Financial technology, or fintech, has brought financial security within reach for previously underserved people and communities, especially in developing countries.
But the benefits brought by companies providing software, services, and products for digital financial services are accompanied by new, often unfamiliar risks.
While many fintech firms have experienced rapid growth during the COVID-19 pandemic, consumers and regulators alike need to know both the upsides and the downsides of new business models emerging in digital finance.
Among these fast-growing new digital financial services, digital microcredits enable quick approval and access for small, short-term loans via mobile phone.
However, their pricing can appear vague, while the mobile format can impede readability for microcredit users.
“When you translate summarized disclosure statements and key facts to a small screen, it becomes even harder to ensure that the consumer is receiving the information they need to understand risks and choose an appropriate product,” observed Jennifer Chien, Senior Financial Sector Specialist at the World Bank Group, during a recent session of the Financial Inclusion Global Initiative (FIGI) Symposium.
Another challenge relates to timing, she explained.
“You may receive information about the pricing for a credit product only after you have finalized a transaction, which makes it too late to use that information effectively.”
Making algorithms accountable
Fintech products are sometimes marketed unscrupulously, such as with certain practices emerging in unsolicited offers of microcredit sent to consumers’ phones. In unbanked markets, such practices can result in unnecessary loans and subsequent repayment struggles.
“Some are marketed in a way that encourages the consumer to take out the maximum loan possible,” said Chien. “The remote nature of the digital channel and rapid transaction speeds increase consumer vulnerability to aggressive marketing practices.”
At every level, fintech’s benefits and drawbacks seem mixed. For example, while automated credit scoring can expand access to financial services, poor algorithm design and non-representative data can produce biased results that are ” systematically worse for certain groups and perpetuate social inequalities,” warned Chien.
Creating algorithmic accountability through regulatory and technical safeguards and controls is a work in progress for many countries and researchers.
The Hong Kong Monetary Authority, for instance, has told digital microcredit providers to ensure that existing rules on fair treatment and anti-discrimination apply to the use of algorithms.
Protection from lending risks
Risks of unfair lending with high annualized rates also persist in digital microcredit products. Loans are sometimes marketed aggressively without assessing the consumer’s need or ability to repay. So-called “lend to learn” models extend access to finance for consumers without a formal credit history to learn their creditworthiness. But risk-blind models can result in loans being taken out by consumers who can’t afford them.
Consumer warning labels, or equivalent notifications, may have to be attached to certain fintech products and services, Chien said.
Testing in Kenya, for example, indicated improved consumer comprehension after brief summaries of terms and conditions were shown on mobile phones earlier in the transaction process. In Paraguay, consumers are offered a final option to accept or reject terms before concluding a digital transaction contract. In such cases, the dynamic interactive nature of mobile channels aids the consumer.
Evolving risks, evolving regulation
Fintech also enables access to credit via peer-to-peer lending platforms. But most such operators remain unregulated, depriving consumers of protection, said Gian Boeddu, another Senior Financial Sector Specialist at the World Bank Group. The UK and Mexico have tried to address this by developing new definitions of activities subject to financial regulation.
In the digital context, low barriers to entry for accessing credit and reliance on technology expose consumers to risks. As a safeguard, policies that apply to traditional financial service providers are now being extended to providers of new digital financial services and related third parties with additional requirements for digital literacy and consumer competence.
Investment-based crowdfunding, which allows small companies to issue debt or equity securities to the public, shows how fintech innovation can prompt regulators to rethink certain rules.
This form of crowdfunding cannot develop within regulatory frameworks for capital markets, opined Ivor Istuk, Senior Financial Sector Specialist at the World Bank Group. “Established rules for offering securities and providing investment intermediary services tend to be too costly for small businesses and start-ups. Companies that would find this market lucrative would also need to register themselves, increasing operational costs.”
Concerns around fraud and platform failure also apply to investment-based crowdfunding. Risks are exacerbated by inexperienced investors, risky issuers, opaque information, and illiquid and complex securities, explained Istuk.
To address gaps in Fintech regulation, experts highlight the value of a step-by-step approach based on the development of an in-depth understanding of the fast-evolving fintech market and experiences of consumers and industry players.
FIGI is an open framework for collaboration led by the International Telecommunication Union (ITU), the World Bank Group, and the Committee on Payments and Market Infrastructures (CPMI), with support from the Bill & Melinda Gates Foundation.
Check out the 2021 symposium’s video playlist.