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Vijaya Ramachandran is a senior fellow at the Center for Global Development. She works on the impact of the business environment on the productivity of firms in developing countries, and is the coauthor of an essay titled "Development as Diffusion: Manufacturing Productivity and Africa's Missing Middle,” published in the Oxford Handbook on Economics and Africa. Vijaya is also studying the unintended consequences of rich countries’ anti-money laundering policies on financial inclusion in poor countries. She has published her research in journals such as World Development, Development Policy Review, Governance, Prism, and AIDS and is the author of a CGD book, Africa’s Private Sector: What’s Wrong with the Business Environment and What to Do About It. Prior to joining CGD, Vijaya worked at the World Bank and in the Executive Office of the Secretary-General of the United Nations. She also served on the faculties of Georgetown University and Duke University. Her work has appeared in several media outlets including the Economist, Financial Times, Guardian, Washington Post, New York Times, National Public Radio, and Vox.
Policies put in place to counter financial crimes have unfortunately had a chilling effect on banks’ willingness to do business in markets perceived to be risky—due in part to the high price of compliance. Even as changes are being made to address this problem, financial institutions are developing solutions in the form of new cutting-edge technologies to help them comply better and faster with anti-money laundering regulations.
“Regtech May be the Solution to Some De-risking Woes,” Says Center for Global Development’s Vijaya Ramachandran
Center for Global Development
Washington – Today, the Center for Global Development released a new study that finds that financial institutions have turned to new technologies, including artificial intelligence, to address de-risking and increase the effectiveness and efficiency of their AML/CFT compliance. These new technologies may enhance transparency and information-sharing capabilities, facilitate automation and interoperability between institutions, and improve banks’ ability to accurately identify illicit activity.
This study is the first comprehensive effort to assess six key new technologies and their potential to solve the de-risking problem: know-your-customer (KYC) utilities, big data, machine learning, distributed ledger technology (DLT), legal entity identifiers (LEIs), and biometrics.
“Some policies that have been put in place to counter financial crimes have unfortunately had a chilling effect on banks’ willingness to do business in markets perceived to be risky in part due to the high price of compliance. This has had costly consequences for people in developing countries, and have hurt migrant workers, small businesses that need to access capital, and recipients of lifesaving aid in conflict, post-conflict, or post-disaster situations the most,” said Vijaya Ramachandran, one of the study’s authors. “But what we’re seeing is that even as these policies are having an impact, financial institutions are coming up with solutions in the form of new cutting edge technologies to help them comply better and faster with anti-money laundering regulations.”
The study suggests that new regulatory technologies (“Regtech”) may offer a partial solution to de-risking by lowering compliance costs and improving risk management capabilities. The technologies include:
Machine learning is a type of artificial intelligence that allows computers to improve their performance at a task through repeated iterations. Machine learning may be used to augment or transform a number of compliance functions, including those for developing more sophisticated customer typologies and for more accurately monitoring transactions. These uses could simultaneously cut down on false alerts and identify undetected illicit finance techniques.
Biometrics use distinctive physiological or behavioral characteristics to authenticate a person’s identity and control his or her access to a system, and are more robust than other authentication factors, such as passwords and tokens, as they are generally more secure and easier to use. Biometrics are being used to address the “identification gap” that exists in many developing countries. This use, in turn, could make it easier for banks to conduct customer identification, verification, and due diligence, which may bolster the confidence of their correspondent banks. However, most biometric identification systems are being developed at the national level, meaning that work is required to develop an internationally recognized and interoperable identification system.
Know Your Customer (KYC) utilities are central repositories for customer due diligence (CDD) information. By centralizing information collection and verification, KYC utilities can reduce the amount of information that has to be exchanged bilaterally between correspondent banks and their respondents, thereby reducing the time banks spend conducting CDD investigations.
Big data refers to datasets that are high in volume, high in velocity, and high in variety, and therefore require systems and analytical techniques that differ from those used for traditional datasets. Compared with relational databases, big data applications offer more scalable storage capacity and processing. They also allow many different types of data to be stored in one place, so compliance staff spend less time gathering information from disparate sources. Most important, they can greatly expand the range and scope of information available for KYC and suspicious transaction investigations.
Distributed Ledger Technology (DLT) is a way of securely organizing data on a peer-to-peer network of computers. In a blockchain, which is a type of DLT, data modifications, such as transactions, are recorded in time-stamped blocks. Each block is connected to previous blocks, forming a chain. Modifications are confirmed and stored by all users on the network, which makes the ledger difficult to tamper with. Although blockchain technology is most commonly associated with virtual currencies, such as Bitcoin, the basic technology has a number of other potential use cases, including uses in regulatory compliance. In particular, DLT may be used for securely storing and sharing KYC information, as well as for cheaper and more secure international payments.
Legal Entity Identifiers (LEI) are unique alphanumeric identifiers, like barcodes, that connect to reference datasets held in a public database. Any legal entity that makes financial transactions or enters into contracts may request an LEI. In many countries, especially developed ones, LEIs are increasingly mandated by regulation. To date, more than 1 million LEIs have been issued worldwide. By serving as common identifiers, LEIs can enable different platforms, organizational units, and institutions to refer to entities clearly and without any ambiguity. This interoperability can, in turn, facilitate greater automation and information sharing. A further extension of the LEI would be to include it in payment messages to identify originators and beneficiaries, which would further enhance the transparency of international payments.
This important study comes ahead of the Financial Action Task Force meeting in Paris – set for next week.
“In the face of de-risking, both the public and private sector have tried to find ways to lower the compliance burden without lowering standards,” said Ramachandran. “Our study finds that Regtech may be the solution to some de-risking woes. But for this to work, policymakers need to invest time in understanding how these technologies work, and what their benefits and limitations may be.”
