MANAGING THE RISKS IN FINANCIAL INCLUSION AND HOW TO STAY AHEAD OF THE THREAT CURVE

MANAGING THE RISKS IN FINANCIAL INCLUSION AND HOW TO STAY AHEAD OF THE THREAT CURVE

Dr. Emmanuel Moore ABOLO

Chief Risk & Compliance Officer

Nigerian Export-Import Bank

Presentation Outline

Quotable Quotes

What is Financial Inclusion?

What Causes Financial Exclusion?

Risks in Financial Inclusion

Financial Inclusion and Risk Management

Financial Inclusion and Financial System Fragility

Understanding the Risk Management Process

Technology as An Enabler

Financial Inclusion: The Role of Technology

Addressing Digital Technology-Related Risks and Data Management

Managing Credit Risks in Financial Inclusion

Risks in Agency Banking

Ensuring Customer Protection Through Management of Agency Outlets

Risk Management in Financial Inclusion: The Final Word

QUOTABLE QUOTES

• Financial inclusion matters not only because it promotes growth, but because it helps ensure prosperity is widely shared.

Access to financial services plays a critical role in lifting people out of poverty, in empowering women, and in helping

governments deliver services to their people.

Sri Mulyani Indrawati

• Lower-income individuals are difficult to serve in an economically sustainable way, available products often fail to

meet their needs, the risks associated with serving them can be difficult to manage, and existing regulations often

impede progress. Critics have rightly asked for evidence that financial services benefit this population, and voices

from all corners have reminded the world that consumer protections are critical. ..McKinsey & Company

• Other generations have eradicated disease, invented radio and television and yes – the telephone. The opportunity to drive

financial inclusion is unique to us and our time. We can bend the arc of history towards financial inclusion and a world where

more people have the opportunity to enjoy what we take for granted. But it takes all of us working together . I’m reminded

of the African proverb that says: “if you want to go quickly, go alone. If you want to go far, go together.” Let’s go together .

Ajay Banga , MasterCard President and CEO

WHAT IS FINANCIAL INCLUSION?

• While there is a consensus regarding the importance of financial inclusion, its definition can vary depending on the

national context and on the stakeholders involved. From “banking the unbanked” to “branchless banking,” a

variety of catch phrases are sometimes used as near synonyms for financial inclusion, when in fact they describe

specific aspects of a broader concept.

• In general terms, financial inclusion involves providing access to an adequate range of safe, convenient and

affordable financial services to disadvantaged and other vulnerable groups, including low income, rural and

undocumented persons, who have been underserved or excluded from the formal financial sector. Financial

inclusion also involves making a broader range of financial products and services available to individuals who

currently only have access to basic financial products.

• Financial inclusion can also be defined as ensuring access to appropriate financial products and services at an

affordable cost in a fair and transparent manner.-----FATF

• Financial Inclusion is the process of ensuring access to appropriate financial products and services needed by all

sections of the society in general and vulnerable groups such as weaker sections and low income groups in

particular at an affordable cost in a fair and transparent manner by mainstream institutional players—RBI

• Financial inclusion aims at drawing the “unbanked” population into the formal financial system so that they have

the opportunity to access financial services ranging from savings, payments, and transfers to credit and

insurance.

• Financial inclusion neither implies that everybody should make use of the supply, nor that providers should

disregard risks and other costs when deciding to offer services. Both voluntary exclusion and unfavorable risk-

return characteristics may preclude a household or a small firm, despite unrestrained access, from using one or

more of the services.

WHAT IS FINANCIAL INCLUSION?

• Financial inclusion is defined as the ability of an individual, household, or group to access a full range of

responsibly delivered, affordably priced and reasonably convenient formal financial services. Without this ability,

people are often referred to as financially excluded.

• People that are financially excluded might not be able to access affordable credit, and are financially at risk of not

having home insurance, struggle to budget and manage money or plan for the unexpected and not know how to

make the most of their money (FSD, 2010).

• In general terms, financial Inclusion is defined as the process of ensuring access to appropriate financial products

and services needed by vulnerable groups such as weaker sections and low income groups at an affordable cost

in a fair and transparent manner by mainstream Institutional players (Joshi, 2011:2).

• Financial inclusion is based on the premise that ‘financial services should reach everyone who can use them,

including disabled, poor, and rural populations’ (Gardeva and Rhyne, 2011:1).

• According to Cheriyan (2011:24), financial inclusion includes access to financial products and services such as no

frill bank account, check in account, micro-credit, savings products, remittances & payment services, insurance,

healthcare, mortgage, financial advisory services, entrepreneurial credit, pension for old age, business

correspondence and selfhelp group branchless banking etc.

• Full financial inclusion is said to have been reached if all people have access to a suite of quality financial

services, provided at affordable prices, in a convenient manner, and with dignity for the clients (Gardeva and

Rhyne, 2011:1).

Defining financial inclusion

WHAT CAUSES FINANCIAL EXCLUSION?

• There are various reasons why some people remain excluded from accessing financial services. The reasons

include:

• cultural mistrust of mainstream financial institutions, maybe due to the fact that individuals may come from

countries where banks are not safe places to deposit funds or may be sources of information (or

misinformation) for government authorities in repressive regimes;

• lack of understanding or familiarity with traditional financial services, maybe due to language barriers,

especially with immigrant populations;

• unavailability of ready access to financial services in rural areas and even in urban areas;

• mismanagement of financial services by some individuals in ways that make them higher risk to the financial

institution, to an extent that there are deterred from using such services; and

• implementation of consumer protection policies that are designed to protect those who are disadvantaged , but

which end up becoming barriers that actually restrict access to financial services, for example, steps that add

to the costs for prepaid products may make them less appealing to those living on the margin

(FATF/OECD,2011:13)

The Financially Excluded are a diverse group:

• Disadvantaged and vulnerable groups

• Low income households

• Agricultural and Industrial Labourers

• People engaged in un-organised sectors

• Unemployed

• Women

• Children

• Old people

• Underprivileged section in rural and urban areas like, Farmers, small vendors, etc.

