Using a Sandbox to digitalise and regulate microfinance services in the Balkans

Luca Borella

Expert in digital finance

When the term financial inclusion is mentioned, the first things that come to mind are usually countries were poor people are financially excluded or unbanked like India, Afghanistan, Senegal, etc. But we don’t really need to look that far from home. 

Financial exclusion is an issue affecting our small neighbouring Balkan countries too. The reasons behind financial exclusion are several, but among these the lack of a credit background is one of the most common reasons for being excluded in these countries where the financial sector is developed. 

The paradox with being unbanked due to lacking credit history is that you can’t have a credit history if you’re unbanked. At least, this was true until now. Imagine a Fintech app that could use your smartphone data to create a credit score. 

By calculating how many contacts you have, counting your call logs and calendar events, checking whether you use organisational apps or not, or finding out if you actively try to save money by using supermarket apps, microfinance institutions could determine personality traits (such as impulsiveness or extroversion) and, consequently, an individual’s credit score and probability of default. 

Providing financial services to the underserved is an investment that will result in the financial growth that the Balkans have been striving to achieve.

I know, I’m probably going too fast, how did I get to this point? Let me take you back to the 5th of September in a city with a questionably high statue-person ratio.


Rich Culture, Complex History – Skopje

Last week I spent a few days in Skopje and took part in the International Conference “Regulating Digital Financial Services”, organised by the Alliance of Microfinance Organizations (MFO) in coordination with the Macedonian regulatory and supervision authorities, and supported by USAID.  

It wasn’t my first time in North Macedonia. Exactly two years ago, towards the end of our gap year, my wife and I travelled from Budapest to Istanbul through Belgrade, Skopje, and Sofia. Positively impressed by the rich culture and complex history that characterise this part of the world, we found that the Balkan countries share some unique and fascinating aspects. 

For example, even though the majority of the population has slavic origins and strong ethnic ties with Eastern European countries and Russia, the Turkish influence remains strong. In fact, for more than 400 years, most of the region was under the rule of the Ottoman Empire. 

The oriental heritage in Skopje is tangible. Especially while strolling around the inhabited bazaar, which contains mosques, Turkish baths (Hammam) and caravanserais (Han). 


The Conference

The conference was an important occasion to discuss what has been done so far to tackle the financial inclusion challenges in the region, the current obstacles and what is needed to overcome them, and the key role of technology. 

The main concern was that ill-advised regulation can deprive consumers of the advantages of financial services innovation. It was commonly shared among all actors that there is a pressing need to find the right balance between precautionary regulation and market development and innovation. Not talking about it is not an option anymore. 

The conference organiser, MFO, invited regulators, the representatives of microfinance institutions (MFIs), and practitioners, from Croatia, Serbia, Kosovo, Bosnia, Albania, Greece, and North Macedonia. 


The Special Guests from the North 

The “special guests” were the delegates from the central banks, the ministries of finance and other supervisory authorities of the three Baltic states, namely Lithuania, Latvia and Estonia. 

The Balkans, who bear an uncanny resemblance to the Baltics, eyed them constantly for four main reasons. First, the Baltic and Balkan states are relatively small countries of similar order, for example, in terms of GDP growth and population.

Secondly, both regions share the long-lasting consequences of post-world war II regimes. 

Thirdly, the Baltics have recently become members of the EU. Some Balkan states are too (e.g. Croatia), while others, notably Serbia, Albania and North Macedonia, are in the process of taking the required steps to do so.

Most importantly, the Baltics are leading the digitalisation of financial services in Europe. Latvia, for example, has started operating the eurozone’s first instant payment systems (24/7/365) compliant with the Single European Payments Area (SEPA) project. It’s also experimenting innovative Know-Your-Customer (KYC) data-sharing facilities for all financial sector participants, using biometric data for customer identification. 

In October 2018, Lithuania launched the regulatory sandbox, which allows market participants to run innovative fintech products or business models in a live environment with real consumers, under the guidance and supervision of the Bank of Lithuania. 

Estonia digitised many aspects of its citizens lives, ranging from voting routines to pharmacy prescriptions to driving licences. So it’s no wonder that Estonian school children are incentivised to learn about financial education by using banking apps specifically designed for them. 

A regulatory sandbox is a framework set up by a financial sector regulator to allow small scale, live testing of innovations by private firms in a controlled environment (operating under a special exemption, allowance, or other limited, time-bound exception) under the regulator’s supervision

CGAP, Regulatory Sandboxes and Financial Inclusion, Working Paper, 2017


The Balkans

The regulators in the Balkan region are also actively approaching digitalisation of financial services, each with a specific approach given the peculiarities of each country. 

The Croatia National Bank, being already part of the Eurosystem, is currently busy assisting market participants dealing with the implementation of the Payment Service Directive 2 (PSD2). 

The National Bank of Serbia is launching a ‘regulatory sandbox framework’, while the National Bank of North Macedonia has established an ‘innovation hub’ and is extending the cooperation and coordination to other national regulators in view of the future EU membership and PSD2 compliance. 

The Bank of Albania, which is the sole authority to licence, supervise and regulate all lending and payment activities performed by banks and non-banking financial institutions, has recently issued a new payment law. By establishing the concepts of payment initiation service (PIS) and account information service (AIS), the law aims to reduce transaction costs and to align with EU regulation. 

