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Defragmenting Financial Identities

Image by Markus Spiske on Unsplash

What are financial identities? What are digital identities? What is their role in economies? What are digital financial identities? Why is it important that Africa takes control of the narrative of defragmenting financial identities?

Josh Lauer postulates that financial identity was invented between 1840 and 1940 as a consequence of credit reporting. These institutionalized systems of credit evaluation created new categories of social reality and led to the growth of novel methods through which economic objectification was achieved. Essentially, financial identity enabled individuals and businesses to access financial services that they needed – insurance, credit, transactions, savings and payments – delivered to them. Financial inclusion was a later concept used to refer to the ability of the financial identity to deliver access to all entities equally - responsibly and sustainably – within the jurisdiction of the economy it was recognized.

Digital identities - on the other hand - are the identities of the virtual relationship between the digital avatar that performs transactions, and the physical person. These identities have enabled identification, authentication and authorization in transactional spaces.

In two African countries studied by McKinsey in 2019, these digital identity schemes have the potential to unlock economic value equivalent to 3% - 13% of GDP in 2030. While other African countries were not analysed, these values are promising given that AfDb portrayed Nigeria's Economic Outlook – one of the two economies analysed - as in bad shape in the past half-decade. Slightly more than half of the potential economic value would possibly accrue to individuals. While realizing this value is not guaranteed, it necessitates novel high-value use cases and levels of usage. Yet, with careful system design and policies to promote uptake and mitigate risks, digital ID could be a powerful key to inclusive growth, offering quantifiable economic value to individuals, beyond significant noneconomic benefits.

According to World Bank’s ID4D, 1.1 Billion people (including refugees, women and children) do not have formal identification. According to Bill & Melinda Gates Foundation, 40% of these are in central Africa alone. With the African Leadership Group projecting the continent’s population to double in less than 4500 days, this problem remains a major roadblock to financial inclusion and other development agendas – a problem that the international community has been increasingly focusing on solving. For example, by 2030, the United Nations' SDG Goal 16 intends to "establish legal identification for all, including registration of birth." While this goal appears simple when viewed through the eyes of a wealthy country, it is a significantly challenging angle in Africa; many people in Africa are still restricted access to basic services due to a lack of ID cards. Without universal digital IDs – the project syndicate says - equitable access to health care cannot be achieved, and virus containment techniques such as quarantining and contact tracing are unfeasible.

How do you create a financial identity when you don’t have a way to prove your identity and spending habits? What solutions have been explored?

Digital financial identities present a digitized approach to financial identities. While digital identity does not replace the country’s national ID, the digital identity system enables financial institutions to authenticate and serve all clients. While Africa has been praised for mobile money innovations that broke the barriers to financial services, the continent still has a lot to learn from its peers; while African telecom providers have partnered with identity solutions to provide credit ratings for clients who would not otherwise have access to the service, these financial identities created are fragmented within the country itself and are not transferable to other jurisdictions thereby limiting their capacity to what could only be best described as experimentation at providing financial services.

What could we do better? What could we do differently?

A Nairobi University repository article identifies Credit referencing bureaus (CRBs) as the first step towards building national digital financial identities, albeit under poor coordination among stakeholders. The creation of financial identities in the continent has been fragmented; this has resulted in multiple financial identities for the same businesses and physical people. While these financial identities are valid in the whole country, they are only used by the financial institutions that form part of the ecosystem under a particular (or group of) CRB(s), and cannot be used across borders within - and without - trading blocks.

Nordic Banking systems were the first to implement a shared infrastructure of digital identification and moved on to form the first national electronic identity systems. With the banking system leading such innovations, they were able to create a unified digital ID (eID) system that worked in a group of countries within the Nordic region. Over the years, many countries adopted a form of a national ID system. There has been a sharp correlation between the adoption of digital identity systems and a reduction in money laundering/terrorism financing as shown by the 2021 Basel AML Index shown in Figure 1.1. Countries that adopted digital identity systems seem to register an average score of 4.0 on the index while those without the digital Identity system rank much worse, and – according to money laundering news- remain too badly exposed to money laundering and terrorist financing risks.

Figure 1.1This chart shows Basel Anti-Money Laundering (AML) Index by Country

Digital financial identity: Benefits and challenges

Some African countries have repeatedly cited inaccuracies and unfair rating practices by Moody’s, Standard & Poor’s, and Fitch – agencies owned by the west. This informs the reason AU is pushing for an African credit rating agencythat shall provide a friendlier and more suitable credit assessment of African economies. Besides providing information about the sovereign debt of countries, information from these agencies also helps investors decide whether countries can meet the obligations of their floated bonds. Receiving biased credit assessment is not a problem unique to the financial identities of the African governments in the AU; it is also a problem that touches the financial identities of all legal entities in each of the economies that make up Africa – you and your business.

According to a 2014 research done by World Bank, eIDs will play a pivotal role in:

· Economic and financial analysis as eIDs shall digitize more transactions and grow e-commerce.

· The development and setup of a national civil register thereby addressing the priorities of public policymakers by increasing access to information about individuals and businesses, for tax management and Know-Your-Customer purposes.

· Managing identity relationships concerning cross-border contracts and transactions thereby enabling regional payment arrangements.

Without an eID system, 11FS postulates that financial institutions are forced to bear the burden of AML costs by the governments without the ability to monetize it. According to PWC Fraud has not been kind to this inefficiency; people and organisations defrauded have risen from 8% to 46% in the past decade of mobile money uptake, while the recovery of stolen funds has been below 0.1% of the amount spent in AML processes – according to 11FS. While this phenomenon is not unique to Africa, it still points out the existence of financial inefficiencies within the existing control systems in which African economies run. Enabling financial institutions to centralize their resources and monetize their AML infrastructure would cut down on AML costs thereby freeing up valuable human and capital resources to spur innovation.

The existence of a digital identity scheme that allows provisioning of access to data and the revoking of access to data would go a long way toward improving the efficiency of usage of digital identities within many industries of the economy. Managing such reputations in a privacy-enhancing infrastructure (either centralized or self-sovereign) would unlock new ways of doing business by enabling a trusted system with an ability to enable trustless transactions, which comply with AML/CFT regulations.

The main challenge, however, would be to have harmonized regulations among participating states; they would need to overcome different cultural and privacy paradigms around digital identities. As we look into the future of defragmenting identity, we need to ensure that the systems we are developing are open to everyone; we need the right technology stack that looks above the security and cultural concerns.

To sum it up, the benefits of a regional/continental digital financial identity are heavier than the challenges. While we consider that the lack of a formal identity has impoverished African communities, providing people and institutions across the continent access to a defragmented digital financial identity would go a long way in making sure fair formal financial services are accessible to every entity in the region. In my opinion, this would be the most important milestone in building data points for an alternative African credit rating agency that has the soul of Africa at its core.

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