Deepening Insights on Financial Exclusion Risks

In 2011, the G20’s Global Partnership for Financial Inclusion (GPFI) released a white paper with recommendations on international standard-setting and financial inclusion of the poor. The paper highlighted the need to deepen understanding of financial exclusion risks, especially in relation to financial integrity and stability. It also argued for a stronger empirical basis to enable global financial Standard-Setting Bodies (SSBs) to reflect these risks properly in proportionate standards and guidance.

Since 2011, the SSBs have taken fundamental steps on financial inclusion, acting on most of the observations and recommendations in the white paper. Yet five years later, a new GPFI White Paper, "Global Standard-Setting Bodies and Financial Inclusion: The Evolving Landscape," observes that little progress has been made on understanding financial exclusion risks, especially as they relate to the four key objectives of financial regulators: inclusion, stability, integrity and consumer protection (I-SIP). In the absence of deeper insights, how are policymakers to weigh financial exclusion risks against the risk that the financial system will be abused to further money laundering or terrorist financing? More broadly, how will the SSBs guide policymaking on the most appropriate ways to promote all four I-SIP objectives?

Hands exchanging cash
Hands exchanging cash. Photo by Fehmiu Roffytavare, 2015 CGAP Photo Contest.

FATF’s progress – financial exclusion and financial integrity

When consumers are excluded from the formal financial system and, consequently, use informal services in the opaque cash economy, clear risks emerge. For the Financial Action Task Force (FATF), the key SSB responsible for financial integrity, undocumented cash-based transactions tend to escape measures aimed at anti-money laundering (AML) and combating of financing of terrorism (CFT). In fact, cash inadvertently improves the cover for criminal activities.

FATF has taken strides since 2011 to incorporate aspects of financial exclusion risk in its standards framework. For instance:

  • The ministerial declaration that accompanied FATF’s 2012-2020 mandate recognized that financial exclusion can present a risk to achieving effective implementation of its integrity standards by confining transactions to the opaque world of cash.
  • FATF’s 2012 revised recommendations introduced a mandatory risk-based approach and explicitly allowed simplified customer due diligence measures for lower risk products and services that can increase financial inclusion.
  • FATF’s 2013 mutual evaluation methodology allows country assessors to consider elements of financial inclusion and exclusion where they deem that relevant to assess the effectiveness of a country’s AML/CFT system.
  • FATF issued guidance on AML/CFT and financial inclusion in 2011 and updated the guidance in 2013.

Notwithstanding these steps, national policymakers are still uncertain about how best to use the space created by FATF to align integrity and inclusion. Only deeper understanding of financial exclusion risks will position them to calibrate their actions on both of these key policy objectives.

Financial exclusion – the concerns broaden

Regulators, particularly in poorer countries, often grapple with trade-offs relating to financial exclusion risks. These questions arise for example when features and control measures of products targeting the poor are considered, especially when the national crime or terrorism risk levels are high. The current debates around appropriate financial services for undocumented refugees in Europe illustrate the complexity of the questions policymakers in developed economies also face when confronted with vulnerable, excluded individuals.

And since the 2011 white paper, the financial exclusion discussion has broadened beyond individual customers. Now money service businesses, charities, fintech companies, diplomatic missions and even politicians are affected by banks’ decisions to terminate accounts and services to certain groups of customers. Banks use the term “de-risking” to describe these actions, which enable the banks to move compliance, reputational, and other risks off their balance sheets.  Yet the term “de-risking” is misleading, as financial exclusion risks increase to the extent customers are forced instead to transact in cash.  

The banks’ drive to limit their own risk exposure is also causing some banks to shed correspondent banking relationships in countries perceived as risky. Poor countries, particularly those in conflict, are more likely to be perceived as risky. This raises the spectre that entire economies – including some of the most vulnerable – could find themselves excluded from the global financial system. This danger has raised sufficient concern to cause the Financial Stability Board join forces with the World Bank, FATF, the Committee on Payments and Market Infrastructures, and other bodies to investigate the implications of financial exclusion for global systemic stability, as well as possible steps to address it.

What is to be done?

Against this backdrop, the 2016 GPFI white paper recognizes anew that a better understanding of financial exclusion drivers and risks is important both to the design of proportionate global standards and to proportionate national regulation, supervision, and enforcement. The paper recommends a broad plan and concrete steps to move ahead:

  • First, FATF, the Financial Stability Board and other SSBs should work toward the development of a common understanding of the risks of financial exclusion, starting with an analysis of challenges posed by financial exclusion to each SSB’s pursuit of its mandate.
  • Second, SSBs should explore the development of a framework to assess the impact of financial sector regulation, supervision, enforcement, and institutional compliance practices on financial exclusion risks and their mitigation. Country case studies undertaken jointly by SSBs may be an initial step toward the development of such a framework. This could be followed by the development of processes for collecting quantitative and qualitative data to track changes in financial exclusion risk levels.

The suggested plan reflects an awareness of the complexities that surround financial exclusion risks while presenting the SSBs with concrete steps forward. It is now incumbent on the SSBs to take the first steps toward a deeper understanding of financial exclusion risks.

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