CGAP 44605 April 2006 May 2006 SUPPORTING COMMUNITYAML/CFT RLEGULATIONS: -MANAGED OAN FUNDS 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 As a result, the new international framework and l report suspicious transactions to national national measures for anti-money laundering authorities. (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 The Financial Action Task Force (FATF) is an of reducing the access of low-income people to international body that recommends standards for formal financial services. Besides the additional national regulation on AML/CFT.2 Currently, there costs of compliance to financial service providers, are 40 FATF recommendations on anti-money standard customer due diligence rules may be laundering and 9 special recommendations on difficult to apply for typical microfinance clients, combating the financing of terrorism.3 While each especially in countries that have weak national country may adapt the international AML/CFT identification systems. For example, it may be standards developed by FATF in designing its impossible to verify the physical addresses of national regulation, in general, financial service clients who share living quarters or have no utility providers are required to do the following: bill, land title, rental agreement, or other legal proof of residence. Serving such clients may become too _______________________ burdensome for many financial service providers. 1 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 2 FATF and so-called FATF-style regional bodies perform enforcement objectives of AML/CFT regulation evaluations of countries' AML/CFT regulatory regimes and 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 their country context and gradually implement the 3 FATF 40 Recommendations on AML can be found at www.fatf-gafi.org/dataoecd/38/47/34030579.PDF and 9 Special Recommendations on CFT can be found at new regulations to give institutions time to adapt www.fatf-gafi.org/document/9/0,2340,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 providers might spurn low-income clients out of l Product or institutional exemptions: Credit and insurance services may be less vulnerable to abuse, while international money transfers uncertainty as to their regulatory obligations. and deposits may carry relatively higher risk. Conclusions For example, countries could exempt non- depository institutions that offer low-risk In the post September 11 world, AML/CFT financial products and have no direct link to regulation cannot be ignored. This area of the payments system. regulation is a young but rapidly developing field, 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 References authorities have now adopted a more flexible Financial Action Task Force. 2003. The Forty approach to client identification and verification Recommendations. Paris: FATF/GAPI, www.fatf-gafi.org/ dataoecd/38/47/34030579.PDF. and introduced a compliance exemption that relaxes requirements for "mass banking clients"-- ------. 2001. "Nine Special Recommendation on Terrorist Financing." Paris: FATF/GAP, October, those clients with small balances and small size www.fatf-gafi.org/dataoecd/55/16/34266142.pdf. 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, www.cgap.org/docs/FocusNote_29.pdf. 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 www.cgap.org to access relevant material, selves, and as the South African experience including "AML/CFT Regulation: Implications for shows, this can reduce real and perceived Financial Service Providers That Serve Low-Income People," by Jennifer Isern, et al. Focus Note 29, 2005. obstacles to serving low-income clients. CGAP 1818 H Street, NW lWashington, DC 20433 Tel: 202 473 9594lFax: 202 522 3744 E-mail: cgap@worldbank.orgl Web: www.cgap.org