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Last year, the Financial Action Task Force (FATF), the international standard setter for anti-money laundering and counterterrorist financing (AML/CFT), celebrated its 30th anniversary. Accompanying the celebrations, the group made a statement in which it committed to promoting financial inclusion through the proportionate and effective implementation of its standards.
This FATF commitment is important. Since its inception, the organisation has driven up global standards to fight illicit finance through its 40 recommendations and a process of mutual evaluation. However, at times, this process has unwittingly found itself at odds with ensuring inclusive access to finance.
Economies that are financially inclusive provide all consumers with equal access to formal financial products and services, such as bank accounts, saving accounts, credit and insurance. Inclusive access to finance is not only crucial for global development and the eradication of poverty, it is also key to achieving FATF’s mission of curtailing illicit finance. Formal economies that are inclusive remove the need for individuals to use informal financial mechanisms that exist outside of the FATF system, and which are hard to trace and can easily hide illicit transactions.
Despite this theoretically mutually beneficial relationship, in practice the FATF system is perceived to frustrate rather than facilitate financial inclusion. The question is, to what extent is this true and are barriers to financial inclusion really created by the FATF framework?
Are There Tools in the Box?
The answer lies in the two core elements of the FATF system – the spirit of its methodology and the way in which countries are assessed. In 2012, the FATF revised the methodology for its framework and prioritised a Risk Based Approach (RBA). The RBA replaced the notion that successful compliance with AML/CFT standards should be measured by the extent to which the exact wording of the 40 recommendations had been met with the idea that procedures should be proportionate and tailored to the specific risk exposure of a country and success measured by the extent to which financial crime and its associated harm is curtailed.
In practice this has created three baskets of compliance procedures: simplified due diligence (SDD), where fewer AML/CFT checks need to be performed as the risk level is deemed to be low; customer due diligence, where the risk level is deemed to be normal for that regulated entity and standard levels of checks are performed; and enhanced due diligence, where the risk is high and the most detailed checks are required.
The SDD classification should be a blessing for financial inclusion. It should allow countries and regulated entities to create cost-effective compliance practices for low-risk, low-value clients – those who tend to be at most risk of financial exclusion. In reality, however, this has not materialised as it should. The threat of falling foul of the FATF system and being penalised for missing a risk when using SDD means that countries and regulated entities have erred on the side of overcompliance, requiring unnecessary and expensive compliance checks to be carried out in all cases to the detriment of financial inclusion.
To its credit, the FATF has tried to rectify this problem by producing guidance on due diligence and financial inclusion. This month, the FATF also released guidance on the use of digital identity for due diligence, a tool which is touted by many as key to enabling inclusion by reducing the cost of conducting identity verification checks during the initial stages of due diligence. Despite this guidance and the creation of the SDD process, there still remains apprehension around using the full breadth of the RBA to service the financially excluded.
Why Are They Not Being Used?
The reason these tools are used less than intended might be found in the way that the FATF assesses compliance with its framework. Every seven to 10 years a country undergoes a ‘mutual evaluation’, a peer-review in which a team of assessors determines the extent to which a country complies with the FATF’s 40 recommendations and immediate outcomes. A poor rating can result in a country being placed on the FATF grey- or black-lists which can make it hard to sustain international banking relationships.
Although it has been found that the mutual evaluation process does not actively damage financial inclusion, it also does not promote it; it is not uncommon for countries to prioritise ‘getting it right’ in order to obtain the best rating, even if this comes at the cost of doing what is right in facilitating inclusion.
The evaluations themselves only consider financial exclusion if this has been identified during the pre-work as elevating a country’s risk of terrorist financing, and not if financial inclusion is reducing AML/CFT risk and improving financial integrity. Additionally, assessors who carry out the evaluations receive no formal training on financial inclusion which obviates the need to pay attention to the issue or to commend country initiatives that protect and promote financial inclusion.
After such an evaluation, any identified deficiencies within a country must be rectified and, again, financial inclusion tends not to be considered in a standardised fashion. Technical assistance is usually found on an ad hoc basis by countries, and can consist of flying in external experts who lack the in-country knowledge to make the required changes in a way that is appropriate for that country’s financial inclusion context.
Additionally, corrective efforts are often given short deadlines and are accompanied by the fear that insufficient work could result in a FATF listing, all of which serves to further downgrade the promotion of financial inclusion.
Breaking Down the Barriers
It is overly simplistic to argue that the FATF is solely responsible for overcompliance with its standards, and that this leads, in turn, to the perpetuation of financial exclusion. The truth is that the tools that could facilitate financial inclusion lie within the system already, most notably those available within the SDD procedures. The problem, however, is that incentives do not exist to make entities use those tools. Ultimately, countries and regulated entities are harshly punished when things go wrong and they receive no reward for getting it right or for promoting inclusive finance.
Without an incentive to experiment at the fringes of the FATF system, progress will remain slow. To change this, we need innovative companies that offer products that service the poor, supported by agile and fearless national regulators who allow them to confidently use SDD, within countries that are prepared to defend what they are doing at the FATF forum. Without this, we will continue to prioritise ‘getting it right’ over doing what is right.
BANNER IMAGE: Courtesy of HMRC/flickr
The views expressed in this Commentary are the author’s, and do not represent those of RUSI or any other institution.