Incumbents and regulatory responses to fintech disruption in South Africa

Title: Incumbents and regulatory responses to fintech disruption in South Africa

Simphiwe Cele

UNISA, Graduate School of Business Leadership

Ensovoort, volume 45 (2024), number 10: 2

Table of Contents | Inhoudsopgawe

Abstract

Background: The rise of fintechs has had various effects on the South African financial services industry. Fintechs threaten incumbent financial institutions by increasing competition and lowering profits. They also negatively impact regulation by introducing new risks because most fintechs fall outside the traditional regulatory guidelines. Therefore, incumbents and regulators need to find ways to mitigate these negative effects while capitalising on the positive.

Objectives: This study’s objective was to investigate response strategies used by incumbent financial institutions and regulators to mitigate fintechs disruptions.

Method: Semi-structured interviews were used to conduct this study, in which 18 industry experts were interviewed. Experts were selected using purposive non-probability sampling. ATLAS.ti was used to analyse data collected using thematic analysis.

Results: Financial services institutions are adopting several strategies to mitigate the negative effects of fintechs. These strategies include partnering with fintechs, expanding the role of the bank, upskilling their staff, acquiring fintechs and lowering the prices of financial services. Regulators are expanding the regulatory framework to incorporate fintechs by establishing special task teams such as IFWG and forming regulatory sandboxes.

Conclusion: Regulators must exercise caution to avoid creating an uneven playing field that unfairly favours fintechs over incumbents. They must avoid falling behind or racing ahead of innovation. Incumbents should not ignore industry changes and should seek ways to help them remain competitive.

Contribution: The empirical findings have important practical implications for financial institutions because they explain how to respond to the negative effects of fintechs. Financial institutions can use these strategies to gain a competitive advantage.

1. Introduction

The financial services industry has witnessed several changes and disruptions driven by fintechs in the past few years. These fintechs have changed the industry significantly, and it is believed that they are still going to change the industry in ways that have never been seen before(Bruggink and Mouilleron, 2016; Lee and Shin, 2018). They are changing the industry by closing the gaps left by the incumbent financial institutions in service delivery.

A striking feature of these technologies is that they affect all stakeholders in this industry differently. They affect the customers positively by improving consumer service and experience (Truong, 2016) by producing faster, cheaper, and human-centred financial products and services (Varga, 2017; Chen and Robinson, 2019). They also pose risks that threaten the stability of the financial services industry by increasing competition for the incumbent companies and introducing new regulatory risks(Cortez, 2014; Wall, 2018; Xu, Tang and Guttman, 2019).

As a result, it is essential that incumbent financial services institutions respond to protect their market share. Regulators must also respond to maintain industry stability and credibility. Responding to these changes is critical, but incumbents must do it with extreme caution. If they respond inadvertently, they risk wasting valuable resources, and if they do not respond in time or at all, they risk falling too far behind the innovation curve and being displaced by innovative new entrants or competitors (Charitou and Markides, 2003) . Similarly, regulators should be careful about their strategies to respond to these disruptions (Coetzee, 2019). They should not run ahead of innovation, because introducing regulation too soon may disrupt the introduction of valuable innovation (South African Reserve Bank, 2018b).

To this end, the aim of this study was to investigate how incumbents and regulators respond to the challenges brought by fintechs in the financial services industry in South Africa.

2. Literature Review

2.1 Incumbents’ responses to fintechs’ disruption

Surviving disruption is mainly within the companies’ control and depends on the organisation’s tactics. Christensen (1997) contends that activities related to management and leadership style are some of the key determinants of organisations’ survival. Charitou & Markides (2003) concur and add that the ability of an organisation to respond is also dictated by factors, including the expertise of the organisation, its resources, the time it has at its disposal to respond, the nature and magnitude of the conflicts between the incumbent business and the new technology or model. Ultimately, an organisation’s motivation to respond is determined by factors such as the rate of innovation growth and its threat to the organisation’s core business. Furthermore, the approach that an organisation chooses to respond to the disruption depends on how the organisation’s management perceives the disruption. If they perceive the disruption as a serious threat to their organisation’s survival, they allocate adequate resources to respond. Conversely, if they see it as insignificant, they devote insufficient resources to respond or do not respond at all (Clark Gilbert, 2002). Charitou & Markides (2003) and Eurosystem (2015) list some contrasting strategies that have helped companies respond to technological innovations:

- Ignore innovations and focus on their traditional business.
- Adopt the innovations and integrate them into the organisation’s business models.
- Embrace innovations and scale them up.
- Ignore the innovation and focus on the traditional business.

