A Bold Move Toward Simplifying AML/CFT: Lessons from Mexico

This blog is written by Xavier Faz, CGAP & Denise Dias, independent consultant; with contributions from Carlos Lopez-Moctezuma & Brenda Samaniego, both from CNBV.

Regulators around the world today are beginning to realize that the chances of expanding access through branchless banking can be very limited without reducing the account-opening requirements through agents and mobile phones. The challenge is to strike the right balance between reducing account-opening requirements while maintaining basic controls for AML/CFT.

Enforcing full account-opening procedures often excludes important segments of the population from formal financial services, keeping them “operating” in the informal economy. There are countries where many people (particularly among lower income segments) lack formal identity mechanisms, and other cases where people do have identity documents, but the requirements to fulfill KYC procedures make it too cumbersome and/or expensive to effectively carry out. In either case, the risk is to inadvertently push these services beyond the reach of the poor (even if geographical reach exists). Therefore, maintaining the same level of KYC requirements as for bank branches supports the prevalence of informal financial systems which in turn acts against the AML objective that was sought in the first place.

Most regulators would agree that some middle ground would be needed, but striking the right balance is not an easy thing. Early examples of this are regulations in South Africa and Colombia, which established exemptions to enable opening of deposit accounts at agents or by the individual themselves through their mobile, relying on broadly adopted national ID mechanisms and population registries that could be checked online at the time of account opening. The BCEAO in West Africa allows the use of anonymous electronic money accounts with caps in the balances. The actual implementation of these schemes have varied in practice.

Financial sector authorities in Mexico have gone a step further in adopting an approach that addresses the challenges above. Authorities followed a ‘tiered’ approach that implements flexible account opening requirements for low-value, low-risk accounts that are subject to increasing caps and restrictions on permitted transactions. Opening requirements increase progressively as such restrictions on transactions are eased. This incorporates several innovative aspects:

• Five different types of deposit accounts, targeting different market segments and income brackets, with varying KYC requirements
• At the “lowest” tier (Level 1), an anonymous account enabling e-wallets as a substitute for small amounts of cash
• Non face-to-face account opening
• Paperless record keeping for the four lower levels
• Outsourcing of KYC to third parties

In addition to being a practical example of how to implement a risk-based approach to FATF recommendations, this is expected to have a positive impact in the Mexican market by 1) making products more appealing to mass markets (simpler and fewer requirements to open accounts); 2) reducing the cost of acquisition for banks (online opening, no paper file required); and 3) enabling new business models (retailers can “sell” anonymous accounts, corporations can open payroll accounts, banking agents and MNOs can open bank accounts for their clients).

About the approach

Mexican financial authorities consider that the transactional limits and caps on deposits make them unsuitable for money laundering & financing of terrorism activities. Simultaneously, in choosing to limit deposits (rather than the balance or withdrawals), regulators leave room to design both savings and payments products. Once a customer has stored his money in the account, he can conduct multiple small payments or a few large-value ones.

In addition to the said limits and caps, additional safeguards are being implemented in order to further reduce the risk of money laundering & financing of terrorism: these accounts are monitored for suspicious use-patterns which financial institutions report to the Financial Intelligence Unit; agents are subject to periodic reporting of all transactions conducted; mechanisms for cross-checking clients data must be established for accounts that are not opened face-to-face; and receipts must be issued for transactions. In sum, all transactions leave an auditable trace.

The Level 1 accounts (“anonymous” accounts) have additional restrictions: the total balance is capped, and the account can’t be operated via a mobile phone. In the event that one of these accounts is suspect of misuse, the financial institution must ‘freeze’ the account until the user provides further identification information. Similarly, for accounts in which opening need not be face-to-face, if a client’s identification information is not validated after a period of time, the account must be cancelled or sanctions will be imposed on the bank.

The monthly deposit cap in each account is set just above the average monthly income of households in each of the lower economic segments of the population. This ensures the accounts remain attractive to customers of different socioeconomic levels while still limiting risk significantly. The figure below shows how the caps on deposits per month relate to the income level of lower socioeconomic segments of the population, which would ensure access to unattended market segments.

Summary of accounts:

• Level 1: This is an “anonymous” account that can be opened at branches, agents, through the web, or “sold” through retailers; it is capped at 285 USD in monthly deposits and 380 USD maximum balance. Customers can use any channel, except mobile phones, to deposit, transfer or withdraw money. ◦
• Level 2: This is a “named” account that can be opened “remotely”; customers self-report name, state and date of birth, gender and address; monthly deposits are capped at 570 USD. A physical/paper file with customer ID information need not to be created. For these type of accounts opened remotely, a 24-month grace period is granted to banks in order to do a more complete KYC procedure.
• Level 3: This is the same as Level 2, but the bank is able to validate the self-declared data online against a public database; the cap in monthly deposits doubles to 1,140 USD.
• Level 4: This can be opened only at branches, agents and enterprises (for mass payroll); it requires additional information to Level 3 (nationality, occupation, phone number, and ID). Information must be cross-checked against a valid ID document and thus account opening must be face-to-face; monthly deposits are capped at 3,800 USD; as with Level 2 and Level 3 paperless record keeping is allowed.
• Level 5: This is a full-fledged bank account, opened only at branches. The bank needs to file copies of ID, proof of address, tax ID and other.

