Identification is the cornerstone of financial services, as all financial service providers must verify their customers’ identity under ‘know-your-customer’ (KYC) rules. These guidelines require individuals to present official identification documents to open accounts and conduct transactions. This approach is crucial for preventing money laundering and terrorist financing.
However, in many jurisdictions, a significant number of people lack the necessary identity documents, preventing them from accessing financial services. To address this, policymakers and international bodies like the Financial Action Task Force (FATF) have advocated for risk-based KYC procedures to enhance financial inclusion. Despite these efforts, implementation remains inconsistent and inadequate.
This issue is particularly relevant in remittances, where a substantial portion of funds is still transferred through informal channels, posing high risks and costs. Although comprehensive global data on informal flows is unavailable, the persistent use of these channels underscores the need for more effective and inclusive KYC solutions.
Remittances are low-value cross-border payments sent by migrants to their relatives in their country of origin. Globally, remittances amount to approximately US$647 billion, serving as a crucial financial lifeline for- and middle-income countries. To maximize the impact of remittances, two key strategies should be pursued: reducing transfer costs and minimizing informal flows.
Transitioning from cash-based to digital remittances can lower costs and encourage the use of formal remittance channels, particularly among women. However, overcoming identification challenges are essential to achieve this shift. Approaches include simplified KYC requirements, recognition of the low-risk nature of remittances, and the use of biometric-backed digital identities for unique user verification.
The implementation of foundational biometric-backed digital ID systems, such as India’s Aadhaar, the benefits are immense and extend well beyond financial services. Aadhaar-like implementations are supported in many jurisdictions, such as West Africa, with the World Bank WURI programme aiming to provide digital identity to 100 million people in West Africa.
However, in countries without foundational digital ID systems, central banks can step in by establishing functional digital ID systems for financial service users. This approach can enhance the adoption of formal financial services and promote the use of formal cross-border payment channels.
In 2021, the UN Capital Development Fund (UNCDF) supported the Central Bank of West African States (BCEAO) in conducting an assessment on setting up a unique identification system for financial service users in WAEMU. The BCEAO ID system aims to serve as a reliable central database of all financial service users to ensure the traceability and security of transactions and provide opportunities to increase the use of electronic means of payment and help improve financial inclusion.
By leveraging innovative technologies, the system will modernize the verification and authentication processes for financial institution, making them more efficient and secure for customers. For migrants and their families, this initiative will enable the end-to-end digitization of cross-border remittances and related financial services, reducing transfer costs and discouraging the use of informal channels.
Additionally, the system will empower authorities to collect and report more accurate data on remittance flows, contributing to better-informed financial policies and improved economic planning. The feasibility assessed the existing identification systems across WAEMU Member States using three key criteria: coverage (accessibility), robustness (security), and interoperability (use cases). Over 50 identification systems and programmes were analysed, identifying the most mature ID systems in each country. Unsurprisingly, the level of maturity varied, with some countries relying on national ID cards and others using electoral voter cards.
To gain insights, a benchmark analysis was conducted with four notable digital ID implementations: Nigeria’s Bank Verification Number, India’s Aadhaar, Estonia’s eID, and the digital ID system project by the Bank of Central African States (BEAC). The analysis revealed that central bank-led digital ID systems were primarily driven by the need for accurate financial inclusion data and enhanced transaction and incident monitoring. Additional benefits, including increased electronic payments, formal cross-border transactions, and improved data collection stemmed from the enabling features of digital IDs.
Based on the findings, two broad scenarios were proposed for implementing the BCEAO digital ID system:
- Leveraging existing ID systems: this approach is feasible if mature ID systems ensuring user uniqueness are already in place within the country or region.
- Creating new digital IDs: This involves enrolling all financial service users through financial service providers. Notably, all benchmarked systems utilized fresh enrollment methods.
Regardless of the chosen approach, several challenges must be addressed beyond those outlined in the Principles on Identification for Sustainable Development. These include data privacy, cybersecurity, the user enrolment journey, sustainability (return on investment), interoperability, use cases, governance, and effective project management.
The sustainability of the digital ID system is paramount, given the high costs associated with establishing such systems, which are typically borne by governments for long-term benefits. The financial viability of the central bank’s digital ID system depends on its use cases, particularly in generating revenue from services like ID authentication.
Central bank-led digital IDs offer several socio-economic benefits, including:
- Enhanced customer identification efficiency: Digital IDs minimize errors associated with manual identity verification, streamlining the onboarding process for financial institutions.
- Reduced operating costs for financial institutions: By digitizing identity verification, financial institutions can lower the per capita cost of onboarding customers and processing transactions.
- Fraud prevention: Digital IDs decrease the risk of identity theft, falsification, and loss.
- Increased financial inclusion: Digital IDs enable accurate financial inclusion data collection, facilitating evidence-based strategies to better reach underserved populations.
- Increased cross-border payments and remittances: Digital IDs simplify KYC processes, enabling more people to access financial services and formal remittance channels, leading to faster and more secure cross-border transactions.
UNCDF will continue to support the BCEAO and other central banks in jurisdictions lacking robust foundational digital ID systems by assisting in the implementing of functional digital ID solutions. Additionally, UNCDF will advocate for interoperable and portable digital identification across borders, enabling migrants to access financial services using their digital identity from their country of origin. This work can only be achieved through bilateral and multilateral mutual ID recognition schemes, promoting seamless cross-border financial inclusion and enhancing economic participation for migrants.
Success in creating effective digital ID systems will pave the way for an inclusive financial future – where digital identifies unlock opportunities and financial inclusion knows no boundaries.