The Current rules-based vs Principles-based financial regulation:  A Case for the Hybrid Approach Financial Regulation

Ghana’s regulatory model is the Silo Based Approach that focuses on the form of legal entity under regulation and accordingly assigns the Bank of Ghana as regulator and supervisor.

The Bank of Ghana (BoG) acts as the primary regulator and supervisor of Banks and Specialized Deposit-Taking Institutions (BSDIs) in Ghana, as mandated by the Banks and Specialized Deposit-Taking Institutions Act, 2016 (Act 930).

The BoG’s role includes ensuring a sound and stable banking system, protecting depositors and customers, and promoting the overall health of the Ghanaian economy. The Bank of Ghana is mandated to regulate, supervise, and direct the banking and credit systems to ensure the smooth operation of a safe and sound banking system.

The Bank’s mandates are enshrined in the Constitution of Ghana and the Bank of Ghana Act, 2002 (Act 612) as amended Bank of Ghana (Amendment) Act, 2016 (Act 918).

The Bank of Ghana has overall supervisory and regulatory authority in all matters relating to deposit-taking business, non-depositing business, payments as well as clearing and settlement systems. The regulatory and legal framework that governs institutions involved in the above-mentioned activities include, but not limited to the following:

1. Bank of Ghana Act, 2002 (Act 612); ii. Bank of Ghana (Amendment) Act, 2016 (Act 918); iii. Banks and Specialized Deposit-Taking Institutions Act, 2016 (Act 930); iv. Ghana Deposit Protection Act, 2016 (Act 931); v. Non-Bank Financial Institutions Act, 2008 (Act 774); vi. Development Finance Institutions Act, 2020 (Act 1032); vii. Payment Systems and Services Act, 2019 (Act 987); viii. Credit Reporting Act, 2007 (Act 726); ix. Credit Reporting Regulations, 2020 (L.I. 2394); x. Borrowers and Lenders Act, 2020 (Act 1052); xi. Anti-Money Laundering Act, 2020, (Act 1044); xii. Foreign Exchange Act, 2006 (Act 723); xiii. Companies Act, 2019 (Act 992); and xiv. Bank of Ghana Notices / Directives / Guidelines/ Circulars

Bank of Ghana’s key responsibilities include overall supervision and regulation: The BoG has the ultimate authority in all matters related to banking and non-banking financial business within Ghana;(ii) Licensing and Supervision that include licensing and supervising various financial institutions, including banks, specialized deposit-taking institutions, and other non-bank financial institutions; (iii) Ensuring Sound Practices in the banking industry.

The BoG monitors the financial performance and operations of these institutions to ensure they adhere to rules and regulations, and operate soundly; (iv) Enforcing Compliance in the industry. Bank of Ghana ensures that institutions comply with regulations, including those related to capital adequacy, risk management, and consumer protection; (v) Protecting Depositors: The BoG, through its regulatory framework and supervision, plays a crucial role in protecting the interests of depositors and customers of financial institutions; (vi) Promoting Financial Stability: The BoG actively works to dissipate financial imbalances and mitigate risks that could destabilize the financial system; (vii) Promoting Consumer Protection: The BoG is also focused on consumer protection, including measures to ensure transparency in fees and charges by financial institutions; (viii) Addressing Financial Sector Issues: The BoG takes steps to address challenges within the banking sector, such as high levels of Non-Performing Loans (NPLs), banking frauds and opaque fee structures etc.

Bank of Ghana’s banking regulation and supervision refers to a form of financial regulation which subjects banks to certain requirements, restrictions and guidelines, enforced by a financial regulatory authority generally referred to as banking supervisor, with semantic variations across jurisdictions.

Bank of Ghana has practiced rules- based regulation over the past decades. A robust regulatory framework should lay the foundation for effective supervision of financial institutions, and while approaches differ across jurisdictions, three approaches are prevalent: rules-based regulation, principles- based regulation and activity-based regulation.

