In recent years, the international community has begun to focus on financial inclusion as part of a broader strategy to reduce poverty, encourage economic development, and promote stability and security. The term ‘financial inclusion’ refers to the provision of accessible, usable, and affordable financial services, either through the formal or informal financial sector, to underserved populations. Financial inclusion also applies to ‘underbanked’ communities, where people lack reliable access to or are unable to afford the associated costs of financial services.
However, banks, in their effort to pursue risk-based approach, are exiting relationships due to declining risk appetites post global financial crises in 2008 and rising AML/CFT scrutiny globally resulting in ‘financial exclusion’.
‘De-risking’ or ‘de-banking,’ refers to the practice of financial institutions exiting relationships with and closing the accounts of clients perceived to be at ‘high risk’ such as those with money service businesses (MSBs), foreign embassies, international charities, correspondent banks & MNCs. Rather than manage these risky clients, financial institutions opt to end the relationship altogether, consequently minimizing their own risk exposure while leaving clients bank-less. De-risking represents a market failure. All invested stakeholders (banks, regulators, and bank customers and clients) appear to be acting rationally and in their own best interest, but in so doing have created unintended consequences for financial inclusion goals. Rather than reducing risk in the global financial sector, de-risking actually contributes to increased vulnerability by pushing high-risk clients to smaller financial institutions that may lack adequate AML/CFT capacity, or even out of the formal financial sector altogether.
The goals of financial inclusion, and anti-money laundering and countering the financing of terrorism (AML/CFT), are not inherently in conflict; however, tensions do emerge in practice. Overly restrictive AML/CFT measures may negatively affect access to financial services and lead to adverse humanitarian and security implications.
Closures of above mentioned entities’ bank accounts affect financial access for the individuals and populations those businesses serve. MSBs and other financial service providers often referred to as ‘alternative money transfer services,’ hold accounts with formal financial institutions (banks), which allow them to perform transactions and serve as an access point and gateway for their traditionally underserved client bases. They fill an important gap, particularly in jurisdictions with nascent financial systems where the informal sector is in fact the main provider of formal and traditional banking services.
Financial institutions in developing economies often rely on correspondent banking relationships to provide access to the global financial system and underpin trade finance. Charities operating in conflict and other sensitive environments rely on all of these channels to move much needed resources internationally.
Financial exclusion is a huge barrier for marginalized populations. On an individual level, financial exclusion limits the ability of vulnerable populations to manage cash flows, build capital and savings, and mitigate economic shocks. On a macroeconomic level, financial inclusion is linked to economic and social development, and improvements in financial access have been shown to contribute to reductions in extreme poverty and wealth inequality. Additionally, expanded access to the financial sector helps finance small business and microenterprise: a positive correlation has been found between financial inclusion and employment opportunities, and it is generally believed to positively affect economic growth.
De-risking represents a clear instance of market failure. Regulators are scrambling to catch up with the current money laundering and terrorist financing landscape. As a result, they are increasingly shifting monitoring burdens to financial institutions, and the customer base is feeling the brunt of this shift. Financial institutions have been thrust into a policing role, which they refuse to take on in light of a dispassionate cost-benefit analysis that determines the risk is not worth the reward of banking high-risk clients. Threatened with the loss of access to financial services, the customer base is calling for increased clarity about compliance standards and the streamlining of regulatory burdens in an effort to decrease the perception of risk within their sectors. However, regulatory authorities appear hesitant to move beyond the general ambiguity of the risk-based approach, particularly given the complex and dynamic regulatory landscape. All invested stakeholders are understandably acting in their own best interests in order to protect themselves and their profits, but this has served to limit financial access.
De-risking has significant economic, humanitarian, and security implications, and in many ways may be undermine the goal of reducing risk in the global financial system. In instances of market failure, there are precedents for regulatory intervention, but addressing the issue will require a comprehensive response involving regulators, policymakers, banks, and other stakeholders.
The exclusion of an entire customer base from the formal financial sector has created a window of opportunity for innovative banking solutions. This area is precisely the point where incentive for profit can be cultivated, yet it remains nascent and controversial.
One of the most notable innovations for the developing world is the rise of mobile money platforms, which bring financial services directly to the rural unbanked by allowing users to conduct financial transactions, including bill payment and fund transfers.
Another area that may offer promise for financial inclusion is the rise of digital currencies such as Bitcoin. Bitcoin is a virtual private currency that is not controlled by any central authority or supported by any economic system but offers the promise of substantially reduced fees. Although its use has grown in developed countries, lack of a broad technological understanding and infrastructure to handle transactions in digital currencies have limited and will continue to limit its implementation in developing economies in the near term.
The writer is a Karachi based freelance columnist and is a banker by profession. He could be reached on Twitter @ReluctantAhsan