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Modern Central Bank Sandbox

I. Transforming and Transitioning Financial Market Infrastructure –

Embracing A Sandbox Approach

Global acceptance of financial market innovation, including the much-debated Digital Currency-Based Financial Market Infrastructure, moved one step closer to reality in January with three positive strategic actions. The Bank for International Settlements (BIS) and six of the world’s largest banks officially announced the global conversation on the merits of promoting a digital central bank currency. Following a positive BIS press release, the debate of such a transformational shift is much less on the “if”, and more on the “How”.

The Working Group’s unstated mandate is to promote harmonization of new financial innovation although more formally its focus will be on Central Bank Digital Currency. As with other significant game changing global based regulatory and oversight strategies, starting with the 1988 Basel Accord, developing a global framework is premised on overcoming domestic and international political and economic hurdles. This approach has proven to leave many developing and emerging countries behind in the innovation cycles, yet there’s clear consensus those economies stand to benefit the most from such transformation.

 

  • INNOVATION AND RISK MITIGATION

The 2020 World Economic Forum Insight Report in their forty -five country review, notes that central bank and related policy makers must confidently evaluate whether CBDC is appropriate for their economy.  Central Banks in proceeding, must embrace an abundance of caution.  CBDC, as a digitized version of sovereign currency markets, continues to represent a liability of, the country’s monetary authority. The challenge for policy makers is to innovate, while minimizing potential risks to the domestic and global financial system.

Nonetheless, advocates for CBDCs must push for a model built for broad innovation from the private sector. New opportunities are expected across various market segments such as Digital Cash Wallets, Cross Border Trade and MSME Payments not only at domestic and regional levels, but internationally as well.  

  • GATEWAY TO TECHNOLOGY IMPROVEMENTS – TRAVERSING FINANCIAL MARKET INFRASTRUCTURE

Understanding the relationship between Central Banks and domestic as well as regional financial market infrastructure also known as FMI, is critical to its successful transformation. Creating process mapping of these linked gateways and identifying gaps potentially leading to money flow disintermediation creates is requisite to proceeding.  “FMI” as defined by the International Monetary Fund follows:

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Financial infrastructure comprises all institutions, rules, and standards of all the systems which enable financial intermediation. Payment systems constitute a prominent component of financial infrastructure. They facilitate the discharge of financial obligations and the safe transfer of funds across distances, institutions and retail customers, supporting the stability of the financial system. For governments and central banks, both strengthening the security and reliability of the national payments system and fostering the use of efficient payment instruments are important public policy goals. Public authorities have at their disposal policy tools in order to provide a legally sound environment for the private sector to provide a wide range of affordable payment instruments, products and services to individuals and merchants as well as paying particular attention to those financially excluded. The fulfillment of those policy objectives results in economic and social benefits.

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In other words, the systems that facilitate the movement of money from one party to another – regardless of the purpose of the movement – is part of the “financial market infrastructure”, and as such, innovation in those systems take tremendous coordination, resources and strategy, yet is inevitable.

Innovation must consider money movements, digital or cash through interlinked and integrated pathways. Money movements, from one party to another, or between countries and regions – regardless of (legal) purpose – comprises domestic, regional, and often global “financial market infrastructure”. As markets transition with the impact, tremendous coordination among processes, legal framework, resources and strategies among various stakeholders is required.

The 2020s are expected to be era of such transition.

As the owners and regulators of those system, Central Banks need a framework that understand the need to be diligent, but yet supportive of new fintech solutions.

Particularly, to help demystify the links between innovative or transitional technology, ‘SandBox’ solutions provide a useful template to test the implications of technological solutions on both domestic and regional micro and macroeconomic trends.

II. The Sandbox Approach: Strategic and Open Innovation

  • NORMALIZING REGULATORY TRANSFORMATION

The 1988 Basel Committee and its predecessor levied the idea of minimum capital requirements and harmonization of banks regulatory framework. Initially new regulation was rolled out gradually with Basel I and later Basel II.

In 2020 as Basel III becomes the new standard countries from both advanced and transitional economies, thought leaders and practioners both in and outside of central banks, must create new pathways to embrace innovation leaps in financial services – attempting to understand both intended and unintended consequences of new approaches

Before subjecting a country’s financial services sector to extensive fintech/technology driven change across the whole financial services sector, many Central Banks have opted for a moderated and controlled approach. Increasingly many emerging markets throughout Africa, have introduced a “Sandbox Approach” as a functional lever to promote regulatory approvals and maximize the benefits of integrating new ‘fintech’ technology.

There’s more that can be done.

  • A REGULATOR’S GATEWAY TO INNOVATION

Reg -Tech or applying technology to address foundational Central Bank issues, is emerging as a new win-win opportunity.  Central Banks can get to leverage fintech solutions and partner with new comers in order to be more effective at its mandate.  

Moreover, the IT operating model currently deployed by Central Banks is centralized, costly, complex, siloed and for many, coming to the end of its lifecycle. 

Central Banks, as many commercial banks have done, can work with new comers for Reg-Tech, Sup-Tech and Fin-Tech solutions that are innovative and agile in the product development. Tapping into the ecosystem tech and service providers can also help them shift to modern IT provisioning models that are more flexible and scalable (Software as A Service), while being secure and still privately governed.  This changes the cost structure, ability to scale as the need arises, and increases the interoperability to other systems.                                                   

  • LEVERAGE INNOVATION TO IMPROVE GOVERNANCE

Transformation versus disruption is a key part of this strategy. Mauritius, Hong Kong, Malaysia, Ghana, Philippines Tunisia, among other emerging and transitional economies have observed the path forged by the Monetary Authority of Singapore in taking steps to introduce and integrate new technology via a Sandbox Approach  

That also turns out to be an opportunity for Central Banks to consider the analyses and reviews done in collaboration with fintechs/innovators as a factor to adjust regulations that promote new solutions to address challenges. Expecting market and policy changes should be a primary objective in establishing a Sandbox Solution.

  • DOMESTIC SANDBOX… WITH REGIONAL HARMONIZATION

Fintech solutions being built are increasingly cross border by design given the migration of families, cultural integration and increasing cross border trade. See Flutterwave and Paystack as two prime examples of the cross-border nature of solutions investing heavily in fintech solutions.

We see 2 key benefits to aligning the domestic regulatory requirement with a regional regulatory review process:

  • Attracting new solutions to countries that might not be attractive on their own 

Standardizing the review process across multiple countries without overriding a county’s requirements

A regional approach to a Sandbox should harmonize, not override member countries’ regulatory requirements. The current manual and email approach to Sandbox makes this almost impossible… but it’s not.

III. A Sandbox As A Regulatory Technology

If we expect innovation to grow and transform more industries for the foreseeable future, and proliferate further in the industries is has already transformed, then we must address the need for an efficient process to perform regulatory reviews and accelerate the time to market for good solutions.

If we expect Central Banks to embrace modern technology and innovation internally, i.e. Introducing National ID Systems, National Payments Systems and Digital Currencies, then we must address how those solutions become interoperable and open to a broad ecosystem, while limiting risk to market stability, then we must address a modern infrastructure through which that is done.

We believe Regulatory Technology Can Help

Specifically, a Central Bank Sandbox Platform can be designed to provide regulatory clarity, accelerate time to market and also standardize the review process. Central Banks can also tap into such solutions to be more effective in governance. For starters, expecting market and policy changes should be a primary requirement in establishing a Sandbox Solution.