Recently I interviewed Felipe Lega, the Deputy Director of Market Integrity at the Colombian Financial Regulation Agency (URF),[1] on the new approach to financial inclusion that Colombia has taken in allowing non-banks to provide digital financial services.
The URF is the public authority in charge of preparing regulatory projects to enhance the financial sector’s development and integrity. It was created about a year ago and it has been the main authority in drafting the Financial Inclusion Law, which was approved by the Colombian Congress in September this year.
GSMA: What is the main innovation introduced by the Financial Inclusion Bill in the area of digital financial services?
Felipe Lega: The Financial Inclusion Bill, which was approved by the Congress a few weeks ago and is now awaiting the President’s enactment, creates a new financial licence to allow new players, including non-banks such as mobile operators, to enter the low-cost electronic deposits market, with the aim to expand financial access and increase the use of digital financial services in the country.
GSMA: What is the rationale for Colombia to make the shift from a conservative approach that allowed only banks to provide digital financial services to the vision held in the new Law?
Felipe Lega: Colombia used to have a financial framework that reflected a bank-led financial inclusion policy. In fact, the Colombian legal framework has been offering a full range of rules facilitating the offering of low-cost products such as electronic deposits and other kinds of simplified accounts for many years. Some banks have been taking advantage of these regulations and have been offering those products. Nevertheless, evidence has shown that the success of these initiatives has been limited to the public social programs of welfare transfers.
These programs have been critical for expanding the financial access levels of low-income population, however according to the analysis of the URF the transactional levels of these products are low. Therefore, the challenge for policymakers in fostering financial inclusion is to increase the transactional activity. For instance, customers are using financial products only to receive money that they immediately withdraw. Mobile banking has worked as a means for welfare transfers, but this has not matched our expectations to become a driver for more efficient usage of formal financial services. This is one of the factors that did not work out in the bank-led model as we had anticipated.
When we started developing our financial inclusion national strategy , we understood that increased geographical coverage (something we have been relatively successful at within Colombia through mobile banking and banking agents) and digitalisation of welfare transfers through banks were not enough to unleash the benefits of financial inclusion if the users kept relying on cash, and therefore that increasing usage was our major priority.
With the banks, we achieved important levels of geographical coverage using agents. Nevertheless, the majority of their points of sale are concentrated in urban areas. In the smaller municipalities, the transactional levels are still below our target.
When we researched international examples, we found that other countries had greatly benefited from the participation of non-bank mobile money providers in the market, an approach supported by regulatory frameworks that are similar to our new Law and had proved successful in increasing outreach, lowering the costs of financial services and creating more convenience for the customers. For instance we realised that mobile operators have been able to successfully leverage the ubiquity of their pre-existing networks and their experience in managing thousands of retail agents. In addition, the postal service has an extensive distribution network that is widely used in Colombia for domestic remittances.
The body of evidence that we gathered supported the idea that the bank-led model was not completely successful in increasing transactional use, and that other players (all of whom have shown interest in using the new licence) had great potential in helping Colombia to achieve financial inclusion. These considerations were critical to establish the rationale that is behind the new Bill. Luckily the legislators understood the need for increased competition through the creation of a new window to allow qualified non-banks to be granted a license as Sociedades Especializadas en Depositos y Pagos Electronicos (Companies specialized in electronic deposits and payments).
GSMA: What are the key aspects of this law and main features of the Sociedades Especializadas en Depositos y Pagos Electronicos?
Felipe Lega: The fundamental purpose of the Law is to create a new window for these financial entities, to determine the characteristics of these new business models and to establish the supervisory framework under the Colombian financial authorities. The Sociedades Especializadas en Depositos y Pagos Electronicos are not banks, but they are regulated financial services providers subject to financial regulation and supervision. They need authorization prior to establishing their operations and, in order to obtain that authorization, they must comply with governance (e.g., fit and suit rule) and risks mitigation requirements (e.g., AML/CFT rules).
The only activities authorized to these entities are the remote cash-in and cash-out operations, the allocation of customers’ funds in electronic deposit accounts and the offering of transactional services such as remittances, transfers, and payments. This new law allows these new entities to use agents just as the rest of the financial institutions already do.