All accounts are subject to monitoring and all transactions leave an auditable trail. All accounts have the same means of access available for transacting (with the exception of Level 1, where transactions cannot be conducted via mobile phones).

For a detailed description of this scheme, please refer to the table here.

Interview with Carlos Lopez Moctezuma from CNBV

We have asked Carlos Lopez Moctezuma, Chief of Staff for the President of the National Banking Commission in Mexico, a few questions about the challenge financial authorites faced to design this scheme.

1. What made you aware that this was an issue in the market?

In Mexico, a significant percentage of the population lacks access to formal financial services, even the most basic ones. These people are forced to rely on informal providers, in-kind savings, and cash transactions, with high risks and high monetary as well as transactional costs. In the interest of fostering the design and supply of products focused on serving the unbanked, the financial authorities (CNBV, SHCP, and Banxico) joined efforts to identify aspects of the regulatory framework that could pose obstacles for expanding financial access. One of the main obstacles identified was the unequivocal implementation of KYC requirements. While the agent banking framework just recently authorized did allow for an increase in the number of access points, account opening at these establishments was simply unviable if full KYC requirements were to be applied. Thus, we considered the development of this tiered scheme as a comprehensive solution to allow banks to expand their offering to these market segments. We believe this approach not only reaches a balance with AML/CFT goals, but it even promotes them further. As more people are included in the financial system, it is easier to trace and monitor their transactions, reducing the range of unsupervised transactions in the country.

2. What was the most important issue/challenge from the perspective of the authority and how did you address it?

Several issues come to mind, such as defining the threshold, avoiding steering the market to a certain business model or technological platform, determining the most suitable mechanisms to mitigate the risk of misuse; however, the most challenging one was sharing among other relevant authorities and market players the understanding of the need and urgency of establishing a framework that allowed for an expansion in financial access. In order to do so it was acknowledged at all times that money laundering was a primary concern, especially for authorities directly in charge with its prevention, and as such, dialogue was sought as the starting point. Risk measurements, limit definitions, controls and all arguments backing the approach were built around the shared perspective that greater financial inclusion works in hand with reducing informality, strengthening transaction traceability, and thus fighting money laundering and terrorism financing through the financial system.

3. How were you able to demonstrate low risk according to FATF guidelines? What type of negotiations/discussions did you have with the law enforcers (FIU) and other policy makers?

In broad terms, in order for our approach to be in line with FATF guidelines and reach agreements with the FIU, we had to establish an open dialogue with them about the market needs and the risks involved in creating the concept of tiered accounts. This allowed us to understand in detail FATF’s interpretative notes regarding clients’ identification and data verification. We also had continued talks with FIU members who were very open and collaborative to help us understand their concerns. Once these concerns were clear to us, using FATF’s guidelines and notes, and in constant coordination with the relevant authorities, we worked towards building an approach that fulfilled the shared financial inclusion goal while simultaneously addressing the risks that were identified by all involved parties.

4. What aspects of this scheme would you think will have the most impact in the market?

The most direct impact that we expect is to enable access to the formal financial system for a significant part of the population that is still unserved. As a byproduct, we also expect to see more competition between suppliers for these market segments. Up until now banks had mainly focused on higher-income brackets, but we expect that this new account opening scheme, coupled with the banking agents framework, will make the lower-income market a more attractive target group for banks. Thus, we also expect to see a proliferation of products and services fitted to serve the needs of these market segments. Several business models and mobile-linked products, which are based on the opportunities created by this regulatory approach, are being already developed and some are ready to be launched. We see great potential for financial access in them.

5. What would be your advice/suggestions to other regulators who are working to create a risk-based approach to AML/CFT controls?

The main suggestion that I would advance would be that dialogue and cooperation is vital. Communication with market players is needed to identify the obstacles that regulatory requirements might be creating as well as to allow for the development of innovative approaches that might help both the financial inclusion as well as the AML/CFT objectives. Similarly, dialogue with FIU and AML/CFT guideline setters is of great importance, as it allows for a better understanding of the risks at hand and how to better address them while simultaneously abiding by the imperative need to foster financial inclusion. Lastly, cooperation with financial authorities and relevant policy makers worldwide is also of great help as it is helpful to observe the obstacles that need to be tackled and draw lessons from practical approaches, in order to adjust them so that they suit national circumstances.

- Xavier Faz & Denise Dias