April 10, 2018 Andrew Tarpey



As anyone involved in the world of financial compliance can tell you, maintaining regulatory compliance and staying up to date with the latest trends, laws and regulations in this field can sometimes seem to be a never ending pursuit. However, though it may be time-consuming, and at times costly and burdensome to businesses, noncompliance can have devastating results for a company, resulting in a tarnished reputation, loss of clients and revenue, and heavy fines from government regulators. Financial institutions have realised the importance of installing a compliance program which is up to date with the latest in anti-money laundering (AML/CFT) and Know Your Customer (KYC) requirements. There is always room for improvement, however, and staying on top of the trends in this industry can lead to better performance and growth for a company.

Here we’ll take a look at the trend of de-risking, in which businesses are severing relationships with groups of clients in a particular industry due to the high level of risk that this association causes.

“De-risking” (also referred to as “de-banking”) has been a method embraced, for better or worse, by many companies concerned with adhering to AML/CFT requirements.  De-risking is a trend in the industry which involves banks and other financial institutions terminating relationships with entire sectors of clients that are deemed to be high risk. The theory behind this is that by disassociating itself with an entire client type, a financial institution will lose business and income, but this loss will be offset by not having to deal with the increased risk and compliance cost that is part of doing business with a high risk client base.  In recent years, the sectors that are being exited for this reason include embassies and other foreign missions, charities, and money service businesses (MSBs).

Embassies and the diplomats who work for them have been subject to de-risking due to the fact that many countries are deemed to be higher-risk for AML/CFT purposes, especially those from the Middle East and Africa, regions which are more likely to be involved with terrorist financing. Financial institutions see a high money laundering risk in having customers who conduct regular banking transactions with these parts of the world, and this places a greater compliance burden on the bank to monitor transactions to ensure they are not for illegitimate purposes or conducted with nefarious individuals. Also, many individuals who work at embassies are classified as politically exposed persons, which from an AML perspective means they are higher risk due to their potential association with bribery and corruption. Banks’ refusal to continue banking relationships with this sector presents real problems for embassies and diplomats who have great difficulty getting access to banking services, but governments have limited ways to resolve the issue, as they cannot force banks to offer banking services to anyone they don’t wish to do business with.

Charities are also facing the same issue of unwanted bank account closures.  Charities with links to countries that are deemed to be high risk have found their accounts shut down by banks, sometimes with little or no warning or explanation as to why.  The FCA, the UK’s main bank regulator, issued a report in 2016 that they predicted a massive amount of de-risking of banking services for charities which would result in thousands of accounts being shut. Of course, this can be a devastating blow for charities who rely on these banking services for their lifeblood. For charities who provide humanitarian services in impoverished countries, the inability to fund their basic operations can mean dire consequences for those who rely on their services. Banks, however, see a money-laundering risk in providing services to entities whose funding can come from all over the world and who receive donations from individuals and entities who can’t be verified or vetted. Add in the fact that providing banking services for charities and non-profit organizations produces relatively little revenue for financial institutions, and the appetite for banks to continue these relationships diminishes even more. For its part, the Financial Action Task Force (FATF), an intergovernmental organization which provides recommendations for governments to combat money laundering and terrorist financing, has described de-risking as “a serious concern” to non-profits and has said that it is the result of an overreaction to regulations.  However, the trend of financial institutions disassociating themselves from charities operating in high risk countries has showed no signs of slowing down, driven by the desire to avoid large fines from regulators due to lax AML/CFT  controls and the negative publicity that comes with this.

Money services businesses (often referred to as MSBs) have also faced difficulty in the current anti-money laundering environment.  The term “money service business” describes non-banking institutions that transmit or convert money, such as check cashing entities; money transmitters, currency dealers or exchangers; and issuers or redeemers of money orders or stored value cards.

MSBs mainly provide their services to the portion of the public that don’t hold bank accounts. However, in financial institutions’ desire to avoid costly and burdensome AML/CFT compliance requirements, many have decided to cut ties with MSBs as part of their customer base. Although MSBs are government-regulated, often by the same regulators as banks, they deal in high volumes of cash and often conduct currency transmissions to foreign countries, two AML/CFT factors which raise their risk level. As with embassies and charities, many financial institutions have decided that the enhanced AML/CFT oversight that is required in banking MSBs isn’t worth the benefits of keeping them as customers.  However, as with embassies and charities, there could be downstream effects when MSBs struggle to retain banking services.  In the United States, approximately one in four households use an MSB, mainly low-income individuals who for various reasons don’t have a bank account.  If MSBs struggle to stay afloat due to a lack of access to the traditional banking system, many of the transactions they facilitate could drive large numbers of customers into unregulated, underground financial transactions. When this means one-quarter of the households in the United States alone, it’s quite obvious that the volume of customers and amount of money moved is quite large, and society as a whole would benefit if this money movement didn’t fall into the hands of unlicensed, unregulated black market alternatives.

De-risking has also affected the industry of offshore trusts and international business companies (IBCs), which are companies often used to conduct banking, international trade, or investment activities. The nation of Barbados has already felt de-risking’s effects in this manner.  Barbados, an island nation in the Caribbean with a population of approximately 285,000, has a strong offshore financial sector which is an important contributor to its economy.  Many small countries similar in size to Barbados have had their banks’ correspondent banking relationships severed with larger banks in the United States, Europe and elsewhere due to the American and European banks fearing that these banking relationships with smaller countries pose a money laundering threat.  The issue with banks in Barbados isn’t that they have had banking ties severed with economic heavyweights such as the United States and Europe; indeed, the number of banking relationships with larger countries which have been lost is minimal.  However, fear of losing these banking ties to larger countries has caused banks in Barbados to proactively exit relationships with many of its clients on the island, and this includes clients in the offshore financial sector such as IBCs.  The establishment of IBCs plays a major part in the strength of the Barbadian financial sector, and provides much to the island in the way of employment for its residents and tax revenue for its government.  However, in recent years there has been a noticeable decline in the renewal of IBC registrations in Barbados, a decline which some attribute to difficulties that IBCs have in establishing and maintaining banking relationships.  Between 2013 and 2016, the number of IBC license renewals declined by over 15%.  This has been attributed to money laundering fears tied to de-risking, as Barbadian banks see more risk than reward in having IBCs as customers.  It’s not hard to see the domino effect this can have on an economy that has a strong reliance on the establishment of offshore entities like IBCs.

Financial institutions seem to be stuck between a rock and a hard place with regards to de-risking.  On the one hand, government regulations require them to be vigilant against any potential instances of money laundering flowing through their accounts, and they are encouraged to
reduce their exposure to risk. At the same time, there are those critical of de-risking practices as they eliminate access to the banking system for large numbers of individuals and entities who are not engaging in anything illegal. What it often comes down to is the bottom line, and for many financial institutions, the cost and burden of maintaining relationships with groups of high-risk clients simply isn’t worth the benefit of maintaining them.

Andrew Tarpey

Andrew Tarpey is Southpac's Compliance Officer. He is responsible for ensuring AML and financial best practice is followed throughout the business.
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