Although some organisations ignore the disruptors, it has been proven to be a very dangerous approach that might lead to an organisation’s complete displacement and demise (Charitou and Markides, 2003). This approach has proven very dangerous for incumbent organisations that ignore innovation. For example, during major industry transformations in the film industry, companies that ignored the changes were displaced by the innovative ones, and the new entrants (Christensen, 1997). The once-mighty Kodak had to file for bankruptcy because when the film industry moved to digital, they hesitated too long to shift from their chemical film processing to innovative digital printing (Christensen, 1997; Assink, 2006).

2.1.1 Adopt the innovation by playing both games at once, and fully adopt the innovation

As a caution regarding the importance of responding positively to fintech, Christensen et al. (2015) suggest that incumbents must respond to disruptions carefully. They should not overreact and commit all their resources as this might end up destroying a profitable business. Instead, they should continue serving and cultivating good relationships with mainstream customers by investing in sustaining innovations. Companies should continue improving their products and services to satisfy the changing needs of these customers. Companies should also create separate divisions or innovation laboratories focused on disruptive innovations,(Christensenet al., 2015; Oshodiet al., 2017). Christensen et al. (2015) emphasise that to ensure these divisions become successful, they must be separated from the company’s core business. Wagner et al. (2016) support this notion and add that companies should establish fintech-dedicated teams and flexible governance structures to improve the capacity to adopt new technologies faster. This can help streamline decision-making, which is essential to keep up with the speed of change in the market. IBM used this strategy successfully to survive and evolve in the information technology industry. It used two different plants to carry out its business. It made the mainframes at the plant in Poughkeepsie and went to Rochester, Minnesota, to make minis (Denning, 2016). Acar and Çitak (2019) argue that incumbents should integrate fintechs into their core businesses in the financial services industry. They should do this by forming strategic partnerships with fintechs (Wagneret al., 2016) or acquiring fintech companies to leverage the expertise of the fintechs. Incumbents should incubate fintech organisations. In this approach, both organisations benefit. Incumbents provide support and capital (Oshodiet al., 2017) whilst they benefit from the innovative abilities of the fintechs. This type of collaboration enables the partners to transfer knowledge from both sides. Further, in these partnerships, fintech organisations bring their customer-centric approach, agility, and technology expertise, while the incumbents bring their experience, brand equity (Camarate and Brinckmann, 2019), large and established customer base and distribution networks(Holmes and King, 2019).

2.1.2 Embrace innovations completely and scale them up

Eurosystem (2015) suggests that incumbents should adopt technological innovations and bring them to the market. Charitou & Markides (2003) agree and argue that, in some cases, incumbents have abandoned their existing business models and embraced innovations totally. In this strategy, the incumbents do not only copy the innovation; they scale it up and grow it into a mass market. Incumbents can successfully employ this strategy because they are usually in a better position than new entrants to scale innovations. Moreover, Christensen et al. (2015) argue that incumbents are best at creating products and services to serve mass markets because of their established distribution network and their financial muscle, which is essential in growing businesses.

Charitou & Markides (2003) caution that for innovations to be successful the organisations should couple the new technology with creating a market out of it. Usually, these activities require different sets of skills and do not need to come from the same organization. One organisation could introduce technology into the industry, and a second one could take the baton and champion it. These authors remind us that the company credited with scaling up online brokerage was not the same company that introduced it. Howe Barnes Investments and Security APL launched a joint venture called Net Investor in January 1995 to introduce online-based stock trading, but six years later, Charles Schwab embraced it wholeheartedly and scaled it up in the mass market.

