Increasing burdens to meet global compliance standards have had the unintended consequence of preventing much of the world’s population from accessing the banking system. Traditional banks have, to date, failed to innovate, but by smartly deploying innovative financial and regulatory technologies (“fintech” and “regtech”) to measure actual risk versus perceived risk, not only can financial inclusion be dramatically increased, but a stronger and more resilient financial system can be achieved as well, write Amit Sharma and William Mayville in this opinion piece.
Amit Sharma is the founder and CEO of FinClusive, a firm that provides an integrated blockchain-architected banking and payments platform for companies and individuals de-risked by traditional banking. Earlier, he was a senior official at the U.S. Treasury Department, in the office of terrorism and financial intelligence, where he helped create anti-money laundering/counter-terrorist financing strategies.
William Mayville is a retired U.S. Army Lieutenant General with multiple combat tours in Iraq and Afghanistan. He was the Commander of the First Infantry Division, the Director of Operations for the Joint Staff, and the former Vice Commander for U.S. Cyber Command. He is an advisor to FinClusive on economic resiliency, security, and global compliance and is a frequent lecturer on cyber and national security topics.
Checking your bank account should feel like part of a daily routine, but unfortunately for many Americans — and billions globally — this is far from reality. Basic banking products and services to facilitate daily life remain unavailable to millions in the U.S., thanks in large part to how traditional banks have continued to misunderstand regulatory risk and compliance, and failed to provide secure, cost-effective access to those who need it most. But with advances in both fintech and regtech, and a re-thinking of community-based engagement, the twin aims of broader banking access and increased compliance with global standards can be achieved, and a wave of U.S. — and global — economic resilience can be realized.
In 2017, nearly a quarter of U.S. households, according to the Federal Deposit Insurance Company (FDIC), were considered unbanked (no one in a household had a savings or checking account) or underbanked (a household with an account at an insured institution, but also using financial services outside the banking system). The exclusion of one in four Americans doesn’t count the millions of people who are relatively infrequent users of the financial system. Seasonal workers, for example, are often excluded because of their inconsistent incomes. The un- and underbanked label applies to millennials who may otherwise be “asset rich” but have chosen not to participate in the formal financial sector for one reason or another — including an understandable skepticism of traditional banking, particularly after last decade’s financial crisis. Even many U.S. Service members and their families, particularly the junior enlisted, suffer from being un- and underbanked. Look at many military bases across the country and you can see the proliferation of payday loan operations and pawn shops that fill the gap traditional banks have not served well (or at all) — and too often exacerbate already strained personal financial conditions.
Importantly, beyond individuals and families, businesses and organizations can — and often do — find themselves excluded from the financial system. A large and growing number of institutions, from non-governmental organizations (NGOs) to small and medium enterprises (SMEs) and technology startups, are being denied access to traditional financial tools, effectively impeding entrepreneurism, stifling innovation, and hampering job creation opportunities. The systemic risk lies in the failure to build economic resiliency in places where it is needed most — in individual communities across the country. From a national security perspective, these exclusions prevent NGO and IGO efforts to help those communities in unstable and poorly governed spaces gain access to capital and secure financial services. This systemic risk creates an even greater challenge to the country’s collective security as SMEs account for greater than two-thirds of net new private sector jobs. America’s economic resilience — the foundation of its global strength — is significantly hampered without greater access to capital and secure financial services.
“The systemic risk lies in the failure to build economic resiliency in places where it is needed most — in individual communities across the country.”
How Did We Get Here?
Over the past 20 years, several new regulatory measures were set up to address how financial institutions evaluate risk and manage regulatory compliance. Some of these efforts followed the tragedy of 9/11, when policymakers and regulators turned to every tool available to combat illicit finance and terrorist activity within the financial system. Lawmakers looked to financial institutions themselves to make it riskier, harder and costlier for bad actors to exploit the financial system.
These regulations, particularly the emphasis on anti-money laundering (AML) and Know Your Customer (KYC), were critically important at the time to strengthen America’s national security and preserve the integrity of the financial system. We saw first-hand the protective intent of the rules around risk and compliance as they were promulgated. But nearly 20 years later, the growth of these rules has resulted in unfortunate, unintended consequences due to their mis- or over-application.
The assignment of risk through overly generalized categories by financial institutions has led to the lock-out of millions of well-intentioned individuals and organizations known today as “de-risking.” After these rules were finalized, banks increasingly saw risk and compliance as growing, burdensome back office cost centers that didn’t add value and imposed on them by regulators. To manage compliance costs, many banks opted to flag people and institutions who did not meet the profile of an “average customer” as “high risk,” therefore excluding well-meaning customers from the traditional financial system and forcing them to alternatives that are often less secure to them, and are not fully within the scope of essential regulatory oversight.
Unfortunately, while technologies have evolved to more accurately “know-[their]-customers” to meet risk and compliance needs, traditional banks have been slow to leverage them to identify and serve the financially excluded cost effectively. Indeed, innovation in this area is coming largely from nontraditional sources — mobile payment systems, digital wallets and digital currencies. This combination of lack of innovation by legacy banks with a myopic view of compliance as a regulatory box-ticking exercise not only reinforces exclusion, but does little to actually strengthen the financial system from illicit activity.
