Financial institutions' de-risking puts 700 million at risk
Financial institutions’ de-risking to reduce risk of exposure to money laundering and terrorist financing is depriving market segments and even countries of financial services, including remittances, which around 700 million people rely on globally as a source of income to provide food, healthcare, housing and education.  A total 46% of remittance firms have received notifications from their banks about the closure of their accounts since the Financial Action Task Force's introduction of anti-money laundering and terrorist financing laws in 2010, a World Bank study found.
Photo: Ted Aljibe/AFP/Getty Images

The current era of political unrest and uncertainty, coupled with the rise of terror and cyberattacks, means that financial institutions have had to adhere to increasingly strict policies to minimize their risk of being involved in money laundering or funding terrorism.

The regulations and legislation in place work to prevent the cross-border flow of money to criminal groups, creating a more secure financial sector. However, the consequence of these policies can have a far-reaching costly effect on people in poor countries and has given rise to an inadvertent practice known as “de-risking.”

The Financial Action Task Force (FATF), an intergovernmental policymaking organization aimed at combating money laundering and terrorist financing, defines de-risking as “the phenomenon of financial institutions terminating or restricting business relationships with clients or categories of clients to avoid, rather than manage, risk in line with the FATF’s risk-based approach.”

Since 2008, banks and businesses working within the finance sector have been required to use a risk-based approach to financial crime; we should be vigilant at identifying and assessing the risks that we are presented with and then developing ways to manage them.

De-risking is the act of removing banking services from customers who are deemed “high risk” under the Anti-Money laundering (AML) and Terrorist Financing (TF) legislation. Since these policies were introduced, an increasing number of money transfer operators (MTOs), also known as remittance firms, have closed.

A World Bank study, undertaken at the request of the G20, in 2015 on the de-risking issue noted that “[t]he number of accounts being closed appears to be increasing; both MTOs and banks report an increased trend of closed and/or restricted number of accounts between 2010 and 2014; 46 percent of MTO respondents have received notifications from their banks about the upcoming closure of their accounts.”

A 2016 Dow Jones survey of 812 financial services found that 40 percent of the respondents acknowledged that their companies were de-risking, having closed down a full business line or segment in the past year due to regulatory risk. Another third of the respondents said they were planning or investigating exiting a business line or segment within the next year. “The main reasons for leaving involve [that] the organization is no longer willing to assume the segment risk and the cost of compliance making the segment unprofitable,” the survey says.

The FATF notes that the de-risking issue is a complex one, driven by factors such as “profitability; reputational risk; lower risk appetites of banks; and regulatory burdens related to the implementation of anti-money laundering and counter-terrorist financing (AML/CFT) requirements, the increasing number of sanctions regimes, and regulatory requirements in [the] financial sector.”

The UK government’s Anti-Money Laundering Action Plan acknowledges that the total cost of financial core compliance is 5 billion pounds ($5.86 billion) a year.

De-risking isn’t just affecting small firms. A growing trend has been noticed whereby large global banks are not only limiting, but terminating their relationships with correspondent banks. Between 2014 and 2015, 50 percent of local banks reported a decline in correspondent banking relationships, and 75 percent of international banks admitted that they were scaling back their banking operations. The new conservative approach has seen not only firms, but entire market segments and countries being deprived of financial services; rather than judging each client or case on its individual merit, a broad approach is being taken.

“De-risking that leads to the loss of correspondent banking services is bad news for all of us. It could: undermine financial system resilience; hinder competition; create obstacles to trade; cause financial exclusion; and promote underground financial channels which will be misused by criminals or terrorists,” said FATF Executive Secretary Mr. David Lewis.

Vulnerable Individuals

While it’s easy to understand why de-risking is being largely executed, it’s also just as easy to forget that there are segments of a global society that will directly experience the negative impact of the strategy.

In its study of the de-risking issue, the World Bank said: “Remittances contribute to sustaining the welfare of about 700 million people globally and they often represent the only source of income to provide food, healthcare, housing, and education to migrants’ families.”

My previous article touched on the enormous figure of remittances sent home by migrants, what the number meant with regards to GDP, and the difference between living and surviving.

Those living in post-disaster situations and relying on humanitarian assistance from nongovernmental organizations (NGOs) and charities are also being affected. NGOs and charities have reported that they, too, have experienced difficulties in being able to provide financial assistance due to de-risking efforts that resulted in their accounts being closed, because it has been deemed that they fall outside of the firm’s increasingly narrow risk appetite. Fourteen percent of respondents in the Dow Jones survey said they were considering exiting their business relationships with NGOs and charities.

SMEs in Small or Developing Countries

Firms in small and developing nations rely on their local banks having connections with international financial institutions to supply them with credit to drive their businesses forward.

These institutions are withdrawing services from local banks in such countries; it’s been previously reported that Caribbean countries have been severely affected by de-risking. These small nations and their industries, such as tourism and agriculture, are export-orientated and rely on correspondent services to serve as channels for revenue generated in other countries, as international money transfers also contribute to the payments these businesses receive—a decline would in turn lead to increased borrowing. However, the Central Bank of Barbados reported that their accounts had been closed by banks in the EU, United States and Canada; Belize and Jamaica have also reported similar circumstances.

As a result of these account terminations, local firms are unable to pay for services or invest in foreign projects, severely hindering economic development.

Law Enforcement

In my previous article, I also touched on the fact that a vast amount of remittance is being sent through unofficial channels, and that it is hard to provide the accurate amount that is sent each year. De-risking is only adding to the problem.

MTOs are being forced to use less transparent methods and avenues, such as bulk exchanges—this threatens economic stability. “This is a serious concern … to the extent that de-risking may drive financial transactions into less/non-regulated channels, reducing transparency of financial flows and creating financial exclusion, thereby increasing exposure to money laundering and terrorist financing (ML/TF) risks,” according to the FATF.

The financial industry must pay closer attention to methods of expanding the use of digital technology such as blockchain, the secure public ledgers that distribute funds in a decentralized way almost instantly, provide transparency and are low cost. These ledgers store sender details securely and have built-in facilities for smart contracts and fundraising for businesses.

Strengthening the risk-based approach with technology, coupled with increased sharing of information, would enable financial businesses and banks to facilitate low-cost and more secure customer identification and due diligence checks.

“We believe a solution to this issue requires dialogue between countries, regulators and banks, and increased information exchange. This can help clarify regulatory expectations, build trust, facilitate capacity building and highlight best practices,” said Mr. Tao Zhang, deputy managing director of the International Monetary Fund.

The IMF notes that some banks are setting the pace for tackling the de-risking issue:

Standard Chartered, a UK bank with a large presence in Asia, established a correspondent banking training program to help its clients, local banks, and the clients’ clients comply with anti-money-laundering and terrorism financing rules. The program is active in 23 countries. Mexico, a major emerging market economy also affected by the loss of correspondent banking relations, has been active on several fronts. In some countries, privacy laws forbid subsidiaries of the same global bank to exchange information about clients’ risk profiles. So Mexico amended its legal framework to facilitate this cross-border information sharing. It also established a domestic U.S. dollar payment system and uses the central bank’s correspondent banking relations to facilitate transfers.

Clear risk rewards are needed, along with a focus on developing innovative solutions that ensure firms are compliant and that individuals in need of financial support, in whichever capacity that may be, are provided with it.