and Medium Enterprises NBFC

Non-banking Financial Companies

NTC

New-to-credit

PSMOR Principles for Sound Management of

Operational Risk P2P

Peer-to-peer

RBI

Reserve Bank of India

RegTech Regulatory Technology SEBI

Securities and Exchange Board of India

SEC

Securities and Exchange Commission

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REFERENCES Alliance for Financial Inclusion, February 2020, "Policy Framework for Responsible Digital Credit." (https://www. afi-global.org/sites/default/files/publications/2020-10/ AFI_PM_AfPI_FINAL_digital%20-%20v2.pdf) Alliance for Financial Inclusion, October 2020, "Scoping and Assessment Report on Responsible Digital Credit in Africa." (https://www.afi-global.org/sites/default/files/ publications/2020-10/AFI_AFPI_scoping%20report_AW2_ digital.pdf) Alliance for Financial Inclusion, October 2019, “Cybersecurity for Financial Inclusion: Framework and Risk Guide.” (https://www.afi-global.org/wp-content/ uploads/2020/07/AFI_GN37_DFS_AW_digital_0.pdf) Alliance for Financial Inclusion, September 2015, "Policy Guidance Note on Digitally Delivered Credit." (https:// www.afi-global.org/sites/default/files/publications/ guidelinenote-17_cemc_digitally_delivered.pdf) Alliance for Financial Inclusion, September 2018, "Sochi Accord: FinTech for Financial Inclusion." (https://www. afi-global.org/sites/default/files/publications/2018-09/ Sochi_FS18_AW_digital.pdf) Alliance for Financial Inclusion, September 2018, "Special Report on FinTech for Financial Inclusion: A Framework for Digital Financial Transformation." (https://www.afi-global.org/sites/default/files/ publications/2018-09/AFI_FinTech_Special%20Report_ AW_digital.pdf) PriceWaterhouseCoopers, July 2017, “Women unbound: Unleashing female entrepreneurial potential.” (https:// www.pwc.com/gx/en/about/diversity/womenunbound. html) SME Finance Forum, 2020. (https://www. smefinanceforum.org/data-sites/msme-finance-gap) Women’s World Banking, 2020. “Sexist AI? What to do about gender-based algorithmic bias in the financial sector.” (https://www.womensworldbanking.org/ insights-and-impact/sexist-ai-what-to-do-about-genderbased-algorithmic-bias-in-the-financial-sector/) World Bank Group and CGAP, 04 May 2018, “Data Protection and Privacy for Alternative Data." (https:// www.gpfi.org/sites/gpfi/files/documents/Data_ Protection_and_Privacy_for_Alternative_Data_WBG.pdf)

Alliance for Financial Inclusion AFI, Sasana Kijang, 2, Jalan Dato’ Onn, 50480 Kuala Lumpur, Malaysia t +60 3 2776 9000 e info@afi-global.org www.afi-global.org Alliance for Financial Inclusion

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