The Toll of Financial Exclusion
More than $528 billion in remittances were sent to developing countries around the world in 2018, and this amount is expected to increase to reach $549 billion this year. Lacking access to secure pathways to send money home, people are forced to turn to costly and risky alternatives like unregistered money remitters. These alternatives — though filling vital needs — are often unregulated and less secure, and can be costly in both economic and personal security terms.
SME challenges extend well beyond the U.S., as new and growing companies are usually labeled as high credit and compliance risks, constraining their ability to start, sustain, and grow their business and entrepreneurial ventures. Cash intensive businesses are often treated in the same light — impacting thousands of non-bank financial institutions like money servicers, contractors and independents, and other similarly situated endeavors. How do we build global economic resilience when 70% of micro, small and medium enterprises lack access to basic credit?
Some have pointed to the potential for major tech companies to provide the financial services many of their customers desperately need, but unfortunately we may be hamstrung here, too. These companies lack the essential risk and compliance controls — the same placed on licensed banks — needed to protect financial system integrity and consumer safety.
The result: Consumers and businesses again are left without the critical financial services they need, and collective economic security continues to weaken as only large, powerful corporations appear to banks to be creditworthy, profitable endeavors deserving of their services, but in practice are themselves highly leveraged and prone to high risk taking practices. The belief is that these practices improve the security of the financial system when in fact they have led to harmful derisking, damaged the very health of the financial system, and required large tax-supported bailouts. It doesn’t have to be this way.
Today’s fintech and regtech applications can help institutions drive inclusion while reinforcing foundational protections.
With the modernization of both how people access financial products and services, and how financial intermediaries understand and manage risk and compliance, new platforms exist today to provide individuals with critical resources like FDIC-insured bank accounts and secure access to a variety of payment options. We must use these new tools not only to meet regulatory compliance requirements but also to engage more potential customers profitably.
“Today’s fintech and regtech applications can help institutions drive inclusion while reinforcing foundational protections.”
However, more compliance management does not equal better or stronger risk management. New data science and algorithmic applications should be deployed to address actual risk — instead of perceived risk. In doing so, relationships with strong scalable partners and innovative financial institutions — many of which are built at the community level — can ultimately provide all those who have been de-risked with secure access to a global depository network and payments systems — all wrapped with comprehensive compliance.
Put simply, smart technology deployment facilitates “know-your-customer” not only for meeting regulatory obligations, but also as an essential driver of safe, secure and profitable financial services.
Furthermore, such efforts are essential to rebuild trust in systems that have excluded people for decades. Hard work needs to be done to put the “community” back in community banking.
Why do this?
To reach consumers and communities in greatest need of access to financial services, some organizations find themselves serving as financial intermediaries but lack a toolkit for compliance and risk management. However, comprehensive compliance combined with innovative technology and community-based engagement will directly lead to economic growth and greater economic resilience.
How? Financial access can be facilitated through institutions that never conceived of themselves as being banks, like social services and other community-based organizations. These groups are an essential bridge to core banking infrastructure to deliver the financial products and services, as well as offer the regulatory compliance tools, integral to keeping consumers’ information safe and the financial system secure from exploitation by illicit actors.
Beyond enhanced security, the additional regulatory data creates a positive feedback loop. As banks onboard customers and learn more about their preferences and needs, they’re able to optimize offerings to ensure those customers receive even better service in the future — reinforcing responsible financial engagement and system security in tandem.
Finally, when banks are able to know their customers better, the whole system is safer. Real illicit finance threats are easier to find and stop when the proverbial finance haystack shrinks. Modernized regulation allows regulators to intervene proactively, block truly bad actors before they’re able to enter the financial system, and interdict illicit activities as they happen or before. Being able to more accurately pinpoint those who are most likely to exploit the system means banks can onboard those who were previously misperceived as being “high risk.”
“New data science and algorithmic applications should be deployed to address actual risk — instead of perceived risk.”
With an Inclusive Financial System, Everyone Wins
With better tools to more accurately assess true risk, instead of relying on categorical classifications, more organizations, from social service groups to fintech startups, will be able to provide critical financial services to those in need. This is also where development professionals and the military share a common goal: Applied globally, this provides the international community with an effective method to raise communities out of poverty by enabling entrepreneurs and to hold the gains of stabilization itself. Communities with secure access to financial support contribute to the economic security of their country. And, when compliance is built into that access, identifying and targeting illicit activities are properly enabled. Households and communities benefit from increased economic security, and local communities to nation states are emphatically more stable. And regulators and law enforcement are better equipped to identify and target actual illicit actors, effectively and efficiently keeping the global financial system safe.
Most importantly, more people, like many of our parents, who came to the U.S. as immigrants, will be able to access the financial tools necessary for economic resilience, whether that’s an FDIC-backed deposit account or a secure pathway to send remittances to their home markets. More people can bounce back during economic downturns, protect against economic shocks, and contribute to their communities sustainably.
The solutions are at hand. We must lead the charge to make the financial system accessible and secure for everyone.