Together with financial stability, financial integrity and consumer protection, financial inclusion is one of the key objectives of financial regulation. Essential to operationalising financial integrity is the need for financial institutions to know who their customers are. A financial system in which customers are anonymous is one that can easily be abused and corrupted. Such a system is also more subject to the risk of financial cronyism and related financial instability. In addition, financial institutions that are not able to establish clearly the identities of their clients will be less willing to lend to them, thus hindering financial inclusion. Appropriate Know-Your-Customer (KYC) rules governing all financial institutions are indispensable to the efforts of the global community toward both financial integrity and financial inclusion.
In last several years, we have come from a situation where financial integrity was seen as barrier to financial inclusion to the situation today where there is a general recognition that financial inclusion, financial integrity and financial stability are not only compatible, but also mutually reinforcing. Financial inclusion relates to effectiveness in several ways. Rigorous customer due diligence standards may make the risk very low for existing accounts. However, total risks for illicit activity may be even further reduced if more people are encouraged to transact through the formal financial system. The inappropriate implementation of AML/CFT standards-especially in emerging markets-plays a role in excluding millions of low-income people from formal financial services. It can relegate the unserved majority to the informal world of cash, undermining social and economic advancements and denying regulators and law-enforcement agencies a key means of strengthening financial integrity: the ability to trace the movement of money. It need not be this way. Financial inclusion and an effective financial integrity regime can and should be complementary national policy objectives. International AML/CFT standards have some flexibility, enabling countries to craft effective and appropriate controls.
The challenge in designing such rules, at both the national and the international levels, is to ensure that they are consistent with the objective of financial inclusion. A consensus on this goal is shared among policymakers worldwide who are working to develop sound KYC rules. It is reflected, in particular, in the 2012 recommendations of the Financial Action Task Force (FATF) that explicitly mandate a risk-based approach (RBA) to be developed through the principle of proportionality. As expressed by the G20 Principles for Innovative Financial Inclusion, "To strike the right balance, existing regulations should be carefully analysed to establish whether their demands on service-providers are proportionate to the risk". What is less clear is how, precisely, to implement the risk-based approach in the financial sector! What exactly are the magnitudes of the various risks and the probability that they materialise! The question is perhaps most stark for small customers. If KYC rules are not defined differently for small from large customers, the objective of financial inclusion will be undermined. Financial services providers will find it uneconomic to apply exacting rules to the smallest accountholders and may therefore choose not to accept them as customers, or may charge them more in fees than most low-income customers can afford. More generally, KYC rules need to reflect the realities and the risks posed by those seeking access to financial services.
In designing Financial Inclusion Product Risk Assessment Module (FIRM), following critical issues always need to be considered:
n A flexible and evolving approach is essential: Dynamic financial inclusion agendas, coupled with a growing understanding of FATF standards that are relevant to or have an impact on financial inclusion and exclusion, require a flexible regulatory framework that can accommodate change. Attempts to create a fixed, ideal model are unlikely to stand the test of time. In fact, most regulators that adopted a risk-based approach to financial inclusion products had to amend their models at least once to accommodate new products and services (especially mobile financial services), or because of negative feedback from providers and customers.
n Risk assessments create both challenges and opportunities: Most countries seem willing to conduct a national risk assessment to map out their national exposure to money laundering/financing of terrorism threats but do not have sufficient data to carry out a comprehensive initial risk assessment. The initial risk assessment should therefore be seen as the first in a series of steps toward improving the breadth, depth and quality of data. Alternatively, countries can also conduct sector, multi-sector or thematic risk assessments to start with.
n Simplifying due diligence is not simple: Simplified customer due diligence (CDD) is critical for enabling greater access to more cost-effective financial inclusion products and services, but reaching this point is challenging. At each stage of the process, from determining restrictions on products to identifying and verifying customers, a complex range of issues must be taken into account.
Keeping these issues into mind, following process can be adopted for developing Financial Inclusion Product Risk Assessment Module (FIRM).
n Conducting a well-informed national risk assessment: a) To ensure a coordinated national approach, it is important to involve public and private institutions in the assessment process through workshops and other forms of stakeholder engagement. b) Given that risks need to be assessed regularly, a robust system for collecting high-quality data quickly and effectively is essential. c) To capitalise on the expertise of intergovernmental bodies, collaboration with them creates synergy.
n Applying proportionate customer due diligence (CDD) requirements: a) Increasingly, regulators are designing tiered regulatory parameters and CDD controls for products with different risk levels. In general, the lower the risk, the lower the CDD requirements. b) The vulnerability of a low-value product or service to criminal abuse can be reduced by: restricting access to lower-risk customers only and limiting its functionality. c) Deciding when and how to conduct identification and verification of customers is inevitable where national identity (NID) database would play a crucial role.
Financial inclusion is one of the core development agenda of the Government of Bangladesh laid down in its all national plan. Thus, we have to work collaboratively to expedite financial inclusion along with financial stability through maintaining financial integrity. By moving individuals from the shadow economy into the formal financial system, greater opportunities emerge for introducing underserved populations to a broad suite of formal financial services, and ensuring those services are accompanied by suitable consumer protections. Thus, financial inclusion, financial integrity, and financial stability can act as complementary objectives that will fulfill national developmental targets comprehensively and effectively.
The writer is a deputy governor of the Bangladesh Bank.
khairul.khandoker@bb.org.bd