Financial innovation in Ghana had brought about new, more advanced forms of intermediation for example digital platforms and Fintech apps.  New forms of intermediation create more room for divergence. Some regulators in the Sub-Saharan Africa acted fast, enjoyed the first mover advantage, and led the debate.

Other regulators like Bank of Ghana adopted a ‘wait and see’ approach, letting the innovation develop free of specific regulatory constraints. This allows jurisdictions to experiment with different legal tools and determine which one(s) better fit their system and their regulatory preferences

Current Rules based financial regulation.

In Ghana, the regulatory landscape for financial services has not evolved in tandem with global trends, because of the country has only adopted the rule based financial regulation which said to  stifle new technological innovation and digital finance in the financial landscape.

Existing regulatory framework is fragmented across financial industry, which has led to regulatory arbitrage, policy gaps, and a buildup of financial stability risks across borders, FinTech operations are cross-border by nature.

Rule based when regulations are applied to licensed entities or groups that engage in regulated activities (such as deposit taking, payment facilitation, lending, and securities under-writing). Requirements are imposed at the entity level and may include governance, prudential, and conduct requirements.

Implementation of those regulations is supported by a number of supervisory activities (such as offsite monitoring and onsite inspections). The current rules-based approach has provided clear guidelines, thereby reduced ambiguity and the potential for subjective interpretation by both regulators and regulated entities. For the country rules-based frameworks had been particularly important where regulatory certainty was required, as in the areas of anti-money laundering (AML) or consumer protection, where specific, enforceable requirements ensured robust safeguards and consistent practices across the industry.

The existing rule- based regulation included specific capital adequacy requirements, reporting obligations, and anti-money laundering procedures. Rules-based Regulation has involved setting out specific, detailed rules for Banks and Specialized Deposit Taking Institutions under BSDI Act 2016 Act 930 must follow.

There has been little room for interpretation, and the rules detailed exactly what is and isn’t allowed.  Rule-based regulation relied on detailed, specific rules that dictate how regulated entities should behave. Rule-based regulation was based on specificity where rules are clearly defined and prescribe specific actions or behaviors.

Also, rule- based regulations had been based on clarity that rules had been often explicit, that left little room for interpretation and on rigidity where rules had been inflexible and may not easily adapt to changing circumstances or unique situations but  enforcement is generally straightforward, as violations are typically easy to identify.

Rules-based systems had led to a checklist mentality, where firms focus more on ticking boxes than ensuring overall compliance. Bank of Ghana as the supervisor, has often began with a rules-based mindset, applied specific benchmarks to measure compliance. In doing so, they had quickly identified and addressed any overt violations without needing to interpret broader principles on a case-by-case basis. However, the downside is that rules-based regulation has been too rigid, lacking the flexibility to respond to nuanced or evolving market situations. Rule based regulation has employed specific, detailed rules and regulations to guide behavior and ensure compliance, Rule based regulation also provided clear, unambiguous guidelines for regulated entities.

Also, the rule-based regulation allowed for easier enforcement due to defined rules, but it said to be stifling innovation and flexibility as entities strictly adhere to the rules but it has been difficult to adapt to changing circumstances or new technologies. Prevailing regulatory structures in the country are facing several challenges in fostering the growth of a country’s digital financial space.

These include outdated frameworks that struggle to keep up with rapidly advancing technologies, fragmented regulations across sectors, and slow policy adaptation. The regulatory paradigm shifts from rules- based regulation to the principles -based regulation could be the starting journey to the ultimate hybrid -based regulation like the South Africa

Principles based financial regulation.

