Fintech ecosystem - opportunities amid emerging challenges

Analyzing opportunities amidst challenges

In the aftermath of Covid-19 pandemic, the digitization process within financial transactions has experienced an unparalleled surge. The financial landscape has witnessed the integration of mobile applications, web platforms, and other advanced systems, leading to notable advancements in automation. Numerous tasks can now be conveniently accomplished using mobile phones from the comfort of one's home. However, this digital transformation brings forth its fair share of security concerns. Consequently, the discourse surrounding the digitization of banks and financial institutions resurfaces periodically. While online bill payments, utility management, mobile top-ups, e-shopping, and ticket bookings can be easily accessed via mobile devices, essential financial services such as investment, savings, and loans are yet to become fully technology-friendly. Despite the significant global leap in technology, Nepal's financial sector remains restrained by outdated technologies, as indicated by established standards and action plans.

The banking sector has experienced a simplification of financial activities through automation. Rapid progress is being made in terms of infrastructure, capacity, and cost. Banks view innovation, technology, and cybersecurity as crucially sensitive aspects. However, limited financial resources hinder their ability to embrace new inventions and technological advancements. Consequently, automation in the banking sector falls short. While certain banks offer commendable mobile banking services, their internet banking facilities remain outdated. Customers increasingly demand web-based e-banking services alongside mobile applications. Banks should offer customers the option to access services through both web and mobile channels, with full automation being the ultimate practical solution. Therefore, increased investment in technology is crucial. The lack of comprehensive training in digital banking and cybersecurity has prevented the full realization of technological perfection within financial transactions. Given Nepal's economic landscape and evolving market conditions, the demand for automation is substantial. In today's society, where mobile phones are ubiquitous, individuals expect to accomplish a multitude of tasks through these devices. A competitive environment is emerging within the technology sector, necessitating both investment and strategic guidance.

Digital transformation heavily relies on financial literacy. It is crucial to foster balanced literacy not only among consumers but also regulators and service providers. Future endeavors encompass regulatory reforms aimed at facilitating automation, awareness campaigns promoting the advantages of technology-friendly financial services, the establishment of entrepreneurial groups to enhance skills, investments in automation, and an overall shift toward digital literacy.

Open Banking and Open Finance

The current limitations of mere top-up and bill payment services are inadequate for facilitating a seamless banking system. To enhance our banking infrastructure, it is imperative to develop banking software incorporating cutting-edge technologies such as blockchain, artificial intelligence (AI), business intelligence (BI), and machine learning (ML). Moreover, embracing open banking principles is crucial for our nation's financial ecosystem. Open banking allows authorized third-party financial service providers to access customers' banking data, including transactional and other financial information. Customers explicitly give their consent for this access. This practice is made possible through the utilization of application programming interfaces (APIs), enabling secure and efficient data sharing between diverse financial service providers. The core objective of open banking is to foster innovation and competition within the financial services industry, thereby giving rise to novel applications and services that benefit consumers. It empowers individuals by affording them greater control over their financial data and facilitating access to a broader array of financial products and services.

Open banking functions as a mechanism for financial services, wherein service providers participate in sharing access and utilization of specific transactions between banks and financial institutions. It fosters secure interoperability within the banking sector by permitting third-party payment services and other financial service providers to access banking transactions and related data from banks and financial institutions. An essential condition in open banking is that service providers partnering for the provision of services must ensure data security and uphold the confidentiality of user data. In this context, customer data is shared with the third party to enable access to designated financial services while ensuring secure transactions. For instance, in a conventional mobile banking application, the bank represents the first party, and the customer is the second party. Traditionally, only the first and second parties are involved in activities such as withdrawals, deposits, payments, fund transfers, and bill settlements. However, if additional functionalities beyond these tasks are made available through the mobile application, the involvement of a third party becomes evident. This could include services such as purchasing airline tickets, paying utility bills, availing internet services, making government agency payments, settling educational institution fees, IPO fees, and engaging in share investments. As this transactional mechanism involves more than the bank and the customer, it falls under the purview of open banking, with multiple parties involved. Open banking is anticipated to enhance the efficiency of financial services, thereby increasing stakeholders' access to diverse transactions within the financial market. It hinges entirely on the collection and utilization of data. Open banking has gained global prominence due to its pivotal role in managing customer finances, enabling faster and more secure transactions from any location.

