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Correspondent banking: Are we heading towards a crisis?
Regulatory pressure and the burden of compliance have increased to such an extent that correspondent banks are now routinely taking the decision to reduce their number of global banking relationships
Correspondent banking is undergoing a critical challenge to its status quo. Regulatory pressure and the burden of compliance, particularly with regards to Anti-Money Laundering (AML) and Counter-Financing Terrorism (CFT), have increased to such an extent that correspondent banks are now routinely taking the decision to reduce the number of global banking relationships they maintain.
With the fines for regulation breaches now so severe (for example, in 2012 HSBC was fined $1.9bn following accusations of money-laundering in the US), and cost of compliance so high, the financial incentive simply isn’t there for banks to sustain the correspondent banking network they had grown previously. Add to this the level of confusion banks complain of due to inconsistent interpretations of the regulations (Standard Chartered, BNP Paribas, ING, and Barclays are just some of the banks that have received fines due to varying interpretations of regulations) and at least on one level it is easy to see why correspondent banks are scaling back the breadth of their operations.
The most obvious example of this is in the US. US regulators are exerting stringent legislation on correspondent banks that in turning are protecting themselves from non-compliance by shutting off services to overseas financial organisations and businesses that are complying with their local regulators.
This process, known as de-risking, where correspondent banks are choosing to reduce the number of financial institutions and businesses they process transactions from, could potentially have a dramatic impact on international trade, financial inclusion, and remittances.
“Where local remittance firms are being driven out of the market through de-risking, the reduction in competition has resulted in the cost of doing business creeping back higher.”
The risk to international trade
Perhaps the most obvious impact of a reduction in overseas banking facilities is its negative influence on international trade. The consequences of this are already visible in some areas of the globe; according to the IMF, SMEs in Latin America and the Caribbean have endured an increase in cost of financing, in addition to losing access to credit from US exporters.
Where local remittance firms were once helping to drive down prices for exporters in third world countries, the cost of financial services is now on the rise. Where local remittance firms are being driven out of the market through de-risking, the reduction in competition has resulted in the cost of doing business creeping back higher. This is stifling businesses’ ability to flourish, and is therefore a downward force on economic growth.
With such a clear correlation linking trade share to income per capita (evidence shows that a 1% increase in a country’s trade share raises income per capita by 2%) there should be a genuine concern that de-risking could lead to increased poverty in developing countries. Financially excluding countries or regions to the extent that there is no access to international finance has been recognised as a trigger for terrorism and anti-money laundering activities.
“Save the Children, the Red Cross, and Christian Aid are just a handful of the organisations that have complained about the difficulty in transferring funds to countries such as Syria that are desperately in need of financial aid, despite having been approved to do by American regulators.”
A decline in remittances and charity overseas funding: A humanitarian crisis on the horizon?
A second consequence to a fall in the global breadth of financial services is the limitations this is putting on personal remittances. The size of remittance industry continues to grow as more and more people, particularly from emerging countries, move overseas to work and provide money for their families, but servicing the demand is becoming an increasing problem. At $432m, this critical source of finance was three times the value of foreign aid in 2015; disrupting this financial flow has serious implications for poverty in countries that rely on remittances as a major source of GDP.
This threat to quality of life in the developing world has not prevented de-risking operations from escalating. According to IMF figures Money Transfer Organisations (MTOs) account for over 90% of international remittances in many markets, and it is these financial services that are being hit hardest by correspondent banking de-risking. In 2013 more than 140 UK-based remittance organisations had their accounts closed by a major high street bank, and this trend is evident globally, with MTOs in the Pacific and MENA regions particularly affected.
This developing humanitarian crisis is compounded by the fact that charities are also encountering resistance in delivering aid to the countries that need it the most. Save the Children, the Red Cross, and Christian Aid are just a handful of the organisations that have complained about the difficulty in transferring funds to countries such as Syria that are desperately in need of financial aid, despite having been approved to do by American regulators. For smaller charities the situation is worse; AML/CFT regulations have meant that many have been de-risked by banks altogether.
And it is not even clear that the regulations are having the desired impact, without factoring in the significant cost the AML/CFT measures is causing civilians in third world countries to suffer. According to an Oxfam report, the current regulations are being complied with by banks in such a way that is having an adverse impact on financial inclusion, and that “overly restrictive AML/CFT measures may negatively affect access to financial services and lead to adverse humanitarian and security implications.”
At the same time, “rather than reducing risk in the global financial sector, de-risking actually contributes to increased vulnerability by pushing high-risk clients to smaller financial institutions that may lack adequate AML/CFT capacity, or even out of the formal financial sector altogether.”
Where do we go from here?
Moving forward regulators need to rethink how to approach the issue of terrorist financing and anti-money laundering when it comes to cross border payments, and that starts with having globally recognised regulatory standards for AML/CFT compliance.
Clarity and the reduced threat of huge fines should encourage banks to slow down their de-risking strategies, but if the financial incentives to maintain certain clients still are not apparent political pressure will be required to ensure the correspondent banking network remains fit for purpose.
In addition to aligning regulatory standards so that banks have a single threshold test to meet, better training must be provided to banks on how to interpret and apply the regulations in a way that doesn’t compromise the network, and the network itself must be more transparent, in order that better accountability is levied upon banks that are overly decline transfers or de-risking.
