AML-CFT Regulations Case of Microfinance

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					                                                                                            CGAP                  April 2006

                                                                                                                    May 2006

                                                AML/CFT REGULATIONS:
                                        BALANCING SECURITY WITH ACCESS

Across the world, new measures are being                             l   enhance their internal controls and staff training
introduced to combat money laundering and                                to deal specifically with AML/CFT risks;
the financing of terrorism. Once the concern                         l   undertake customer due diligence procedures
primarily of banks, governments have expanded                            on all new and existing clients;
regulations and requirements for compliance since                    l   introduce heightened surveillance of
the late 1990s. Now all financial service                                suspicious transactions and keep transaction
providers, including those working with low-                             records for future verification; and
income communities, are—or will—be affected.1
                                                                     l   report suspicious transactions to national
As a result, the new international framework and
national measures for anti-money laundering
(AML) and combating the financing of terrorism                       What is the concern?
(CFT) could have far-reaching effects.
                                                                     The introduction of new or tightened AML/CFT
What are the regulations?                                            regulations may have the unintended consequence
                                                                     of reducing the access of low-income people to
The Financial Action Task Force (FATF) is an
                                                                     formal financial services. Besides the additional
international body that recommends standards for
                                                                     costs of compliance to financial service providers,
national regulation on AML/CFT.2 Currently, there
                                                                     standard customer due diligence rules may be
are 40 FATF recommendations on anti-money
                                                                     difficult to apply for typical microfinance clients,
laundering and 9 special recommendations on
                                                                     especially in countries that have weak national
combating the financing of terrorism.3 While each
                                                                     identification systems. For example, it may be
country may adapt the international AML/CFT
                                                                     impossible to verify the physical addresses of
standards developed by FATF in designing its
                                                                     clients who share living quarters or have no utility
national regulation, in general, financial service
                                                                     bill, land title, rental agreement, or other legal proof
providers are required to do the following:
                                                                     of residence. Serving such clients may become too
                                                                     burdensome for many financial service providers.
   Today, financial service providers that serve low-income
clients go well beyond the traditional nonprofit organization
model that dominated the early days of modern microcredit or         How to balance access and security?
microfinance. In some countries, some of the original nonprofit
institutions have expanded their services to become regulated        Regulators and financial service providers
financial institutions, such as banks. Likewise, some conventional   serving low-income clients need to work together
banks provide microfinance services to low-income clients.           to strike a careful balance between meeting law
  FATF and so-called FATF-style regional bodies perform
evaluations of countries’ AML/CFT regulatory regimes and
                                                                     enforcement objectives of AML/CFT regulation
enforcement activities to assess their level of consistency with     and serving client needs.
FATF’s recommendations. An unfavorable assessment can
have a serious adverse impact on a country’s reputation within       Gradually implement regulations. Country
the global financial system.                                         regulators should tailor AML/CFT regulations to
   FATF 40 Recommendations on AML can be found at                    their country context and gradually implement the and 9
Special Recommendations on CFT can be found at
                                                                     new regulations to give institutions time to adapt,2340,en_32250379_                     their internal procedures and minimize disruptions
32236920_34032073_1_1_1_1,00.html                                    for their clients.
Take a risk-based approach for appropriate               In the UK, the Financial Services Authority
exemptions. AML/CFT risks of financial service           (FSA), banks, law enforcement, and consumer
providers vary by country, institutional type,           groups studied the issue and agreed to accept only
and financial services provided. In certain              one proof of a customer’s address from a wider
circumstances, where there are low risks,                range of documents. Further, FSA and bank
countries may decide that financial institutions         associations provide guidance on compliance to
can apply reduced or simplified measures.                institutions subject to AML/CFT regulation, to
                                                         reduce the likelihood that financial service
l   Product or institutional exemptions: Credit
                                                         providers might spurn low-income clients out of
    and insurance services may be less vulnerable
                                                         uncertainty as to their regulatory obligations.
    to abuse, while international money transfers
    and deposits may carry relatively higher risk.       Conclusions
    For example, countries could exempt non-
                                                         In the post September 11 world, AML/CFT
    depository institutions that offer low-risk
                                                         regulation cannot be ignored. This area of
    financial products and have no direct link to
                                                         regulation is a young but rapidly developing field,
    the payments system.
                                                         and there is scope for further work to explore the
l   Minimum transaction thresholds: Small-               particular challenges facing institutions serving
    balance transactions may also carry lower            low-income clients in complying with the new
    risk. FATF recommendations recognize                 regulations. However, measures that drive low-
    governments’ discretion to exempt low-value          income people back to informal providers of
    transactions that fall below a certain threshold     savings, loans, and money transfer services will
    from AML/CFT requirements.                           be counter-productive and make it harder to
South Africa and the United Kingdom provide              secure the integrity of the financial system. It is
good examples of how a country’s AML/CFT                 therefore in everyone’s interests—regulators and
regulations can be modified to take into account         financial institutions alike—to grapple with these
better the situation of low-income clients.              issues and develop solutions that accommodate
                                                         low-income clients.
In South Africa, low-income clients often have
                                                                                n n n
no tax registration number and cannot produce
third-party address verification. South African
                                                         Financial Action Task Force. 2003. The Forty
authorities have now adopted a more flexible
                                                         Recommendations. Paris: FATF/GAPI,
approach to client identification and verification       dataoecd/38/47/34030579.PDF.
and introduced a compliance exemption that
                                                         ———. 2001. “Nine Special Recommendation on
relaxes requirements for “mass banking clients”—         Terrorist Financing.” Paris: FATF/GAP, October,
those clients with small balances and small size
transactions. After this exemption, the four largest     Isern, J., D. Porteous, R. Hernandez-Coss, and C.
banks and the South African post office launched         Egwuagu. 2005. “AML/CFT Regulation: Implications
the so-called Mzansi account in late 2004.               for Financial Service Providers That Serve Low-Income
Impossible to offer before the exemptions, the           People.” CGAP Focus Note 29. Washington, D.C.: The
Mzansi account has proven very successful, with          World Bank,
more than 1.6 million previously unserved clients        Author: Jennifer Isern
opening a basic transaction account. A uniform
threshold exemption established in their country’s        For more information on anti-money laundering and
AML/CFT regulation frees financial institutions           combating the financing of terrorism …
from having to make the judgment call them-               Visit to access relevant material,
                                                          including “AML/CFT Regulation: Implications for
selves, and as the South African experience
                                                          Financial Service Providers That Serve Low-Income
shows, this can reduce real and perceived                 People,” by Jennifer Isern, et al. Focus Note 29, 2005.
obstacles to serving low-income clients.

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