“De-risking”: a global phenomenon (Part 1)

There are few issues that one could say register on the economic Richter scale more significantly than one that could potentially cripple or disable a country’s ability to process payments across international borders. Fundamentally, any open economy, including Belize, needs to be able to send or receive money from abroad in order to facilitate trade in goods and services. However, outside the bankers’ guild, not many individuals traditionally concern themselves with the technicalities that make such operations possible. And, up until the recent global “de-risking” trend by correspondent banks, frankly, there was no immediate need for the non-banker to do so.

Nonetheless, times have changed, and the newfound global “de-risking” phenomenon demands that even the layman gains some insight into what is “de-risking”, what consequences this trend has on jurisdictions like Belize whose banks run the risk of losing their Correspondent Banking Relations (CBRs), and, lastly, what solutions or remedies are available.

What is Correspondent Banking?
First, let’s be clear on what a correspondent bank is, and why it is necessary. A correspondent bank is simply a bank in a foreign jurisdiction that is authorized to provide services for a bank or financial institution that is located in another country (the respondent bank). These banks provide the respondent bank with services such as the handling of business transactions, money transfers, and currency exchange.

A simple example could help bring the role of CBRs into focus. Let’s say in Belize, a customer of one of our domestic commercial bank needs to pay for a product that he has bought from some company in the United States. After the domestic bank has determined the necessary foreign currency exchange to pay the US-based supplier of the good, the local bank will deduct the appropriate amount from the Belizean’s domestic bank account. Subsequently, the domestic bank (i.e. the respondent bank) instructs its correspondent banking partner in the United States to pay out the corresponding amount to the US-based supplier from the respondent bank’s correspondent account that it has with the foreign bank.
In short, CBRs enable respondent banks to establish a correspondent account (vostro or nostro account) with a correspondent bank. As the above example demonstrates, these accounts enable banks to handle international financial transactions for their clients that usually require foreign exchange, especially as it relates to international trade transactions.

The Committee on Payment and Market Infrastructures (CPMI) defines correspondent banking thus: “An arrangement under which one bank (correspondent) holds deposits owned by other banks (respondents) and provides payment and other services to those respondent banks.”

After having clarified correspondent banking, it’s necessary to also define what is meant by “de-risking”. The Financial Action Task Force (FATF)—which a recent World Bank study on correspondent banks “de-risking” labeled as the international “standard setter” on anti-money laundering—defines de-risking as:

“The phenomenon of financial institutions terminating or restricting business relationships with clients or categories of clients to avoid, rather than manage, risk … De-risking can be the result of various drivers, such as concerns about profitability, prudential requirements, anxiety after that global financial crisis, and reputational risk.”

“De-risking”: a Global Trend
As was stated earlier, the “de-risking” phenomenon is a global trend. In a recent study by the World Bank (2015), entitled “Withdrawal from Correspondent Banking: Where, Why, and What to Do about It?” 75% of the international banks surveyed indicated that they have reduced the number of vostros accounts (the account that a correspondent bank holds on behalf of a foreign respondent bank) between the “end of 2012 and mid-2015.”

The majority of the international banks surveyed also indicated that the termination or cutting back of their CBRs with certain jurisdiction is part of a larger revision of wider policy changes.

According to the aforementioned World Bank study, 70% of the large international banks said the reason for the change in policy was in “relation to broader risk management”. Half the respondents also said that the change was to either comply with new or revised legal requirements (regulations) or simply as part of their business strategy.

Regardless of the rationale governing the correspondent banks’ change of policy, the effects are felt globally. Of the 170 local or regional banks that participated in the World Bank (2015) study, the regions that are most affected “by declining foreign CBRs included Europe and Central Asia where over 80 percent indicated a moderate or significant decline in CBRs.

“Latin America and the Caribbean was also highlighted as being a region significantly affected by declining CBRs where 66 percent of the banks reported a decline. The Caribbean, more specifically, was affected with 69 percent (32 banks) indicating a moderate or significant decline in CBRs. Follow-up conversations and phone interviews with several local banks confirmed this trend in the Caribbean” (World Bank, 2015).

Why are banks de-risking?
The primary “drivers” behind the trend can be categorized into two primary groups: business- and economic-related reasons, and risk-related reasons.

In terms of the latter, the World Bank study states: “The decision to server ties with certain actors as based on the level of ML/FT (Money Laundering and Financing of Terrorism) risk on the counterpart being unmanageable, and concerns that one might fall foul of AML/CFT [anti-money laundering/Combating the financing of terrorism], international/regional sanctions—or other legislation or regulations.”

More specifically, many of the international banks that participated in the study cited concerns regarding AML/CFT regulations and Customer Due Diligence (CDD) and Know Your Customer (KYC) procedures. The increased risk of running afoul of the regulations and the simultaneous fact of “lack of profitability of certain foreign CB services/products” were also cited among the top (of many possible) reasons for terminating and/or restricting CBRs” (World Bank, 2015, p. 32).

Belize at this time
The generalized vantage point is helpful in putting this issue into its proper global context. Nevertheless, the need to focus on Belize is paramount. As has been discussed above, the number-one reason among the correspondent bankers for discontinuing or diminishing their CBRs is due to their “concerns about money laundering/terrorism financing risks”. Among the top-three concerns was also the fear of the penalties associated with a lack of compliance with AML/CFT regulations, with 85% international bankers citing this as a key driver.

It is for this reason that the recent message from Minister of Finance and Prime Minister Dean Barrow, upon his and his team’s return from Washington, DC, USA, is quite significant. Prime Minister Barrow outlined that in their meetings with United States’ government regulators, including the FDIC (Federal Deposit Insurance Corporation) and the Office of the Comptroller of Currency (OCC), the US regulators made it abundantly clear that the US government is pleased with the Central Bank of Belize (CBB)’s, the Financial Intelligence Unit (FIU)’s and the commercial banks’ measures to comply with the AML/CFT regulations.

According to PM Barrow and his team, the regulators have gone as far as to say that they would even serve as a type of “character reference” on behalf of the Belize jurisdiction as officials seek to establish new correspondent banking relationship.

The feedback from the regulators echoes the Financial Action Task Forces (FATF) own comments regarding Belize from as far back as May 2014 when FATF wrote on its website that the “CFAFT [Caribbean Financial Action Task Force] recognized the significant progress made by Belize to address AML/CFT deficiencies” (FATF, 2014).

A Public-Private Sector Matter
Naturally, this issue is likely to remain on the economic radar for some time; however, as has hopefully become conspicuous at this juncture, the matter of “de-risking” is a decision within the purview of private correspondent banks responding to market factors that they consider as a justification for their “exit” strategies and change in their business models. For instance, let’s recall that apart from the AML/CFT concerns, 80% of the international banks surveyed said that their decision is based on the lack of profitability of certain CBR services and/or products.

With that said, it is only fitting that this week’s “Strictly Business” concludes with one appropriate comment from the World Bank (2015) study cited throughout this article (and is the source of all accompanying images): “It is important to emphasize that this is a joint public-private responsibility that needs to be dealt with in partnership. Only such an approach, with efforts by all actors, can help reverse the decline experienced in certain parts of the world.”

About the EDC
The Economic Development Council (EDC) serves as the principal liaison body between the public and private sectors, and is designed to advocate for, plan, and coordinate the institutionalization of policy reforms that engender the business- and investment-friendly environment that is suitable for Belize’s private sector development and overall economic growth. The EDC executes its function by maintaining constant and open communication with both sectors via its technical unit, the Public-Private Sector Dialogue, which is housed in the Office of the Prime Minister.

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