“The key challenge for us as regulators lies in fostering an environment that promotes financial innovation and growth while simultaneously safeguarding the integrity of the financial system and protecting vulnerable financial customers,” said FSCA Commissioner Unathi Kamlana.
At a recent public lecture hosted by North West University’s Faculty of Law, Kamlana delved into this dual challenge, exploring the drivers and impact of financial innovation, the economic benefits, the barriers to development, and the necessity and cost of regulation. He also discussed the delicate balance required to nurture innovation while controlling risks.
Touching on the drivers of financial innovation, Kamlana explained that the financial sector evolves in response to changing economic conditions, technological advancements, and consumer needs. He noted that during periods of economic growth, there’s increased demand for new financial products and services, while economic downturns often spur innovation as institutions seek cost reductions and efficiency improvements.
“For example, during the Covid-19 pandemic, financial institutions rapidly adopted digital solutions to ensure continuity in the provision of financial services while adhering at the time to social distancing measures,” Kamlana noted.
This period saw a significant acceleration in digital financial services, transforming product delivery and driving further innovation to enhance sector resilience and efficiency.
Technological advancements, such as blockchain, artificial intelligence, and machine learning, have streamlined processes and reduced transaction and operational costs.
“Today, the sector is able to execute a variety of financial transactions, from making payments to investing and to do all of this with unprecedented speed and efficiency,” he said.
These technologies not only improve agility and operational efficiency but also enhance transaction accuracy and security, making financial services more reliable and cost-effective.
In addition, consumer demand for convenience, speed, and personalisation drives the development of user-friendly financial products and services. Competition from fintech startups also pushes established institutions to innovate to stay competitive. And then there are regulatory changes that create new opportunities and frameworks for innovation.
The key impacts of financial innovation
Financial innovation has transformative impacts beyond technology enhancements, extending across the financial sector. Efficiency gains in service provision and innovative technologies streamline processes, reduce operational costs, and improve service delivery.
“For example, automation and artificial intelligence can handle routine tasks, such as data entry and customer inquiries, freeing up human resources for more complex and more strategic roles and tasks. This not only reduces the risk of human error, but also speeds up transaction processing, thereby improving overall customer satisfaction,” Kamlana explained.
Blockchain technology offers transparent and secure ways to record transactions, reducing intermediary needs and transaction costs. Innovation also improves financial service accessibility.
“In many parts of the world, traditional banking infrastructure is limited, leaving vast populations unbanked or underbanked. Mobile banking and digital payment systems can bridge this gap by providing financial services through mobile phones and other digital platforms,” he said, citing Kenya’s M-PESA as an example.
The creation of new financial products and services is another critical impact. Fintech companies and innovative institutions develop products catering to diverse customer needs, such as micro-loans, peer-to-peer lending platforms, digital wallets, and robo-advisers. He said, these innovations provide consumers with a broader range of tailored options.
The economic impacts of financial innovation
Kamlana highlighted the economic benefits of financial innovation, including job creation, investment attraction, and economic diversification. The rise of crypto assets is a compelling example.
“Crypto and blockchain technology have not only created a new asset class but have also driven investment in new sectors such as decentralised finance and blockchain infrastructure,” he noted.
In South Africa, the FSCA has received more than 300 applications from potential crypto asset service providers and approved just over 100.
Kamlana said these figures indicate real investment inflows into this dynamic part of the financial sector. However, he acknowledged that the jury is still out on the value creation of these innovations compared to traditional finance, given their inherent high risks.
Barriers to the development and implementation of innovation
Despite the benefits, several barriers hinder financial innovation. He admitted that regulatory constraints can be a significant obstacle.
“The financial sector is heavily regulated for good reasons to ensure stability, protect consumers, prevent financial crimes. While these regulations are crucial, they can also be burdensome to innovation,” Kamlana stated.
He explained that compliance often requires significant resources and time, particularly for smaller fintech startups that may lack funds and resources. Regulatory uncertainty or evolving regulations can also create risk aversion, discouraging investment in innovative solutions.
Kamlana listed market resistance as another critical factor impeding growth and innovation. He said incumbent financial institutions, such as established banks and insurance companies, often dominate the market and may resist change.