• Poor people without permanent residential address

• Handicapped persons

• Undocumented migrants

• Women-owned SMEs

• SMEs in rural areas

• Newly established SMEs

A Diverse Group

Graphic: The World Bank / Global Findex project

The Global Picture of Unbanked

Source: McKinsey & Company

Self –Reported Barriers

RISKS IN FINANCIAL INCLUSION

Large numbers of low-value transactions

Lack of collateral for lending

High levels of dormancy Customers / Products

Developing pro-poor products, appropriately priced, for the chosen market segments

Avoiding “contamination” of existing customers/products Delivery model

Managing a remote network Reaching the remote poor at low cost

Harnessing technology

IT and staff capacity to cope with increased volumes

Physical security, especially for cash transportation

Poor infrastructure – power and communications

Staff with negative attitude to the poor and to micro segment

Banking the poor still often seen as largely a CSR activity

Financial literacy improving but not perfect

Difficulty of customer identification

Inflexible AML/CFT rules

.

RISKS IN FINANCIAL INCLUSION

Risk is difficult to manage in this segment using traditional banking methodologies. Poor households that own property may not have

proper titles, and savings that could be used as collateral may be limited and informal; in addition, most people have no recorded

financial history, since they have not used products via formal channels in the past.

Members of these households typically work in the informal economy and do not receive pay stubs, which makes it hard to assess their

work histories, and some may not have permanent addresses. Providers are thus unable to rely on traditional means for assessing risk.

Product development lags significantly behind demand, and thus available products often fail to meet this population’s needs.

Organizations that provide financial services to the poor have had more success offering microcredit than any other product, yet only 5

percent to 10 percent of the target population uses credit. Savings accounts are becoming more widely available, yet according to a

2009 survey by the Microfinance Information Exchange (MIX), for various reasons only 27 percent of the 166 MFIs surveyed offer

savings accounts.

Penetration of insurance, payments, and remittances can be even lower—though dramatic increases in mobile-phone use in emerging

markets are driving significant growth in mobile payments in some markets.

A number of organizations have developed innovative products, but many others still struggle to understand the segment well enough to

design products that suit its needs. Simply cutting costs on existing products to improve affordability or tacking on new products without

adjusting delivery mechanisms and systems are not full solutions.

Regulations have usually been designed to protect traditional financial-services customers and may not serve the needs of poor

customers quite as well. Indeed, rules can sometimes stand in the way of innovations that would expand access for poor individuals. For

example, many regulators prohibit nonbanks from intermediating financial products such as savings accounts, credit, or insurance.

Other issues include strict limits on uncollateralized lending and “know your customer” rules that block poor households from entering

the financial system. Regulators may also prohibit the use of certain types of information for risk-analysis purposes. It is of course critical

to ensure that regulations protect consumers from predatory activities and promote an appropriate distribution of risk, but rules that suit

the circumstances of the poor can provide this while also encouraging innovation.

In Brazil, for instance, regulators gave permission to banks to provide simplified current accounts, which had limited features and were

lower-cost to operate. Regulators also enabled the use of future payments, such as salaries or pensions, as collateral for lower-cost

borrowing.

FINANCIAL INCLUSION AND RISK MANAGEMENT

• Risk management is creating a comprehensive framework to manage the various inherent financial and non-financial risks

facing financial institutions. It includes developing policies and procedures to identify, measure, monitor and control these risks.

Risk management also entails having the proper staff resources, in terms of a chief risk officer or risk manager, internal auditor,

and risk management and/or internal audit committees at the board level. Sound risk management aims to strike a balance on

which risks are worth taking for the financial institution and how to minimize losses generated by those risks.

• Risks in the inclusive finance industry can be categorized into institutional risks and external risks. Institutional risks are those

under the direct control of the institution themselves, such as corporate governance, management quality, credit risk, client

management, and liquidity risk. External risks are those outside the control of the institution, such as changes in foreign

exchange values or interest rates, client over-indebtedness, competition, reputation risk, political interference, etc.

• Risks can also be classified as traditional financial risks (e.g. credit, foreign exchange, liquidity) and “higher level” or broader

risks, such as reputational, political, and regulatory risks, as well as new risks emerging from the use of technology, such as

mobile and agent banking. Traditional financial risks can typically be managed with competent staff, effective internal controls,

and the proper policies, procedures and oversight. Emerging risks may require more sophisticated forms of management.

• Boards should play a proactive role in addressing all institutional and external risks, providing leadership and clear direction

from the top. The first step is understanding the importance of risk management and what it entails.

• As part of the board’s role in setting the institution’s risk appetite when determining the MFI’s strategy, annual plans, and

budgets, the board’s mandate should include ensuring that the risks being taken are in-line with the mission and risk culture and

not negatively impacting clients. In addition, the board should be monitoring and ensuring the effectiveness of internal controls,

including establishing clear lines of accountability and requiring formal and regular information technology reports on risk, the

regulatory framework and compliance supplemented.

• The board’s duty is to ensure a robust, independent, and authoritative risk management unit, with which the board

communicates regularly.

FINANCIAL INCLUSION AND RISK MANAGEMENT

• Some of the main players working on inclusive financing risk management include: The World Bank, IFC, CGAP,

Centre for the Study of Financial Innovation (CFSI), Center for Financial Inclusion (CFI), various independent risk

consultants, investors, and the newly established Risk management Initiative in Microfinance (RIM). Other

players, like MicroSave, MEDA, and Triodos Facet have produced a number of tools on Risk Management.

• The chief risk officer (CRO) has three main functions: risk reporting, risk monitoring and analysis, and

representing the risk perspective on the management team. Risk reporting ensures that all necessary reports are

being produced and are based on accurate inputs.