2.1.3 Regulatory responses to fintechs disruption

As the financial services industry moves towards the digital age and becomes more innovative, and financial technologies become more advanced, the regulatory and legislative framework must be flexible and adaptable to these developments and provide an enabling environment that encourages innovation (Deloitte, 2022) and does not stifle innovation (Coetzee, 2019). Anagnostopoulos (2018) suggests that regulation must work symbiotically with innovation and the industry’s developments, monitor the potential risks, and constantly evaluate whether it is necessary to intervene or allow evolution before action. Collaboration between the stakeholders – regulators, incumbents, and new entrants – is key to understanding the ramifications of the innovations and how they will change the industry’s risk profile. It is imperative that regulators do not second-guess or front-run innovation since introducing regulation prematurely may come disproportionally and stifle innovation and potentially disrupt the introduction of valuable innovation. The regulators should only intervene when disruptive technology’s risk crosses the systemic proportions threshold and become materially destabilising (South African Reserve Bank, 2018). Therefore, regulators’ biggest challenge lies in resolving the conflict between a futuristic framework that promotes innovation and encourage new business to intensify competition and provide better customer experience, and a framework that protects the system and consumers from risky behaviour, and maintains market confidence (Buckley, Arner and Barberis, 2016; Gomberet al., 2018). As fintechs innovate, regulators should respond by providing regulatory clarity and establishing minimum stability and security tailored for that market(Miskam, Yaacob and Rosman, 2019). Failure to manage this correctly can cause many problems because a collapse or disorder caused by fintechs in the industry can send panic to consumers and lower their confidence in the industry.

Ng and Kwok (2017) opine that the institutionalisation of a risk-based approach may provide a baseline of precautionary measures to ensure compliance. They further suggest that training should be provided to those who work in financial services. These authors believe this would be a complementary measure in securing a pathway for mitigating financial technologies’ threats while embracing fintech. Buckley, Arner and Barberis (2016) add that a more experimental and innovative regulatory approach is needed to regulate this industry to ensure long-term success and consumer acceptance of fintechs. This can be achieved by introducing regulatory sandboxes like semi-controlled testing environments similar to clinical trials in the healthcare and pharmaceutical industries (Cliffe Dekker Hofmeyr, 2020). Sangwan et al., 2019b) agree and argue that sandboxes will offer the right incubation environment for the new entrants in the market. Therefore, sandboxes will help maintain a balance between freedom to innovate and necessary consumer protection. They will allow start-ups to undertake the experimental phase without burdensome regulations. Regulatory sandboxes will provide an opportunity to test innovations more efficiently by temporarily avoiding ordinary licensing obligations and further giving regulators time to design regulations for new technological offerings. Fundamentally, sandboxes will ensure that there is a balance between innovation and regulation (Cliffe Dekker Hofmeyr, 2020).

(Gomberet al., 2018) caution that developing regulatory parameters for fintechs is going to be a challenging task like it has been with other financial services innovations, and it must be done correctly. An International Monetary Fund (2019) policy paper identified key areas that need international cooperation – including roles for the IMF and World Bank. These include a need to prioritise cybersecurity, anti-money laundering, and combating the financing of terrorism (AML/CFT) ; development of legal, regulatory, and supervisory frameworks; development of payment and securities settlement systems and cross-border payments.

3. Research Methodology

The aim of this research was to investigate how incumbent financial institutions and regulators respond to the regulatory challenges brought by fintechs. To achieve this aim, aqualitative research was conducted using semi-structured interviews. The interviews helped to explore several dimensions of the financial services industry, including the everyday life, views and experiences of the research participants, as asserted by Mason (2002). In studying these phenomena, the researcher embedded himself inside the traditional financial institutions (banks), fintechs and regulators to comprehend their reality and the research phenomena using the perspectives of the industry experts who are involved in the day-to-day activities. A purposive non-probability sampling method was used, and 18 industry experts were interviewed.The interviews were recorded and then transcribed for data analysis. The data was analysed using ATLAS.ti, and thematic analysis was used to organise and group the data into similar themes.

4. Findings

The emergence of fintechs has affected the financial services industry positively and negatively. To this end, incumbent financial institutions and regulators need to find strategies to mitigate the negative effects so that they do not lose their competitive advantage. They also need to find ways to amplify the positive effects so that they can benefit from these changes. Industry experts were asked to share insights into how traditional financial institutions and regulators in South Africa respond to fintech disruptions. Research findings were then categorised into two themes: responses by incumbents and responses by regulators, which are presented below.

4.1 Incumbents’ response strategies

As fintechs increasingly impose themselves and their offerings, and consumers’ expectations of financial services institutions start shifting, incumbent financial institutions are pressured to respond to the impact. Incumbent expert 5 (IE5) argued,“human behaviour is changing already, and beyond banks, all companies must change how they deliver the product. And the banks must change how they deliver their products and services too.”

