For Somalis, U.S. Remittance Crackdown Cuts Deep

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First of two parts

Slowly but steadily, the list keeps shrinking.

First the bigger banks bowed out. As their regulators demanded more safeguards against money laundering and terrorist-financing schemes, these institutions could no longer stomach doing business with money transmitters that help Somali-Americans send funds to relatives back home.

Next to pull up stakes was a small bank in the Twin Cities, which is home to the nation's largest community of Somali immigrants.

And now a small West Coast bank that specializes in serving money transmitters is having second thoughts. Merchants Bank of California has informed numerous clients that send remittances to Somalia that their accounts will be closed at the end of September, according to three sources with knowledge of the situation.

Today, only a few U.S. banks are still doing business with Somali money transmitters, said Degan Ali, executive director of Adeso, an aid organization that is working to preserve the remittance pipeline. "Our fear is that the few remaining banks will follow suit and shut down accounts in the near future."

Inside the banking industry, it's no secret that the government's focus on anti-money-laundering and anti-fraud rules has tightened. Banks have been hit by delays of merger applications, subpoenas tied to the Department of Justice's Operation Choke Point probe and regulatory orders that restrict their revenue opportunities. In some cases they have responded to the scrutiny by cutting ties with business customers who are more likely to cause regulatory headaches.

The increasingly dire predicament facing the Somali money transmitters is both a typical and extraordinary example of the regulatory push's consequences.

While the government's efforts do offer protection from financial crime,they also carry significant costs for banks, their customers, members of the public and even the regulators themselves.

The stakes are far higher with respect to Somali money transmitters than they are for most other business lines affected by the ongoing crackdown. If the regulators push too hard, they may inadvertently precipitate a humanitarian crisis in Somalia. Fail to push hard enough, and they could have a deadly terrorist attack on their hands.

A Critical Lifeline

Somalia faces enormous problems. It's one of the poorest countries in the world. It's been enmeshed in civil war for more than two decades. Its central government is extremely weak, and various regions have de facto autonomy.

Given the ongoing warfare and the lack of central authority, it's not surprising that Somalia's financial system operates mostly outside of the government's watch. According to the U.S. State Department, Somalia has no anti-money-laundering laws, nor does it have any requirements for reporting suspicious transactions.

At the same time, Somali citizens are heavily dependent on money transfers from relatives who live overseas. Globally, Somali migrants send about $1.2 billion home each year, according to an estimate by Adeso and other aid groups, which also rely on the money transfer system in order to operate inside Somalia.

Somalis who receive cash from family members abroad are hugely dependent on that money. It comprises roughly 60% of the recipients' annual income, the aid groups estimate. And much of the money comes from the United States. Around 130,000 people of Somali heritage live in this country, according to the State Department.

There's also research suggesting that remittances offer a better way to help poor families in the developing world than foreign aid. A 10% increase in remittances led to a 7% increase in savings, according to one 2010 study that looked at countries in sub-Saharan Africa, while the same increase in foreign aid yielded only a 1.6% boost in savings.

The Money Flow

The Somali money transmitters, often called hawalas, are usually based in Dubai. In both the U.S. and the U.K., which has also been grappling with the question of how to maintain the remittance pipeline, the transmitters have agents in cities with large communities of Somali migrants. Firms with significant American operations include Amal Express, Dahabshiil, Kaah Express and Tawakal Express.

For most Somalis, hawalas are the only realistic way to receive cash from overseas. Their offices are scattered throughout the fractured nation, near where people live, and better regulated options are virtually nonexistent. Western Union has one office in the entire country.

From the customer's standpoint, the hawalas have two important advantages. First, the money arrives fast.

A U.S.-based agent collects the cash and uploads the transaction information into a clearinghouse, often in Dubai. Once the clearinghouse approves the transfer, a company agent in Somalia views the transaction information in an online system, and notifies the intended recipient, often by text message, that the funds are available. Within about 30 minutes of when funds are dropped off in Minneapolis, a relative in Mogadishu will have been notified to pick them up.

The hawala system is also cheap, at least compared with more regulated money transmitters. In 2013, Somali migrants to the U.K. paid about 7 pounds sterling to send 120 pounds home, according to a paper by researchers at Oxford University and the University of London. That compared to about 9 pounds for Nigerian migrants, 10 pounds for those from Ethiopia, and 12 pounds for Kenyan migrants.

