In a global landscape fraught with financial crime and well-funded terrorist operations, combating money laundering has rightly become a priority for the banking community. Tightening regulatory requirements have made nine- and 10-figure penalties familiar occurrences. Global banks everywhere are being put on notice: stamp out money laundering or face the consequences.
But as regulators have pursued stricter enforcement, banks have struggled to comply with the mounting regulatory burden. An international bank may have to navigate many moving goalposts and overlapping rules, doubly so if it works in markets where multiple jurisdictions apply. The more correspondent relationships a bank has, the more complex the regulatory oversight becomes and the harder it is to ensure effective and rigid internal controls. Moreover, maintaining thousands of correspondent banking relationships around the world comes at a high price, whether or not these entities pose significant risks. In such an environment, banks that maintain correspondent relationships in higher-risk environments find themselves caught between the rock of exorbitant penalties and the hard place of escalating compliance costs.
Some banks have made the rational decision to sever a number of correspondent banking relationships in order to reduce both risks and costs. As a result, they have pulled out of certain markets and implemented systemic, wholesale closures of correspondent bank accounts. De-risking, as this process is known, has disproportionately affected small countries with developing financial regulatory environments, especially in Africa, Latin America and the Caribbean.
The unfortunate irony of de-risking is that it hurts the banks and countries that most depend on access to the international banking system. When small regional banks lose their correspondent relationships, they lose access to foreign currency, a vital resource for customers operating in a global economy. Without the ability to provide clearing, handle remittances or offer other services involving cross-border transactions, these banks become dependent on other sources of liquid capital that bring even greater risk.
In addition to stifling banks and discouraging potential customers, de-risking has driven capital into riskier environments. Legitimate customers who have been de-risked must still address their financing needs. Many turn to so-called shadow banking channels that may be unmonitored or nonregulated and where legitimate monies may freely mix with illicit funds before making their way back into the core financial system. De-risking isolates entire regions from the global banking system, while only pushing illicit activity further underground. It renders efforts to contain money laundering worse than ineffectual — and actually harmful.
Not only can de-risking have a significant impact on banks, but it can also impact their end customers. If countries are cut off from the global financial community, the consequences to individuals can range from inconvenient to life-threatening. It can inhibit families from sending important funds to relatives abroad, obstruct the purchase of life-sustaining goods and block payments for education or medical care.
When it comes to solving de-risking, there is no single panacea in a system as complex as the global banking network. For its part, the global banking community must do what it can to reverse the crisis, whether by providing timely communication about compliance gaps or by working together with respondents to increase transparency levels.
Regional banks that know they are in perceived high-risk areas can improve their levels of transparency by collaborating through utilities and other shared repositories of customer data to expand anti-fraud protections while cutting compliance costs. When faced with the imminent prospect or aftermath of being de-risked, a bank can make improvements to its transparency regime that will make it an attractive respondent to mid-tier correspondent banks.
Adopting the Financial Action Task Force’s recommended standard for originator and beneficiary details in payments messages (FATF Recommendation 16), for instance, can help remedy the widespread deficiency in transparent payments message information. By including full originator and beneficiary information for every cross-border wire transfer, banks can increase transparency and put their correspondent banks at ease.
The industry needs to respond with a proactive solution to the crisis it faces. As banks around the world pull out of developing countries and sever thousands of correspondent relationships in the name of de-risking, we must ask where we can strike a healthy balance between the safety measures that keep illicit funds out of our financial networks and the health of the banking systems of entire regions.
Paul Taylor works for Swift (the Society for Worldwide Interbank Financial Telecommunication) as the global head of business development and head of financial crime compliance initiatives in the Americas, United Kingdom, Ireland and the Nordics.