According to regulatory expert 2 (RE2), “this (change) forces the incumbents to reimagine their operating models because if they don’t, their margins will be seriously squeezed”. IE6 unequivocally stated: “As we speak today, banks need to rethink their role going forward because they may be irrelevant in the future.” IE1 conceded and said, “we (incumbents) cannot continue doing things the way we have done before. Deepening the focus and ensuring that we make the lives of our customers easier and more digitally oriented will be the solution. So even when designing products now, some are digitally-based; even when we think of how people can engage with us, we have started creating chatbots. IE4 agreed and added that “fintech innovation causes us as banks to accelerate our own innovation plans”. IE5 concurred: “banks are reinventing themselves,” and “are trying to become fintechs”, IE2 added.

IE6 cautioned:“I think long term it would be suicidal to offer the current products and services for the next generation. I think change is forced upon us. We must evolve, and we have to reinvent banking and our role in society.” In support of this, IE8 emphasised: “we are not being complacent. We recognise that we are competing globally with fintechs that are operating across global markets.” RE2 assured that“they (incumbents) are coming up with a new way of operating in order to respond to these fintechs.” In agreement, RE3 contended “the banks themselves are also changing their systems to be more innovative”.

Table 1 depicts response strategies used by incumbents to counter fintech disruption according to financial services experts.

Table 1 Incumbents response strategies

Incumbents’ response strategy	Description
Interoperability and partnering with fintechs	Financial institutions partner with fintechs, retail stores, and telecoms to enhance the consumer experience.
Expanding the role of the bank	The banks aim to transform into one-stop shops where customers can do more than banking.
Upskilling staff so that they are ready for the industry changes	Traditional financial services institutions are providing their employees with additional skills to equip them for the revolution in financial technology.
Improving customer experience	Banks are prioritizing customer experience by emphasizing the importance of being customer-centric.
Copying the fintechs and acquiring the fintechs	Incumbents are copying fintech organisations as a means of responding to market changes.
Reducing the costs of financial products and services	Incumbent financial institutions are adopting fintech business models and eliminating monthly account fees.

4.1.1 Interoperability and partnering with the fintechs

The industry experts argued that incumbent financial institutions embrace fintechs and partner with them. They also partner with retail stores and telecoms to improve the consumer experience. Supporting this argument, IE1 contended: “My sense is if you want to grow and you want to go and scale faster, you need to partner with good fintechs.” A statement that IE7 agreed with: “I would say a lot of times you cannot go at it alone. Partnerships will make all of us win. So, the incumbents must find good partners. It might be retailers, etc. Partnerships are going to make all of us win. Because the reality is that no one can go into it alone, so, banks cannot do it alone, the same way fintechs must quickly realise they cannot do it alone.” RE3 argued: “the incumbents use the technology of the fintech to expand their footprint.” This creates what IE2 called “shared value.” IE8 added: “We are very supportive of situations where we can partner.” In tandem, IE2 agreed: “That is why we are saying we will compete with fintechs, and we will partner with them at the same time where we believe they can fast track our competitiveness.”

RE3 argued that “interoperability is extremely important to become successful”. IE8 emphasised the importance of partnerships and said, “fintechs by nature need a bank to manage their own banking relationships or to be sponsored into the banking ecosystem… we embrace competition, and, we partner with fintechs where we believe it makes business sense to improve the client experience that we are trying to offer”. IE4 added: “we have a lot of partnerships with big companies like Amazon.” IE8 cautioned, contending that“incumbents that do not embrace the concepts behind fintech and partner with fintechs, I think they will be impacted. But incumbents that can embrace the thinking, the concepts, and the partnership approach, I think, will be stronger and even more relevant.”

These relationships do not only benefit the incumbents; RE3 argued that “banks also give fintechs access to large numbers of customers through their networks.” This corroborated the assertion by Holmes & King (2019) that in the partnerships, the banks give fintechs large and established customer bases and distribution networks. This is also supported by Camarate and Brinckmann (2019) in their argument that in these partnerships, all participants benefit. While incumbents provide support and experience, fintechs bring innovative capabilities. FE3 posited that “fintechs in the payment space must be affiliated with a traditional bank in the background to support their effort.” This is because the regulation in South Africa requires that non-banks who wish to provide payment services must partner with banks. In corroboration, Eurosystem (2015) and Wagner et al. (2016) argue that incumbents should incorporate fintech innovations into their strategy by developing strategic alliances with fintechs or acquiring fintechs and investing in technology-related skills and knowledge to utilise the fintech expertise.

