The introduction of the draft CBN FX Code marks a significant milestone in Nigeria’s foreign exchange market regulation as it signifies a shift away from a regulatory approach that is largely rules-based toward a more dynamic, principles-based regulatory approach. Effectively, the Central Bank of Nigeria now employs a hybrid regulatory approach, in the foreign exchange market, utilising principles-based and rules-based frameworks. By adopting a hybrid model, the CBN is signalling its intention to deepen regulatory scrutiny in Nigeria’s foreign exchange markets, which has been long-plagued by sharp practices. What is a principles-based regulatory approach and how does this approach impact the regulatory environment for Nigerian banks, fintechs and other financial institutions?
Principles-Based Regulation
Broadly speaking, a principles-based approach to banking supervision is one that sets broad, high-level principles to guide the conduct of regulated entities rather than detailed prescriptive rules. A principles-based regime helps regulators and institutions focus on outcomes rather than technicalities. On the other hand, a rules-based regime focuses on establishing specific, detailed, and prescriptive rules and guidelines to govern the conduct of regulated entities.
How Does a Principles-Based Regulation Approach Impact Regulatory Environment for Nigerian Banks, Fintechs & Other Financial Institutions?
From a regulatory standpoint, a principles-based approach heightens regulatory risk for Nigerian banks, fintechs and other financial institutions as this approach provides the Central Bank with considerable flexibility to adapt its supervisory approach to changing market conditions in the foreign exchange markets, without the limitations imposed by specific rules. With a principles-based approach, there is little wiggle-room for regulatory arbitrage as a principles-based approach focuses on broader standards that are harder to manipulate, ensuring that Nigerian banks, fintechs and other financial institutions comply with the spirit of central banking regulations in the foreign exchange market.
Other than the effect of increased regulatory risk, Nigerian banks, fintechs and other financial institutions will have to adopt innovative risk assessment and compliance strategies in view of the ambiguity and regulatory uncertainty which can often be a consequence of a principles-based regulatory approach. For instance, banks, fintechs and other financial institutions may interpret principles in the FX Code differently. It may also be difficult for banks, fintechs and other financial institutions to benchmark compliance and to accurately predict, how to meet regulatory expectations or what the regulatory position of the Central Bank will be on particular issues.
Additional Comments
Overall, we expect that a hybrid-approach will be a positive development for Nigeria’s foreign exchange market which has been plagued by sharp practices. Compliance teams I’m Nigerian banks, fintechs and other financial institutions would have to be proactive by deepening a culture of open dialogue with the CBN. This approach will help to ascertain regulatory expectations and to ensure compliance. It would also be prudent for banks, fintechs and other financial institutions, with a FX market exposure or business, to consider an independent compliance assessment. Amongst others, an independent compliance assessment will help banks, fintechs and other financial institutions to identify potential compliance risks and help address those risks before they result in regulatory penalties or reputation damages. An independent compliance assessment is also a great way to demonstrate accountability, improve internal processes and prepare for regulatory audits.
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