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AML/CFT Regulation

What Should Financial Service Providers that Serve Low-Income Clients Do?

It is important that microfinance institutions do not compromise their core objective of providing financial services to a broad range of poor people as a result of compliance with AML-CFT regulations. At the same time, to ensure their long-term sustainability and to meet their client needs, these institutions must protect themselves from abuse by terrorists and money launderers. In working towards compliance with AML/CFT measures, regulators and financial service providers serving low-income clients need to work together to strike a careful balance between regulation and sustainability and client needs:

  • Gradually implement regulations. Financial service providers should coordinate with country regulators to develop and gradually implement new AML/CFT regulations in order to give institutions adequate time to adapt their internal procedures in accordance with the new regulations. Such an approach will help minimize disruptions in their services to clients.
  • Take a risk-based approach. The AML/CFT risks of financial service providers vary by country, institutional type, and financial services provided. FATF Recommendation V states that "for higher-risk categories, financial institutions should perform enhanced due diligence. In certain circumstances, where there are low risks, countries may decide that financial institutions can apply reduced or simplified measures". For example countries could exempt non-depository institutions that offer low-risk financial products and have no link to the payments system.
  • Create appropriate exemptions. FATF recommendations recognize governments' discretion to exempt low-value transactions that fall below a certain threshold from AML/CFT requirements. For example, FATF Special Recommendation IX requires cash couriers to declare amounts exceeding a preset maximum threshold of US $15,000.13 Associations of financial service providers that serve low- income clients would be well advised to use this approach to negotiate with their respective governments to reduce or eliminate the AML/CFT regulation requirements applicable to them for transactions below a specified threshold value.
As financial institutions serving low-income people face rising pressure to comply with increasingly strict AML/CFT regimes in many countries, they should seek to identify, understand, and comply with the local laws and regulations applicable to them. Even where there is no national AML/CFT regime or where national supervision capacity is weak, institutions should take the initiative to establish measures based on internationally-accepted practices to protect themselves from being used for money laundering and the financing of terrorism. Financial service providers that serve low-income clients should develop an AML/CFT policy that identifies areas of risk based on their country, client, and product profiles, and strengthens institutional capacity. Based on the implications of planned or existing laws and regulations, microfinance institutions should engage policy makers and law enforcement experts in dialogue about changes where such laws and regulations could potentially affect their operations.

In the post 9/11 world, AML/CFT regulation cannot be ignored. This area of regulation is a young and rapidly developing field, and there is scope for further work to explore the particular challenges facing institutions serving low-income clients in complying with the new regulations. However, measures that drive low-income people back to informal means of saving and credit will be counter-productive and make it even harder to secure the integrity of the financial system. It is therefore in everyone's interests - regulators and institutions alike - to grapple with these issues and develop solutions that accommodate low-income clients.

Box 6 South Africa's Customer Due Diligence Framework

South Africa was admitted as the fifth developing-country member of FATF in June 2003. The Financial Intelligence Centre Act (FICA) of 2001 established the Financial Intelligence Centre (FIC) as the unit within the South African National Treasury responsible for surveillance of suspicious transactions and coordinating policy efforts to counter money laundering in the country. (Legislation to criminalize terrorist funding is currently being developed by the parliament).

FICA covers a broad range of institutions, from banks and insurance companies to money remitters. Non-depository microfinance institutions are not specifically covered unless they remit money, but regulated institutions which offer products at the low end of the market are "accountable" under the legislation.

To date, the FIC has promulgated regulations that govern customer due diligence and require "accountable" institutions to report suspicious and unusual transactions. These "know your customer" regulations, which applied to new clients as of June 2003 and were phased in for existing clients beginning in 2004, follow international precedent and require financial institutions to verify identity number, date of birth, income tax number (currently exempt due to system-related issues), and residential address "by comparing these particulars with information which can reasonably be expected to achieve such verification and is obtained by reasonably practical means". In practice, the latter has been interpreted by the banking sector to require utility bills, as is common in other countries.

Many low-income clients have no tax number and are unable to produce third-party verification of address - as an estimated one third of SA households have no formal address. These requirements therefore prevent low-income and/or some self-employed people from opening bank accounts.

A guidance note was issued by the FIC in April 2004 that advocates a risk-based approach for client identification and verification. A compliance exemption (Number 17) in the FICA law relaxes the "know your customer" requirements for a category of clients known as "mass banking clients". The exemption applies to accounts that have a maximum balance at any time of around US $4,000, that limit the size of deposits or withdrawals, and that do not have the ability to transfer funds internationally.

Because of difficulties in applying this exemption, the Money Laundering Advisory Council raised the issue with the minister of finance in June 2004. He requested proposals from the Council for an exemption to promote the national priority of greater access to financial services. This resulted in the issuance of a revised exemption regulation in November 2004 that gives greater clarity and addresses industry concerns about customer due diligence requirements for low-income clients. However, informed commentators have proposed that changes should go further to eliminate the need for a tax payer number and the verification of address except where there are grounds to suspect it is false.