4.1.2 Expanding the role of the bank

Industry experts argued that traditional banks have begun to utilise strategies that are gradually expanding the bank’s function. They want banks to become more than just financial institutions- they want them to be one-stop shops where customers can do more than banking. IE3 claimed that “if you come into the banking environment, you do not want to do banking; you want to do various other things as well.We could join up with the travel industry. You can buy your tickets through us. We can insure you for your travel. We can help you book your hotel. We can get your transfers, and everything just by coming to the bank or coming onto our platform, which means that we are more than a bank. We are not just the bank anymore; we describe that as more like a shopping mall. You come into our bank as a mall…This is how we are responding to the disruption. The bank is becoming a platform business with ecosystems for homes, ecosystems for business, ecosystems for travel etc. We will invite partners to join us”.

IE2 agreed and stated:“as time goes on, we are saying, what should a branch exist to do in the future? The branch will become a coffee shop. It will become a place to do complex deals and will become a place to negotiate, very big deals, not to open a bank account”. IE5 echoed: “what it looks like now and the services it (the bank) provides will be different. Maybe ten years from now, you will be able to do other things more than just banking.… In the future and the near future, not like far, five, ten years from now, the bank wants to be the shopping centre so that if you go there, there is a section of money, a different section that’s still part of the platform where you can buy clothes”. IE6 concurred: “we launched a platform, which is currently a marketplace. You can buy whatever you want on this platform. But it should evolve into something bigger than Amazon’s competitors. Ideally, it should be the bank of the future where you can do everything finance-related”.

Furthermore, IE8 added: “we do not see ourselves as operating in banking. If you listen to our group CEO, we are effectively doing two things right. We want to be a leading integrated client-centric financial services provider. So, we want to be relevant across the banking insurance investment needs as well as being a lifestyle provider. If you think about a lot of the things we do, you know it is also about how we add value to clients’ lives outside of formal banking products or investment or insurance products. I mean the fact that you can renew your car license on our platform, or you can get your smart ID (Identity Document) renewed in a branch, you can pay your traffic fines, or you can sell your car on a marketplace between trusted parties on both the buying and the selling side or your home”. This is consistent with KPMG’s (2022) assertion that banks want to provide a customer experience that includes financial services as part of a larger offering.

4.1.3 Upskilling staff so that they are ready for the industry changes

Industry experts also argued that the incumbents are upskilling their staff to prepare them for the fintech revolution. IE4 contended that “the skills that we needed in the second and the third industrial revolution were very much physically-based skills… The skills that we need going into the fourth industrial revolution are very different. You need to be able to analyse data. You need to be able to code. You need to be able to function in a technology-based world. And so, I think we are going to need a different set of skills. Not necessarily the skills that we needed as a traditional bank.” IE3 added: “we need leaders who can lead this transformation.” In support, IE4 reported: “We have backed on many programs to upskill our staff. You know, you hear internally, that there is a lot of conversation about personnel development. There is a lot of conversation about learning about what is cloud and what does it mean? We are really upskilling our staff to ensure they continue to be relevant as we change how we do business. So yes, somebody might be working in a branch today, but we are in the process of upskilling people so that tomorrow they might be the person analysing data or facilitating an online interaction with a client. I think if we are not proactive, and do things like that, like upskilling our staff and teaching them how to work in a technology-enabled world, there is a risk of people getting left behind.” In tandem, IE8 added: “We believe for the next few decades we will invest as much in people as we invest in tech.” This supports the recommendation of Wagner et al. (2016) that incumbents must invest in technology-related skills.

4.1.4 Improving customer experience

In response to the interruption by fintechs, the industry experts also stated that their organisations are paying attention to customer experience by emphasising the importance of being customer-centric businesses. IE4 argued: “we are doing two things- focus on clients and client experience. Those are the two main things. Technology is easy to duplicate. Anyone can buy technology, but it is not easy to replicate a relationship with a client. So, I see a strong focus on deepening relationships with our clients among the incumbents”.As part of improving customer experience, the incumbents are assisting the customers through the digital journey. They have zero-rated their banking apps so that the customers do not need data or airtime to transact via their banking apps. Fintech expert 4(FE4) argued: “access to data is not any better. That is why we have zero-rated the app.” Incumbents are also considering giving their customers technology enablers such as smartphones, SIM (Subscriber Identity Module) cards and data. IE2 stated: “what we want to do is when you open your bank account, we give you a SIM card, a phone, a bank account, and the app that is already active with a virtual card… so you got a bank in your hands. We call it bank everywhere.”

