Financial Inclusion and Law Enforcement: United by a Common Enemy

> Posted by Claire Alexandre and Ignacio Mas, Bill & Melinda Gates Foundation

It is commonly perceived that there is tension between the goals of financial inclusion and those of law enforcement. Many people point at the enhanced money laundering and terrorist financing risks which would arise if two to ten times more people were able to do financially what you and I can already do. (A little help on the math: That’s what it means to achieve universal financial inclusion in developing countries that currently have coverage rates in the 10-50 percent range.)
Enlightened policy makers on both sides talk about the need to be reasonable, to find the right balance between these two objectives through risk-based regulations.
This plea for balance is nice, and it’s nicer still to see more and more policy makers striving to be aware of the multiple agendas. But the trade-off isn’t between these two objectives, it’s elsewhere.
A key objective of financial inclusion is to take people out of the cash world in which they live. If you live in a cash world, your options for storing value are limited mostly to physical assets (cash, bricks, goats, gold) which are risky, of varying liquidity, and do not make good payment instruments. If you need a loan, there are only a few local lenders within easy reach for you and your cash, and fewer still who have any way to know that you have always paid back your loans, regularly send money to your family, and pay your bills on time (i.e. no financial history). Or you’ll fall back to family, friends, and neighbors (ROSCAs and such) in which case you will get little privacy and less control over your financial life.
At the same time, a key objective of law enforcement is to make it hard for criminals to hide in the invisible cash economy — to make their large cash stashes and payments suspect.
So if we share a common enemy  – cash – why does it feel like we need to make hard choices between these two goals?
In a paper soon to be published in Challenge magazine, we argue that the real trade-off lies elsewhere. It’s located squarely within the law enforcement domain. On the one hand, authorities would like to know who is transacting (preventing anonymity); on the other hand, they would like to know how money is flowing through the system (tracing transactions). To put it in very simple terms: Should law enforcement authorities put as a first priority to follow people or to follow transactions?
Onerous Know Your Customer (KYC) requirements that strive for certainty on who is transacting electronically push many transactions back into the anonymous cash world. Not only does that hinder financial inclusion, but we wonder whether it even helps on the law enforcement side.
Law enforcement cannot aspire to make crime impossible, so it generally attempts to deter crime by increasing the probability of getting caught. This is more likely to happen if authorities favor the use of electronic transactions over cash and require banks to have state-of-the-art real-time transaction monitoring systems and good suspicious-transaction reporting mechanisms. Access to electronic payments may make it easier for criminals to move money around faster, but it also increases the risk of getting caught. With good monitoring and compliance systems, law enforcement objectives might be better served if their first objective was to get people onto a formal electronic – traceable – financial system.
That requires account opening procedures that are friendly to both customers (in terms of the documents they need to produce) and financial institutions (in terms of the paperwork they need to capture and process). Of course, there need to be relatively low limits on such accounts, allowing clients to trade up to bigger and more useful accounts when they are ready to undergo tougher KYC. As you use the system more and more, KYC can catch up. The technical term is tiered KYC. The main point is that law enforcement can observe you even if they don’t know who you are. That’s already a vast improvement over cash.
The trade-off is there, between financial inclusion and KYC policies, but not necessarily between financial inclusion and the broader goal of law enforcement. Imposing tough KYC standards up-front as a prerequisite to participating in the banking system is not the only way to fight money laundering. KYC policies need to be put in the perspective of the broader set of objectives and tools in the law enforcement arsenal.
We should strive for quality of financial services from the moment a person decides to open an account. Account opening is job #1. We won’t bring the masses to banking if their first experience – opening an account – is not easy and dignified for them.
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