Core policy objectives and evolving trade-offs Main Policy Challenges Authorities are eager to foster the benefits of digital transformation, but they are also mindful of various challenges that emerge as digital transformation continues to permeate market activities. Fintech can promote poverty alleviation and economic growth by enhancing financial efficiency, inclusion, competition, and innovation; however, these benefits must be carefully weighed against challenges and risks such as those described in chapter 3. To that end, the Bali Fintech Agenda outlined by the World Bank Group and International Monetary Fund (IMF) advocates embracing the promise of fintech while managing risks to consumers and to the stability and integrity of the financial system (box 4.1). Fundamentally, fintech-related risks are similar in nature to those of traditional financial activities, but their shape and materiality can differ significantly. Mitigating risks to core policy objectives-such as financial stability, integrity, and safety is a precondition for reaping the benefits of fintech adoption. All forms of financial services provision ultimately may give rise to, among other things, liquidity, credit, market, and operational risks at the organisational level and risks from system-level externalities at the macroprudential level. Digital transformation causes these risks to present themselves in different ways and could also trigger risk migration outside of the regulatory perimeter. As such, several interrelated and heightened challenges stand out in several areaschallenges that will continue to evolve as the industry develops. Financial stability. Fintech developments can help diversify the financial sector and strengthen risk management, which may increase financial resilience and integrity. However, untested and potentially risky business models and new entrants, new financial interlinkages and interdependencies across the sector, and new concentration risks may pose challenges to financial stability. Financial integrity. Fintech and digital identification approaches can improve transparency and reduce financial integrity risks. However, money laundering and financing of terrorism threats may increase when technology enables anonymity and instant global reach. Consumer protection and data protection. A proliferation of new players and new business models can, in principle, enhance the consumer experience and make products safer because fintech enables tailoring to specific consumer needs and can better protect consumers and their data (for example, through encryption). However, so far this proliferation often has occurred in unregulated product areas, creating challenges to ensuring whether products are appropriate for different consumers as well as to ensuring that fraudsters are not among the new entrants. Limited electronic disclosure of terms and conditions as well as lack of transparency on costs and business models create additional risks to consumers, particularly those who are less financially literate. Unauthorized disclosure and use of personal data, including identify theft, is another key challenge. Pass-through compliance. In a partnership between fintech or Big Tech firms with incumbent financial institutions, the latter would be expected to ensure compliance with existing regulations but might not have the full visibility or ability to enforce it. When these incumbent institutions are smaller, they might be perceived to be lower risk under a risk- based supervision framework, and hence risk buildups could go unnoticed. Operational and cybersecurity risks. The distribution of technology and access points to end users and the restructuring of value chains leads to increased complexity, more points of vulnerability, and broader attack surfaces for cybercriminals. Cyberattacks or failures necessitate strong operational resilience frameworks because they compromise business continuity, carry economic and reputational risks, and potentially threaten financial stability. Another source of elevated operational risk is the higher reliance on third-party service providers, such as for cloud storage and computing, data provision, and critical business services such as third-party payment processing services. Competition. As described in chapter 3, owing to economies of scale, network effects, reputation, and capital, large providers such as Big Tech companies could achieve dominant positions quickly, thereby raising entry barriers and reducing overall competition or contestability. Market dominance by a limited number of providers could reduce consumer welfare. However, in markets where competition is limited, the entry of large providers could have important welfare gains and enhance competition in the short to medium term. How the market develops from that point will depend on the confluence of policy actions and market developments. Regulatory arbitrage. Financial services have been offered by new entrants that largely operate outside of the regulatory perimeter, although their activities and risks are similar in nature to those offered by regulated entities. Similarly, decentralized systems, such as crypto-assets and peer-to-peer or decentralized finance (DeFi) platforms, may prove more difficult to regulate and supervise if a central governing body is absent. Given the supranational nature of some fintech solutions, cross-border arbitrage opportunities complicate matters further and call for more international coordination. Policy for an evolving Fintech Market How policy goals regarding sound inclusive financial systems and competitive markets can be achieved depends on the entities providing financial services, the business models they use, and the market structure that ensues. The analysis here focuses on likely market structure outcomes based on underlying technology and economic drivers. It raises new issues for financial supervision, competition regulation, and consumer protection as (a) financial services move from the first phase of disaggregation and competition to a new phase of reaggregation and concentration alongside competitive entry and atomization, and (b) embedded finance has begun to demonstrate its power, particularly during the COVID-19 pandemic Regulating the Concentrated Market Salient issues include how to regulate and supervise a growing number of new entrants and how to manage increasing concentration at the other end of the spectrum. On the consumer side, growing competition, entry of new players from unregulated sectors, and broadened inclusion of new customer segments all combine to create a dynamic where consumers' best interests may be lost in the rush for efficiency, market share, and revenues. The raft of new, smaller entrants challenges financial supervisors to review the regulatory perimeter and to become more adept at monitoring and supervisingand leveraging digital tools in regulatory technology (regtech) and supervisory technology (suptech), where appropriate. The reaggregation and emerging concentration of market power introduces challenges in managing both the systemic risks and the market-conduct risks of an emerging set of large and potentially important global players whose activities cut across banking and nonfinancial businesses. For example, concentrated infrastructure providers serving the financial sector, such as cloud services and digital payments networks, present potential systemic concentrations of operational risk. A hardware failure at one payments network left millions unable to pay with their cards for about five hours across Europe in June 2018 (Bank of England 2019; Togoh and Topping 2018). The Financial Stability Board and other standard-setting bodies are doing further work in this area to provide guidance on addressing concentration risks (see, for example, Crisanto et al. 2019; FSB 2019). Regulating the