• The reporting process should be reviewed on an annual basis. Next, the CRO must monitor and analyze all risks

– credit, market, operational, social performance, solvency, reputational risk, etc. - with a specific focus on where

those risks overlap.

• Lastly, in representing the risk perspective on the senior management team (including the Asset Liability

Committee, if it exists) and the board’s Risk Management Committee, the CRO provides input as needed when

discussing new products, strategies, etc. and is responsible for stress testing and scenario planning.

FINANCIAL INCLUSION AND FINANCIAL SYSTEM FRAGILITY

• Financial inclusion has the potential to engender financial fragility (Ghosh, 2008:2). In other words, financial inclusion has the potential of posing

risks to the financial system. This is because financial inclusion changes the composition of the financial system with regard to the transactions that

take place, the clients that use the various services, the new risks created, and possibly the institutions that operate in newly created or expanded

markets, Hannig and Jansen (2010:22).

• More specifically the processes of increasing financial inclusion changes the nature of risks and these changes result from a variety of factors

which include the characteristics of currently financially excluded customers (which differ from the “already served”), as well as the nature of the

products, services, and providers capable of reaching them, and especially the innovative approaches needed to accomplish significant increases

in financial inclusion (CGAP, 2011:2).

• One only has to recall the savings and loan crisis in the US in 1980s to appreciate that even financial institutions geared to cater to the retail

investors and, thereby, to foster financial inclusion, could be a source of financial instability (Khan, 2011:5). The 2008/2009 crisis in US subprime

markets is another case in point in which loans were marketed to subprime borrowers as a way of promoting financial inclusion, but the resultant

over-extension of credit, which has the potential to affect the quality of the credit portfolio of banks and financial institutions, ended up sowing the

seeds of financial fragility, and ultimately of financial instability (Ghosh, 2008:2).

• In essence, financial inclusion can actually lead to financial instability rather than financial stability.

• The concerns that financial inclusion can pose risks to the financial system that will eventually result in financial instability were however disputed

by Hannig and Jansen (2010) who pointed out that greater financial inclusion presents opportunities to enhance financial stability.

• Their arguments were based on the following insights:

• Financial inclusion poses risks at the institutional level but these are hardly systematic in nature. Evidence suggests that low income savers

and borrowers tend to maintain solid financial behavior throughout financial crises, keeping deposits in a safe place and paying back their

loans.

• Institutional risk profiles at the bottom end of the financial market are characterized by large numbers of vulnerable clients who own limited

balances and transact small volumes. Although this profile may raise some concerns regarding reputational risks for the central banks and

consumer protection, in terms of financial stability, the risk posed by inclusive policies is negligible.

• In addition, risks prevalent at the institutional level are manageable with known prudential tools and more effective customer protection.


Despite the argument that financial inclusion mitigates the risks that the financial inclusion may pose to the financial

systems, the possibility that financial inclusion may result in financial instability imply that there must be specific

conditions under which financial inclusion may lead to financial stability.

Some proponents of the financial inclusion-financial stability link have provided several ways in which financial

inclusion may lead to financial stability. Cull et al (2012:2) pointed out four distinct ways in which financial inclusion is

related to financial stability.

• Firstly, since financial inclusion attracts small savers, the authors argue that such savings bolster stability at

the individual and household level and given their large numbers, small savers potentially contribute to stability

at the financial system level.

• Secondly, since an inclusive financial system lead to healthier household and small business sector, the

authors argued that it could also contribute to enhanced macroeconomic and financial stability.

• Thirdly, since, at the country level evidence suggest financial inclusion can lead to greater financial

intermediation (for example, via intermediation of greater amounts of domestic savings), the authors argue that

this should lead to the strengthening of sound domestic savings and investment cycles and thereby greater

stability.

• Fourthly, the authors argue that since greater diversification in clientele served associated with financial

inclusion might also be expected to lead to a more resilient and more stable economy, consequent reduction of

income inequality through financial development and inclusion could lead to greater social and political stability

which in turn could contribute to greater financial stability.


Khan (2011:4-5) points out seven ways in which financial inclusion promotes financial stability.

• Firstly, financial inclusion improves the efficiency of the process of intermediation between savings and investments, whilst

facilitating change in the composition of the financial system with regard to the transactions that take place, the clients that use the

various services, the risks created, and possibly the institutions that operate in newly created or expanded markets.

• Secondly, because low income savers and borrowers tend to maintain stable financial behavior, financial inclusion provide a more

stable retail source of deposits for financial institutions (especially banks) and such sources enhance the soundness and resilience

of financial institutions.

• Thirdly, financial inclusion facilitates greater participation by different segments of the economy, thereby increasing the share of the

formal sector. The large presence of the informal sector tends to impair the transmission of monetary policy and as such an increase

in the share of the formal sector improves the effectiveness of monetary policy transmission.

• Fourthly, financial inclusion helps people move from the cash economy to bank accounts which can be monitored, thereby helping to

facilitate implementation of Anti-Money Laundering and Combating the Financing of Terrorism (AML/CFT) guidelines and making it

possible to deploy suspicious transactions’ monitoring and reporting to a larger share of financial transactions in the economy.

• Fifthly, financial inclusion can contribute to enhanced financial stability through contributing to the improved health of the household

sector, of small businesses and, to some extent, that of the corporate sector.

• Sixthly, in most cases, efforts to include an increasingly larger section of the population within the fold of formal banking and financial

services have resulted in the deployment of innovative solutions and outsourcing arrangements and such financial innovations have

the potential of reducing costs and thereby contributing to increasing the overall efficiency of the economy and the financial stability.

• Lastly, financial inclusion, through careful policy orientation, may help facilitate reduction in income inequalities and, by bridging the

gap between the prosperous and the poor, can foster social and political stability.

• Hadad (2010) asserts that financial inclusion has strong links to financial stability. The author argues that financial stability is a

consequence of a well-functioning financial intermediation and financial inclusion is one of the important states of financial

intermediation and consequently financial stability.

