Financial innovation can make the financial system more accessible to underserved segments of the population and improve lives, but it can also lead to disaster. Governments must find the right balance between promoting innovation and managing risks. The pace of innovations, including some truly groundbreaking ones, has picked up, heightening the urgency of addressing this question.
In the early 2000s, financial innovations took the form of new products that ostensibly made it easier for consumers to get credit. Today’s innovation is underpinned by new technologies that are encapsulated by the term “fintech”. Fintech is putting banking and other services literally in the hands of consumers. We can now make payments, do basic banking and even trade stocks with apps on our mobile phones.
Digital banks, robo-advisers and online platforms that directly connect savers and borrowers are transforming financial intermediation. They have made saving and credit products easily available even to low-income households as well as those in rural and remote areas. Digital payments that are cheap, quick and efficient are proving a boon for consumers and businesses.
Governments must still work to protect investors and ensure basic financial literacy, so that investors understand the products on offer and risks involved. Network effects that benefit incumbents can lead to even greater concentration in the digital realm. China’s government gave Alipay and WeChat Pay free rein, which they used to create innovations that expanded financial access to the masses. India’s Unified Payments Interface provides a model for how a government can foster private sector innovation and competition in financial services.
Aadhaar makes it easy for even illiterate and poor individuals to establish their identity, facilitating access to the financial system. The government has proposed regulations to give consumers control over use of their data. Fintech can play a powerful role in democratizing finance in advanced and developing economies, but its perils must not be discounted. Governments have an indispensable role in securing the benefits and managing the risks.
