Increased regulation and staggering fines have put reducing risk at the top of the agenda for many banks, but often at the expense of financial inclusion. How can financial institutions ensure they walk the line between compliance while ensuring sectors of society are not excluded?

'De-risking' is the buzzword of the day among anti-money laundering specialists, who are now operating in an environment of fear with increased regulation and more prevalent fines. Some banks have responded by dropping ‘risky’ clients, but now there are fears that de-risking has gone too far, coming at the expense of financial inclusion.

Banks are caught in a contradiction. If they don’t comply with money laundering regulations, they could be fined billions of dollars. At the other extreme, if they cut access to certain markets, they stand accused of stemming transactions to developing economies, causing major hardships for the people who relied on them.

Balanced approach

The issue is now being discussed among development agencies, with cries getting louder that there needs to be a more balanced approach to finding a way to promote financial inclusion at the same time as combating financial crime.

“De-risking is a new name for an old issue,” says John Byrne, executive vice-president of the Association of Certified Anti-Money Laundering Specialists. He points out that for years banks have had to assess the money-laundering risk of their customers and find ways to mitigate that risk.

What is different now, however, is the tone of the regulatory environment. “It’s not so much a difference in regulation,” says Sven Stumbauer, a director in the financial and advisory services practice at consultancy AlixPartners. “The biggest difference is in the enforcement efforts and the fines growing exponentially.”

This has led to a knee-jerk reaction by some financial institutions to exit relationships based on perceived risk. “It becomes a business decision whether to keep a line of business or not,” says Mr Stumbauer.

Reassessing transactions

One banker, who has had to cut some of his client relationships, says the size of the fines being handed out has forced banks to look again at the entire value chain of their transactions.

The $9bn fine slapped on BNP Paribas in 2014, for example, has prompted a certain clarity of thought in making decisions about anti-money laundering risk, he says, and so banks have been forced to be more cautious.

The regulations are clear, says the banker, in that the responsibility lies with the bank for the sender and the receiver of each transaction and everything in between. But where it gets difficult, he says, is in knowing a customer’s customer and knowing a customer’s customer’s customer and so on. Doing that is extremely difficult, he says, and banks are therefore having to rely on their customers to have the appropriate controls in place.

Money service businesses

Money service businesses (MSBs) are one segment that can be considered risky from an anti-money laundering point of view. Handling their risk has been something banks have grappled with for years, says Mr Byrne.

Now, however, the issue of de-risking has become topical because of the reaction of the MSBs, which have been “quite vocal”, says Mr Byrne, about having their banking relationships severed. Law enforcement agencies are also complaining that the de-risking has meant their intelligence gathering has been hampered, he says. With banks exiting relationships, these transactions no longer flow through the banking system, driving them underground and making them more difficult to track.

While banks have de-risked some of their relationships, Mr Stumbauer says that “the overall risk did not change for the system”. What many observers point out, however, is that now the transactions are flowing on more unstable, unregulated channels which could cause a systemic risk that could have consequences for the banking industry at a later date.

The worst impact, says Mr Byrne, is for society in general as crimes such as terrorism, or drug and human trafficking, will occur if their financing continues.

Dahabshiil's suspension

Dahabshiil is an example of an MSB that had its banking services suspended even though there is no suggestion that the firm has failed in its anti-money laundering measures. In a high-profile case, the African money transfer operator’s bank, Barclays, cut off its relationship. However, Dahabshiil fought back and in November 2013 won a court injunction against Barclays so it had time to find another bank, without which its business would have frozen.

Back in September 2013, Barclays stated its position: “As a global bank, we operate in a very different regulatory environment to money service businesses. It is well recognised in the industry, as well as by regulators and law enforcement agencies, that some money service businesses (including some money remitters) don’t have the necessary checks in place to spot criminal activity with the degree of confidence required by Barclays’ regulatory environment.

“Barclays does not want to unwittingly facilitate such transactions, given these serious risks. Additionally, if we were caught up in such transactions, Barclays could be punished by our regulators and potentially fined, as we have seen with global banks receiving fines of hundreds of millions [of dollars] for anti-financial crime failures.”

One suggestion has been that banks are not comfortable with the amount of cash in the money transfer system. “Markets dominated by cash create the most difficulties for the banks,” says Mike Aynsley, a non-executive director of Dahabshiil.

In handling that cash, Mr Aynsley says: “We know exactly where that cash is coming from and who it is being delivered to.” He adds that Dahabshiil has a “tight set” of know-your-customer procedures and due diligence.

“The vast majority of our clients are long-standing clients of Dahabshiil, sending money every month. We have never been accused of any wrongdoing [by the authorities],” says Mr Aynsley.

Somalia in isolation

It is, however, difficult for MSBs to find banks willing to take them on. “[Banks] are not interested in banking-specific MSBs that service difficult countries such as Somalia, where the risk of money laundering and terror financing is heightened,” says Mr Aynsley.

This is also true in the US, where Merchants Bank shut down its accounts with MSBs that operate in Somalia, effectively turning off the tap for the bulk of remittances from the US into Somalia.