Open finance represents a paradigm shift in the realm of financial transactions, constituting the next evolutionary stage beyond open banking. It entails the establishment of a comprehensive financial ecosystem, encompassing a broad spectrum of economic entities that introduce novel products and services. Functionally, open banking operates as a subset within the framework of open finance. While open banking operates within regulatory boundaries, open finance accommodates business units that extend beyond these confines, engaging in financial activities.

Open finance denotes an inclusive financial system that surpasses the boundaries of open banking, encompassing diverse financial services such as investments, pensions, savings, accounting systems, sales proceeds, and indirect financial transactions. Moreover, it facilitates third-party service providers' access to a plethora of customer information across multiple accounts, including savings, pensions, investments, insurance, mortgages, etc., via an Application Programming Interface (API). This expansive concept entails sharing financial information, with customer consent, from various sources, encompassing not only banks but also insurers, investment firms, fintech companies, and other financial institutions. The ultimate objective of open finance is to forge a comprehensive and interconnected financial ecosystem, enabling customers to access and manage their financial information and services from multiple providers in a unified and streamlined manner.

In the United Kingdom, open banking has become passé, as the integrated form of open finance gains traction. Conversely, Europe and Australia have witnessed a surge in open finance adoption, while the preference for open finance has also emerged in the United States and Canada. In the era of smart technology, the demand for open banking has grown, driven by the desire for seamless multitasking with a single click. However, in Nepal, open banking remains limited, rendering open finance a mere utopian concept for the time being. Consequently, financial customers face challenges in attaining the broader scope offered by open banking, owing to factors such as the level of financial literacy, scarcity of skilled technicians, infrastructure quality, and the underdevelopment of commercial applicability.

Thus, in this technology-driven modern era, the objectives of open banking and open finance converge upon expediting, facilitating, and securing financial transactions through data integration, customer consent and control, information standards, interoperability, enhanced financial services, innovation and competition, expanded financial reach, and data sharing, among other factors.

Apathy and disorientation in the phenetic realm

The actual use of technology remains unrealized, leaving certain individuals bereft of banking services due to limited technological access. While we exalt the information technology revolution, we often overlook the stark reality that millions of people are excluded from accessing rudimentary financial services. In rural regions of Nepal, some inhabitants lack any form of official identification, and even if they possess such documents, they are disorganized or lost. However, this should not preclude them from availing themselves of financial services. How can we ensure their financial inclusion? How can they be brought within the purview of taxation and foster institutional efforts for economic activities? The unequivocal solution lies in embracing technology-based systems. Policy-driven approaches must be undertaken to address identity-related challenges and explore novel avenues. Regulatory entities, customer protection networks, and government representatives should take proactive measures to alleviate these predicaments.

For technology-driven financial services to thrive, it is imperative to establish policies, regulations, and guidelines that embrace emerging technologies and foster innovative thinking to dismantle antiquated banking paradigms. Banks and financial institutions, renowned for their profit-making acumen, ought to establish dedicated innovation units analogous to the need for financial analysts or economists who scrutinize economic fluctuations, banking system deviations, and business and economic sector relaxations. Actions pertaining to innovation should be orchestrated, incorporating a strategic blueprint delineating the assimilation of novel discoveries, challenges, and revised regulations. Concurrently, an implementation plan must be devised. Designating positions such as Chief Innovation Officer and Chief Economist within banks and financial institutions becomes crucial. They are pivotal in effectuating positive transformations in the business model, navigating economic challenges, aligning the bank's business strategy, ensuring compliance efficiency, and maintaining a harmonious balance in customer-centric services that are convenient, cost-effective, and far-reaching. Regulators, too, must exercise vigilance to ensure banks do not cling to outdated technologies. Technology should not be relegated to a secondary role, subservient to regulations. In the current era of technological evolution, bolstering the technological prowess of regulatory bodies becomes paramount, enabling them to seamlessly and timely spearhead the financial landscape.