UNDERSTANDING THE RISK MANAGEMENT PROCESS

RISK MANAGEMENT PROCESS

Enterprise risk management is a process, effected by an entity’s board of directors, management

and other personnel, applied in strategy setting and across the enterprise, designed to identify

potential events that may affect the entity, and manage risk to be within its risk appetite, to

provide reasonable assurance regarding the achievement of entity objectives.

ERM: THE WAY TO GO

ERM: THE WAY TO GO

• ERM focuses on developing thoughtful strategies that address risks in a variety of areas, including strategy, finance,

operations and technology. While it is not a new concept, it is an evolved way of approaching risk management, where a

company proactively looks at risk from the strategic, enterprise level, versus taking a siloed approach. ERM

acknowledges that risk is not good or bad, but rather that it needs to be recognized and understood so a company can

most effectively prepare and react.

• ERM should align with a company’s goals and objectives. It’s more than just a program or process: It’s a cultural shift.

ERM should approach risk from a wide-angle view of a company, rather than homing in on specific activities or areas.

ERM is becoming more than just a way of managing risk but also a way of doing business.

• Ultimately, a company should seek to be more aware of risk at all levels, and to make decisions and set goals utilizing

that understanding. ERM helps make risk part of the everyday agenda; it’s a way to bake it into the culture. That is when

you begin to see the real benefits. Risk management then becomes less bureaucratic, less resource intensive and more

focused on implementing strategies that help a company reach its long-term goals.

• Organisations involved in the financial inclusion value chain interact with thousands of third parties. Even small

companies have connections outside their walls with vendors, customers, licensed distributors, royalty owners, supply

chain intermediaries and even competitors that can impact their achievement of objectives. The number of third parties

can be astounding and those relationships carry risk. So, a risk-based approach is needed to ensure the most critical

risks are considered.

• Several incidents in the news highlight the need for third-party risk management. For example, Apple has faced

significant concerns over the labor practices of its primary supplier of iPhone and iPad assembly in China. While this

issue came to light in 2011, it continued in the news throughout 2013 and still lingers today.

• In another instance, an HVAC contractor had access to Target’s internal network for billing and project communication.

In 2012, the contractor’s account was leveraged to gain access to the network and plant malware that resulted in 40

million stolen credit cards, a 46 percent drop in fourth quarter profit in 2013 and the removal of the company’s CEO.

Technology- An Enabler

For:

Simplification of process;

Cost reduction to make it affordable to masses; and

Product design to suit the requirements of the Rural masses

Innovation does not become technology till it reaches the masses.

FINANCIAL INCLUSION: THE ROLE OF TECHNOLOGY

• Technological advances are improving data transmission, collection, and analysis, enabling organizations to

develop low-cost distribution models and scalable risk-management practices. Examples of technological

innovations: mobile payments, mobile money, use of biometric information for borrower identification Note: by

“biometric information” we mean fingerprinting, iris scans, and other techniques. These are now increasingly used

for example for borrower identification.

Source: World Development Index


• Historically, the banking sector and its products have been focused on transactional and fee income from

corporate and retail lending. In order to grow this income, banks are interested in higher or more-frequent

transactions or deposits. This goal is only achievable if the client who is banking with a certain financial

institution has a certain cash value.

• Current transactional banking systems do have a high operational cost factor, which banks have to consider

when offering services to customers. Taking into consideration the cost and complexity of running a

transactional system and the current banking income structure in most markets, there is limited interest in

porting low-income, unbanked people onto a traditional banking platform and embedding them in a standard

banking network.

• A differentiation has to be made, however, that in developed societies where wage structures and minimum

wages are applied, governments have helped to form a somewhat affluent society, whose members are

bankable with traditional banking services. The situation is entirely different in developing and emerging

markets where, in addition to having low incomes, people often do not even have physical access to a bank or

banking services.

• Because of several governmental initiatives in emerging markets, financial institutions are now required or

willing to offer banking services to unbanked and underbanked people in rural areas. If done correctly, this not

only offers entirely new revenue streams but also can be done without the expense of having those customers

on a traditional, transactional banking system.

• The situation is entirely different in developing and emerging markets where, in addition to having low

incomes, people often do not even have physical access to a bank or banking services. Because of several

governmental initiatives in emerging markets, financial institutions are now required or willing to offer banking

services to unbanked and underbanked people in rural areas. If done correctly, this not only offers entirely new

revenue streams but also can be done without the expense of having those customers on a traditional,

transactional banking system.


• Technology enables banks interested in offering banking services to low-income groups without the cost and

complexity of a current core banking system. Through a smaller, more agile, and low-cost mobile payment

system, banks can offer specific low-cost products that are tailor made to the needs of the unbanked.

• This mobile payment system can run parallel to the actual core banking system, where integration can provide

all the regulatory aspects. It then allows the configuration of specific, low-cost products, which can be offered

through various channels to new potential customers.

• The cost incurred by this system compared to a traditional core banking system in terms of account

maintenance can be as low as nothing, while the financial institution can still offer full banking services.

Furthermore, the investment in such a system is a fraction of the investment in other traditional systems in

terms of risk, compliance, and analytics.

• After implementing a mobile payment system, the financial institution must create products and services that

cater to the actual requirements of the general group the financial institution wants to reach. Simply offering

conventional deposit accounts will most likely not produce extensive growth since people will be hesitant to

use a new system.

• It is therefore important to offer benefits that ease the lives of the people the financial institution wants to

reach. These benefits will differ from country to country, based on the various challenges the unbanked

population faces during their daily lives. An example of such a system is the implementation of prepaid

electricity purchases in a developing country through a mobile phone with a simple short message service

(SMS).

