A policymaker’s dilemma: how to pursue a policy of access to a bank account for everyone, while at the same time erecting regulatory barriers to the opening of those accounts to prevent their misuse. It’s like pushing the accelerator and putting on the brakes at the same time.  This is not to belittle law enforcement concerns, chiefly the need to prevent or detect money laundering.  But as we argued in a previous blog post, neither financial inclusion nor law enforcement are well served by keeping the bulk of the population away from modern digital — and hence, inherently more traceable — payment systems.

These objectives can be easily reconciled by making account opening trivially easy at first, and tightening the requirements for documentation and record-keeping progressively as the accounts become larger and more active. With this approach, everyone wins. New-to-banking customers can learn about how to use the account before they are asked to submit to onerous Know Your Customer (KYC) obligations. Banks don’t need to put in place costly KYC processes for customers that are not yet profitable. And law enforcement agencies can get relevant information on accounts commensurate with the risks involved.

In 2011, the Mexican authorities implemented such a scheme, a world first in its breadth and clarity. The scheme is also a model for inter-agency coordination, as it involved the relevant departments at the central bank, the ministry of finance and the banking regulator.

The authorities created four tiers of accounts based on the value of transactions. Level 1 accounts are anonymous, and no account holder data needs to be captured at the point of sale or subsequently. The restrictions are that the cumulative value of monthly deposits cannot exceed U.S. $280, and customers cannot transfer funds to others from the account. For level 2 accounts, customers must self-report some basic information, but verification of the data can be delegated to third parties and no paperwork needs to be exchanged with the bank. The cumulative value of monthly deposits is capped at $1,160, and there are no restrictions on money transfers. For level 3 accounts, customer information must be verified through face-to-face meeting with bank staff, but no hard copies of customer documents need to be kept. The cumulative value of monthly deposits is capped at $3,860. Level 4 accounts are full-fledged: the customer data requirement is the same as for level 3, but the bank needs to file copies of ID, proof of address and tax ID.

Indonesia is implementing a similar regulatory logic, although it applies only to e-money (rather than bank) accounts. E-money accounts do not require recording of customer identity as long as their balance does not exceed about $110.

The Haitian authorities are enabling easy account opening through selective authorizations rather than broad regulation. To accommodate the nascent mobile money market, the central bank has allowed Tcash and Tchtcho Mobile to offer entry-level accounts without face to face registration and identification requirements. These accounts are capped at $62 and subject to transaction monitoring.

There is huge pent-up demand for savings accounts among the world’s poor, and we need to make it as easy as possible for them to opt into the financial system, which has become such an essential element of participation in modern commerce and society. Law enforcement risks only come from use of the account, so let’s peg the severity of law enforcement requirements to the use of the account. That’s not only fair but also efficient.

Claire Alexandre works with the Bill & Melinda Gates Foundation. Ignacio Mas is an independent consultant whose work can be found at www.ignaciomas.com.

Image credit: Renaud d’Avout

Have you read?

Promoting Formal Financial Savings: Know Your Goal, Know Your Competition

Financial Inclusion and Law Enforcement: United by a Common Enemy

At the Gates Foundation, Savings Is It

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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