Principles-based regulation will be designed to establish norms and values that financial institutions should embody. In Ghana, this approach is seen as a framework that transcends detailed rules, instead providing guiding principles that align with the country’s broader goals of sustainability, equity, and responsible financial conduct. Anchored in values, this method encourages firms to adhere to a standard of behavior that is flexible enough to adapt to varying circumstances and emerging risks. Key principles such as transparency, fairness, and accountability are intended to underpin all actions within the financial sector, providing a sustainable model for regulatory compliance. A core component of principles-based regulation is the risk-based approach, which mandates that firms allocate resources and attention proportionally to the risks posed by different aspects of their business. This approach is particularly pertinent in the Bank of Ghana’s supervision of financial institutions, where risk assessment, rather than rote compliance, is the basis for regulatory inspections. For example, in Bank of Ghana’s BSD inspection, supervisors may prioritize issues that present the most significant potential risks to customers or the financial system, embodying the principle of proportionality rather than rigid adherence to minor rule breaches. In this way, principles-based regulation in Ghana aspires to foster a proactive, thoughtful compliance culture, emphasizing why compliance is essential rather than merely prescribing how to comply.

To foster digital finance innovation and growth, regulatory paradigm shift is needed towards more flexible, risk-based, and technology-neutral frameworks. This involves adopting principles-based regulation, allowing non-banks to issue e-money, and embracing regulatory technology (RegTech) for oversight. Additionally, provision of clear regulatory guidance, focus on cross-border cooperation, and a focus on consumer protection are crucial for building trust and ensuring a level playing field. The current fragmented rules and regulatory complexity slow down innovation, delay safer financial products reaching the unbanked and under-banked and deter investment. Key regulatory paradigm shift moving away from rules-based approaches that provide clear guidelines, thereby reducing ambiguity and the potential for subjective interpretation by both regulators and regulated entities to the principle-based regulation, risk-based approach, technology-neutral regulation, enabling non-Bank E-money issuance, agent network regulation, regulatory sandboxes, Regtech adoption, strengthened consumer protection: cross-border cooperation and clear regulatory guidance. A “Risk-based approach” (RBA) is a related concept in which regulatory and supervisory measures are applied based on the risks posed by the activities or entities taking into account limited supervisory resources. In the context of financial inclusion, the application of a RBA requires appropriate identification of the risks presented by individual transactions, users, or PSPs to mitigate the risks sufficiently to continue to ensure the access of legitimate parties to those services. The entity-based approach can be built on principle-based regulations that allow more flexibility, relying on governance arrangements and oversight. Importantly, a continuous engagement between supervised firms and supervisors allows for the monitoring of the buildup of risks and the evolution of business models. Supervisors normally have a range of early actions that can be taken to modify firms’ behavior that could lead to excessive- risk taking and instability. Supervisors can take enforcement actions (such as fines and revocation of licenses), but there is usually a ladder of interventions to achieve supervisory goals

Principles-based regulation involves setting out high-level principles that Banks and Specialized Deposit Taking Institutions must adhere to, rather than prescribing specific rules. It allows for flexibility in how the principles are applied, depending on the specific circumstances of each case. Principle-based regulation allows for flexibility and judgment in applying principles to specific situations, whereas rule-based regulation provides clear, specific requirements that firms must adhere to. Principle-based regulation is based on generality that principles are broad statements of desired outcomes or objectives and incorporate flexibility that principles allow for tailored solutions and adaptations to specific contexts.

Principle based regulation allows for discretion where regulated entities have more freedom to determine how to achieve the stated principles but enforcement  may require more judgment and interpretation of the principles. Principle-based regulation emphasizes safety and soundness, risk management, and consumer protection. Principle-based regulation, on the other hand, focuses on broad principles or guidelines, leaving the specific implementation to the discretion of the regulated entity.

Principles-based regulation allows regulators to provide broad standards that can adapt to changing technologies and business models, rather than being tied to specific, potentially outdated rules. A principles-based approach gives fintech firms and technology firms the flexibility to innovate without being hindered by rigid rules. This can lead to the development of more efficient, user-friendly, and secure financial products and services. . Principles-based regulation can reduce the number of specific regulations, making it easier for firms to understand and comply. Principles-based regulation emphasizes the desired outcome (e.g., consumer protection or financial stability) rather than dictating the specific means to achieve it.