ADDRESSING DIGITAL TECHNOLOGY-RELATED RISKS AND DATA MANAGEMENT

• It is commonly understood that one of the main methods to allow the most disadvantaged (and typically

unbanked) population to access financial services, is to offer them new instruments to transfer and receive money,

in particular small amounts of money. This would not only improve the speed and safety of remittances and

payments, thus addressing the specific need of such population to execute money transfers of a very small value,

but would also induce those same people to consider the use of other retail financial services.

• Technology has played an extremely relevant role in this process, in light of the widespread use of innovative

communication tools. Use of innovative communication tools is widespread within the most disadvantaged

population and this has come to be seen as a fitting tool to provide financial services. The most mentioned

example of developments in this field relates to the use of mobile devices.

• These devices have allowed for the exchange of domestic (and international) remittances, potentially in real time,

and the possibility for people in remote areas to cash-in and cash-out at local stores with the money received from

third parties using the mobile phone as the device to access the service. Further, some payment service providers

have started offering simplified accounts to be used for the sole purpose of executing small value payments.

These accounts are subject to various limitations but still permit the client to store very small amounts of money

for a short period. Finally, some financial institutions (payment service providers and/or micro-finance institutions)

have begun to offer further financial services by way of the same instruments, such as micro-credit and micro-

insurance.

• Customer identity—new opportunities and challenges in the digital context. Financial identity for poor people when

services are delivered digitally carries the potential for both inclusion and AML/ CFT gains, but also raises privacy

and fraud risks. Meaningful and manageable privacy principles— which will involve work at both the national and

global levels—offer the prospect of win-win solutions.


• New information and communications technology (ICT) is rapidly changing the face of financial services across the globe. In

particular, ICT promises to enable hundreds of millions of people to access financial services for the first time, thanks to their

ability to reach people wherever they are, at a lower delivery cost than ever before.

• Technology also offers the prospect of more convenient, tailored and responsive services, even for clients1 recently considered

non-users. ICT is by no means new to financial services: products like ATMs, credit cards and debit cards have transformed

consumer access points for many users around the world, and newer technology-supported products, including online banking,

prepaid cards and mobile devices for payments are penetrating global markets, in some cases very quickly.

• Just around the corner, new technologies and innovations promise to change business models in ways that will undoubtedly

surprise us all before the decade is over. The successful application of ICT is undoubtedly a key to achieving full financial

inclusion. To realize its promise, solutions must be embedded in business models that work for both service providers and

clients, enabled by sound regulatory frameworks.

• ICT-enabled financial services are already bringing users some of the following benefits and have the potential to multiply such

benefits quickly:

• Ubiquitous Access. By making a range of services available at all times and from almost all locations, financial services use

and management becomes convenient for clients.

• Lower Costs. By making the provision of financial services more efficient, technology can allow services to become

affordable for clients, which in turn allows more clients to participate.

• Security. When use of cash is reduced, financial services can become safer and more transparent— for individuals,

businesses and governments alike. • Improved Products and Channels. Technology-enabled business models can open the

door to new products and delivery methods that are easy to use and blend or extend the characteristics of traditional

financial products. For example, an ATM that uses audio to assist illiterate clients or persons with disabilities brings access

to people who might otherwise remain excluded. Also, as more transactions move into digital format, service providers can

unlock the behavioral data that is generated to improve product design.


A variety of issues could prevent technology-enabled financial services (including

mobile money and digital financial service platforms) from reaching their full potential

to help achieve financial inclusion:

• Fear of technology (by prospective customers, providers and regulators)

• Lack of clear value propositions for providers, governments and individuals

• Difficulties in establishing effective partnerships

• Lack of client education (related to both financial and technological innovation)

• Gaps between access and use (as people sign up initially but do not continue

to use)

• Lack of scale and linkages (for example, creating many unconnected mobile

money platforms)

• Regulation that inhibit new applications of technology

PROS AND CONS OF SOME TECHNOLOGIES

MANAGING CREDIT RISKS IN FINANCIAL INCLUSION

• Lending to otherwise unserved households is challenging, not only because of their limited familiarity with formal financial services, but

also because lenders often have little to none of the data they might traditionally use to assess the risk of lending to them.

Conventionally you would look to a borrower’s banking and credit history. This tactic has proved less effective in emerging economies,

especially among poorer customers who often have no record of past borrowing or earnings and lack formal savings or assets that could

serve as collateral.

• An alternative approach has emerged that would help lenders to build better risk models and help borrowers to receive improved and

affordable products and services. Being pioneered by a handful of mobile operators, utilities, retailers, and direct-sales companies, the

approach entails tapping into new forms data spun off from their core businesses to lend in responsible, low-touch and low-cost ways.

• How does it happen? It involves lenders leveraging increased computing power and new sources of information and data, such as

mobile-phone usage patterns and utility bill payment history to assess creditworthiness. The potential to reap this information in

emerging markets is enormous. For example, by the beginning of 2009, these countries accounted for approximately 75 percent of the

world’s four billion mobile phones.

• It has been found that lenders will benefit from exploring six sources, among others, for this new information and data:

• Telecommunications providers (e.g. data about financial transactions done via mobile phone serve as indicators of cash flow)

• Utilities (e.g. whether or how often bills are paid as a proxy for willingness and ability to repay)

• Wholesale suppliers (e.g. payment histories for small businesses as a proxy for revenue estimation)

• Retailers (e.g. data about customer purchases can help to estimate income levels)

• Government (e.g. demographic and census data can indicate default risk)

• Financial institutions’ own, previously overlooked data (e.g. paper records that have not been digitized).

Indeed, credit risk innovators such as Brazilian wholesaler Grupo Martins and the Chinese B2B internet company Alibaba have already

begun to successfully use such non-traditional data.

