FATF 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’. One such example of where this is taking place, and where the effects are markedly being felt, particularly in the decline of correspondent banking relationships, is in the Caribbean, with former Barbadian Prime Minister Owen Arthur stating that the ‘de-risking crisis is threatening to be a disruptive force’.
Back in November 2015, the World Bank Group published a report into the decline of correspondent banking due to de-risking and identified the Caribbean as the region most affected. So this has been recognised as a problem for a substantial amount of time; and unfortunately the issue is just as bad today.
While it is expected that financial institutions will seek to manage their risk by terminating any relationships where the level of risk is unacceptable, it is also increasingly recognised that de-risking can do more harm than good. The affected respondent banks are likely to face considerable difficulty in finding alternative correspondent banking service providers and has the potential to drive them underground, towards higher risk and unregulated routes for transferring funds, reduce the transparency of financial flows and create financial exclusion. This also has the capacity to enhance, or even create new threats to the financial system.
If the affected banks are not able to find an alternative means of transferring funds, this could cause the Caribbean to be seriously limited in its ability to undertake international trade/transactions, which could cause a downturn in the economy/economic growth, collapse of business, a steep upsurge in unemployment and an increase in poverty.
In the last year, the IMF has taken an interest in the decline of correspondent banking relationships. It actually embarked on a ‘fact-finding expedition’ in order to better understand the concerns of all parties involved in/affected by de-risking including the impacted countries, the regulators in key financial centres and major global banks. The information gathered from this expedition was then documented in a report published by the IMF entitled ‘The Withdrawal of Correspondent Banking Relationships: A Case for Policy Action’. Amongst other areas and jurisdictions, the report focuses on the Caribbean and illustrates just how big of an impact de-risking is having on the jurisdiction. For example, as of May 2016, at least sixteen banks across the five countries have lost some or all of their correspondent banking relationships. Several reasons were given by the banks for terminating correspondent banking relationships included concerns regarding anti money laundering (AML) compliance costs, the inclusion of higher-risk categories of customers in respondent banks’ customer base, a change in the correspondent bank’s risk appetite and perceived lack of profitability of certain correspondent banking services.
Another reason posited as to why banks are terminating correspondent banking relationships in the Caribbean has been given by Bahamian Foreign Minister Frederick Mitchell during a speech at the UN General Assembly. He states that the risk of policing banks in the Caribbean on compliance to the rules is too high and that the business they get is too low.
It also appears that the Caribbean has been labelled as tax haven by the US government and the EU which is also causing the big banks in the US to consider the risk of having a correspondent banking relationship in this jurisdiction too high. This does appear however, according to Ronald Sanders, the Ambassador Plenipotentiary to the United States and the Organisation of American States for Antigua and Barbuda, to be incorrect. He states in an article that all Caribbean countries, except for two, are ‘signatories to the US Foreign Account Tax Compliance Act (FATCA) which obliges them to report US citizens or companies that store financial assets with them’.
FATF have also issued several public statements clarifying its position on de-risking and the decline in correspondent banking, and have stated that de-risking ‘should never be an excuse for a bank to avoid implementing a risk-based approach, in line with the FATF standards’. They have also emphasised that they don’t expect correspondent banks to perform KYCC (know your customer’s customer) on their respondents. Then in October 2016, they issued guidance for correspondent banks to address de-risking by explaining the FATF’s position on several points, including the risk-based approach.
It seems a bit unfair however for big US banks to be concerned about AML/CFT issues in the Caribbean as, in the last two FATF mutual evaluation reports (MER) of countries in the Caribbean (Trinidad and Tobago and Jamaica), they were only found to be non-compliant with two of the Recommendations. Whereas in the most recent MER of the US, they were found to be non-compliant with four of the Recommendations, double that of the two Caribbean countries mentioned above.
What can be done?
From a Caribbean perspective, a good starting point would be to strengthen their AML/CFT frameworks and bring them up to international standard. Although they are compliant with more of the FATF Recommendations, implementing the same AML/CFT policies and procedures as the US (where most of the banks conducting the de-risking reside) and making these frameworks more visible could help show that they are committed to fighting money laundering/terrorist financing and help to address the correspondent banks concerns.
In a speech at the Conference on the Withdrawal of Correspondent Banking Relationships, IMF Deputy Managing Director Tao Zhang suggested that to combat the non-profitability of the small Caribbean banks to the big US banks, the small banks could consolidate their banking systems and ‘bundle transactions’ to generate the scale that that big banks require to maintain a relationship.
Communication, information sharing and increased transparency must be embraced to improve the information flow between correspondent and respondent banks and these channels must be strengthened to ensure future communication. This could start an effective dialogue between both parties which will increase awareness of each other’s challenges and concerns. Sharing information more efficiently will help to reduce the correspondents due diligence costs and increase the profitability of these relationships.
Another way around the issue of the high cost of compliance for correspondent banks could be a ‘KYC utility’. This is a central database/platform where a customer’s data is entered and can be viewed by member institutions. This could dramatically reduce the cost of CDD and compliance for correspondent banks, making them more likely to maintain a relationship.
Although de-risking can happen for a multitude of reasons, it is evident that measures put in place to tackle money laundering/terrorist financing are actually contributing to some correspondent banks exiting their relationship with financial institutions in the Caribbean. This, in turn, is forcing some financial institutions underground to use higher risk and unregulated routes for transferring funds which could actually have the opposite effect and encourage money laundering/terrorist financing.
However, it’s not just down to the financial institutions in the Caribbean to prevent this from happening. The correspondent banks have a responsibility too and until they start contributing to preventing de-risking, the situation in the Caribbean doesn’t look set to improve. The global implications of de-risking may not be so visible right now, however there are fears if they are not addressed they could become systemic.
Would you like to develop your knowledge on the subject?
The ICA Certificate in Money Laundering Risk in Correspondent Banking provides you with an opportunity to understand the fundamentals of correspondent banking. You will look at the inherent money laundering risks and develop skills that will help you recognise potentially dangerous situations in correspondent banking relationships before they escalate into what could become major events.