Examining Nepal's technology-driven business units, a few firms have monopolized the fintech industry. While there exists an opportunity for aspiring entrepreneurs to compete and establish new ventures, entry barriers are heightened due to the entrenched involvement of established banks and corporations. New entrants have raised allegations of syndication among certain companies. Despite a scope for technologically driven youth with entrepreneurial mindsets to operate, such opportunities are scarce. Consequently, there is a looming risk of investment losses, and nascent initiatives may languish in obscurity, leaving the entrepreneurs disillusioned. Furthermore, another challenge lies in the dominance of technology-related suppliers or vendors. Most vendors offer technical goods or services alongside consultation services. However, their approach to technological development lacks equilibrium. Driven by commercial interests, they engage in unhealthy market competition to promote their offerings. Consequently, visionary technology experts with foresight encounter arduous circumstances when operating within Nepal's market environment.

Exploring Opportunities

Innovation, as an iterative process, continually evolves, necessitating timely updates as an imperative aspect of technology adoption. Windows, developed in 1995, is no longer the operating system of choice. Similarly, the initial software employed in iPhones has undergone multiple transformations to the present day. Change is a constant, and technology possesses the capability to embrace and leverage it. Consequently, the financial sector must develop a strategic framework to embrace technological advancements. For instance, the need for regular review of a programmer's code within an application or software, ensuring user convenience and safety. Given the sensitive nature of user data confidentiality, a comprehensive system architecture is required to address source code structure, usage, and potential risks. Integrating security standards within an application programming interface (API) for one or more transactions or purposes is vital. Considering the gravity of risks such as unauthorized access, data breaches, or illicit financial transfers, an urgent strategic approach is imperative to minimize these threats. With the recognition that there is always room for improvement in existing technology and the necessity of fostering user trust, persistence becomes indispensable. Security stands as the fundamental prerequisite for sustaining open finance, an ecosystem encompassing diverse financial services such as payments, transfers, credits, savings, insurance, and investments. Additionally, compliance with regulatory frameworks, fostering competition among fintech companies, and ensuring customer benefits through technological adoption will drive the commercialization of the fintech ecosystem, rendering technology enterprises sustainable.

Nepali youth, pioneering technology-based services, are observed working for foreign entities while residing in Nepal. To integrate them into the mainstream technology sector and facilitate institutional technological services, it becomes essential to introduce regulations mandating technology adoption across various domains within Nepal. Numerous young individuals possess untapped potential, utilizing the dark web for foreign companies in areas like data analytics, cybersecurity, artificial intelligence, machine learning, and identity management. Considering Nepal's historical involvement in trade of goods, there exists an opportunity to alleviate the trade deficit to some extent by exporting technology services. To realize this potential, it becomes necessary to promote technological entrepreneurship and enhance the skills, mindset, and capabilities of young professionals engaged in foreign enterprises. The government can play a vital role by simplifying the establishment of entrepreneurial units and providing capital for skill development and efficiency enhancement. By doing so, the quality of Nepali technology services will rapidly advance on a global scale. In the era of technology, the concept of being 'viral' can effectively promote Nepali technology and youth. Achieving this requires strategic planning, allocation of resources for capital accumulation, provision of essential infrastructure at concessional rates, and fostering close partnerships with the youth.