“These institutions have established business models, customer bases, and infrastructure that may not be easily adapted to new technologies,” said Kamlana. “They may perceive innovative set up as threats to the mindset and prefer to maintain this sort of support rather than disrupt their existing operations.”
He said this may manifest in various ways, such as slow adoption of new technologies and reluctance to partner with or invest in innovative firms.
The necessity of regulation
Kamlana emphasised the critical role of regulation in ensuring stability, protecting consumers, and maintaining financial system integrity.
“Without adequate regulatory oversight these innovations can lead to exploitation, fraud and financial loss for unsuspecting consumers,” he warned.
He cited a 24% year-on-year increase in digital banking fraud incidents in South Africa, as reported by the South African Banking Risk Identification Centre (SABRIC), highlighting the vulnerability of digital financial services to cyber threats and fraud.
SABRIC reported a 24% year-on-year increase in digital banking fraud incidents between 2021 and 2022, with gross losses escalating from R440 million to R740.8m.
Regulation also maintains financial system stability by preventing risky behaviour that could lead to instability and economic losses. Trust, he said, is the cornerstone of the financial sector.
“Effective regulation helps maintain and enhance this trust by ensuring that transparency and accountability and ethical behaviour exist within the industry by requiring financial institutions to adhere to these high standards of ethics and conduct,” Kamlana said.
The cost of regulation
However, while essential, regulation comes with significant costs. Financial institutions must invest substantial resources to meet regulatory requirements, including implementing new systems, training staff, conducting audits, and ensuring ongoing compliance. For smaller fintech startups, these costs can be prohibitive. The high compliance costs can divert funds from research and development into regulatory compliance.
“Furthermore, an excessive regulatory burden can itself become a barrier to entry, protecting established incumbents and reducing competition in the market. This ultimately leads to higher costs and fewer choices for consumers,” Kamlana noted.
Finding the balance
Balancing the costs and benefits of regulation is crucial for a vibrant and resilient financial sector that encourages innovation while protecting consumers, he said.
He added that achieving this balance requires a regulatory environment that promotes technological advancement while safeguarding the financial system from potential risks. To do so, a robust framework must evaluate the trade-offs of regulations, considering their direct and indirect impacts on innovation, financial stability, and consumer protection.
“To effectively manage the dynamic and rapidly evolving financial sector and strike the right balance, we have been enhancing our regulatory framework to ensure they are principles-based, risk-focused, and proportionate. This adaptive approach allows for targeted regulations that foster innovation while mitigating potential risks,” Kamlana explained.
He said this approach is anchored in the Financial Sector Regulation Act, enabling regulators swiftly to address emerging risks and gaps by issuing standards for specific sectors or risk areas. Additionally, there is a shift towards an outcomes-focused and principles-based regulatory approach that ensures fair treatment of customers rather than prescribing detailed rules.
“This transition is supported by the development of the conduct of financial institutions via the COFI (Conduct of Financial Institutions) Bill by National Treasury, which aims to consolidate areas conduct related financial powers into a unified list. This Bill enables us to be agile in responding to cross-sectoral risks through the issuing of conduct standards,” Kamlana stated.
Nurturing innovation while controlling risks
Recognising the importance of nurturing innovation while controlling risks, the Intergovernmental FinTech Working Group (IFWG) was established to foster collaboration among South Africa’s primary financial sector regulators. The IFWG’s efforts led to the creation of the country’s first Innovation Hub, including a Regulatory Guidance Unit, a Regulatory Sandbox, and an Innovation Accelerator.
“These facilities collectively support the safe testing and scaling of fintech innovations, ensuring they align with regulatory standards while fostering industry growth,” Kamlana said.
The FSCA has also established a dedicated fintech department to monitor technological trends and changes, producing insightful papers to inform regulatory frameworks.
Kamlana emphasised the need for regulators to be proactive and adaptive.
“The future demands that as regulators we should be both proactive and adaptive, continuously evolving approaches to keep pace with technological advancements. This will involve embracing new regulatory frameworks, leveraging advanced technologies for offsite and maintaining a flexible mindset to accommodate the rapid changes in the financial sector,” he stated.