MANAGING CREDIT RISKS IN FINANCIAL INCLUSION

• Beyond identifying these new data sources, lenders should pursue two additional steps to develop effective credit assessment strategies

and approaches for lending to lower-income households (and micro enterprises too). First, they need to secure access to the appropriate

data. The simplest – though least cost effective— way is to pay for it. A better solution may be to strike partnerships with mobile

companies, retailers, utilities and/or wholesalers to gain access in ways that benefit all parties.

• The other requirement is for lenders to convert data into actionable credit insights. Many consumer lenders have advanced credit-risk

modeling capabilities, but incorporating new data into strategies, models, and processes will require some major changes in people,

technologies, and workflows. Three areas to target for change are talent, information technology, and the collaboration between risk and

marketing teams.

• Of course this new approach is not without shortcomings. Non-traditional data must sometimes be gathered from diverse sources, and

the volume is often several times that of traditional sources. For example, each mobile account may generate hundreds or even

thousands of calls and text messages per month, each carrying a rich data set that includes when the call was made, the location of the

caller at the time of the call, the type of information accessed via text messaging, and the types and number of payment transactions

made through the device. This indicates that successful lenders who lever such data typically are not unsophisticated and in fact string

together a very thoughtful business system that is tailored to the peculiar opportunities and constraints of each situation, carefully

resolving which partner is doing what with each piece of data.

• Another challenge is that many practitioners are not yet skilled in new data standards and protocols and new tools that bring together

disparate data sets, matching and comparing them to generate insights. They are also unfamiliar with aggregating diverse and oblique

data to derive meaningful insights. And finally, gaining access to data can be difficult as well. In many cases, the data sets that lenders

want are owned by entities that may not want—or are not allowed—to share them. In markets where privacy laws are well-established,

regulatory requirements and privacy laws may restrict lenders from gaining access to and/or fully using certain types of information.

• Challenges notwithstanding, this new approach enables a more complete understanding of lower-income clients’ financial needs and

behaviors. With that understanding, providers can move beyond simple lending to help customers make good financial decisions, offer

the right noncredit products and conduct marketing and communications in ways that are more likely to resonate for distinct segments.

• Until now, neither microcredit nor traditional consumer finance has sufficiently served the diverse needs of economically active

lower-income families and smaller/informal businesses on a truly sustainable basis. Today there are inarguably more viable

approach on the horizon.

RISKS IN AGENCY BANKING

• The level and kinds of risk to which a bank will be exposed as a result of its use of agents will depend on:

• the extent of such use—the picture is quite different if a bank uses agents minimally or for 100 percent of its business;

• the activities in which its agents are engaged; and

• the bank’s management of the agent business, including not only proper oversight and monitoring of agent activities but

also the process by which agents are selected and trained.

The use of agents can trigger operational, technological, legal/compliance, reputational, and other risks.

OPERATIONAL RISK

The use of a nonemployee—i.e., an agent—to service bank customers introduces new operational risks that may stem from

lack of capacity, poor training, and lack of necessary tools and systems. These risks include the following:

Agent fraud or theft Unauthorized fees

Abusive service by agent of customers (in particular, tying—i.e., requiring clients to purchase certain goods and services to

obtain other services) or

misrepresentations regarding the agent’s role as acting on behalf of a bank

Loss of customer assets and records Data entry errors

Poor cash management resulting in an agent not having sufficient cash on hand to enable the customer to make a

withdrawal

Agent failure to resolve or forward consumer complaints to the bank.

Agents may themselves be subjected to theft and third party fraud.


TECHNOLOGICAL

• Utility disruptions or software or hardware failures can cause a lack of service availability and information loss.

LEGAL/COMPLIANCE RISK

• Customers may sue a bank as a result of agent theft or an agent’s violation of privacy laws/bank secrecy laws or other

misuse of confidential customer data. Agents may sue the bank for breach of contract or for broader claims.

• Uncertainty in the applicability of agent-related laws or regulations and the interpretation of contracts give rise to the risk of

lawsuit.

• For instance, in Brazil, agents are suing banks, claiming that they are the functional equivalent of bank staff and should

receive the same benefits, including salary and leave.

• Compliance risks include risks of fines or other civil actions due to an agent’s noncompliance with law or regulation, such as

anti-money laundering and combating the financing of terrorism (AML/CFT) regulations, bank reporting requirements, or

applicable consumer protection rules (e.g., transparency of pricing and other disclosure).

REPUTATIONAL RISKS

Underperformance by agents or agent fraud, robbery, agent liquidity shortfalls, loss of customer records, leakage of

confidential customer data, and violation of consumer protection rules regarding price disclosure.

There may also be negative media due to systems failures.

Agent-related AML/CFT lapses that result in a bank being used for financial crimes may result in the public’s association of the

bank with criminals. Even if it is derivative, reputational risks can be the most damaging.


CREDIT RISK

• Credit risks are tied primarily to operational risk: the bank may not receive the money owed by the agent (if, e.g., an agent

has a credit line to help manage its liquidity) due to robbery of the agent or agent theft.

• To reduce the risk of loss of cash in Brazil, for instance , agents are required by regulation to go to the bank every other

business day to deposit funds. In Mexico, each agent is required to have an account with the contracting bank.

APPROACH TO RISK MANAGEMENT

Banks manage and mitigate risks triggered by the use of agents through various policies and procedures, internal audits, and

review processes. Regulations may specify the required policies and procedures and corporate governance arrangements or

the supervisor may impose them.

Even in the absence of regulatory or supervisory requirements, a bank would typically have such policies and procedures in

place to manage the risks of its agent business. A bank’s approach to risk management in relation to its agent business will

depend on the services performed by its agents, the aggregate value of the transactions they handle, as well as the number of

agents and their geographic spread.

There will be only minor agent-related risks to manage if a bank has only a small number of agents or uses agents for very

limited services. In addition, independent and internal audits serve to determine the bank’s level of compliance with its own

policies and procedures and with applicable regulation, including minimum technology standards.

