AML and De-risking: How to Square the Circle
13 Feb 2016

Regulatory investigations specialist Tom Devlin considers the tension between de-risking and the global fight against financial crime

If the billions of dollars in fines imposed on banks for failings in money laundering and terrorist financing compliance have achieved nothing else, they have begun to persuade them, finally, to clean up their act and stop doing business with bad guys in risky countries. As a result of the US regulatory arms race, by which different agencies seek to outdo each other in the competition for who can levy the biggest fines, the world’s leading banks are in headlong flight from whole countries which, only ten short years ago, they were climbing over themselves to get into.

HSBC no longer wishes to be ‘the world’s local bank’; its announcement in June 2015 that it would sell its Turkish and Brazilian operations followed a slew of similar disposals over the last couple of years. JP Morgan stated in February last year that it had exited around 500 correspondent relationships with foreign banks and even the once rampant Citi has been drawing in its horns, revealing plans to sell its retail banking businesses in 11 countries at the end of 2014.

In the argot, this is ‘de-risking’; exiting of whole business lines on the basis that it is easier to throw out a barrel of apples than to root through it for one or two bad ones which may lurk within, particularly when the apples were not especially profitable in the first place.

‘Good’, one might be tempted to conclude. It’s about time these lumbering behemoths, which for years now have failed to deliver the shareholder value that their global status used to promise, turned their backs on the frenzied empire building of the last decade and began to focus on fewer, more profitable markets.

But, for some time, banks have been more than simply businesses. Since the 1980s, they have also been the (sometimes recalcitrant) partners of western law enforcement, obliged by a relentlessly expanding corpus of laws to not only provide services to their customers, but also to tell tales on them to the authorities. And, despite the periodic beatings that they receive from their ‘partners’ in the police and the regulators, the product of their suspicious activity reporting regimes has been of immense value in the fight to combat financial crime and the financing of terrorism.

All of which should give us pause when considering who the winners and losers from the process of de-risking are likely to be. It is a not a policy which is advocated by government in either the US or the UK; in 2014 both US regulators and the global standards setting body the Financial Action Task Force spoke out against it, calling for a more calibrated, risk-sensitive approach.

De-risking is, however, undoubtedly a consequence of the more risk-averse climate in which banks now find themselves operating, the roots of which lie in blockbusting fines and inflexible regulations overseen by the very regulators and standards setters now speaking out against the process.

To the extent that there was any clear ambition for the future in the swingeing fines to which the industry has been subject (as opposed to vengeance for past mistakes) it was this: to encourage banks to weed out the few genuinely very risky clients on their books, and properly risk manage the rest. Instead, banks have decided to simply withdraw their services from whole swathes of customers, some of whom are risky, some not. Typically the customers most affected will be retail clients in ‘higher risk jurisdictions’ or domestic customers with characteristics that make them ‘high risk’, such as religious charities and money services businesses.

When viewed from the perspective of the banks, the emergence of de-risking was not only predictable; it was the most obvious rational response to the blunt instrument of gigantic fines.  When viewed from the perspective of the interests of wider society – both here and in the countries which are becoming ‘unbanked’, however, de-risking is a disaster.

The main reason why money laundering rules and regulations were imposed on the financial services industry was so that law enforcement could keep tabs on, and disrupt the flow of, criminal funds.  As a result of de-risking, big, well-organised, and well-resourced banks, the very institutions best placed to help law enforcement keep track of the dirty money swirling around the globe, are no longer dealing with those markets that carry some of the highest risks of terrorist financing and financial crime. The flows of money that law enforcement are most interested in are instead pushed into opaque and unregulated channels out of sight of the authorities, or into smaller national banks with limited ability and desire to cooperate with the US.

In an age in which, thanks to the internet and other technologies, governments enjoy surveillance powers over other aspects of individuals’ lives beyond the wildest dreams of the Stasi, this abrupt termination of the flow of financial information ranks as a spectacular own-goal and risks sending international anti-money laundering efforts into reverse.

