How can FinTechs innovate on the right side of regulation, and what is the best way to avoid a crisis?

In this article Binu Paul, Specialist Lead, FinTech explains how business innovation and regulation can go hand-in-hand, and how you can avoid issues and crises through preparation.

A healthy financial services sector translates to financial stability, growth in jobs and alleviation of poverty. Innovation can magnify these benefits. Yet, these benefits come hand in hand with potential for crises, given the novel risks for consumers, businesses and nations.

They say the best way to predict the future is to make it. On the flip side, the only thing harder than managing a crisis is explaining why you hadn’t prepared for it!

The road to innovation

The past decade has been witness to the start of a gradual disruption of the financial services sector. This has been aided by changing consumer expectations and a spurt of innovation enabled by a handful of technologies. Examples include those that enable social media platforms, and more recent developments such as blockchain and advances made in artificial intelligence.

Yet, a vast majority of the sector continues to operate in traditional ways – ripe for further disruption.

These disruptive trends have accelerated even further as a result of the ongoing global health crisis. Lockdowns have imposed physical distancing and international border closures have challenged trade flows. Against that backdrop, even more financial services have moved to being digitally delivered.

But what does innovation look like practically and what goes into it?

Any definition of ‘innovation’ is going to be subjective. There is no universal agreement on what this buzzword really means. But, there is undeniably an element of a new idea and its successful implementation to create value. Minus the successful execution, it is merely an invention.

Drivers of innovation can vary. Popular drivers include the response to a crisis, the need to stay relevant or a passion for breaking new ground.

Innovation in financial services aims for cheaper, faster or better customer experiences and financial outcomes for consumers. Easier said than done! Any entrepreneur will vouch for the fact that this innovation journey is complex, volatile and requires perseverance.

Innovators start with a problem statement or a thorough understanding of a customer pain point. The innovation journey then becomes largely experimental, bringing together various combinations of talent, tools and processes. Along the way the innovator is prepared to abandon one approach and pivot to another for the most optimal outcome. By its very nature, innovation lives in the world of uncertainty and the unknown. After all, it is trying something new that is going to lead to creating something new.

Yet, with new benefits come new risks to consumers. Regulations provide a safety net for consumers against risks and a potential crisis.

Regulatory approach to innovation

The financial services sector, by virtue of its significance to the global economy attracts regulation. This is to mitigate consumer harms.

Regulatory frameworks strive to find the balance between the benefits from innovation and the accompanying risks. Anytime, anywhere access to personalised financial services immediately raises worries about around privacy, ethics, security and trust.

In New Zealand, regulation of the financial services sector follows a principles-based system, rather than a rules-based system.

A rules-based system is prescriptive in what financial providers can and can’t do when offering services to consumers. In our principles-based system, providers are expected to meet broad-based standards, with a greater focus on good consumer outcomes.

While open to interpretation, the principles-based system comes with a certain amount of flexibility, as the ultimate objective is achieving better consumer outcomes. On that basis, a principles-based approach is more amenable to the innovation journey.

The best way to prepare for a crisis is to…avoid it

Both the regulator and the innovator seeks similar objectives – better customer outcomes. For the innvoator, balancing a profit motive with achieving better customer outcomes can be challenging – their path is already filled with twists and turns. It makes sense then, for any innovator to be aware of the regulators’ expectations as early as possible on the innovation journey.

Here are a few tips to avoid a crisis:

• Prepare a short brief of your idea, including what is the pain point you are trying to solve, who you are solving it for and how you aim to do so.
• Contact the relevant regulators and share your plans
• Be clear about the areas you need guidance on
• Seek external legal advice based on their feedback
• Use these insights to build your solution

You can find out more and get in touch with the Council of Financial Regulators here.

This article is contributed by Binu Paul, Specialist Lead, FinTech at the Financial Markets Authority. For more on how you can avoid a crisis, and deal with one when it happens, read our other blog pieces or refer to the Company Crisis resources here.