Digital Identity and the Rulebook: Bringing More People Into Today’s Financial Systems
Digital Identity and the Rulebook: Bringing More People Into Today’s Financial Systems
As the world becomes more digitally connected, digital identities have taken on even more importance. This has been underscored by the COVID-19 pandemic. Families and businesses are increasingly turning to digital tools to facilitate everyday tasks, which often require the disclosure of sensitive personal or business information.
But this is also revealing significant cracks in an increasingly engaged online system. Access to essential services, such as health, education, and finance have long centered on the fundamental need to verify and validate identities in order to access them. But the problem is that many people around the world simply lack the tools and resources necessary to do that.
One of the most important reasons for this lack of access lies in global financial compliance rules, like Know Your Customer (KYC) and anti-money laundering/counter-financing of terrorism (AML/CTF) regulations — collectively known as financial crimes compliance (FCC). They are the backbone of maintaining integrity in our financial systems, but they also make it more difficult for already underserved communities to access digital financial products and services. Over 30% of the global population is unbanked, which has negative consequences for global economic growth. Beyond the unbanked are the billions otherwise poorly banked or financially underserved, and the millions of organizations, small businesses, and nonprofits — which rely on personnel that control and operate these organizations — that also lack secure and sustainable financial access.
And because these financially marginalized communities are largely low-income, many usually lack a verifiable identity — understood most often as the proof of a government or federally issued identity — which prevents them from establishing a bank account or carrying out day-to-day financial tasks.
It’s important to contextualize this issue. You might be thinking, why is this a problem for me? There are a few reasons. First, the innovative financial companies of today are heavily concentrated in the financial technology space — including those engaged in virtual asset (crypto) services, which are often labeled by traditional banks as ‘high-compliance risk’ by governments and banks and. Thus, these companies find it more difficult to access traditional accounts and payments services. Second, there are millions of small businesses, entrepreneurs, and organizations considered or labeled ‘high compliance risk’ by governments, banks, and global AML/CFT standards-setters. This can cause financial institutions to ‘de-risk,’ or deny service to customers. Finally, financial exclusion is (mis)understood to only impact the global poor in developing and frontier economies. But in reality, the challenges of financial exclusion impact even those in the U.S., where 25% of the U.S. population is under or fully un-banked.
Key to solving this problem is the concept of identity validation. KYC rules vary across countries, but they more or less rely on paper identification. All of these rules are formulated to help keep illicit actors outside of the financial system — and rightly so. But unfortunately, these policies have also shut people out of the financial system.
As we consider the evolving financial inclusion landscape, there are several important trends to understand. First, there has been, and continues to be, an exponential increase in financial intermediation taking place outside traditionally covered or regulated channels, such as person-to-person (P2P) transactions. Second, the growth of financial activities outside of traditionally regulated channels is noteworthy, as they provide tremendous opportunity to increase access for the globally underserved, un/under-banked, and those otherwise financially excluded. Finally, since the tragic events of September 2001 and the credit and financial crisis of 2008, a growing body of regulations and financial oversight rules have understandably caused consternation among financial market participants — traditional and non-traditional alike — working to adhere to these additional, and often costly, requirements.
As the digital financial landscape continues to evolve, digital financial innovations are following suit. The advent of new technologies such as mobile and digital banking, alternative payments, advanced analytics (including artificial intelligence (AI) and machine learning), and distributed ledger technologies (DLT), have expanded opportunities never before afforded to financial market participants.
Specifically, DLT has emerged as an additional potential value additive capability that drives secure, cost-efficient payments, as well as enhanced compliance to meet AML/CFT goals and obligations. Blockchain technology — a form of DLT — has characteristics that strengthen the use of digital identity tools, which facilitate stronger compliance and inclusion. One can easily see where they can add value to underserved/excluded markets and further AML/CFT goals in tandem. Responsible and disciplined application testing and deployment of such technology alongside regulatory oversight will pay dividends to the industry, regulators, and law enforcement alike.
However, even with these new technologies, validation and identity problems remain. Many countries have made strides to strengthen the security features and attributes associated with paper-based identities. But this overreliance on centralized government-issued documentation does little to address the plight of the over one billion people that never receive a formal identity in the first place. What’s more, many of these countries’ validation methods aren’t transferable across borders, and the digitization of our economies requires the ability to operate in a more digital and cross-border world. These issues are holding back greater financial inclusion and hampering economic growth.
The solution, however, is the coupling of digital identity initiatives with financial inclusion. This is already apparent to many in both the private sector and in governments alike. Imagine a world in which one’s identity remains governed by the identity holder and could be accessed by any financial institution anywhere in the world, but only with the holder’s consent. These capabilities move beyond just the digitization of identity to one that also promotes self-sovereignty, which is an important goal. That’s a type of system that would promote greater financial inclusion, protect privacy, and uplift underserved populations.
In the absence of governmental action on this front, many in the private sector are committed to building a community around their technology platforms to share best practices and realize open-source spaces to build, innovate, and provide commercial value.
Proactive fintech companies are creating security and compliance frameworks that can be applied to these newly accessible financial ecosystems. These communities are important mechanisms to drive incentivized self-governance, whereby established rules can ensure transparency and safety for all participants in driving a more inclusive economy.
One such effort is The Rulebook, led by FinClusive, which provides a framework and set of governing principles regarding the application of anti-money laundering and financial crimes compliance (“FCC”) requirements. It aspires to create and optimize working relationships by and between digital asset-based and/or blockchain-enabled network participants engaged in the issuance, storage, and/or transfer of value between themselves and their counterparties/clients. The Rulebook’s governance framework is driven by a foundational commitment to achieve the twin aims of promoting financial inclusion and meeting global compliance standards. While new financial intermediaries and technologies are enabling access to individuals and organizations who have previously faced barriers to the financial system, the infrastructure to include essential FCC requirements that have become compulsory for regulated financial institutions has lagged behind those innovations — which is exactly why The Rulebook was created. With the Rulebook, the growing non-bank financial services sector — including virtual asset service providers, decentralized financial services applications, and others — can ensure they have the appropriate risk, governance, and compliance frameworks in place.
While regulated financial service providers continue to be required to control identity-related information of their clients, the movement to ensure essential privacy controls that still maintain the ability for providers to verify and validate bona fide identity information paves the way for greater inclusion opportunities. Secure sovereign identity management solutions and other compliance guidelines provided in The Rulebook helps broaden access to digital financial products and services that many individuals, communities, and businesses have previously lacked the means to access. Further, this framework helps us collectively advance modernized FCC protocols in an increasingly digitized and decentralized financial services ecosystem in a manner that reinforces the foundation of identity being owned and ultimately controlled by the identity holder. We at FinClusive fundamentally believe that The Rulebook, and its compliance efforts aimed at helping users develop compliance solutions, will help facilitate a pathway to a more sustainable, inclusive economic future for all of us.