But the impact on law enforcement is not the only danger that de-risking brings. It has also caused real suffering for some of the world’s poorest communities, particularly those with family members living and working abroad who find it increasingly difficult to remit funds to their home country through legitimate channels.

Throughout the developed world many of the most poorly paid and dangerous jobs are performed by migrant workers from poorer countries. Over the last couple of years, migrants living in wealthy jurisdictions have found that charges to remit money back to countries like India, Bangladesh and the Philippines have rocketed. In many instances, western banks have closed their accounts altogether.

The frustration that this causes was eloquently voiced by a senior member of one of the Middle East’s central banks: ‘these people want to send perhaps $200 home per month. Their identity documents are in order and they have wage slips from their employers to show where the money has come from. And the banks are just not interested. A money broker, if they can find one, may now charge $30-$50 to transfer $200. So these people are sometimes having to physically fly home just to get cash back to their families.’

In 2015, the last US bank willing to do business with Somali money-transfer agents ceased performing transfers, leaving the millions of Somalis living and working in the US financially cut off from their dependents at home and risking the further impoverishment of a country which is already one of the poorest in the world.

Clearly we can’t have an entire country or community pushed out of the legitimate financial system.  So what is to be done?

The Financial Action Task Force (‘FATF’) has issued guidance on the proper risk-based approach that banks should take when complying with their anti-money laundering obligations and has clarified that wholesale de-risking is not in line with FATF standards. MONEYVAL, a European body similar to FATF, has said that European countries should take into account de-risking, and the associated concept of financial inclusion, when producing their respective ‘national risk assessments’. These are nudges in the right direction but banks around the world will need more than a nudge to change their ways.

One possible solution is for governments to step in where private companies will not. A state-run institution could provide banking services to those customers perceived as high risk and unable to bank elsewhere. It could shoulder the regulatory and reputational risks that come with banking customers discarded by other financial institutions and, by designing its financial crime prevention architecture with the aim of dealing with such customers from the outset, minimize its own chance of becoming a statistic.

In the UK, when Barclays said it was closing down accounts held by Somali money transfer businesses the government announced that it would work with the World Bank on a ‘Safer Corridor’ initiative for payments to Somalia using risk mitigation measures such as biometric identity cards for recipients; it remains to be seen if this will bear fruit.

Another solution would be for regulators to declare a threshold for transfers, below which not only would there be less onerous requirements on financial institutions, but also, crucially, reduced or capped penalties if there was abuse of the system, provided that banks could demonstrate that they had carried out the required anti-money laundering measures correctly. If this threshold level were set at, say USD 1,000 per customer per month then at least the world’s poor would still have a chance to make the remittances on which whole economies in the developing world depend.

In fact such an approach is currently being piloted in South Africa. At the start of June 2015 Finance Minister Nhlanhla Nene approved an exemption from the country’s Financial Intelligence Centre Act for certain cross-border remittances. Foreign workers in South Africa were finding it increasingly difficult and expensive to send money home to other African states as banks and other financial institutions struggled to comply with rules aimed at combatting money laundering and terrorist financing. The change to the rules will mean that financial institutions will no longer be required to obtain proof of residence or a South African tax number for cross-border transactions less than ZAR 3 000 a day or ZAR 10 000 (approximately GBP 500) per month.

A balance must be struck: the response to historic bank failures in relation to money laundering and terrorist financing rules cannot be allowed to lead to the vulnerable being unable to use banking services and authorities unable to track illicit money flows. The recent allegations of bribery surrounding FIFA and the IAAF should not result in other international sports organisations being unable to get a bank account. What we need is for financial institutions to pay proper attention when it is warranted and, at one remove, for regulators to give more credit to those firms which adopt a responsible approach to the risk management of their customers.

Tom Devlin is a partner at Stephen Platt & Associates LLP, a firm which conducts investigations for financial regulators worldwide.

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