This allows firms to determine the best way to meet regulatory objectives, tailored to their specific circumstances. Principles-based regulations do encourage FinTechs to develop a deeper understanding of their own risks and to implement more comprehensive and tailored risk management strategies. As FinTechs often operate across borders, a principles-based approach can provide a more consistent regulatory framework across different jurisdictions. Principle based regulation allows for flexibility in how regulated entities like Banks and Specialized Deposit Taking Institutions achieve the desired outcomes, adapting to specific circumstances and fostering innovation. Instead of prescribing specific actions, it focuses on the intended outcome and allows firms to determine the best way to achieve it based on their specific context and risk profile.

The principle- based regulation enables current financial regulators including Bank of Ghana to adopt risk-based approach where regulators by prioritizing regulatory attention and resources based on the potential impact of digital financial activities on financial stability and consumer protection. The principle -based regulation enables regulators to adopt technology-neutral regulation by ensuring that regulations apply equally to traditional and digital financial services, regardless of the specific technology used.

Under the principle- based regulation. regulators also are able to adopt agent network regulation where the regulators shift the focus from individual financial service provider agents to independent, licensed cash-in/cash-out networks can create a more scalable and accessible agent network. The principle -based regulation, financial sector regulators including Bank of Ghana will be able to adopt RegTech Adoption which utilizes regulatory technology (RegTech) to enhance market oversight, improve compliance, and strengthen customer recourse.

In the principle- based regulation regime, regulators including Bank of Ghana could strengthen consumer protection by implementing robust consumer protection measures, including clear disclosure requirements, dispute resolution mechanisms, and data privacy regulations, which are essential for building trust and confidence in digital financial services. Under the principle-based regulation, regulators are able to provide clear regulatory guidance and leadership by providing clear and consistent guidance on regulatory expectations for digital financial services can reduce uncertainty and encourage innovation.

Under the principle-based regulation Ghanaian regulators must adopt closer cross-border cooperation especially with Nigeria and the South African regulatory authorities. Collaborating with other jurisdictions to harmonize regulatory standards and facilitate the seamless integration of digital financial services across borders.

Challenges in the Principles Based Regulation in Practices

While principles-based regulation aims to empower institutions with the flexibility to navigate complex issues, it also presents significant challenges. A primary difficulty lies in the inconsistency of application and interpretation. Bank of Ghana as supervisor and regulator for instance, may come from a rules-based background and struggle to adapt to the ambiguity of principles-based assessment. When supervisors lack clear criteria, judgments may vary significantly between inspections, leading to uncertainty among institutions and potential inconsistencies in enforcement.

Moreover, the absence of a fully developed, principles-based system may lead to gaps in enforcement. While Ghana’s regulatory environment aspires toward a principles-based ethos, there is currently no entirely principles-based system. Some areas still require rules-based guidelines to ensure clarity and fairness. In essence, the effectiveness of principles-based regulation often hinges on the competence, judgment, and consistency of regulatory bodies, which presents a logistical challenge for the Bank of Ghana.  Under the principle- based regulation, financial institutions can tailor their compliance strategies to their specific circumstances, fostering a more dynamic and responsive regulatory environment. This flexibility is particularly beneficial in rapidly changing markets where rigid rules may quickly become obsolete.

In summary, while Ghana’s regulatory system still contains significant rules-based components, the shift toward principles-based regulation represents a forward-thinking strategy. By balancing purpose-driven principles with the clarity of rules, the Bank of Ghana will help to foster a sustainable, compliant, and ethically responsible financial industry in Ghana—one that is equipped to navigate both current and emerging risks effectively

Activity-based approach Regulation

Activity-based approach is when regulations are applied to any person or firm that engages in certain regulated activities, for example, facilitating the buying and selling of investments or operating lending activities. Those regulations are typically used in the Integrated model or Unified Approach and Twin Peak model for market conduct regulators’ purposes and are generally prescriptive, and compliance is ensured by fines and other enforcement actions. Many regulations prohibit certain activities under specified conditions.

