Unintended consequences of regulation

With companies of all sizes now involved in global trade, with complex, widely distributed supply chains, the ability to make and receive international payments is essential to doing business. No bank has a global network that can facilitate cross-border payments and collections across all currencies, so correspondent banking fulfils a vital role in achieving this. However, there is growing evidence that the need for more stringent regulation on one hand, but the cost and risk of compliance with these regulations and potential for reputational risk on the other, is resulting in some banks choosing to reduce their correspondent banking activities from specific client segments or entire markets. This particularly applies to regions where banks perceive the potential risks and costs of associated controls to outweigh the strategic benefits of serving those markets, with the Caribbean, East Asia Pacific, Eastern Europe and Central Asia most affected.

Banks are committed to the fight against financial crime and have invested billions of dollars to reduce access to the banking system for its perpetrators. However, the complexity of compliance with diverse regulations across markets, the uncertainty around interpretation and implementation, and the risk of significant penalties in case of non compliance – fines and multi-year remediation work - is having unintended consequences. Specifically, the impact of banks’ decisions to de-risk their business is that local and regional banks, and remittance providers, are finding it more difficult, and potentially impossible to access international services. This in turn affects cross-border payments and collections and trade finance, endangering already fragile trade and posing a threat to financial inclusion.

These issues are now being discussed at the top table of international finance. Christine Lagarde, Managing Director of the International Monetary Fund (IMF), at a speech at the Federal Reserve Bank of New York in July 2016 emphasised that regulators in both developed and emerging countries had a role to play in halting this decline and helping banks to maintain their correspondent banking relationships.

By way of example, she illustrated that at least 16 banks in five countries in the Caribbean had lost all or some of their correspondent banking relationships by May of this year, and countries such as Belize have been particularly hard-hit. She stressed: "Even if the global implications of these disruptions are not visible so far, they can become systemic if left unaddressed."

She added that these smaller countries need to upgrade their regulatory and supervisory frameworks to enhance compliance with international standards, particularly in areas such as anti-money laundering and anti-terrorism finance compliance.

Restoring access and transparency

Despite the perceived challenges, banks and key international bodies such as the Financial Stability Board (FSB) are united in their recognition and desire to maintain access to the international financial system for businesses and individuals in many of the world’s most vulnerable regions. The FSB is working in partnership with the Basel Committee for Banking Supervision (BCBS), Committee on Payments and Market Infrastructures (CPMI), Financial Action Task Force (FATF), International Monetary Fund (IMF), Legal Entity Identifier Regulatory Oversight Committee (LEI ROC) and World Bank to address this issue. In July 2016, for example, a report released by the CPMI emphasised that the banks’ network of correspondent relationships appears to be shrinking, with the risk that cross-border payment networks could fragment, resulting in a narrower choice of options for payment users.

The CPMI proposes amongst other things three particular next steps. Firstly, there is a focus on further data collection and examination to understand the current situation more fully and the implications, with a number of bodies having undertaken studies. A second priority is to clarify regulatory expectations, including more guidance from FATF, which is working to outline in more detail customer due diligence expectations for correspondent banks when working with respondent banks. Third, continued support for domestic capacity building in the most affected locations is important, including assessments and technical assistance to help identify and address deficiencies to avoid reduced access to the global financial system.

From exit to education

Banks also have a role to play by recognising the wider implications of their commercial and regulatory decisions to exit specific markets or activities. There are undoubtedly challenges; however, the banks have an important role to play in collaborating to build consensus over controls such as KYC.

At Standard Chartered, we take our responsibility for effectively managing financial crime risk very seriously. We are also focused strategically on facilitating global trade, supporting growth in emerging markets and promoting financial inclusion. Aligning these ambitions, we have therefore developed a strategy for correspondent banking we call ‘de-risking through education’, focusing increasingly on how we partner with those clients who have the right intent but not yet the right tools or experience to build robust controls for financial crime risks. For example, we are actively promoting training and workshops for our clients through our Correspondent Banking Academy, as well as continuing to invest in due diligence and oversight.

The value of this approach is not simply to strengthen compliance, but also to build strong, open and pragmatic relationships with clients. We are also collaborating through industry bodies such as the Wolfsberg Group to engage in the discussion as to what constitutes an appropriate level of transparency, how the regulators can support correspondent banking, and how law enforcement can derive benefit from financial intelligence. These measures will help to make the financial system a hostile environment for criminals and terrorists whilst supporting the economic development that is important for the societies we serve.

David Howes | Deputy Head, Group Financial Crime Compliance