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Documenting economy through financial inclusion

Huzaima Bukhari, Dr. Ikramul Haq & Abdul Rauf Shakoori

To achieve financial inclusion-related objectives National Financial Inclusion Strategy (NFIS) was launched by Pakistan in May 2015. The strategy was devised to achieve short-term as well as long-term goals. The short-term goal of the strategy is tantamount to financial inclusion of 50% adults whereas the broader objective was about universal financial inclusion by encouraging digital financial services, sector-specific lending such as for agriculture, small and medium enterprises, involvement of Islamic Banking, and financing low-cost housing.

World Bank in its 2016 study about Financial Inclusion stated that about 100 million adults in Pakistan do not have access to formal and regulated financial services. The story highlighted that the ratio of women with access to the financial sector is very low as compared to an average of 37% in South Asia. It highlighted that around 27.5 million adults cite distance to financial institutions while only 2.9% of adults in Pakistan have a debit card; and that 1.4% of adults have a bank account to receive wages whereas 1.8% use it to receive government transfers.

After taking charge in 2018, the incumbent government prioritized NFIS and treated it as part of their first 100 days plan defining targets for 2023 by claiming that objectives are completely aligned with the government’s priorities of achieving inclusive economic growth through enhanced access to finance & deposit base, promotion of small & medium enterprises, easy & affordable access to finance to farmers, facilitation in low-cost housing finance and provision of Shariah-compliant banking solutions.

The new strategy for 2023 highlighted the progress made through NFIS 2015 in different sectors especially improvement in agriculture lending. In its first 100 days’ action plan, the government revised the goals of NFIS regarding usage of digital payments with a target of 65 million active digital transaction accounts with gender segregation of 20 million accounts by the women. The revised target for enhancing the deposit base was set to achieve a 55% deposit ratio to GDP. The target for the promotion of SME finance was extended to 700,000 SMEs with 17% of the private sector credit and the agricultural finance target was set to serve 6 million farmers through digital solutions with an annual disbursement of 1.8 trillion. Moreover, the target is to enhance the share of Islamic banking to 25% of the banking industry and increase branches of Islamic banks to 30% of the banking industry.

It remains a fact that the low-income class has limited access to the financial sector. Similarly, the size of the undocumented economy of Pakistan is rated as 71.7% in a survey conducted by the International Labour Force in 2017-2018. The steps being taken through NFIS will promote economic growth and its documentation. However, keeping in view the current deteriorating economic condition, these targets seem exaggerated. The key challenges faced by people in Pakistan are unemployment because of which their financial inclusion is only possible if they have earnings to open an account. Also, in certain cases banks require a specific amount to be maintained, annual fees charged on digital products, and religious reluctance on “interest-based system” creating hurdles for documentation.

Implementation of the strategy to achieve these goals needs to be carefully drafted and proper control should be exercised and for achieving higher numbers and attracting more customers, compliance requirements vis-a-vis anti-money laundering and terrorist financing regulations should not be ignored. Financial Action Task Force (FATF) has issued standards on anti-money laundering (AML) and combating financing of terrorism (CFT) which focuses on financial integrity requiring proper implementation of its standards from member countries. The first requirement of the standards is the implementation of a risk-based approach.

It is pertinent to mention that the recent Asia Pacific Group mutual evaluation report on Pakistan was not satisfactory. It raised concerns both about the public and private sectors. The report also highlighted inefficiencies of law enforcement agencies as well as a low understanding of our judiciary about AML–CFT. In this situation, the achievements of the target set by the government for financial inclusion do not appear to be practical. Moreover, implementing recommendation 10 by FATF which specifically deals with “customer due diligence” will also be a challenge, especially where the entire family and even in some cases, friends also depend on one bank account. In such situations identification of the customer, verifying the customer’s identity, using reliable and independent source documents data, or information that establishes a true business relationship and determines the source of income, will not be easy tasks.

The identification of the beneficial owner would be a complex task as the funds being deposited in an account can be through different persons and may originate from informal sectors.  Similarly, the risks of potential fraud may occur due to alternative forms of acceptable identification. The officials of our law enforcement agencies need to be trained to comprehend these different scenarios of fraud as well as interpret red flags originating from business relationships, source of funds, and other money laundering and terrorist financing activities. Also, recommendation 11 of the FATF requires retention of records and binds financial institutions to maintain customers’ record as per its rules. Recommendation 20 requires reporting of the activity.

The Mutual Evaluation Report 2019 highlighted that not all predicate crimes were covered and there was no obligation to file an STR when there are reasonable grounds to suspect that funds are linked to, related to, or are to be used for terrorism, terrorist acts, or terrorist organizations. Since FATF promotes financial integrity and support to fight against Money Laundering and Terrorist financing, therefore, reporting of suspicion can be a tool to curtail the potential threats attached to financial inclusion. Similarly, recommendation 14 has also implications related to financial inclusion of the agents of money value transfer services (MVTs).

Pakistan is already accused of not fully regulating the informal sector and State Department in their report mentioned that Hundi and Hawala system still exists in the country. Pakistan needs proper regulation to ensure that any natural or legal person operating as money value transfer service provider should be licensed and registered otherwise, it would continue to pose potential threats to our financial system.

Though the guidelines issued by FATF related to anti-money laundering and terrorist financing measures and financial inclusion recognize that financial inclusion and AML/CFT are complementary objectives provide vital directions to countries, regulators, and supervisors that wish to translate financial inclusion’s objectives into real progress on the ground but the country’s capability to enforce, implement and supervise Anti-Money Laundering and Terrorist Financing measures can impact financial inclusion. Normally due to limited resources, governments focus on larger institutions that can be easily monitored.

However, exerting so much compliance pressure on these large institutions may finally bring them to the position where they prefer to terminate their relationship with low-income people and targeting larger entities.  Further, law enforcement officials perform risk assessments that are not based on facts but on assumptions and typologies, therefore, controls exercised as a result of assumption-based risk assessment do not contribute enough thus badly impacting the process of financial inclusion.

It is right time that we adopt international best practices to formalize our economy which on the one hand will help us in economic growth and on the other, will improve global standing re combating Money Laundering and Terrorist Financing.


Huzaima Bukhari & Dr. Ikramul Haq, lawyers and partners of Huzaima, Ikram & Ijaz, are Adjunct Faculty at Lahore University of Management Sciences (LUMS), members Advisory Board and Visiting Senior Fellows of Pakistan Institute of Development Economics (PIDE). Abdul Rauf Shakoori is a corporate lawyer based in the USA and an expert in ‘White Collar Crimes and Sanctions Compliance’. They have recently coauthored a book, Pakistan Tackling FATF: Challenges and Solutions

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