4.1.5 Copying the fintechs and acquiring the fintechs

Industry experts argued that incumbents also copy fintech companies as part of their response strategies. FE5 posited: “The incumbents are trying to be seen to be just as innovative and are trying to launch similar copycat products…They are also starting to adopt some of the business model aspects of fintech companies.”FE2 added: “You will see in the media that Standard Bank has signed a deal with Pick n Pay to be inside their stores. You will also see that ABSA has built a kiosk like that of Tymebank…So, it is obvious they have seen that the model works, so they want to replicate it”.Other than copying the fintechs, the industry experts reported that the incumbents are acquiring the fintechs companies. RE2 argued: “Some of these incumbents are buying the fintech companies and are putting them on their platforms. You might have seen it lately; FNB just bought this fintech. It is a payment fintech. Its target is spaza shops and SMEs because they also want to capture that market.”

4.1.6 Reducing the costs of financial products and services

Industry experts argued that fintechs are lowering the costs of financial products and services costs to undercut incumbents. When asked about incumbents’ response strategies to this threat, industry experts agreed that incumbents are lowering their prices too. IE5 confirmed: “we are starting to reduce our costs. One of the biggest flaws of traditional banks is bank charges”. To do this successfully, banks are reinventing themselves and looking for solutions that will help them reduce their charges. “We are starting to have accounts where you pay nothing if you do not transact or pay as you transact”, IE5, added. FE5 agreed: “incumbents are starting to adopt business models of the fintech and dropping monthly account fees.” RE3 added: “The banks are developing a system called instant payment system, which is going to be very low cost and which you can run off your cell phone.” Furthermore, FE 5argued:“The banks have actively been consolidating or reducing their branch footprint… they are trying to optimise and save cash by actually reducing their branch footprint.”

4.2 Response by regulatory authorities

Fintechs have accelerated the pace of change in the financial services industry, making it difficult for regulators to keep up. Consequently, they are threatening the financial system’s stability (Elia, Stefanelli and Ferilli, 2022) because fintechs are not covered by the traditional regulatory framework. This, in turn, has a detrimental impact on incumbents since it creates an imbalance as incumbents, on the other hand, are subjected to strict regulatory requirements (Nguyen, Tran and Ho, 2021).

To investigate how regulators respond to fintechs’ disruptions in South Africa, the industry experts were asked to provide insights into the regulators’ response strategies. The industry experts corroborated the observations of authors such as Elia, Stefanelli and Ferilli (2022) and Nguyen, Tran and Ho, (2021) that fintechs have brought severe regulatory challenges to the industry. IE2 agreed and contended that “regulation has not caught up to them (fintech).”IE5 added: “regulations are watching the big banks more than fintechs.”To combat this threat IE9 argued: “I think from a regulatory perspective; similarly, I think that as technology advances, as the way in which we deliver products and services to our customers change, regulations fundamentally aim to identify potential risks and to ensure that appropriate controls are being put in place to mitigate those risks.”

In response to the changing landscape, IE1 contended that “regulators tend to fall into at least two buckets. There are regulators that take a wait-and-see approach, and there are progressive regulators, that look ahead.” IE9 argued: “some people have the view that regulators almost need to pre-empt what is going to happen. But I think at the current pace of change, so many new things are happening from a financial services perspective. It is unrealistic to expect regulators to be able to anticipate every form of innovation in their field.”

According to the findings of this study, the regulator in South Africa is using the approaches in Table 2 to respond to fintech disruption.

Table 2 Regulatory response strategies

Regulatory response strategy	Description
Special task teams/committees	Frameworks like the National Payment Framework and Strategy Vision 2025 manage fintech risks by providing guidance and oversight.
The Innovation Hub	This hub includes a regulatory guidance unit, which provides advice to those launching new products.
Forming regulatory sandboxes	These are testing environments that function like scientific laboratories where fintechs can innovate without harming the industry.