By some estimates, remittances account for between one-quarter and one-half of gross domestic product (GDP) in Somalia. Without those funds flowing into the country, it is feared that the people who would normally receive those payments are now unable to pay for food or medicine, for example.

Indeed, banks have a compelling reason to bank MSBs, according to Mr Aynsley. “People have a right to basic banking services,” he says. Many of those remitting money back to Somalia are British citizens who “ have a right to be banked”, adds Mr Aynsley.

For banks that fear the fines, however, a business decision has to be taken about whether it is worth the risk. “Banks and bank officials certainly want to improve communities – they recognise their obligations in general, but at the end of the day they are not a utility,” says Mr Byrne. Mr Stumbauer adds that “financial institutions are not charities”.

Policy issue

The issue is being looked at by policy-makers, who are considering how remittances can flow without those channels being used for illicit funds. The UK, for example, has the Safer Corridors project which looks at how remittances can flow to Somalia, which has no formal banking system and is reliant on MSBs to receive funds.

There are many other countries where de-risking has caused concern. Bangladesh’s central bank governor, Dr Atiur Rahman, for example, has highlighted the issue for remittance-receiving developing countries. In a speech in Washington, DC, in April, he estimated that 8.6 million non-resident Bangladeshis working abroad send home about $14bn every year, which is more than 8% of the country's GDP. He estimated that 60% of that amount goes into consumption, while the remaining 40% is invested in Bangladesh.

“Financial exclusion of low-wage foreign workers arising from ‘de-risking’ tendencies of banks in advanced economies is causing major hardships for their families,” said Mr Rahman.

Such comments highlight the concern among policy-makers that the impact of the regulatory fines means de-risking has gone too far. “The opposite of de-risking is financial inclusion,” says Mr Byrne.

Wholesale de-risking

This issue is now being addressed by regulators, who are saying banks should not engage in indiscriminate, wholesale de-risking of entire sectors. In April 2015, the UK’s Financial Conduct Authority (FCA) stated that banks had stopped offering services to whole categories of customers. “We are clear that effective money-laundering risk management need not result in wholesale de-risking,” it said.

“Where a bank does not believe that it can manage the money-laundering risk associated with a business relationship effectively, it should not enter into, or maintain, that business relationship. But the risk-based approach does not require banks to deal generically with whole categories of customers or potential customers: instead, we expect banks to recognise that the risk associated with different individual business relationships within a single broad category varies and to manage that risk appropriately.

“While the decision to accept or maintain a business relationship is ultimately a commercial one for the bank, we think that there should be relatively few cases where it is necessary to decline business relationships solely because of anti-money laundering requirements. As a result, we now consider during our [anti-money laundering] work whether firms’ de-risking strategies give rise to consumer protection and/or competition issues.”

This echoes the stance of the US Federal Deposit Insurance Corporation (FDIC) and the Financial Action Task Force (FATF). In January 2015, the FDIC encouraged financial institutions to consider customer relationships on a case-by-case basis and urged them to take a risk-based approach in assessing individual customer relationships, rather than cutting services to whole segments of customers.

And earlier, in October 2014, the FATF said it had discussed the issue at its plenary and clarified that a risk-based approach is one of assessing risk on a case-by-case basis and not wholesale de-risking.

In November 2014, the Financial Times quoted Roger Wilkins, president of the FATF, as saying that banks were taking a “blunderbuss approach” to de-risking and were using it as an excuse – or “fig leaf” – to drop uneconomic clients. “This so-called de-risking, it is not so much a function of our standards as a fig leaf for the banks doing what they need to do and are going to do anyway by taking people off their balance sheets,” he said.

Mr Byrne, however, believes that the wholesale de-risking is a “misconception”. He says: “Regulators in the UK and US and the FATF are saying banks are wholesale exiting of customers – I do not believe that is happening.”

Case by case

The banker who has severed some of his client relationships also agrees with this view, saying the decisions had been made on a case-by-case basis. Also, he says, he is not aware of any of his partner banks that have de-risked on a wholesale basis.

Despite this and the statements of the regulators, there is a sense that more could be done to bring the various parties together. “We could continue whinging about the banks, but the challenge here is to try and get a few of the larger banks in the UK to engage with the industry to build solutions to both help and satisfy [the banks’] control requirements,” says Mr Aynsley.

“In my view, regulators won’t provide a safe harbour to banks [against fines or prosecution]. In the absence of that, we are trying to convince the banks to come back to the table and have a conversation about how to solve the problem. The banking industry is simplifying itself to the point of exclusion over problems that are resolvable,” he says.

Mr Byrne also urges more dialogue. “Everybody needs to get together and talk this through in order to have a resolution,” he says.

For now, banks continue to be trapped in the dichotomy of needing to comply with anti-money laundering regulations while also being under pressure to be inclusive. The issue of de-risking, however, is gaining more momentum among policy-makers and development agencies, in the hope that a balance can be struck between the two.


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