By Imesha Dissanayake
The sandbox concept evolved from the children’s learning game, vindicating the old “test and learn” approach to foster innovation. According to the UK Financial Conduct Authority (FCA), sandboxes are a safe space in which individuals can test innovative products, services, business models, and delivery mechanisms in a controlled environment.
There are many types of sandboxes available globally with one such type being the regulatory sandbox. A regulatory sandbox apart from its functions as a sandbox, is also a mechanism where the regulator is able to identify regulatory barriers that hinders innovations. UK FCA was the first to introduce a regulatory sandbox in 2016 followed by other countries such as Singapore, Malaysia, Indonesia, Jordan and Australia. The Central Bank of Sri Lanka (CBSL) too launched a regulatory sandbox on 17th February 2020 with a focus on the country’s FinTech industry.
Financial technology (abbreviated to FinTech) is the integration of technology to the financial services offered. However, Sri Lanka is at a very early stage of FinTech development in comparison to other Asian countries such as India, Singapore and Malaysia. The introduced FinTech regulatory sandbox will provide an opportunity for FinTechs to engage in live experiments and, facilitate a test and learn approach without infringing regulatory requirements. Since, focusing on regulatory compliance can drain capital before realising whether an idea could work and be scaled up.
How does Our FinTech Regulatory Sandbox Work?
The CBSL FinTech regulatory sandbox can be utilised by both foreign and local players in a situation where there is an absence of similar services or technologies in the domestic financial market. This is on a roll-over basis where applicants will be accepted to the sandbox on a continuous basis rather than in group basis (cohorts). In order to enter the sandbox, an applicant should partner with a CBSL licensed financial institution (unless the applicant is a CBSL licensed financial institution) and, have a solution that is tested in a lab and verified by an independent third-party.
Applicants will be informed whether they have met the eligibility criteria by the CBSL within 15 working days of submitting the application. After which, the Financial Technology Advancement Committee (FTAC) that is headed by a Deputy Governor of the CBSL will approve it, within another 30 working days. In a situation where the application is rejected, the applicant is eligible to re-apply after a cooling period of 6 months and after meeting criteria.
On entry to the Sandbox, relaxations of required regulation issued by the Financial Intelligence Unit (FIU) of CBSL and relaxations in the Customer Due Diligence (CDD) rules can be seen, which however, will end once the testing period is over. However, CBSL may relax a regulation that is hindering the product from being released to the market based on the progress and success of the product/solution while in the sandbox. In a situation where a product successfully exit the sandbox and enters an undefined area then introduction of new regulations can be seen.
Acceptance into a regulatory sandbox increases an applicant’s credibility with both their customers and investors. It can potentially convince investors who have been reluctant to invest earlier, in the context that they are working on both regulatory obligations and product innovations.
Innovators also get the opportunity to work with regulators and customers get better protection, since products are tested in a controlled environment. Regulators, on the other hand, have greater visibility into new innovations and will be able to implement more focused policies.
Factors to consider for Sri Lanka
According to research by the Consultative Group to Assist the Poor (CGAP), a regulatory sandbox requires adequate resources (staff and funding) to operate. However, CGAP has observed that often times regulators put sandbox responsibilities at the top of their staff’s existing work, instead of hiring dedicated staff. This results in further stretching of capacity and may have a negative impact on other areas of regulator’s responsibilities such as regulation, monitoring and supervision.
There is a growing tendency for financial services or products being interlinked with various sectors such as Insurance and Telecommunication. Therefore, establishment of a regulatory sandbox by one authority as opposed to multiple may disadvantage innovators in other areas such as Insurance. A coordination mechanism can remedy such situations by benefitting all the interlinked sectors.
Where does Sri Lanka stand with FinTech and Financial Inclusion?
FinTech has much potential to grow in Sri Lanka, although, it is still at a very early stage with few FinTech initiatives emerging successful while, others have failed owing to either the market not being ready to embrace the technology or due to regulatory barriers. Therefore, Sri Lanka’s regulatory sandbox was established with a focus to develop the FinTech industry by bringing in technologies that the market is ready to embrace and identify the existing laws that hinders the development of such technologies. Since, FinTech can offer many benefits to the country with moving the country towards a less-cash society and improving financial inclusion amongst them.