Kosovo, on the other hand, is still in its early stage also due to its political instability, which is hampering the development of new regulations. 


How does a regulatory sandbox help? 

The main challenges faced by regulators were the: 

  1. knowledge curve, i.e. often regulators are facing technological issues that they have no knowledge about; 
  2. distinction of competence, i.e. some issues might need to involve various departments within the regulators or even other entities, which requires some coordination efforts;
  3. unharmonised areas of service, i.e. the technology could be installed in one country but the services delivered in another country, with a different regulation (a.k.a passporting issue).

According to research funded by the Bill and Melinda Gates Foundation, regulatory sandbox frameworks and other initiatives, like innovation hubs, can gradually help regulators address the above-mentioned challenges. However, there are certain limits to be taken into account, ranging from regulatory capacity, to conservationism, to transparency.  

Moreover, establishing thematic regional sandboxes is crucial in order to remove regional obstacles, which include limited funding, the absence of local talents in the technology sector, and varied legal and regulatory frameworks across jurisdictions. 

But, regional sandboxes would undoubtedly require substantial cross-border coordination efforts. 


Industry sandbox vs regulatory sandbox 

In other words, setting up regulatory sandboxes is just not enough to foster innovation, cut experimentation costs, and avoid financial exclusion. Something more widespread and agile is needed in parallel. An industry sandbox (IS) could be a viable option. In fact, an IS differs from any form of regulatory sandbox because it’s off-market and does not involve or provide any regulatory relief. 

Innovate Finance, who was invited by the UK FCA to chair an industry consultation on an industry-led sandbox for financial innovation in 2017, defines an IS as “a shared off-market development environment where developers of Fintech solutions can access data, technologies, and services from different providers in order to validate innovative ideas or address common industry challenges”. 

The key findings of the study found that an IS is useful to accelerate: 

  1. solutions development by providing the whole of the Fintech ecosystem access to resources such as data, APIs, and reference architectures; 
  2. complex problem solving by facilitating industry collaboration;
  3. regulatory efficiency by encouraging regulators to engage as observers.


How does the partnership between Microfinanza and Open Bank Project help? 

During my panel discussion, I had the chance to present the benefits of a hypothetical IS deployed by Open Bank Project (OBP) and fine-tuned by Microfinanza. 

Back in 2017, OBP deployed one of the first industry sandboxes populated by a mixture of real and simulated data for the Australian Payment Council (APC). APC is the strategic coordination body for the Australian payment industry, representing organisations like Australian Payments Network (APN), various financial institutions, and market infrastructure providers like SWIFT. 

This cross-industry sandbox and its launch event brought together financial institutions and the Fintech community. One year later, as evidence of how this initiative fostered innovation, APN sponsored another initiative, the New Payment Platform (NPP) Program, which “enables Australian consumers, businesses and government agencies to make real-time, data-rich payments between accounts at participating financial institutions.” 

Taking the Australian case as an example of innovation best-practices, this approach could be replicated in each Balkan, but also Baltic, state. Leveraging on OBP experience in deploying ready-to-use IS technology, each state could have its own IS live in a few weeks and filled with country-specific data. 

Microfinanza, on the other hand, with more than nineteen years of experience in access to finance and financial inclusion challenges, would support regulators, MFIs, and Fintechs to prioritise their goals and monitor their impacts. 


We envision a three-phase approach

In the set-up phase, Microfinanza and OBP would advise the ‘sponsors/donors’ of the initiative by providing a list of participants required to take part and those who would be nice-to-have, as well as by providing training and relevant use cases.

Industry Sandbox Consultation Report, Innovate Finance

Generally, for each IS, ‘observer’ rights would be granted to the local regulators, while ‘user’ rights to MFIs and Fintechs. In theory there would also be the possibility to offer ‘cross-country observer’ rights to foreign organisations too. 

In the second phase, i.e. when the Industry Sandbox goes live, Microfinanza and OBP would govern the innovation funnel by providing technical assistance and training for products and services development, risk management best-practises, and consulting on sensitive topics such as data protection. 

In the final phase, after twelve months of experimentation, the best ideas and applications will be tested with real data within regulatory sandbox frameworks, and implemented by the MFIs in collaboration with the Fintechs. 

To sum up, thanks to Microfinanza experience in the financial inclusion space and Open Bank Project technology, this initiative would help:

1) market participants (MFIs and Fintech) speed up innovation and fulfil their social mission faster; 

2) regulators monitor innovation, engage in dialogue with sandbox participants, review IS tests in application to regulatory sandboxes, and feedback into policy development.


Captain obvious moment: Who’s the third beneficiary?

That’s right, the sponsor/donor! Reaching their social impact goals, which is the reason their organisations were created in the first place, is one of the main reasons that sponsors would get involved in such an initiative. 

By promoting this initiative and fostering ideas and knowledge, the sponsor/donor would promote an initiative in the field of financial inclusion, for the development of technical and social innovation capable to drive social changes, for the benefit of vulnerable people and communities, and to enhance microfinance institutions’ economic, social and environmental performances. 

To use a quote of Bill Gates “to turn caring into action, we need to see the problem, find a solution, and deliver impact”. An IS helps you do exactly that.


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