Comprehensive Fintech Mandate

In the realm of technology-driven financial services, it is evident that fintech in Nepal has predominantly centered around payments and money transfers. However, for a holistic financial transaction experience, the integration of technology is crucial across other vital domains, including savings, investments, insurance, and loans. Just as banking has automated payments and money transfers, credit and insurance processes must also undergo automation. While the insurance sector remains largely manual, the recent partnership between the Nepal Insurance Authority (NIA) and Nepal Clearing House Limited (NCHL) is a step towards automation. Nevertheless, true equilibrium in the realm of fintech can only be achieved by automating all insurance companies and their services through seamless technological integration. Practical and technology-friendly automation is required for various insurance functions, such as premium collection, claims processing, underwriting, and gaining insights into the insurance preferences, habits, and tendencies of the general public.

According to the payment system indicators released by Nepal Rastra Bank until the month of Mid May 2023, there has been a significant surge in mobile banking and internet banking customers. Within a year, 3.387 million customers adopted mobile banking, while approximately 20 million customers embraced internet banking. Presently, the number of mobile banking users has surpassed 20 million, whereas internet banking users total 1.8365 million. Additionally, the adoption of Connect IPS, especially for large-scale transactions conducted by individuals and organizations, has experienced notable growth. In the past year alone, over 200 thousand customers have embraced Connect IPS. In terms of transactions, the utilization of QR code-based payments has soared by 179.24 percent in Mid May 2023 compared to Mid May 2022. During Mid May 2022, the number of QR code transactions stood at 3,071,843, but it reached 8,587,224 in Mid May 2023. Likewise, e-commerce transactions, conducted online, witnessed a 17.91 percent increase over the course of a year, totaling 81,286 transactions. By Mid May 2022, e-commerce transactions were limited to 68,939. The surge in QR code and e-commerce-based transactions signifies a growing preference for technology-driven financial services, driven by their affordability, convenience, security, and seamless user experience. As a result, online transactions will continue to rise in the future. Nevertheless, relying on the growth of a single payment instrument is not deemed favorable. Concentrated growth in a particular medium can pose technical security and operational risks. Therefore, it is imperative to diversify the utilization of available tools to ensure balanced development of the payment system. This diversification serves as a critical aspect in mitigating potential risks and adapting to continuous technological changes.

Technology is rapidly evolving worldwide, introducing new dimensions to various sectors. An application developed today may become obsolete tomorrow if not adaptable to changing circumstances. Similarly, achieving technology-friendly financial inclusion necessitates aligning technological innovations and inventions with the financial system. Regulatory bodies overseeing the financial system should invest in innovation, establish dedicated units, and appoint personnel specializing in innovation. Furthermore, promoting financial literacy, facilitating debates, and conducting training programs are vital to foster ongoing discussions on innovation and keep stakeholders updated. To ensure customer satisfaction and consistent access to technology-driven financial services, automation must be implemented across all sectors. This calls for the formulation of strategic plans accompanied by actionable implementation plans. The widespread adoption of QR codes exemplifies customers' willingness to embrace technology. Currently, no other payment method matches the ease, cost-effectiveness, and transparency of QR code payments. Even unorganized retail shops and businesses with low literacy levels have digitized their operations. Hence, in order to embrace cutting-edge technology, close collaboration between regulators, service providers, users, and government agencies is imperative.

Stern actions by the Regulator

Nepal Rastra Bank (NRB) has initiated a strategic plan (2022-2026) to establish a robust digital financial ecosystem. As part of this endeavor, NRB is exploring the implementation of a regulatory sandbox and innovation hub in the current fiscal year's monetary policy, aiming to embrace technological advancements and capitalize on the pervasive utilization of technology within the financial system. The regulator's proactive stance towards fostering technology and identifying emerging enterprises is both opportune and commendable.

A regulatory sandbox, serving as a controlled testing environment, empowers fintech firms to directly experiment with novel products or services while operating within the regulatory framework of the financial system. Its application is expected to extend to various domains, including microfinance, savings, mobile banking, remittance, digital payments, and the acceleration of technology adoption to enhance financial access. The primary objective of sandboxes is to gain insights into the opportunities and risks associated with specific innovations, ultimately facilitating the development of regulatory perspectives and guidelines. Countries such as the UK, Singapore, Germany, Australia, and India have successfully implemented regulatory sandboxes, thereby fostering innovation and infusing technological advancements into their financial systems.