In some respects, the activity-based approach may encourage competition by requiring that only relevant regulatory permissions are needed to carry out certain activities. However, the approach needs to define activities very precisely, which could create regulatory arbitrage opportunities—and may not be able to capture rapidly changing fintech activities. It could have negative impacts on innovation, as the prescribed rules may not be technology neutral.

Supervisors may issue warnings before taking enforcement actions, but other than that there is less room for supervisors to take actions before proceeding to enforcement. Because of the heavy reliance on enforcement, the activity-based approach is not generally suitable for early supervisory action to modify risky behavior by the firms. It is also not very effective for cross-border activities, unless global regulators consider regulatory approaches that are closely aligned, and international agreements allow for cross-border enforcement actions

 Adoption of Hybrid Based Financial Regulation

Hybrid financial regulation refers to a regulatory approach that combines different regulatory models or strategies, rather than relying on a single, monolithic system. This can involve a mix of prudential regulation, independent agency oversight, contractual agreements, and even outsourcing of regulatory functions. The goal is to create a more flexible and effective framework for managing the complexities of modern financial market. Hybrid based regulation incorporates flexibility and adaptability: Hybrid systems are designed to be more adaptable to the ever-evolving financial landscape, allowing for tailored solutions to address specific challenges and opportunities

In banking regulation, principle-based approaches emphasize broad, overarching principles, while rule-based approaches focus on detailed, prescriptive rules so Ghana may have to adopt the hybrid approach financial regulation of because of advantages and benefits of both rules based and principles based financial regulation. To summarize, while principles-based regulation offers many advantages, it’s essential to note that it may not be suitable for all aspects of financial regulation. Some areas might still benefit from specific rules to provide clarity and certainty.

Ideally, a combination of both approaches might be the most effective way to regulate the fintech industry. While principles-based regulation holds significant promise, it’s crucial to approach its implementation with discernment. This method emphasizes broad guidelines that underscore the spirit of the law rather than strict rules. Such an approach can be advantageous as it offers flexibility, allowing financial institutions to adapt to evolving market conditions without being constrained by rigid rules. This adaptability can be particularly vital in fast-paced sectors like fintech, where innovation can quickly outpace traditional regulatory frameworks.

However, the very flexibility that is the strength of principles-based regulation can also be its Achilles’ heel. Without specific rules, there can be ambiguity, leading to varied interpretations. In certain areas of financial regulation, such ambiguity can be risky. Institutions might exploit loopholes, or there could be inconsistencies in enforcement. For instance, when dealing with consumer protection or fraud prevention, clear-cut rules might be necessary to ensure that all entities understand their obligations and are held to consistent standards.

On the other hand, rules-based regulation, while offering clarity and certainty, might be too restrictive. Such a system can stifle innovation, especially in a rapidly evolving field like fintech. Moreover, with a detailed set of rules, there’s always the danger of becoming too bureaucratic, making it difficult for institutions to operate efficiently. Given these considerations, a hybrid approach might be the most pragmatic solution for the fintech industry.

By merging the flexibility of principles-based regulation with the clarity of rules-based regulation, regulators can create a dynamic environment. This environment would support innovation while ensuring that critical areas have definitive guidelines, striking a balance between fostering growth and ensuring safety and consistency in the sector.  Hybrid financial regulation is becoming increasingly relevant as financial markets become more interconnected and complex, and with technological innovation requiring a more nuanced and adaptable approach to oversight

 Conclusion

The trajectory of financial regulation in Ghana suggests that a continued blending of principles and rules, moving toward a flexible, responsive framework that can adapt to future challenges. As issues like artificial intelligence, data protection, and climate risk increasingly shape the financial digital landscape, the Bank of Ghana’s approach will likely lean on principles-based frameworks to foster an ethical, proactive industry culture while retaining essential rules to maintain regulatory certainty. This balanced approach can help Ghana remain aligned with global best practices, ensuring that its financial services sector remains both innovative and resilient.

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