You can read the full report at https://www.cgdev.org/reader/fixing-aml-can-new-technology-help-address-de-risking-dilemma.
Even while policy solutions to address de-risking are being implemented, new technologies have emerged to address de-risking by increasing the efficiency and effectiveness of AML/CFT compliance by financial institutions.
IFC Spokesman Frederick Jones has replied to our blog on the IFC’s risk appetite. First off, thanks to Fred and the IFC for replying. The Corporation has a unique role to play in global development finance and we’re keen for that role to grow, so we’re happy that the report has generated so much conversation about IFC’s portfolio, both within and outside IFC. And second, we commend IFC for its plans to do more in poor countries and those that are classified as fragile states—it is where the Corporation can have the most impact and where it is most needed.
Since the publication of our paper on the IFC’s project portfolio last week, we have received several helpful comments from readers. They plausibly suggest that the portfolio may be (even) less risky than we suggested, with even more space to pivot towards the low income countries where the IFC can make the most difference. But until the IFC publishes more information, we won’t really know.
The IFC is designed to catalyze investments in countries that investors might consider too risky to invest in alone. But our recent analysis of IFC’s portfolio found that it is shying away from risky investments, raising serious questions about whether the IFC is focusing on the places where it can make the most difference.
Development Finance Institutions (DFIs)—which provide financing to private investors in developing economies—have seen rapid expansion over the past few years. This paper describes and analyses a new dataset covering the five largest bilateral DFIs alongside the IFC which includes project amounts, standardized sectors, instruments, and countries. The aim is to establish the size and scope of DFIs and to compare and contrast them with the IFC.
IFC’s portfolio is not focused where it could make the most difference. Low income countries are where IFC has the scale to make a considerable difference to development outcomes. While an excessive portfolio shift might imperil IFC’s credit rating, the evidence suggests that there is considerable scope for increasing commitments to low income countries without significant impact to IFC’s credit scores.
Africa’s industrial progress has been disappointing. Part of the reason is that labor costs are higher than one might expect, given GDP per capita. Alan Gelb, Christian Meyer, and Vijaya Ramachandran distill the policy lessons.
What's keeping private business from flourishing in Africa? On the basis of unique enterprise surveys, Vijaya Ramachandran and her co-authors identify poor roads and unreliable power as major physical challenges; ethnic segmentation and the economic predominance ethnic minorities further constrain the business environment. The author show how investing in infrastructure and improving access to education can help bring about a broad-based business class in Africa.
Many countries in Africa suffer high rates of underemployment or low rates of productive employment; many also anticipate large numbers of people to enter the workforce in the near future. This paper asks the question: Are African firms creating fewer jobs than those located in other parts of the world? And, if so, why?
The White House and the World: A Global Development Agenda for the Next U.S. President shows how modest changes in U.S. policies could greatly improve the lives of poor people in developing countries, thus fostering greater stability, security, and prosperity globally and at home. Center for Global Development experts offer fresh perspectives and practical advice on trade policy, migration, foreign aid, climate change and more. In an introductory essay, CGD President Nancy Birdsall explains why and how the next U.S. president must lead in the creation of a better, safer world.
The U.S. military has become substantially engaged in the development and stabilization space and will likely continue to operate in this space for some time to come. This paper proposed five policy changes for the military to improve its development activities.
This paper addresses the response to historically high rice prices in 2008 first by presenting a historical review of trends in the West African rice sector and, second, by assessing the effect of world rice prices on domestic prices, primarily at the consumer level.
The World Food Programme has world-class logistics, but its ability to manage financial risk is extremely limited. The WFP should consider implementing a targeted hedging pilot strategy for increased predictability. Greater commitments of untied cash from donors and support for the proposed Food Security Trust Fund at the World Bank would help.
This paper examines how the lack of recognition of Somaliland by the international community—and the consequent ineligibility for foreign financial assistance—has shaped the region's political development. It finds evidence that Somaliland’s ineligibility for foreign aid facilitated the development of accountable political institutions and contributed to the willingness of Somalilanders to engage constructively in the state-building process.
Why do so many businesses choose to remain informal? Vijaya Ramachandran and co-authors discover that the answer is more nuanced than often believed. In East Africa, for instance, the difference in productivity between formal and informal firms is often indistinguishable, while in Southern Africa productivity it is more differentiated. Policies to encourage formalization and increase productivity are likely to be more successful in East Africa, whereas an emphasis on job training and vocational skills might be more appropriate in Southern Africa.
The authors of this CGD working paper analyze what the principal bodies of global government—the Bretton Woods institutions and the UN, the G-20 and the OECD—would like if a country’s membership and roles were contingent upon objective criteria that would better balance representation and effectiveness. They find major disparities between the results of their analysis and the state of affairs today, and they point to the need for changes far more fundamental than the incremental tweaks now being considered.
In this paper, witha foreword by senior fellow Vijaya Ramachandran, Benjamin Eifert of UC-Berkeley investigates the effects of regulatory reform by drawing on years of data across 90 countries. He discusses the characteristics of countries that choose to reform and the results of these reforms. The paper it contains valuable insights for policymakers and institutions focused on regulatory reform in weak states.
CGD visiting fellow Vijaya Ramachandran and co-authors Manju Kedia Shah and Gaiv Tata used firm-level survey data from more than 1,500 enterprises in six African countries to discover how and why African firms lobby. Their working paper concludes that larger, entrenched firms lobby to protect their market share, and that this inhibits competition, reducing efficiency and growth. The authors suggest that regional integration could be one way out of this trap, because it expands the number of enterprises in the marketplace as well as the size of the market, thus making it both harder and less worthwhile for domestically entrenched enterprises to lobby to protect their market share.