WRITTEN BY ALISE ELLIOTT

The 2008 Financial Crisis marked a turning-point in banking practices. With regulatory requirements for financial institutions increasing and retrospective penalties for improper practices being imposed, banks were placed under somewhat of a burden. While the pre-crisis approach to terrorist crime was somewhat lax, it later came to the forefront of the legislator’s agenda. This article discusses the issue of de-risking – the incidental effect of increasing Financial Crime legislation.

What is a risk-based approach?

Banks are required to take a risk-based approach to financial crime. Institutions should identify and assess any risks which they are exposed to and develop systems to mitigate these risks. This approach was spearheaded by the Financial Action Task Force, who state that “implementation should be aimed at managing (not avoiding risks)”[1].

 What is de-risking?

De-risking is the removal of banking services from customers deemed to be ‘high risk’ under Anti-Money Laundering (AML) and Terrorist Financing (TF) legislation. It has seen record numbers of businesses be off-boarded – in particular international charities and money service businesses

It is estimated by the British Bankers’ Association that £5bn is spent annually on core financial crime compliance. This is excluding additional fines levied on banks for failing to meet prudential and conduct obligations, which has cost UK banks an estimated £53bn in the last 15 years. De-risking is a response to these increasing regulatory burdens placed on banks since the 2008 financial crisis.

De-risking – a risky business?

Whilst undertaken to protect an individual institution from regulatory risk, the wider consequences of de-risking are much more far-reaching.

Charitable Organisations

The FCA reported that in one bank, 2500 charity bank accounts were closed in 2015[2]. Only 59 of those were closed due to compliance concerns (John Howell & Co Ltd, July 2015). These closures have significant humanitarian effects. Inability to operate financially in high-risk jurisdictions cuts off charitable aid to local communities. Oxfam warns that this is “further isolating communities from the global financial system [and] exacerbating political tensions”[3].

Remittance Services

In May 2013, Barclays closed its money transmitter accounts and filed an injunction against Dahabshiil, one of the largest Somali remittance companies. Given that 25-40% of Somalia’s GDP is attributed to remittance services, the effect was economically damning. The decision to rescind contracts with these Money Service Businesses was attributed to reputational concerns – engaging in business with high-risk jurisdictions renders the bank susceptible to claims of abetting terrorism. In reality though, with 40% of Somalia’s population valuing remittances as a main source of income, it is the poorest communities being harmed.

Effect

An inevitable consequence of de-risking is the deprivation of vital charitable and financial services from already vulnerable communities. This will affect the financial industry globally. As high-risk clients are forced out of the formal financial sector, they turn to smaller financial institutions which lack the AML/TF measures inherent in the regulated sector. James Richards of Wells Fargo warns that “the ironic result of de-risking is re-risking… you are sending them to banks that probably can’t handle it”[4].

Is there a solution?

Regulatory authorities have repeatedly stated that de-risking is a misapplication of the risk-based approach and is out of line with international guidelines. However, in the absence of a clear definition, banks may exploit the ‘grey area’ and continue avoiding risk rather than managing it.

Supplementing the risk-based approach with clear principle-based guidance on how to manage high-risk clients is imperative. While the FATF provide recommendations on this, there is a large amount of scope for interpretation. The effect of this is a direct contradiction of the FCA’s strategic objectives: to protect consumers and enhance the integrity of the financial system.

The Bank of England and Financial Services Act 2016 requires the FCA to issue guidance on the meaning of Politically Exposed Persons (PEPs) in relation to AML regulations. This in itself is not enough. Much of the problem comes from banks’ determination to pigeonhole clients on the basis of domicile, jurisdiction and nationality.

Balancing punitive measures (i.e. sanctions, penalties and fines) with incentives for effective risk management is key. Furthermore, greater consideration should be given to corporate social responsibility in determining risk appetite. Incentivising dealings with high-risk clients such as charities and money service businesses has the potential to retain vulnerable clients within the regulated banking system and protect vulnerable communities. Only then may we begin to offset the risks of de-risking.

[1] FATF statement on derisking, 23 October 2015: http://fatf-gafi.org/publications/fatfrecommendations/documents/fatf-action-to-tackle-derisking.html

[2] Drivers and Impacts of Derisking by John Howell & Co Ltd for the Financial Conduct Authority: http://fca.org.uk/publication/research/drivers-impacts-of-derisking.pdf (February 2016)

[3] Understanding Bank De-risking and its Effects on Financial Inclusion, Tracey Durney and Liat Shetret (November 2015): http://www.globalcentre.org/wp-content/uploads/2015/11/rr-bank-de-risking-181115-en.pdf

[4] Ibid