4.2.1 Special task teams/committees

In response to the changes in the payment space, the South African Reserve Bank established the National Payment System Framework and Strategy Vision 2025. The vision of this initiative is to “enhance the safety, efficiency and accessibility of the national payment system in a manner that promotes competition and minimises risk to the payments ecosystem by leveraging technological developments to extend the availability of digital payment services to all sectors of society while meeting domestic, regional and international requirements for the benefit of all members of South African society” (South African Reserve Bank, 2020:3). Amongst other things, payment fintechs must register with the payment association of South Africa (PASA) and be approved as a third-party payment provider (TPPP) and/or a systems operator (SO), and all non-banks who want to participate in the payment industry must partner with a sponsor bank (Deloitte, 2022). In corroboration, IE7 argued: “Our regulators realised that if they want to facilitate innovation in the country, they have to put all this infrastructure and processes in place.”

FE4 argued: “the payment (sector) is a good example where payments are governed by the South African Reserve Bank, which has mandated the PASA to govern the payments industry.”As part of this intervention, IE2 contended that “for fintechs to play in the payment space, they need a sponsor bank.”In agreement, IE7 posited that “up until now, as we speak, the fintech, have not been allowed to participate directly in the national payment system (on their own). They always need to go through a bank and get a bank to sponsor them so that they can participate.”However, plans are underway to establish a system that will allow more non-banks to participate in the payment space. IE7 and FE5 reported that “SARB and PASA have set up the rapid payment programme (RPP) as part of SARB vision 2025 modernisation of payments technologies and industries to allow non-banks to participate in the national payment system. This is done to help the fintechs to overcome the regulatory burden, and to enforce the regulation through one of the big players (incumbents).”

One other challenge that fintechs have brought to the financial services industry is screen scraping. To circumvent the challenges of screen scraping, FE5 argued: “there is a whole new screen scraping body or tasks team at the SARB.” To increase fintech participation in financial services, FE5 added that “the Payment Industry Body (PIB) is another fantastic idea by SARB to be inclusive. With the establishment of PIB, fintechs will also have a ‘seat at the table’ where rules and compliance are being discussed and enforced”.

According to the industry experts interviewed, more specialised bodies have been launched in South Africa to expand the regulatory framework to include fintechs. FE5 argued: “the regulator has formed the Intergovernmental Fintech Working Group (IFWG) that cuts across Treasury, Reserve Bank, SARS (South African Revenue Service), NCR (National Credit Regulator), FIC (Financial Intelligence Centre), Competition Commission South Africa and FCSA (Financial Sector Conduct Authority)”. RE1 added: “the IFWG is almost a world first in the sense that the IFWG provides a collaborative platform for all the various financial sector regulators to come together in the same place and to consider and openly discuss emerging fintech-related issues such as crypto assets. And it is also very much around ensuring that we do not act unilaterally where an individual action by an individual or regulator might have unintended consequences or spill-over effects for another financial sector regulator.”

Accordingly, RE2 reiterated: “we are there to help the FSCA, the regulator, to proactively respond to the changes that are currently happening in the financial space. As you can see, there are a lot of innovations and developments that are happening in the financial space. And as a result, you find that regulators are always caught off-guard; they are always behind the curve. So, we are changing that in a way we want to be in a situation where we can proactively respond to those developments, and work along with the developments to foster innovation and produce policies and regulations that are informed by the developments that are happening in our environment.”According to RE3, South Africa also has the “National payment systems department (NPSD) of the Reserve Bank, responsible for payment systems regulation. Their mandate is the safety and soundness of the payment system.”

4.2.2 The Innovation Hub

In addition,according to RE2: “We have put in place what we call an Innovation Hub. So, in this hub, we have the regulator guidance unit, whereby if you launch a new product and want to navigate the landscape, you will come to us, and we will advise. And, what we find out most, is that 80% of the fintechs that come and ask for advice from us fit within the current framework. So, we can send them to relevant people who can help them; it is only 20% that you find that do not fit in the current framework. And those are the ones that we normally refer to the sandbox so that their products can be tested because there are no frameworks that cater for them, or they challenge the current framework.”

