Africa loses an estimated USD 88.6 billion annually due to illicit financial flows (IFFs), according to a United Nations General Assembly report in 2020. This lost revenue threatens an already vulnerable continent and may lead to inadequate infrastructure, erratic power supply, and limited access to health, education, and broadband internet services 1.
IFFs refer to the illegal movement of money or capital across borders, often involving illegally earned, transferred, or used funds. Global Financial Integrity (GFI) defines these financial flows as the “illegal movements of money or capital from one country to another” 2. These flows are linked to activities like money laundering, fraud, and trafficking and often go through unregulated channels, making them hard to trace, investigate or prevent illegal transactions.
While informal remittance channels are also unregulated, they serve a legitimate purpose for those excluded from formal financial services. Financial exclusion can drive people to use these channels to support their families back home.
Informal remittance channels
Informal remittance channels are common in migrant communities. Every day, thousands of Africans living abroad must send money to their families to help pay for food, housing, school fees, and other essentials. When choosing a remittance channel, the main factors they consider are cost, convenience, speed of delivery, and the safekeeping of their funds.
The formal financial system often requires documentation many do not have, which is challenging and limits migrants' options. Low-income customers and undocumented migrants have few affordable choices, which may be why they resort to sending remittances informally through taxis, buses, or with friends.
This trust-based delivery channel has a strong historical background in Africa. Modelled on the hawala system in the Middle East, these informal money transfer systems offer minimal paperwork, anonymity, and often speed. Although not regulated, they are generally used for legitimate purposes, such as helping families with essential living costs. However, since many of these informal cross-border remittances go undocumented, it becomes difficult for authorities to track and regulate the flow of funds.
The effect of IFFs on financial systems
IFFs are characterised by illegal intent and criminal activity. Unlike informal remittances, IFFs can drain much-needed resources from a country’s development, undermine the government, and damage public trust. They also create obstacles for governments to provide healthcare, education, and infrastructure services. By restraining and preventing illegal funds from leaving a country, better essential services like sanitation, water, and housing can be provided.
Although both informal remittances and IIFs bypass formal financial channels, informal remittances are motivated by legitimate needs, whereas IFFs are driven by illegal activities. Both can undermine financial transparency and accountability and increase vulnerability to financial crimes, which is why it is essential to address financial exclusion.
Adopting a risk-based approach to financial services
Numerous countries have adopted the risk-based approach developed by the Financial Action Task Force (FATF) to address these challenges in 2007. This strategy allows financial service providers to assess and prioritise the risk rate of their products, services, and delivery methods. It enables them to allocate resources more effectively towards higher-risk customers and transactions.
Migrant customers, who primarily need to send money home to their families, may be considered lower risk and require less customer due diligence during onboarding. Bringing these customers into the formal financial system encourages self-reliance and economic freedom and helps protect a country’s financial integrity.
The role of financial inclusion in combating financial crime
While financial inclusion is more often linked to socioeconomic development, it also plays a vital role in the fight against financial crime. A country’s anti-money laundering legislation safeguards the global financial system. Its regulators require formal financial institutions to comply with laws established by their governments and recommendations from international bodies like the FATF. Informal financial systems, on the other hand, operate outside of these regulations.
Financial inclusion improves access to formal financial systems, which may help reduce reliance on informal channels for cross-border remittances. The widespread use of cash in these markets is appealing not only to migrants for their legitimate transactions but also to criminals because it often goes undetected by authorities. This vulnerability increases the risk of financial crimes, including money laundering and terrorist financing. Without proper oversight and risk management, using informal markets for illicit purposes may continue unabated.
Building a stronger financial future for Africa
Financial inclusion can improve the financial integrity of countries, particularly in Africa. In the fight against financial crimes, greater transparency in financial transactions and the increased capability of financial institutions and law enforcement to ‘follow the money’ will naturally lend itself to a more robust and safer economic environment for consumers and businesses. Financial inclusion also provides much-needed access to services by bringing the historically underserved and excluded communities into the formal system. It reduces the risks of informal markets, paving the way to greater financial equality and contributing to combatting financial crimes.