Seizing the Moment: FATF Revisions and Financial Inclusion 2.0

The Financial Action Task Force (FATF) is consulting about proposed revisions to its anti-money laundering, counter-terrorism financing, and counter-proliferation financing (AML/CFT/CPF) standards. The proposed revisions to Recommendation 1 (R.1) aim to bolster financial inclusion by refining how the risk-based approach (RBA) is implemented globally. While the updates are a step forward, the financial inclusion community should consider how much these changes can be leveraged to ensure greater financial inclusion.

Why a risk-based approach is key

At its core, RBA is meant to help allocate resources efficiently by directing attention to higher-risk areas while allowing simplified measures for lower-risk individuals. The proposed revisions of Recommendation 1 aim to promote a wider and more efficient application of the RBA and especially better identification of low and lower risk and the improved use of simplified due diligence and regulatory exemptions.  Since becoming mandatory for AML/CFT in 2012, the approach, when correctly applied, has opened pathways to financial inclusion, for example by allowing the simplification of identity verification requirements for customers who lack the otherwise required ID.

This move by the FATF to adopt a mandatory risk-based approach in 2012 came in part as a response to evidence of the exclusionary impact of its previous rule-based standards. The FATF Guidance on Anti-Money Laundering and Terrorist Financing Measures and Financial Inclusion of 2013 (amended in 2017 and currently under revision) provided practical examples of RBA implementation in selected countries, including examples of alternative verification methods. This was an important change given that for over a decade since the launch of the Findex survey that tracks this data point, an integrity-related challenge (lack of documentation) has remained among the top five reasons for financial exclusion globally.

One RBA measure that has been instrumental in expanding access to financial services, particularly to payments accounts, is the so-called ‘tiered customer due diligence (CDD)’ also known as ‘tiered know-your-customer (KYC)’ or ‘tiered accounts.’ Tiered CDD enables the provision of basic lower-risk services to customers with minimal identity verification and allows access to additional services where and when identity assurance can be improved. Under tiered CDD, financial institutions are allowed to issue accounts and products with different levels of functionality. The products with the most limited functionality would be available to lower-risk customers subject to minimal identity verification. Such accounts commonly restrict the number and value of transactions, the maximum balance that can be maintained, etc. As customers provide more identity assurance, they gain access to accounts and products with higher functionality.

Tiered CDD has proved vital for improving access to payment accounts – a fundamental metric in financial inclusion and, for a long time, the key focus of financial inclusion efforts. Tiered accounts were assumed to create a gateway to formal financial services, the first rung on the inclusion ladder allowing customers to eventually reach products previously unavailable, including credit and insurance.

However, many customers with limited means to verify their identity end up locked into lower-tier accounts they use minimally, in part because the limited functionality of this type of account also limits its usefulness.

That presents a problem for customers, the financial inclusion community, and the FATF. Customers only benefit from being financially included when they use formal financial services that bring them value. And FATF’s integrity objectives are only served when customers use formal financial services. Where FATF-related measures limit product functionality and use, financial integrity and inclusion policy objectives are both frustrated. How can the practical alignment of these policies be improved?

Unlocking the potential of a risk-based approach

The FATF's proposed revisions provide an opportunity to rethink how the RBA can support inclusion more effectively. With the tiered CDD as a building block in place, policymakers and providers should ideally experiment with additional approaches to the RBA. Technology is likely to play a bigger role in these experiments than a decade ago, and regulatory tools such as sandboxes could come in handy. Concepts such as digital IDs, collaborative CDD, progressive KYC, and open finance could enable upward mobility for lower-tier account holders. Technology may also lead to solutions that help financial institutions better differentiate their CDD processes based on the customers’ risk profiles while allowing access to full accounts and other services.

Innovation facilitators, such as regulatory sandboxes, could also play a transformative role, allowing regulators and providers to experiment with novel solutions. Such experimentation is needed to reach the 1.4 billion adults currently excluded from the formal financial system, many of whom live in extreme poverty, in remote areas, and have minimum documentation.

What needs to happen next?

The proposed revisions of R.1 signal that FATF expects countries to implement the RBA not only to curtail higher risks but also to effectively support appropriate financial inclusion of lower-risk customers through more efficient AML/CFT/CPF measures. This should give countries and providers a strong motivation to review their current, often highly conservative, approaches and their actual progress to include those who are still financially excluded. For any change to be adopted, however, FATF members will need to vote for it. Knowing the proposed revisions enjoy wide support will help guide their decision on the FATF delegations. That is why the proposed changes should be resoundingly supported by the financial inclusion community.

There are some concerns too, however, highlighted in our previous blog. Building on that, there are additional critical steps needed to fully support and maximize the impact of the proposed revisions.

Capacity-building around risk

Effective RBA implementation hinges on improved risk assessment and management skills among regulators and providers. Relevant capacity building may come from outside (i.e., the World Bank, International Monetary Fund, regional development banks, and others), but should be also encouraged inside the regulatory agencies and providers. The investment needed for the adoption of an effective RBA should be generously compensated by higher compliance and supervision efficiency and financial inclusion gains.

Cross-sector collaboration

The financial inclusion and law enforcement communities must engage to share their perspectives, educate each other, and work collaboratively toward achieving their respective goals. Financial inclusion helps to build stronger AML/CFT/CPF systems. A well-regulated financial system that serves most of society is more resilient against criminal abuse. And vice versa – large, informal, cash-based economies often hold higher risks of money laundering and financing of terrorism and proliferation.

Encouraging experimentation

FATF should consider establishing its own regulatory sandbox, enabling countries to test innovative solutions without fear of punitive assessments. Allowing for sandbox-like experimentation under the aegis of FATF could inform the next round of the FATF Recommendations revisions, going beyond the current proposals.

The FATF consultation represents a pivotal opportunity to reshape the relationship between financial integrity and inclusion. We call on the financial inclusion community to join in considering the proposals and to submit comments by the December 6, 2024, deadline.