The network of Somali money transmitters is "probably the most cost-effective remittance system in the world," Ali said.

Within this system, each individual remittance happens without any money being moved between countries. But over time, to reconcile their transactions, the money transmitters need access to the U.S. banking system, which they use to move to Dubai the large sums they collect here.

And no matter how much due diligence the hawalas perform on their U.S. customers, their anti-money-laundering programs have no way to fully compensate for the weaknesses in the Somali financial system.

"The one major impediment is the banking system in Somalia itself, which is in turmoil," says Robert Rowe, vice president and senior counsel at the American Bankers Association.

The Terrorist Threat

U.S. authorities are fervently seeking to prevent flow of money to Al-Shabaab, a terrorist group that's linked to Al-Qaeda and is at war with Somalia's central government. And there's reason to fear that the money transmitters may be used to finance Al-Shabaab.

"There's a huge amount of remittances that come in to support" Al-Shabaab, said Jonathan Schanzer, a former terrorism-finance analyst at the U.S. Treasury Department.

In October 2010, U.S. authorities charged Issa Doreh, a Somali immigrant who worked for a money transmitter in San Diego, with conspiring to finance terrorists.

Along with two cab drivers and an imam, Doreh was eventually convicted of funneling more than $8,000 to Al-Shabaab. Doreh played a key role in the conspiracy, using his now-defunct employer, Shidaal Express, to transmit funds that might be used to purchase land mines, ammunition or rocket-propelled grenades.

In October 2011, two Minnesota women were found guilty of raising money for Al-Shabaab. The women made door-to-door solicitations in Somali communities, sometimes claiming that the money was to help the poor and needy, and then lied to various remittances houses about who would be receiving the funds.

And last September, Al-Shabaab claimed responsibility for the attack on the Westgate mall in Nairobi, Kenya, resulting in 68 deaths.

That attack, which relied on assault rifles and explosives, probably cost less than $50,000 to carry out, according to Schanzer, who is now vice president for research at the Foundation for Defense of Democracies. "To have that kind of money moved does not take much at all," he said.

What's more, Al-Shabaab doesn't necessarily need sympathizers outside of Somalia to send it money intentionally in order to profit from the remittance system. A State Department report published early this year stated that the group has the ability to raise funds via the "taxation" and "extortion" of local businesses.

In other words, Al-Shabaab functions much like the Mafia. And Somali-based remittance agents, who essentially function as the bankers in a country without formal banks, may offer an attractive potential target for the terrorist group.

The U.S. government has a tool that could be used to shut down Somali money transmitters directly, without the involvement of the bank regulators. Specific hawalas could be added to the "specially designated nationals" list by the Treasury Department's Office of Foreign Assets Control; people in the U.S. are generally barred from dealing with "designated" organizations.

But any such decision would likely spark a sharp backlash in the Somali-American community, and among the hawalas, which say they have strong anti-money laundering programs.

How Far is Too Far?

Even the strongest supporters of the existing Somali money-transfer pipeline acknowledge that some funds inevitably wind up in the hands of terrorists.

But they question the claim that large sums are getting to Al-Shabaab, and they argue that the impact of shutting down the current system would be far worse than the status quo. The price for preventing any seepage to Al-Shabaab would be too steep, they say.

"We come from a region where a lot of people rely on these small remittances for their food for their shelter, for their children's education, for their medical needs," said Aden Hassan, the Bank Secrecy Act compliance officer at Kaah Express, one of the largest Somali remittance houses in the U.S.

"There are families out there, millions of them, who will not have food on the table the day that remittances stop."

If that's the reality, what would happen if Kaah Express and its competitors lost their access to the U.S. banking system? According to Hassan, the flow of cash into Somalia would likely continue, but through illegal means. Think cash-filled suitcases.

"Somehow it will continue, and I suspect it will be through illegitimate, underground means," Hassan said.

Carol Beaumier, a former bank examiner at the Office of the Comptroller of the Currency, agrees.

"Somehow the money's going to move," said Beaumier, who is now with the consulting firm Protiviti. "I think that's a concern whenever the traditional financial system doesn't want to provide a service."