A bank’s approach to agents will, in many ways, be similar to its approach to outsourcing more generally. In addition to policies

and procedures regarding the selection, training, and monitoring of agents, a bank often will have other risk management

policies and processes for its branchless banking operations, including periodic review, internal controls and audits, and

contingency planning. In addition, while not common, banks may also seek insurance coverage and risk-sharing arrangements.

ENSURING CUSTOMER PROTECTION THROUGH AGENCY OUTLETS MANAGEMENT

Consumer protection is an essential element of inclusive financial systems, both to ensure that current users of formal financial services get

transparent and fair treatment in the market and to instill overall confidence regarding formal financial services and providers among

potential consumers. Most policy makers and regulators in emerging markets and developing economies view effective consumer protection

as an essential enabler of financial inclusion.

The most important objectives of consumer protection include:

• Transparency – consumers understand the prices, terms and conditions, and risks associated with use of financial services;

• Fair treatment – the financial products on offer are not deceptive or unsafe and the conduct of financial service providers and their

employees and agents is not abusive or aggressive, reflects appropriate ethics, and is respectful of consumers’ rights;

• Risk mitigation – financial service providers take reasonable steps to identify, monitor and mitigate customer risks such as fraud or

inadequate handling of customer data, which evolve with innovations in products and business models and with the entry of new

market actors; and

• Effective recourse – when customers have queries, complaints or other problems, financial service providers have access and

effective systems in place to address them.

Governments set out and enforce the rules of the game to safeguard financial consumers’ welfare and ensure the above objectives through

consumer protection regulation and supervision.

Retail financial service providers contribute to responsible market development by offering appropriate services and observing standards of

business conduct. Industry associations and private standard-setting bodies can lead the establishment of collective “self-regulatory”

measures such as codes of conduct or technical service standards.

Consumers also have an important role to play, by choosing providers and products carefully, taking action to self-protect such as handling

PINs carefully, and meeting their obligations. Interventions to improve consumers’ “financial capability” and advocate for their interests also

contribute to an enabling but protective environment and stronger client value from use of formal financial services.


• Agent banking is an innovative delivery model that has brought trained financial services providers and access points within

closer reach for millions of people around the world. However, little is known about the quantitative impact of branchless banking

on financial inclusion. Agent networks have succeeded in taking person-to-person (P2P) payments and bill pay to scale, but how

successful is this channel in delivering savings, credit, and other financial products, especially to the poor? The results have

been quite mixed.

• The legal relationship of agency permits an agent to act on behalf of a principal. Agency banking in its simplest form is where a

licensed financial institution engages an agent to provide special financial services on their behalf outside the conventional

avenues of tellers, cashiers and ATMs. These services may range from deposits, withdrawals and savings. This is usually

legitimised by formal agency agreements stipulating the scope of the mandate by which the agent may act on behalf of the

principal.

• Around the world, banks, mobile network operators, governments, and international organizations are promoting agent

banking—or engaging a third party to carry out transactions on behalf of a bank—as an important tool for extending financial

services to remote and poor areas. While agents (called banking correspondents in Brazil and hereafter referred to as

correspondents) have helped bring financial access points closer to millions of clients around the world, little is known about the

quantitative impact of branchless banking on financial inclusion. Correspondent networks have succeeded in taking person-to-

person (P2P) payments and bill pay to scale, but how successful is this model in delivering savings, credit, and other financial

products?

• Agents and agent networks introduce new operational, financial crime and consumer risks, many of which are due to the

physical distance between agents and the provider or the agent network manager and the resulting challenges to effective

training and oversight.

• Operational risks include fraud, agent error, poor cash management by the agent, and poor data handling. In addition to the

financial crime risks of fraud and theft (including data theft), agents may fail to comply with anti-money laundering and

combatting the financing of terrorism (AML/CFT) rules regarding customer due diligence, handling records, and reporting

suspicious transactions.

• Agents may also take actions that reduce transparency (e.g., on pricing, terms, and recourse), engage in abusive treatment of

customers (including overcharging), or fail to handle customer data connfidentially.


• Agency banking will make financial services available at a much lesser cost to rural areas. It will in fact aid banks

in infiltrating rural areas that have been labelled as “hard to reach” considering the cost of setting up branches,

ATM’s and any relevant access points.

• Kenya has taken great strides over the past 10 years since they introduced agent banking. Kenya’s economy has

produced about 14,168 agents who have facilitated transactions. Leaders in the Kenyan banking sector have

capitalised this to widen their customer base. When one goes to Kenya, the sights of bank logos are adjacent to

boreholes and can be conveniently accessed by all regardless of remoteness. This banking phenomenon is not

alien to the world; Brazil, Columbia and South Africa have made the most of it.

• The principal-agent relationship will permit the agent to offer selected services on behalf of the bank. This

minimises the cost of setting up access points where the costs would be invariably obscene. This facilitates wider

financial inclusion of common people in the banking sector.

• After a rigorous selection process, CBN recently licenced four firms as super-agent for commercial banks and

mobile money operators. The licences were granted to two mobile network operators (MNOs) and two financial

technology companies. The companies were Etisalat, Glo, Interswitch and Innovatives Limited.

• The Approval-In-Principle (AIP) was to enable them perform the responsibility of super-agents. According to the

CBN Regulatory Framework for Licensing Super-Agents in Nigeria, the super- agents shall among other things,

be responsible for monitoring and supervising the activities of agents; have information on the volume and value

of transactions carried out for each type of service by each agent; and monitor effective compliance with set limits

and establish other prudential measures in each case.


RISK MANAGEMENT: CENTRAL BANK OF NIGERIA GUIDELINES-2013—CASE STUDY

• FIs shall be responsible for monitoring and supervising the activities of their agents.

• FIs shall have information on the numbers and volumes of transactions carried out for each type of service by each agent.

• FIs shall monitor effective compliance with set limits and establish other prudential measures in each case.

• FIs shall implement measures to control operating risks, including having clause(s) in the contract establishing the liabilit ies of the agent.

