Financial Inclusion, Stability, Integrity, and Consumer Protection

Leaders and policymakers from a large number of countries recognize that financial inclusion is an important ingredient for economic and social progress. Access to appropriate financial services helps self—employed families in the informal sector and small businesses better manage their affairs; it spurs local economic activity; and at -- a macro-level -- the depth of financial intermediation is associated with faster economic growth and less inequality.

But how do you ensure that financial inclusion – only relatively recently elevated as a critical policy objective on the global stage – reinforces the more established objectives of maintaining the stability of the financial sector, preserving its integrity by preventing financial crime, and protecting financial consumers, rather than creating tensions between them? The 100+ national-level policymaking bodies in the Alliance for Financial Inclusion (AFI) have dedicated a good deal of their September 2013 Global Policy Forum in Kuala Lumpur to better understanding this question and learning from each other.

Conceptually, it’s not difficult to see positive linkages between these four policy objectives. Financial sector stability, for example, is arguably a prerequisite for households and firms to trust the system and wanting to participate. Conversely, an inclusive financial system that reaches all citizens will have a more stable retail deposit base, which should increase systematic stability. 

One important, technical recognition of another such pair of synergies has come from the Financial Action Task Force (FATF), the global standard setting body tasked with anti-money laundering (AML) and combatting terrorism finance (CTF) efforts. In its recent guidance paper, FATF recognizes that financial exclusion is a risk to its core mandate and recommends a tiering of “Know-Your-Customer” norms that makes it easier for low-value, low-risk transactions to be flowing through the formal payment systems rather than staying outside where they can’t be traced.

In practice, financial policy objectives can of course conflict. Most dramatically this arguably happened with the U.S. subprime mortgage crisis. For years, the disaggregated U.S. retail mortgage business system with its government subsidies and guarantees was viewed by many as a successful inclusion effort that extended credit to more families and increased homeownership with its related positive impact on communities. With the benefit of hindsight, we of course know it played out differently. Booming mortgage origination with increasingly loose underwriting standards, a lack of attention to consumer protection, opaque and complex securitization vehicles, and ignorance of true underlying risks, combined to trigger one of the biggest financial stability crisis in recent memory.

In their effort to support the G20’s goal of advancing financial inclusion, Martin Alsop, Timothy Lyman, David Porteous and others have looked how these financial policy objectives are linked. Their South Africa case study, not surprisingly, shows examples of positive and negative linkages. In the case of the low-cost “Mzansi” retail bank accounts, the various national regulatory bodies ensured upfront that the product design took AML/CFT concerns into account without preventing the product from reaching its target customer group.  The case study reports that “Mzansi” accounts are considered largely to be a financial inclusion success story: 6 million new accounts were opened over four years: 72% of them by people who had never been banked, and 61% of account holders were from the targeted low-income groups. Perhaps most importantly, the Mzansi accounts demonstrated to South African banks latent demand and high take up from a new segment. While the “Mzansi” low-frill accounts were not directly commercially viable, they provided an entry pathway for low-income households. After a few years half, of the “Mzansi” dropouts had graduated to a superior bank product, which made business sense for banks.

By contrast, in another inclusion effort, the South African government as a large employer permitted payroll deductions from civil servants salaries specifically for unsecured loans that were to be used for housing finance. But here, pent-up demand for credit and wide-spread abuse of the original intent led to an over-indebtedness crisis and government withdrawal of the payroll deduction mechanism, which in turn triggered loan repayment defaults and a broader banking crisis.

The work for the G20 and the South African case example confirm the in-going intuition: synergies between the various financial policy objectives are achievable, but they are not guaranteed. To maximize the synergies, and to minimize trade-offs, policymakers cannot plan and execute new regulations or initiatives in the isolation of any single policy silo. Success is likely to require an explicit articulation of objectives against the broader set of policy considerations; a priori analyses of benefits and risks across linkages between policy objectives; consultation with financial services providers to help better identify and understand these linkages; and a commitment to adapt policy and regulation over time in light of the evidence collected and the outcomes observed.

Globally, half of working-age adults remain excluded from formal financial services. In many developing countries, for example in Sub Saharan Africa, exclusion can be 80 percent and higher. However well regulated and stable a financial system may be, if it leaves out the vast majority of citizens and doesn’t help spur economic activity nor boost shared prosperity, it misses the bigger point. Policymakers have been right in elevating financial inclusion as one important item on the global development agenda. They will have to continue to work towards better understanding and ultimately managing the linkages between financial inclusion, stability, integrity, and consumer protection so that these can reinforce each other rather than compete.