A black market would be bad news — and not only for its customers, who would likely pay higher prices for a less reliable service. It would also be damaging to Western authorities, who would have less ability to see the flow of cash into Somalia.

As a report commissioned by the U.K. government in 2013 concluded, forcing money transmitters underground can be "highly counterproductive," since it becomes "even harder to trace criminality and terrorism."

Parallel with 'Choke Point'

The bind in which Somali money transmitters currently find themselves is part of a wider anti-money laundering crackdown by U.S. regulators, which is also affecting remittance providers that serve other parts of the globe.

The money transmitters' plight has strong parallels to the predicament facing some check cashers and payday lenders, which have also lost their banking relationships in recent months.

SunTrust Banks, Capital One Financial and Fifth Third Bancorp have all terminated their accounts for payday lenders this year, in what appears to be at least partly a reaction to the federal probe known as Operation Choke Point.

In both situations, the regulators insist that the banks ultimately have the choice about who their customers will be, despite a seeming shift in the regulators' expectations. In turn, the regulators are taking heat in both cases for what critics say is a backdoor method of stigmatizing or even banning disfavored industries.

In both instances, banks have sent vaguely worded letters to their customers abruptly ending the relationships.

And the same clunky verb — "de-risking" — is being used to describe the process by which banks are terminating their relationships with check cashers, payday lenders and money transmitters.

The comparison has its limits: check cashers that lose their accounts are generally able to find new banks, which will not necessarily be true for Somali money transmitters. And ultimately, the human stakes inside Somalia are much higher than they are for domestic firms affected by Operation Choke Point.

But Jay Postma, who heads a consulting firm that specializes in compliance requirements for money services businesses, said the two trends are related. Money transmitters and firms that do check-cashing, a category that often includes payday lenders, are classified under the same regulatory umbrella as MSBs.

"The banks are under tremendous pressure from the regulators, who often don't understand MSBs," said Postma, president of MSB Compliance, Inc. "The bar is getting higher and higher. And the question is: is it reasonable to have the bar set that high?"

Banks Back Out

Since the terrorist attacks of Sept. 11, 2001, and the subsequent passage of the Patriot Act, which tightened banks' anti-money-laundering duties, bank after bank has pulled out of the Somali money-transfer business, despite the high fees these accounts generate.

Larger banks with ties to the Twin Cities — Wells Fargo, U.S. Bancorp, and TCF Financial — pulled out first. Then in 2011, Sunrise Banks — a $909 million-asset institution based in St. Paul — suspended business with money transmitters.

In April 2012, Minnesota-based Somalis organized protests against some of the banks. But as time has passed, more of the blame is being laid at the feet of the regulators.

While the hawalas provide strong fee income for the few banks that serve them, those benefits are being outweighed by the regulators' perception of the risks involved in the business, according to Hassan. "So at some point, the bank will say: Is it worth it?"

Rep. Keith Ellison, D-Minn., is the leading advocate in Congress on behalf of Somali migrants who rely on money transfer businesses. He recalled a conversation with a bank executive who said the problem is not the cost of complying with regulations, but rather the lack of a clear rule that banks can apply consistently.

"It's not a bright-line rule, it's not altogether clear," Ellison recalled the banker telling him. "And yet, if a regulator comes behind you and thinks you're wrong, you could end up paying dearly for that."

Merchants Bank of California, a $95-million institution based in Carson, Calif., has carved out a niche in serving both check cashers and money transmitters. So alarm bells went off inside the Somali-American community when Merchants sent letters to numerous money transmitters saying that their accounts would be closed soon.

Merchants Bank, which signed a consent order with the OCC in June over its Bank Secrecy Act compliance, declined to comment for this story.

"I think Merchants is looking for a way to continue to service these businesses. I don't know if it's been able to find one," said Scott Paul, a policy advisor at the aid group Oxfam America, which has been working to keep the Somali money-transfer pipeline open.

While a couple other small banks are still in the Somali remittance business — sources declined to identify them — they are viewed as likely to be more susceptible to pressure from their regulators.

"Neither of them view money services businesses as their core business," Paul said.

Next: The U.S. government's role on Somali remittances.

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