In an increasingly globalised world, we are very aware that many areas are underserved and would benefit greatly from innovative financial solutions. The Caribbean as a region is one of those areas that, in my opinion, remains underserved by existing financial services and products. This current state is impacted by financial services firms that do not provide a full scope of products and services that are affordable, as well as a lack of more modern financial services and products. As a region, our financial services institutions charge some of the highest fees for outdated facilities that hurt the development of the region. However, these facts can be surmounted with alternative finance solutions that would allow the Caribbean region to leapfrog into modern financial services.
The first salvo of solutions that I envisage is the ‘low hanging fruit’. The 'fruit' that can, with a little support from Governments and Regulators, begin a much-needed transformation within the region. Enter Decentralized Finance (DeFi). Need a small loan? Seeking a real return on savings (and not fractions of a per cent)? DeFi allows these and more options to be possible. Think banking disrupted! And there is very good reason to welcome this disruption.
Banks and Too Little Risk
I look forward to unbundled banking within the Caribbean region to open opportunities for true economic growth to occur. In my humble opinion, the banking constructs that exist within the Caribbean do not sufficiently serve its people. In 2021, commercial banks within the region take little, if any, risks while charging some of the highest fees for basic services. Your minimum balance falls below a certain amount? You can pay an amount that exceeds 1.25% of that minimum balance per month on an account that only earns 0.05% APR if you never fall below that minimum amount. Given the average incomes within the region, the math would not support half of many populations being able to maintain even the minimum balance for three consecutive months. This means that those who can least afford to are having their hard-earned monies soaked up by fees.
Banks in the Caribbean region charge the most for credit card payments processing! This is a further hit to the region and its capacity to compete with the rest of the world that typically pays more than the rest of the world to process credit card payments – up to 4% as compared to 0.5%. Then there is the issue of loans and the interest rates charged. There is an incredible focus on risk-based approaches in financial services, but this approach appears to have missed lending in the Caribbean region. Take, for example, the car loan. In most countries, it does not matter if you are 18 and employed for 4 months at an entry-level job or a 38-year-old college graduate who is continuously employed at middle management for 11 years – you pay the same interest rate on your car loan. The banks, however, can and would change if for one thing – the regulators!
The issues we experience within the region do not exist in a vacuum. They challenge any person to examine the state of regulation within the region. One notable gap is the varied (and often light) approach to Market Conduct regulation. The insurance sector may be better supervised against conduct provisions than others, but all sectors should be held up to implement conduct provisions. Provisions against predatory practices by banks and other financial services providers are a feature of Market Conduct supervision. Restrictions on fees, requirements for clear and fair advertising and effective complaints handling requirements are also a part of Market Conduct supervision.
Beyond AML/CFT measures, there is more that can be done by regulators within the region for consumer protection. Whether there is an issue of ‘regulatory capture’ that prevents real progress on this facet of supervision is not immediately clear without more analysis and research. Regulators within the region are so focused on being ready for the next evaluation that it feels like much of the attention is on AML/CFT and little else.
Adjusting Regulatory Frameworks
However, the transparency that DeFi can provide could go far with consumers to clarify what financial options exist, say for certain banking products, and at what cost. The next question is whether regulators within the region have an appetite to adjust their frameworks to allow for innovative firms to apply, be regulated and permitted to operate. Competition being brought by FinTech and other innovations could also encourage existing service providers to change for the better - for consumers.
In a more recent report produced by ASBA, they found that,
"First, regulation should be neutral towards technological change and business models and should neither encourage nor hinder them. Rather, regulation should allow fair competition between all market players, i.e., analogue versus digital; existing versus new, highly digital business models; and local versus expanding foreign competitors."
One of the primary takeaways is that to properly regulate FinTech and innovative financial services and products, regulators must integrate Market Conduct provisions into their frameworks. The need to protect consumers while simultaneously ensuring that there is no ‘over-regulation’ is going to be an ongoing challenge. A possible solution that could be introduced now? Regulators could introduce gamification of conduct provisions to allow financial services firms to collect ‘points’ that can be applied towards a desired outcome – reduction in capital buffers or other prudential requirements. The regulator decides what activity generates points and how firms can participate. Participating firms need not be FinTech-enabled to benefit (but embracing technology would help).
Let the games begin!
Gamification introduces a competitive element into existing financial services firms (and my thoughts for integrating gamification go far beyond conduct provisions). FinTechs will also introduce much-needed competition in the region. Some may argue against it, reasoning that competition would not be healthy for many regional markets. The healthy tension that strong competition brings would allow for more choice and encourage incumbents in the region to raise their game (and extend true financing to people and businesses). This is supported by research conducted by the Bank for International Settlements (BIS). A BIS piece helpfully encapsulates the issue in a header in a review of the Latin America and Caribbean region – “weak interoperability and low competition drive higher user costs”.
What is the correct balance for a competitive marketplace when reviewing FinTechs? Receptive jurisdictions may have an influx of applicants. The comparatively low population base (when compared to markets such as India and South East Asia) is no longer a barrier to entry for innovation-enabled financial services. Digital payment systems, for example, allow for cheaper payment options that allow Caribbean market participants to engage more readily in global trade. While size does matter, the ability to pay in real-time makes a significant and positive difference in businesses within the region, improving economies and lives!
Paying it Forward
As alluded to, the introduction of digital payment systems throughout the Caribbean can provide tremendous benefits! One immediate benefit is the utility of a digital payments system that can counteract the continued impact of derisking by correspondent banks. Digital payment systems can also provide an avenue for businesses and entrepreneurs to send and receive payments in real-time! This simple facility remains a major hurdle within the region, particularly given the undue delays and expense in wire transfers that hamstring businesses from being more competitive.