• Periodic physical visits by institution’s staff or authorized persons shall be necessary to ensure that agents operate strict ly within the

requirements of the law, guidelines and the contract.

• FIs shall pay special attention to credit risk, operational risk, legal risk, liquidity risk, reputation risk and compliance with rules for

combating money laundering and financing terrorism.

• FIs shall conduct due assessment of agent’s credit worthiness and set limit structures for agent’s various activities commensurate with

this assessment.

• Product programs, procedure manuals and customer transaction limits shall be devised keeping in mind implications for operational and

liquidity risks for agents.

• Wireless or electronic banking related risks as well as information and data security risks shall be managed by the FI in a prudent

manner.

• A business continuity management plan of FI shall accommodate Agent Banking Operations to mitigate any significant disruption,

discontinuity or gaps in agent’s functions.

• FIs shall put in place appropriate product and operations manuals, accounting procedures and systems and design appropriate

forms/stationery to be used by the agent.

• Institute systems and personnel to adequately monitor and control agent banking operations on an ongoing basis.


CONSUMER PROTECTION MEASURES: CBN Guidelines ---2013—CASE STUDY

Appropriate consumer protection systems against risks of fraud, loss of privacy and loss of service shall be put in place by FIs for purposes of

establishing trust among consumers of agent banking services.

Minimum requirements The following requirements shall be complied with at all times:

• FIs shall establish mechanisms that will enable their customers or users to appropriately identify their agents and the services provided

through such agents.

• Agents shall issue receipts for all transactions undertaken through them. FIs shall provide their agents with necessary tools that enable

generation of receipts or acknowledgements for transactions carried out through agents. In this regard, electronic receipts or

acknowledgements are permissible.

• Where an agent acts as a receiver and deliverer of documents, an acknowledgement shall be provided for all documents received or delivered

by the agent to or from the customer.

• A channel for communication of customer/agent complaints to the FIs shall be provided. FIs shall provide dedicated customer care telephone

numbers for lodging complaints by their customers. The customers/agents can also use this telephone numbers to verify with the FI, the

authenticity and identity of the agent, its physical location and the validity of its agent banking business.

• FIs shall establish complaints redress mechanism and shall ensure proper communication of this mechanism to their customers.

• All customer complaints shall be resolved within a reasonable time and not later than fourteen (14) days from the date of reporting or lodging

the complaint with the FI.

• FIs shall keep record of all customer complaints and how such complaints are redressed.

• An agent shall have signs that are clearly visible to the public indicating that it is a provider of services of the FI with which it has an agency

contract. The agent shall not however represent to the public that it is an FI.

• In the provision of agent banking services, FIs shall use secure systems that ensure customer information confidentiality.

• The customer shall be made aware of the fact that he shall not carelessly store PIN and other critical information or share such information

with other parties including agents.

• FIs shall establish contact centres to facilitate communication between a customer and the FI.


From a regulatory and supervisory perspective, the key risks of branchless banking derive from the extensive use of outsourcing—more specifically the

use of agents—and technology-enabled devices, such as mobile phones. It is worth looking at how the Basel Committee relates outsourcing to

consumer risks, since supervisors around the world adopt the Basel guidelines in their oversight.

The framework shown in the Table below illustrates how regulators and supervisors can evaluate the risks of new businesses relying on outsourcing

and having potential to scale up rapidly. The decision of when, and how to regulate will be more precise if it is informed by first, analysis of providers’

incentives to adopt acceptable business practices, and second, monitoring of actual consumer issues.

Table 1: Risks in outsourcing and consumer-related concerns according to the Basel Committee on Banking Supervision


OBSERVED PROBLEMS OR PERCEIVED RISKS AND RELATED POLICY OBJECTIVES

Source: Denise Dias and Katharine McKee, 2010

RISK MANAGEMENT FOR FINANCIAL INCLUSION: THE FINAL WORD

• Organizations in a variety of sectors have begun to experiment with technology to gain access to useful data about poor

customers, for whom very little data were available in the past. Transaction histories generated through mobile-phone use is one

example. Organizations are beginning to use basic customer-relationship-management (CRM) solutions, enabling them to

collect information about the frequency and character of their interactions with customers.

• Many governments are developing improved identification and tracking systems to gather information about citizens—for

instance, through credit bureaus—and thereby facilitate administrative processes and identify social needs.

• A good example is the Unique Identification Authority of India, which brings together top minds from the public and private

sectors to provide unique IDs for Indian citizens and thereby promotes access to finance and other services. Some retailers

have begun to use point-of-sale (POS) devices to gather transaction data. Innovative organizations are using these and other

sources of information to develop data-based models to better assess poor consumers’ credit risk.

• Those that have implemented alternative risk models have succeeded in reducing credit losses by 20 percent to 50 percent.

Some have also simultaneously reduced operating costs by automating processes.

• These encouraging examples are providing useful lessons that will inform further experiments in risk management and enable

more rapid scale-up of financial-services solutions for low-income households.

• New business models and providers have, in many cases, become viable due to technological breakthroughs, including the

worldwide spread of mobile phones. Recent research we conducted with the World Bank’s Consultative Group to Assist the Poor

(CGAP) and the GSM Association (GSMA) trade group indicates not only that the unbanked poor want to use financial services

but that they would use mobile devices to access them.

• The spread of MFS—which includes mobile money transfer, mobile payments, and mobile banking— would be a boon for

individuals and private enterprise.

OVERALL, THE RISKS FACING FINANCIAL INCLUSION MUST BE MANAGED COMPREHENSIVELY WITHIN AN

ENTERPRISE ARCHITECTURE/FRAMEWORK

THANK YOU FOR YOUR KIND ATTENTION

MANAGING THE RISKS IN FINANCIAL INCLUSION AND HOW TO STAY AHEAD OF THE THREAT CURVE

Presentations & Public Speaking

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