On the other hand, Sociedades Especializadas en Depositos y Pagos Electronico are not allowed to intermediate customers’ funds: they cannot offer credit. Because there is no credit risk, these entities are not subject to the full range of prudential requirements that apply to commercial banks, however some rules applies to mitigate liquidity risks. For example, all customers’ funds have to be deposited in commercial banks or in the central bank (if the central bank board deems it appropriate). In addition, a specific ratio between capital and liabilities must be maintained. The liabilities, in this case, would be the customers’ funds. In any case, the new law requires a minimum of USD 3 million in capital for incorporation.
The customers’ funds allocated in electronic deposits are covered by deposit insurance to protect the clients from an eventual default scenario. The Colombian deposit insurance covers up to approximately USD 10,000.
GSMA: On this last point, we have observed that in most jurisdictions that have adopted similar regulation for electronic accounts and payment entities, the accounts are not considered deposits, and, therefore, they are not required to be covered by deposit insurance. Why was the deposit insurance important in the Colombian model?
Felipe Lega: Given that these entities will cover a low-income population that has not previously had access to the formal financial system, we wanted their first experience to be risk and trauma-free. And this is exactly why, to ensure trust in the system, we considered it fundamental to require deposit insurance for mobile accounts.
GSMA: Once the Financial Inclusion Law is enacted, what are the next steps?
Felipe Lega: This Law gives the government some regulatory powers. Basically, these are: first, to determine the ratio between capital and liabilities of these entities; also, the liquidity requirements that these entities need to comply with—even though the totality of the funds are required to be deposited in banks, we understand that, given the nature of the operation, it may not be possible to comply with this requirement at every moment. This is why regulation regarding special liquidity requirements will be in place.
The new law has also assigned the government the power to regulate the entities’ use of agents. But the Colombian regulation regarding the use of agents is very advanced, and we will only have to include these new entities as part of the existing regulation. In the same way, electronic deposits already have a set of rules and the new law authorizes the new entities to offer them so that no regulation is required on this matter. However, existing rules on simplified KYC requirements for opening and handling electronic deposits will be extended to the new entities, and including those that allow electronic deposits to be opened remotely using a mobile phone, by simply entering some data on the national ID card for verification purposes.
We are still exploring whether there is a need to regulate interoperability between electronic deposits.
GSMA: Along with the regulation provided by the Ministry of Finance, will we see other complementary efforts in any other public authority incentivizing the use of electronic deposits?
Felipe Lega: As for the incentives, I must clarify that electronic deposits already have some benefits. For example, tax exemption on financial transactions and rebate of two percentile points in VAT for purchases made with electronic payment instruments.
Another way of accelerating the adoption of these products will be their use by the government in the programs of direct distribution of public benefits as it has happened in the past with the program ‘Familias en Accion,’ provided that these schemes prove to be more efficient for these purposes.
Finally, another complementary measure that could incentivize this business model will be the possibility for these new entities of being recognized as foreign exchange intermediaries (IMC, Intermediarios del Mercado Cambiario) by the central bank, which will allow them to participate in the international remittances business.
These are some of the supplementary topics outside of the finance ministry’s scope that can contribute to the blossoming of this business model.
GSMA: Finally, what is the biggest challenge or opportunity that this law will give to the new financial entities?
Felipe Lega: I believe that the main challenge (and I think many of the interested parties know it) is to be able to capture the expanse of new clients that will add value to the transactional services that these entities can offer. Let me explain: if I can bring in a new client and at the same time I also bring in his landlord and also his local shop owner, I am going to be able to offer a lot more benefits and extract much more value and decrease the use of cash.
So the main challenge is to create ecosystems that add true value to the transactional services offered. This will lower transactional costs for society and increase profitable transactions for these new entities.
[1] Prior to join the URF, Felipe Lega worked as an adviser for the Colombian Financial Superintendent, and, earlier on, at the Colombian central bank, Banco de la Republica. He is an alumni of the Fletcher School Financial Inclusion Leadership Programme at the Tufts University.
Photo: Courtesy of Felipe Lega.