De-risking: towards solutions?

Over the last few years large banks have been de-risking, but collaboration and inclusion are key to avoiding countries being excluded from the global financial system

With minimal changes, therefore, the current gatekeeper role can be abolished while the whistle-blower role is enhanced.

Louis de Koker

La Trobe Law School, Australia

Since 2013, large banks have closed a significant number of accounts of remittance service providers, charitable organisations and even politicians. These terminations extended to correspondent banking relationships, complicating access to trade finance and increasing the threat that some countries and more regions may be excluded from the global financial system.

Such terminations, generally called “de-risking”, are often the result of a complex combination of factors in which anti-money laundering (AML) and the combating of financing of terrorism (CFT) concerns feature prominently.

International action against de-risking

Concerned about de-risking, international standard-setting bodies and national regulators issued statements calling on banks not to engage in large-scale terminations.

The Financial Stability Board is working with the World Bank, the Committee on Payments and Market Infrastructures and the Financial Action Task Force to pursue a four-point plan to: (i) deepen their understanding of the extent and impact of these terminations; (ii) provide increased regulatory clarity; (iii) support AML/CTF capacity building in affected low capacity countries; and (iv) harness technology to improve customer due diligence measures of correspondent and respondent banks.

No compelling evidence has yet emerged that these measures have reversed the de-risking tide. The four-point plan puts forward sound objectives but it may be time for a more fundamental reconsideration of the AML/CFT approach.

Banks as gatekeepers

The current strategy against money laundering and terrorist financingwas formulated in the 1980s. It views banks as gatekeepers of the banking system who should prevent criminal abuse of the system and only allow access to those whose money laundering and terrorist financing risks they are able to control.

What is not often appreciated, however, is that the client risks to be managed in this context are national security and law enforcement risks.

Apart from fraud risks, these are not risks that banks traditionally managed. The identification and assessment of some of these risks depend heavily on sensitive intelligence that governments generally do not share with banks. The potential for making a wrong call on these risks is therefore higher than often appreciated by policy-makers. Spectacular penalties for compliance failures feed a fear of compliance failure. This, in turn, increases the costs of risk management and renders many commercial relationships unprofitable.

So what can be done differently?

Increased collaboration

The accuracy of money laundering and terrorist financing risk management can be increased and the costs diminished by employing public-private risk management partnerships. The state holds key data and information that banks require to manage national security and law enforcement risks.

Governments therefore need to get better at sharing relevant information.

Some intelligence will always remain too sensitive to share with the private sector but improved information flows will enhance the efficiency and effectiveness of risk management processes.

Know Your Customer (KYC) utilities that allow relevant information to be accessed or shared by industry stakeholders are already having a positive impact on client identification costs. Increased government involvement in utility models and collaborative development of improved risk indicators and profiles would increase the risk management value of shared data models.

Right to access payment services?

At a more fundamental level, it is time to rethink the exclusionary approach underpinning the AML/CFT efforts. Clients who are excluded by one bank may be accepted by a smaller bank that has not identified their risk level correctly.

Alternatively, they disappear into the cash and cyber economy. Their exclusion may therefore result in higher crime risk for the system as a whole. Such exclusion undermines the crime combating objectives of AML/CFT. It also undermines financial inclusion, a key enabler of the UN’s Sustainable Development Goals.

Millions of poor clients are excluded by compliance cost and identity verification barriers resulting from conservative AML/CFT compliance practices.

Can we embrace an AML/CFTsystem where the bankers are not gatekeepers but guardians of an all-inclusive banking system?

In such a system they would offer payment and savings products to all, while working collaboratively with industry and government to identify potential criminal behaviour and, as under the current system, report that to the financial intelligence unit. More transactions, especially those more likely to involve crime, would be subject to AML/CFT review while collaboration would aid effectiveness and efficiency. Banks would be liable for failing to use available information to identify and report potential criminal behaviour and not merely for dealing with criminal clients.

Building blocks in place?

Such a future is not fanciful. Elements of it are already evident in the right to a bank account that is recognised in different forms in a number of countries.

Under the Second European Payment Services Directive, credit institutions must provide payment institutions, such as remittance service providers, with non-discriminatory and proportionate access to payment account services.

Public-private partnerships in AML/CFT are also growing. These partnerships, such as Australia’s FinTel Alliance, facilitate intelligence collaboration between banks and government agencies. RegTech (regulatory technology) furthermore enables collaboration in ways that protect the rights of clients and institutions while supporting AML/CFT goals.

With minimal changes, therefore, the current gatekeeper role can be abolished while the whistle-blower role is enhanced.

What can be done better?

Approaching AML/CFT slightly differently does not mean that much of what is currently done should not continue to be done.

Whichever path the AML/CFT community takes, more capacity building will, for example, be required to enable institutions to navigate the complexities of global business better.

Too often de-risking actions appear to result from a lack of understanding of different business models, foreign jurisdictions and the clients and counterparts linked to those.

“De-risking” points to gaps in the current system. Some of these are relatively easy to address but to solve the problem comprehensively we need to reconsider the exclusionary approach. A collaborative and inclusive approach would advance integrity with greater effectiveness and efficiency.