> Posted by Center Staff

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Customers wait to collect money at the Juba Express money transfer company in Mogadishu, Somalia. 

This post is part of a series examining the global phenomenon of de-risking and its impact on financial inclusion. To investigate this issue, CFI staff partnered with Credit Suisse Global Citizen Rissa Ofilada, a compliance lawyer based in the Philippines, to undertake a comprehensive literature review and conduct interviews with key players in the conversation on de-risking.

Are anti-money laundering and counter-terrorism financing (AML/CTF) rules to blame for de-risking and the resulting financial exclusion? A World Bank survey of financial institutions says, “probably.” The survey respondents listed concerns about money laundering and terrorism financing risks, including the imposition of international sanctions pertaining to AML/CTF. To say the least, the de-risking phenomenon has huge implications for the advancement of financial inclusion in our current geopolitical climate.

De-risking has been defined as the trend of financial institutions terminating or restricting business relationships with clients or categories of clients to avoid, rather than manage, risk. This can take the form of: restricting or terminating correspondent banking relationships (CBRs) where one bank provides services to another; restricting or terminating money transfer operators (MTOs); and restricting or terminating the accounts of individual clients deemed to be risky. It’s important to note that recently “de-risking” as a term has been called inappropriate by some as there may be other reasons why, to give one example, CBRs are terminated. Nevertheless, we use it here as it is the most commonly used phrase to describe this phenomenon.

According to the Financial Action Task Force (FATF), the global body charged with policing terrorism finance and other security threats, the drivers of de-risking are complex and include:

  • Regulatory burdens – There is an overwhelming sense in the industry that regulations and sanctions related to the implementation of AML/CFT requirements are excessive and prohibitive for many institutions interested in engaging with the client bases often excluded by de-risking.
  • Reputational risk – Non-compliance with AML/CFT requirements can extend beyond the financial costs of enforcement actions and can potentially damage an institution’s reputation, negatively affecting relationships with investors and stock prices, among other detriments.
  • Lower risk appetites of banks – Banks’ risk appetites have largely declined since the 2008 global financial crisis, many institutions have opted to exit entire categories of relationships where a higher likelihood of connection to illegal activities exists.
  • Profitability – The core decision-making driver of financial institutions, by and large, remains cost-profit analysis. “According to a study conducted by the British Financial Services Authority in 2011, the banks surveyed appeared willing to maintain what appeared to be unacceptable risks related to the handling of the proceeds of crime if the relationships were profitable,” write Durner and Shetret in a 2015 analysis of de-risking. However, often the client base excluded by de-risking brings relatively low profitability, which is a key factor when paired with the costs of satisfying AML/CFT requirements.

But before coming to a conclusion about this issue in subsequent posts, let’s step back and see how we got here.

In 1990, the FATF issued the “Forty Recommendations” to combat the misuse of financial systems by persons laundering drug money. In 1996, revisions were made to include evolving types of money laundering. These recommendations were endorsed by more than 130 countries. In 2001, the FATF revised this list to incorporate combating terrorist financing, with the inclusion of “Eight Special Recommendations on Terrorist Financing.” In 2003, the “Forty Recommendations” were revised again, to include the monitoring and evaluation of countries’ adherence to international standards on AML/CFT. This update established the mutual evaluations by FATF and FATF-styled regional bodies, as well as assessments conducted by the International Monetary Fund  and World Bank.

So, what does all this have to do with financial inclusion? That is exactly the question proponents of financial inclusion around the world asked at this time—their fear was that all of these global standards would limit financial inclusion activities. To help enable expanded, appropriate financial account access, financial inclusion proponents called for a more flexible approach that would allow for innovations like reduced identification requirements for low-value accounts – i.e. proportionate requirements for less risky customers.

The FATF heard these concerns from the financial inclusion community, and in 2012, the “Forty Recommendations” were revised to adopt a risk-based approach in identifying, assessing, and understanding the money laundering and terrorist financing risks of each country. The approach is outlined by the FATF as follows:

Countries should apply a risk-based approach (RBA) to ensure that measures to prevent or mitigate money laundering and terrorist financing are commensurate with the risks identified. This approach should be an essential foundation to efficient allocation of resources across the anti-money laundering and countering the financing of terrorism (AML/CFT) regime and the implementation of risk-based measures throughout the FATF Recommendations. Where countries identify higher risks, they should ensure that their AML/CFT regime adequately addresses such risks. Where countries identify lower risks, they may decide to allow simplified measures for some of the FATF Recommendations under certain conditions.  

The FATF followed-up yet again in 2014 with some additional clarification on this risk-based approach.

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Sounds great, right? The problem is that there remains—two years later—uncertainty as to how to comply with the principles set by FATF. Our literature review and interviews with key players in the space indicates that neither national governments nor banking institutions have sufficient capacity to identify, assess, and understand the risks of engaging with particular population segments—and the consequences of working with population segments perceived as risky are just too great. For example, from 2011 to 2012 there was a 131-fold increase in fines and monetary settlements under deferred prosecution agreements, from $26.6 million to $3.5 billion. This latter figure includes a $1.9 billion settlement paid by HSBC to U.S. and U.K. regulators for inadequately monitoring wire transfers to Mexican drug cartels, and for violating sanctions through business with clients in Cuba, Iran, Libya, Myanmar, and Sudan. The potential and realized costs of serving these typically lower-income populations compared to the profits might just be too great. This trend has caused financial institutions around the world to be very conservative and caused them to close high-risk accounts based on sector or geographic considerations.

As a result, with little clarification on what exactly proportionate standards are, both national governments and individual financial institutions tend to avoid segments perceived as risky, particularly if they are not highly profitable segments.

What we know now, with a few years of evidence, is that de-risking has adversely affected the gains of financial inclusion, with some analysts concluding that it has resulted in the financial exclusion of certain populations. According to the Center for Global Development, those most affected are likely to include “the families of migrant workers, small businesses that need access to working capital or trade finance, and recipients of life-saving aid in active-conflict, post-conflict, or post-disaster situations.” There is mounting empirical evidence to show that it has resulted in the non-delivery of financial services—and especially payments—to specific groups of intended beneficiaries. For Mark Carney, Governor of the Bank of England and Chairman of the Financial Stability Board, de-risking is akin to “financial abandonment.” Federal Reserve Chair Janet Yellen told the U.S. Congress that the trend was causing “a great deal of hardship.” The Universal Financial Access (UFA) goal that by 2020, all adults globally have access to a transaction account or electronic instrument to store money, and send and receive payments – which we thought was attainable – is under serious threat, and in the countries most affected, there are serious humanitarian issues at stake.

De-risking may very well be the single biggest threat to financial inclusion around the world.

Stay tuned for our next post in our series on de-risking. We’ll be talking more about the role of the state of New York, whether banks themselves are to blame, and how governments are responding.

Have you read?

De-Risking: Why You Should Care?

Basel Committee Guidance on Financial Inclusion: Views from a Supervisor

Somalia: Facing Drought with Fewer Remittance Lifelines