The Global Startup Ecosystem Report 2020 (GSER 2020) too recognised FinTech as a sector with strong potential to grow in Sri Lanka. This was owing to initiatives such as the regulatory sandbox, the launch of HatchX; a FinTech Accelerator and other noteworthy startups such as Payhere and Helios present in the ecosystem.
FinTech enhances the services offered to consumers, lowers cost, provides ease and convenience, saves time and effort and, fights fraud by leveraging information about payment history to flag transactions that are outside the accepted standards.
Pandemic such as COVID -19 are also testimony that adoption of FinTech is imperative for the country’s growth. Since these pandemics limit the movement of people and, companies and institutions find it difficult to engage in financial activities such as collecting dues from customers. Thus, resulting in increased Non Performing Loans (NPLs).
FinTech also has the potential to benefit underserved individuals and communities and, improve financial inclusion in the country. Serving the rural area in Sri Lanka will also increase the potential customer base for the FinTech industry as well. Therefore, both FinTech and financial inclusion can go hand-in-hand with much potential to expand on financial inclusion as well. Since, the National Financial Inclusion Survey 2018/19 too highlighted that despite a high level of bank account ownership among both men and women in Sri Lanka, the use of formal financial products remains low.
Section below sets out the causes for the slow growth in FinTech and financial inclusion identified through Industry Interviews and research conducted.
A. Lack of a Customer Identification Mechanism
Financial services require accurate identification of customers in order to detect fraud. The inability to verify prospective clients often leads to financial exclusion and therefore, customer identification mechanisms such as e-KYC and Digital ID becomes a key area in promoting financial inclusion.
B. Impediments in Regulatory and Legal Environment
Supportive regulations and legislations will increase the digital financial innovations and as well as increase trust among consumers while complementing financial inclusion. The recently launched FinTech regulatory sandbox aims to address this concern by working with the innovators and having greater visibility into new innovations in order to develop supportive regulatory policies.
C. Lack of Coordination and Communication Among Various Stakeholders
Collaboration between different organisations is imperative rather than the individual organisations working in silos. This will enable fast and coherent digital interventions in the financial sector as well as improve financial inclusion in the country.
D. Low levels of Financial Literacy
Enhancing financial literacy and developing the financial capability will improve financial inclusion and increase the adoption of FinTech. The National Financial Inclusion Survey 2018/19 revealed that about 56% of Sri Lankans did not compare the interest rates with other providers and did not appreciate the need to do so, proving the need for financial literacy.
E. Lack of Digital Inclusion
Digital inclusion encompasses digital skills, connectivity and accessibility. Improving this will increase the adoption of FinTech, enhance digital financial inclusion and aid to close the digital divide in the country.
Is the Regulatory Sandbox the Right Model for Sri Lanka?
A regulatory sandbox is important for the country since it will identify the impeding regulatory barriers and foster innovation in digital financial services. It can also support financial inclusion through the sandbox’s role in harnessing innovation. However, in our discussion with various industry stakeholders, it was emphasised that the lack of awareness on the benefits of the regulatory sandbox is deterring the industry from reaping the sandbox’s full potential. Therefore, carrying out awareness campaigns on the regulatory sandbox and its benefits is imperative for the successful implementation of the sandbox.
Further, a regulatory sandbox is not the only solution but part of a toolset available to the regulator to facilitate innovation. Few other tools used by regulators around the globe to support the development of FinTech and also to improve the financial sector are Thematic Sandboxes, Innovation Hubs and Regulatory Accelerators or RegTech Labs.
The Author is a Research Associate attached to the Economic Intelligence Unit of the Ceylon Chamber of Commerce. This article is part of the Strategic Insight Series that focuses on key contemporary topics that matter to the private sector based on key informant interviews and secondary research. Topics such as Renewable Energy, REITS, Online Payments and Global Sulphur cap amongst others have been covered by the briefs to date.