Embedded-Finance Market The proliferation of cross-sector players highlights the challenge of interpreting monopoly guidelines in a new era. Concentration may not imply monopoly power in a highly contestable market, and the relevant market is increasingly difficult to define where traditional financial services providers compete with fintech and Big Tech companies in specific product areas. Product tying-part of many platform and embedded-finance value propositions-illustrates the growing complexity of balancing consumer protection with financial and competition regulation as business models and market structures evolve. Although cross-selling services has long been a common strategy in the financial sector, it has been subject to explicit anti- tying provisions in many markets. For example, a credit line was not supposed to be linked to requiring the borrower to move its transaction account to the lender. Unbundling of financial services would tend to reduce anticompetitive product tying. Reaggregation and embedded finance, in contrast, put tying at the centre of financial product economics. In multisided technology platforms, linking, cross-selling, and cross-subsidizing of products has generated both consumer benefits (for example, "free" email accounts tied to advertising) and potentially questionable practices (for example, search engines charging businesses for advertising and favourable search ranking). Now cross-selling is extending across financial and nonfinancial services, potentially allowing for a firm's dominance in the nonfinancial services to extend to the financial sector as well. These developments will test the boundaries of competition analysis and redefine how regulators consider the benefits and costs of concentration, product tying, and other aspects of market structure and conduct. Platform models that combine free services that have network effects with financial services could become highly concentrated and potentially result in abusive exercise of monopoly power, as examined in the Market Structure Note prepared for this report (Feyen et al. 2022). For example, a dominant social network that has a quasi-monopoly position over small local businesses' connections to their customers might embed payments in the social networking experience and make it difficult for a customer to pay businesses through anything other than the network's payment product. For borrowers, the increased resilience and access potentially offered by embedded credit is largely the result of tying credit to other transactions. A distributor offering supply chain finance inevitably ties that working capital to the purchase of its products. What may seem to be low-cost or free tied services from a platform provider are rarely truly free; in many emerging markets and developing economies (EMDES) however, incurring costs in terms of data sharing, loss of privacy, or product lock-ins may be acceptable to gain access to finance that is not otherwise available. In some product areas, open data frameworks that eliminate data monopolies (for example, by conferring data ownership to the data subjects, who can then make their own data available to different finance providers) could help ensure that the benefits of innovative business models can be realized consistent with competitive markets and consumer protection. These data frameworks require a level of consumer financial and data literacy. As an alternative, data intermediaries might enable safe data sharing; they could also help individuals better understand and enforce their rights over their personal data (World Bank 2021). Balancing the Policy Trade-Offs More broadly, policy makers will have to address increasingly complex trade-offs that depend on the level of development of the financial system and its customers, the preexisting competitive environment, and other social preferences. The Market Structure technical note prepared for this publication describes the complex policy trade-offs that may evolve in conjunction with the rapid developments in the financial sector (Feyen et al. 2022). Fast-paced technological innovation and its impact on the industry suggest that balancing trade-offs may become more challenging, especially for EMDES with capacity constraints and multiple competing mandates, including the following: Financial stability and market integrity Efficiency and competition Data privacy and consumer protection. For example, financial inclusion, innovation, and efficiency objectives may run counter to preserving financial stability. Fintech companies may promote new lending based on weak business models, or they may be exposed to increased cyber risks. Big Tech platforms may offer significant efficiency and inclusion gains, but they can also quickly dominate markets and become too big to fail. Similarly, reaping the full innovation and efficiency gains of fintech may require gathering, processing, and exchanging large amounts of consumer data, which may run afoul of consumer and data safeguards and could increase financial integrity risks. Different societies will attach different preferences to different market structure outcomes. Some societies may accept market structures that concentrate data and supercharge network effects if they reduce intermediation costs and broaden inclusion. In other markets, the resulting market power might be seen as more detrimental than these benefits. Concentration of infrastructure and data in state hands may be accepted in some societies, while others may be more concerned about the potential extension of state surveillance. As in other industries, regulators will have to balance the efficiencies of natural monopolies against potential abuse of market power. These trade-offs also evolve as a country moves up the fintech development ladder. At lower levels of fintech development, the range of services, scale, and penetration is still limited. This limitation requires the willingness of policy makers to support innovation and provide basic legal and regulatory clarity. In these less-developed countries, addressing data gaps that prevent effective risk monitoring and taking measures to ensure that financial integrity objectives are met are key priorities because the risks to financial stability, fair competition, and consumer and investor protection are still relatively low. However, as the scale, complexity, interconnectedness, and possible concentration of financial services increase in a given country, policy makers must focus more on safeguarding financial stability, data protection, and fair competition. This requires that legal, regulatory, and supervisory frameworksas well as technology and financial infrastructures-be reviewed and strengthened accordingly to support a smooth transition to a flourishing fintech ecosystem that remains consistent with policy objectives. Figure 4.1 illustrates the policy trade-offs that result from fintech developments. FIGURE 4.1 Policy Trade-Offs due to Fintech Developments Access to data for regulatory goals versus anonymity (for example, AML/CFT, supervisory data) Privacy/consumer protection Stability/integrity "Traditional" stability-competition trade-off Efficiency/competition Access to data for private providers versus anonymity (for example, better/worse access to credit; misuse of data) Required: The main policy challenges researched by the World Bank affects the regulation of FinTech operations and the ongoing development and regulation of the blockchain technologies, especially considering the increased trading in cryptocurrencies at international level. Question: Based on the case study, comprehensively develop a strategic plan to redirect the financial services industry in South Africa by considering the researched policy challenges. The applicable FinTech strategic objectives and any implementation steps thereon should be designed.