4.2.3 Regulatory sandboxes

The regulator has introduced other interventions to circumvent the negative effect of fintech on regulation and ensure that the regulation does not stifle innovation. IE7 contended: “The regulator has introduced regulatory sandboxes. This is to say, bring your innovation here, show it to us, and let us evaluate it. And then, we can see if the current regulations are covered adequately. If it does not, we can create additional regulations before you can make it available to customers… Other regulators call this a test-and-learn type of approach. The second approach is without the use of sandboxes. The regulator says we will allow specific products or services to be delivered. And we will closely watch those, and through our supervision processes, then identify the potential risks over time. These approaches are different to traditional approaches, which were very much like before you bring new products to the market, we put the new controls in place.” IE7 further asserted that “this enables the fintechs to go and build their products into the various regulations. So, I think that aspect is really advanced in South Africa. There is a help desk where you can phone to find out if you need to go to the sandbox.” Sangwan et al. (2019) corroborated this, arguing that using regulatory sandboxes offer the right incubation environment for new entrants in the market.

With all these regulatory interventions, IE4 argued, “I think regulators are creating an enabling environment for new entrants to come into financial services and keep it a competitive market.” It is critical for the regulator to keep near the action, even if it cannot foresee the innovation; it must be abreast of or closely track the innovations. Sandboxes have proven to be one of the most effective approaches in this regard. RE1 concurred: “I think we are seeing that we really must stay close to the market and almost walk side-by-side with the innovators to understand how the market and the ecosystem are evolving. Because if we do not, if we just on our own, go away and come up with a regulatory framework, we probably will not get it quite right because we do not have sufficient and deep insight into the market.”

5. Discussion of findings

The findings showed that the incumbents and the regulators have developed strategies that are helping them to respond to the disruptions by the fintechs and mitigate the negative impact thereof. According to the study findings, these strategies include partnering with the fintechs, changing the bank’s role, incumbents upskilling their staff so that they are ready for the fintech evolution, improving customer experience, reducing the costs of financial products and services, copying what fintechs do, and acquiring the fintech to leverage their expertise. This is consistent with the arguments of authors such as Lee and Shin (2018) and Acar and Çitak, (2019), who argued that incumbents should incorporate fintechs into their businesses, partner with fintechs, acquire fintechs, incubate and accelerate the growth of fintech start-ups.

The findings also showed that, in their response to fintechs, South African regulators are intervening by expanding the scope of financial services legislation to include fintechs. These regulatory interventions include the launch of regulatory sandboxes and fintech task teams such as IFWG, RPP and Innovation Hub, whose objective is to provide regulatory guidance to the fintechs. Regulatory sandboxes allow fintechs to first operate in a controlled environment while being monitored by the regulator. As a result, the regulator encourages innovation while ensuring that innovation does not introduce uncontrolled risk into the industry. These findings are consistent with the reports from the literature, which argued that the regulators need to expand the regulatory framework, make it adaptable to new industry developments, and provide an enabling environment that promotes innovation (Coetzee, 2019; Deloitte, 2022). In support, Buckley, Arner and Barberis (2016) argued that a more experimental, innovative, and collaborative regulatory approach to fintech regulation is needed.

6. Conclusion

This study aimed to investigate how incumbents and regulators strategically respond to fintechs’ disruption in South Africa. The findings provided several response strategies by these industry stakeholders. The responses by incumbent financial institutions include interoperability, collaborating and partnering with the fintech to form symbiotic relationships, expanding the role of the bank so that the bank can provide more services, including those that are non-financial, upskilling their staff so that they are ready for the industry changes, improving customer experience, copying the fintechs and acquiring the fintech, and lowering the costs of financial products and services.

The key strategies by the financial regulators include the establishment of new regulatory frameworks and bodies like the Intergovernmental Fintech Working Group, the National Payment System Framework and Strategy Vision 2025, the Payment Industry Body, the National Payment Systems Department, the Rapid Payments Programme, the Innovation Hub and the sandboxes.

This study demonstrated that incumbents should not ignore industry changes and should look for ways to stay competitive. They should act accordingly to avoid losing their competitive advantage to fintechs. Regulators must also not fall too far behind or race ahead of the innovation. They must also be cautious not to create an uneven playing field that unfairly favours fintechs by subjecting them to less stringent regulatory treatment at the expense of incumbents. They should not, however, impose a regulatory burden on fintechs that they cannot meet, as this will discourage them from seeking regulatory assistance and stifle innovation. A level playing field that does not unfairly advantage or disadvantage any party must be ensured.

The research findings have important practical implications for financial institutions because they provide strategies that could help incumbent financial institutions successfully respond to fintech disruption. These strategies, when implemented correctly, can help financial institutions gain a competitive advantage or, at the very least, ensure that they maintain their market share despite the emergence of fintech threats. This study has also contributed to the body of knowledge regarding fintechs in South Africa.

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