Adding the insult of the expense of a wire transfer is the injury to businesses when monies take 3 business days to 3 weeks to arrive! Imagine the frustration and extra costs that occur in tracking a payment and coordinating shipping of goods, or closing a real estate purchase, or any number of business realities interrupted by inefficient money flows. Coupled with the lack of modern and efficient facilities provided by banks, the current payments framework for domestic, regional and global trade from within the region is simply not good enough!
Payment Systems versus Money Grabs
Money remittances are sometimes propped up as a solution to expensive and slow wire transfers, but the expense is prohibitive for real business operations. Remittances are the mainstay of migrant populations – monies being sent to help loved ones subsist. Several reports have been published that look at the volume of remittances within the region, which is projected to increase in the coming years. The immediacy of remittances also comes at significant costs within the region. Arguably, also driven in part by a lack of competition.
That expense is only increasing with governments adding their tax – an ill-advised step that ignores Behavioural Economics in my humble opinion – that further stymies business growth and development. The deficits that are being experienced by regional governments can be better plugged by embracing innovation. Targeting the subsector of populations that rely on remittances to survive are often underbanked for government revenues also undermines financial inclusion initiatives.
Financial Services, Upgraded
Beyond the earlier suggestion on gamification, there are many areas in traditional financial services that I see as being ready for innovation to be folded in. Every sector has areas that can be quickly upgraded to leverage technology. The tests are already being conducted in some areas, and in others, it only requires a bit of innovation (imagine that) to get things going within the Caribbean!
Around 2018/9, I recall reading an article that reviewed Japan’s testing of smart contracts in insurance payments in a very small subset of the population. Similar integrations of smart contracts were also carried out in Singapore. The subset of the population that allowed for certainty for insurance purposes in both cases? Expectant mothers. Insurance payments were made automatically at key points during pregnancy without a claim needing to be filed.
Imagine smart contracts being introduced within the Caribbean for automatic payment of claims. Introducing smart contracts could be rolled out in just one or two areas to start. Automatic claims payments eliminate some of the costs of claims handling (and eliminate the possibility of a mishandled claim) in a subset of the population. The benefits to both the insurer and the insured could be almost immediately realised within the region. There were discussions towards introducing microinsurance to farmers in the Caribbean; however, it is arguably an easier ask to introduce a facet of InsurTech to better serve pregnant women. The certainty of the outcomes of pregnancy, coupled with the ability to rapidly increase the awareness of the benefits of smart contracts in insurance is an easy quick-win to my mind that would bolster the adoption of innovative insurance solutions.
Activities in Other Spaces
In the more sophisticated investment space, opportunities are likely being explored to incorporate more efficiency. While it's been a few years since I’ve reviewed a fund’s prospectus, there are a few areas that are ripe for an innovative tweak. For example, consider 2 small tweaks to close-ended mutual funds. First step: the investment manager of the mutual fund tokenises its investment into illiquid assets. Second step: integrate smart contracts that set predetermined prices for those bundled illiquid assets that would allow for transparency in both the subscription and redemption process, thereby opening up what would be a close-ended fund to one that could be open-ended. This is not my version of investment advice, but a snapshot of what I see as possible. Add the usually required disclosures in the offering memorandum for professional investors to ensure adherence to market conduct requirements and onto the next!
Financial services practitioners in the fiduciary space are also quietly leveraging innovation. The discretionary element of many trust structures allows for trustees to invest in FinTech initiatives as a means of generating investment income on the trust assets. This may be the first facet that invested into FinTech and innovators, perhaps largely unseen. It is only recently that very few Family Offices have made their activities known. In light of the TCSP sector still being largely unregulated, prudential data collected for other sectors will not be available, in a large part, for the fiduciary services sector.
Visioning the Future / Seen and Unseen
Longer-term visioning within the region is needed, but the long view cannot and should not ignore the tremendous opportunities sitting at our feet now. Consumers are ready for innovation! Regulators have to be engaged and move with a purpose to quickly make space for innovation to thrive. Innovation will stretch regulators. The pace of evolving technological utility also adds to the layers of complexity that regulators must integrate. Innovation means that now and, in the future, regulation will be based more on the ‘what’ a business is doing while factoring in the technological tools that enable the ‘how’ and ‘where’. Governments within the region need to become savvier to get out of the way of innovation. Eliminate the bureaucracy that can often be intertwined with new initiatives – that goes for the regulators as well!
The Caribbean is ripe for a real digital transformation! DeFi, Non-Fungible Tokens (NFTs) and other blockchain-related developments will provide alternatives to traditional financial services. In the end, the transformation that FinTech and innovation can bring must still follow business strategy. There must be wins for all concerned. FinTechs can spur real competition that provides real financing opportunities to truly allow Caribbean people, businesses and governments to participate on that elusive level playing field. It can be achieved if the collective will is there. And for the incumbent financial institutions resisting change, it isn’t a zero-sum game… unless you refuse to innovate.
Blockchain, smart contracts and parametric insurance: Made for each other: https://www.crowell.com/files/20181116-Blockchain-Smart-Contracts-And-Parametric-Insurance-Made-For-Each-Other.pdf
Consumer Protection in the New Environment of Financial Technological Innovation: Regulatory and Supervisory Considerations – Regulation for Responsible and Competitive Financial Sector Innovation. June, 2020. http://www.asbasupervision.com/en/bibl/publications-of-asba/working-groups/2378-consumer-protection-1/file
Retail payments in Latin America and the Caribbean: present and future: https://www.bis.org/publ/qtrpdf/r_qt2012f.htm