Bankable Frontier Weblog

What do money laundering and microfinance have in common? Hopefully, not a lot. However, the regime for countering money laundering (AML), and for its sister, combating the financing of terrorism (CFT), have become more stringent in design and application in recent years. These international regulatory regimes could have a severe impact on access to financial services if their application to and implementation in developing countries is not careful considered. This is one of the implications of a recently released Focus Note (No 29) written jointly by CGAP and the World Bank’s Financial Market Integrity Unit (FSEFI), entitled “AML/CFT: Implications for FSPs that serve low income people.”

“Have you any dirty money, mother dear?”

While money laundering usually involves sums of money well in excess of micro-size transactions, terrorist financing may require small sums. CFT concerns arise about microfinance in two main respects. First, remittances may be used to finance the construction of weapons of terror across the globe; hence the need to identify senders and recipients of international remittances. Second, certain types of NGOs, still common in microfinance today, are considered potential risks in terms of being conduits for terrorist financing.

The international AML/CFT standard is set by the Financial Action Task Force (FATF). FATF is made up mainly of developed countries, with a few developing country members such as Brazil, Mexico and South Africa. FATF standards have to be embodied in country-level laws and regulations to take effect at national level. Increasingly, countries which do not implement satisfactory AML-CFT regimes are likely to be frozen out of the international financial system. This is because developed country bank regulators will discourage their institutions from conducting financial transactions with banks in high risk countries.

The impact of such regulation on access comes primarily through two channels. First, new regulation of this kind raises the cost per customer of doing business. The added cost may affect the willingness of institutions to go down market. Second, and perhaps more importantly, imposing inappropriate customer due diligence (CDD) requirements on new accounts will result in higher financial exclusion: for example, the CGAP paper cites the requirement for third party address verification. Although this is not directly a FATF requirement, it is often understood to be part of proper CDD. In countries where most people do not have formal addresses at all, this will automatically exclude many people.

While it is clearly essential to the integrity of the global financial system and to the fight against terror to have appropriate AML-CFT regimes in place, the key issue is the word ‘appropriate’: the view from developed countries with financial exclusion rates of 10-20% of population is likely to differ from that of developing countries with rates of 50-90%. So, in the months and years ahead, it becomes important that developing countries which take the financial inclusion agenda seriously consider carefully the impact of AML-CFT laws before enacting them. But the international regime must also create space for this to happen. This includes allowing for a risk-based approach which accommodates differences in country-level approaches. Entities like the World Bank need to raise their voices in forums such as FATF where international standards are set, so that the interests of the financially excluded are considered there too. I understand that the FIRST Initiative  of multi-laterals and key donors has agreed to finance an impact study which kicks off shortly—I welcome this and await its outcome early next year eagerly.