Concurrently, an innovation center or hub, often referred to as an innovation promotion center, assumes the responsibility of identifying, promoting, and nurturing groundbreaking innovations within the regulatory landscape. It offers support, advice, and guidance to relevant organizations, while also assessing risks to financial stability and encouraging the leveraging of technological opportunities to mitigate them. Additionally, it serves as an authoritative resource for knowledge exchange and skill development in the realm of technology. Establishing an innovation hub in Nepal will contribute to cultivating a technology-friendly financial market, augmenting regulatory frameworks, and providing customer-centric financial services.

Furthermore, NRB has introduced the concept of a digital currency, known as Central Bank Digital Currency (CBDC), to fortify the fintech ecosystem. The CBDC, issued as e-rupee, represents a virtual currency that operates on a blockchain infrastructure, securely distributed across numerous internet-connected systems under the oversight of the central bank. NRB had previously conducted an in-depth analysis and released a concept paper on CBDC. In line with strategic planning, legal groundwork, and policy objectives, NRB has established a dedicated CBDC Division. It is crucial to note that CBDC differs fundamentally from cryptocurrencies. While cryptocurrencies are decentralized and can be created by anyone (commonly referred to as mining), CBDCs are exclusively issued by central banks. Bitcoin exemplifies a form of cryptocurrency. Notably, Nepal prohibits the usage, transfer, and creation (mining) of cryptocurrencies. Unlike public blockchain networks accessible to all, CBDCs are regulated by the government, acting as fiat money, and can only be accessed by licensed banks and financial institutions possessing the requisite privileges.

In line with the monetary policy's objective to foster innovation and invention, peer-to-peer lending (P2P lending) is being explored. P2P lending, a technology-driven loan disbursement system, enables transactions between peers. This system operates exclusively through web and mobile applications, eliminating the involvement of traditional banking institutions. Potential borrowers seeking loans and investors providing funds for loans both utilize a shared platform for their respective applications. Peer-to-peer lending primarily operates through three models, commonly employed outside Nepal. These models include interest-based loan investment (debt-based model), share investment (equity-based model), and grant-based methods (non-investment or grant-based model). The debt-based loan model, prevalent in neighboring countries like India and China, holds particular appeal for Nepal, given the similar financial market landscape shared with tech-based startups and micro, small, and medium enterprises (MSMEs).

Challenges in regulation

Regulating technological financial services presents a significant challenge despite the inherent potential of emerging technologies. Developing an appropriate regulatory framework necessitates accounting for the operational modalities of pioneering devices or applications and the potential risks and characteristics associated with them. Limited expertise, resource constraints, and a lack of skills further compound the challenge. While Nepal has legislation related to electronic transactions, regulating fintech proves challenging due to practical implementation issues and a lack of expertise in critical areas such as blockchain, digital payments, and data security.

In the context of open banking and API integration, aligning privacy and security mechanisms with consumer interests during the collection, processing, and storage of customer data is paramount. However, limited internet access, bandwidth constraints, money laundering risks, low financial literacy, inadequate tools for fintech service consumption, and a lack of supporting infrastructure introduce additional hurdles. Furthermore, outdated cyber security standards, telecommunication technology, and regulatory methods, alongside suboptimal inter-agency coordination and effective affiliation, prioritization, and vision, pose significant regulatory challenges within the fintech landscape.

Although there are many challenges, overcoming them and achieving the goal of creating a fintech ecosystem is possible by adopting a proactive strategy and implementing a practical action plan. Technology continuously evolves, and we cannot afford to lag behind. Rather, we must embrace technology by establishing appropriate regulations, laws, and precautionary measures. This necessitates engaging in consultations, direct and indirect communications with fintech firms, service clients, banks and financial institutions, business units, entrepreneurial individuals and organizations, as well as subject matter experts possessing technical acumen.

The expressed views are personal.