A wave of retrenchment by global financial institutions may be undermining years of progress in providing the world’s poor with financial services.
What appeared to be only a vague concern a year ago is now front and center in discussions regarding global financial regulation. The reason: new regulatory and legal uncertainty regarding financial services, stemming from record fines levied on a handful of banks for failures to comply with international sanctions and anti-money laundering rules. A recent successful civil action in the U.S. against Arab Bank has further increased banks’ worries about their possible civil liability. Rightly or wrongly, the financial industry is reading these actions as raising the bar for compliance. As a result, we are seeing key and vocal market players use these developments to justify a wholesale retreat from services that are a lifeline for millions of people at the bottom of the economic pyramid.
For example, late last year a big bank in Australia sent letters to companies providing remittance services laying out a stark choice: close their accounts, or the bank would unilaterally shut them down. Accounts held by remittance companies have also been closed by banks in the U.K., the U.S., and New Zealand. If these remittances providers do not find alternatives, we may experience a global reduction in remittance services, and—due to reduced competition—increased cost to use those that remain in operation.
Remittance services are not the only targets. Trade finance and civil society organizations have also been affected. For instance, in the Netherlands an NGO involved in supporting the peace-building work of women’s groups and women leaders in the Middle East and North Africa was recently refused a bank account by a large international bank. After the NGO explained to the bank that its work entails working with partners in the region, the bank decided not to provide a bank account in order to avoid any risk of funds (indirectly) ending up in Syria. And there are many examples like this, hampering the work of NGOs and humanitarian organizations, particularly in areas of conflict where they are most needed. In recent months, stories like this have become too numerous—and too widespread geographically—to be ignored; this is a global phenomenon.
This trend of account closures has become known as “de-risking”—a term that confuses more than it clarifies. Risk management, when properly carried out, is an essential and healthy component of running a bank. Under international financial industry norms, banks are expected to use a risk-based approach to evaluate whether to do business with a potential customer, and to monitor transactions for signs of suspicious activity. If there is a reasonable basis to believe a particular client creates significant risks regarding money laundering (ML) or terrorist financing (TF), a bank is fully justified in ultimately refusing to offer services.
“De-risking,” however, is very different. The influential Financial Action Task Force (FATF), the standard setter for combating money laundering and terrorist financing, noted in an October 2014 statement that “de-risking refers to the phenomenon of financial institutions terminating or restricting business relationships with clients or categories of clients to avoid, rather than manage, risk.” The result, criticized by FATF, is the “wholesale cutting loose of entire classes of customers.”
Our concern lies not with the principle that some clients may be too risky for banks. Rather, the problem is the magnitude of de-risking. Current de-risking measures are excluding many clients that conduct legitimate transactions. And, because de-risking ends up pushing clients and transactions towards the informal and shadow financial system, it can actually increase global risks in this area.
It is therefore urgent for the international community to act. We need to better grasp what is really happening, and why. We believe that the solutions going forward will have to build on three pillars:
- Public authorities need to provide more meaningful information on ML/TF risks to the financial industry, clarify their regulatory expectations, and adopt a genuinely risk-based approach in their supervisory and enforcement actions.
- Financial institutions need to step up their understanding of the risks of their customer base, and direct internal control efforts accordingly. Risk management approaches should focus more on individual clients, and not write off entire sectors.
- Countries with significant inflows of remittances need to improve the effectiveness of their regulatory regimes to combat ML/TF, and to provide more comfort to global financial institutions with banking relationships with clients in the developing world.
Millions of people in developing countries depend on remittances to help pay for basic necessities like food and shelter. In recent years we have seen important progress with banks and mobile network operators introducing innovative ways to serve the poor—including “mobile money” solutions that have enormous potential for enabling cross-border transactions. It would be a shame to see that trend reversed. Let’s not have those at the bottom of the economic pyramid pay for the criminal behavior of a few, and let’s make sure that enforcement action really targets the “bad guys.” Preserving access to the global financial system for the poorest and most vulnerable is a critical imperative, both economically and ethically.