www.ifc.org/ThoughtLeadership Note 22 | November 2016 MITIGATING THE EFFECTS OF DE-RISKING IN EMERGING MARKETS TO PRESERVE REMITTANCE FLOWS Anti-money laundering/combating-the-financing-of-terrorism laws are grounded in reasonable national security concerns—preventing the cross-border flow of funds to terror or criminal groups. But these policies can have unintentional and costly consequences, in particular for people in poor countries. Those most affected are likely to include the families of migrant workers, small businesses that need to access working capital or trade finance, and recipients of life-saving aid in active-conflict, post-conflict or post-disaster situations. Money laundering, terrorism financing, tax evasion, and along with others, have led banks to adopt an understandably sanctions violations by individuals, banks, and other financial conservative position. This includes no longer providing entities are serious offenses with significant negative services to firms, market segments, and countries that are seen consequences for rich and poor countries alike. For this reason, as being higher risk and lower profit, and that could be the cause efforts by international organizations, governments, and others of costly future fines, monitoring, or even prosecutions. In to combat money laundering and curb illicit financial flows are short, banks are engaging in broad-based “de-risking” rather necessary for a safer and more secure financial system, both than judging the risks of clients on a case-by-case basis.3 globally and within individual countries. Yet countries also want finance to flow in the most efficient and De-Banking and its Impact competitive manner possible. This enables global economic An abundance of descriptive evidence points to correlations growth and brings additional people into the financial system in between AML/CFT policies and de-banking of money transfer a formal and transparent manner.1 organizations, correspondent banking, and non-profits trying to access banking services in difficult environments. The people However, these two objectives can conflict, as policies intended and businesses who stand to lose the most from de-risking are to counter financial crimes may obstruct capital flows, often the poorest and most vulnerable: especially for people in poor countries.2 Furthermore, from a national security perspective, these policies may be self-  Migrants who want to send money home and the families defeating to the extent that they reduce the transparency of who rely on that money need a healthy money transfer financial flows. organization (MTO) sector. MTOs are seeing banking services denied, downgraded, or made more expensive. Under the current approach, banks are asked to prevent Consequently, MTOs are pushed out of one bank and have sanctions violations and assess and mitigate money laundering to find another that may be more expensive, or based in a and terrorist financing risks, or face penalties that can be severe. less transparent jurisdiction. In 2013 more than 140 UK- However, regulators sometimes convey mixed signals about based remittance companies were told by Barclays Bank whether and how banks and other entities should manage these that their accounts would be closed. Following this and risks. This can drive banks to use simplistic risk assessment similar de-banking episodes in the United States and methodologies. Australia, only larger money transfer organizations have There may also be a chilling effect resulting from the access to bank accounts. Industry bodies report that many imposition of legitimate fines on large banks for egregious smaller players have been forced to close, become agents contraventions of anti-money laundering efforts and combating of larger businesses, or even disguise the true nature of the financing of terror (commonly referred to collectively as their operations in order to remain banked. This could have AML/CFT), and, particularly, sanctions laws. These factors, a severe impact on remittances from migrant workers, which total $440 billion a year—more than three times overseas development assistance has remained broadly foreign aid—and are a vital source of finance for poor stagnant, many donors have emphasized the importance of countries. private flows to developing countries to meet their development goals (Figure 1).5  Vulnerable people in post-disaster or conflict situations who rely on non-profit organizations to deliver In addition to remittances, trade between developed countries humanitarian assistance. These organizations have and emerging countries is in the hundreds of billions of dollars reported difficulties carrying out their operations due to and humanitarian aid is over $20 billion per year. Analysis of closed bank accounts, often because the organization has data from the World Bank shows that for fragile and conflict- fallen outside of a bank’s narrowed risk appetite. affected states, remittances can make up a significant share of GDP. For example, remittances to Nepal were 29 percent of  Small to medium-sized firms in poor countries that lack GDP in 2014 (Figure 2). So enabling legitimate remittances is the credit needed to create jobs. Such credit often depends essential. on local banks’ connections to large international financial institutions and the global financial system. Yet rich- Figure 2: Remittances (Inflows) as a % of GDP in 2014 in country banks increasingly report withdrawing selected countries and territories correspondent banking services from banks in high risk jurisdictions, which include many poor countries.  Law Enforcement, who find it increasingly difficult to track transactions because money transfer organizations affected by de-banking are resorting to less transparent transfer mechanisms, including bulk currency exchanges. This threatens public safety and economic stability across the globe. So serious is the problem of de-risking that Mark Carney, Source: World Bank Migration and Remittances Data (Annual Inflows), World Development Indicators. Governor of the Bank of England and Chairman of the Financial Stability Board, has termed it ‘financial Regulatory Pressure abandonment’; U.S. Federal Reserve Chair Janet Yellen told a Since 2000, regulatory pressure on financial institutions congressional committee that anti-terror financing and anti- relating to anti-money laundering and anti-terror financing money laundering efforts were “causing a great deal of compliance has increased. This is reflected in the increases in hardship”. both the number and value of related fines imposed by Figure 1: Capital flows to developing countries since 1990 regulators in the United States (Figure 3).6 In the five-year period from 2010 to 2015, the number of fines increased by more than 65 percent, and their value increased from $161 million to more than $2.6 billion. Financial exclusion resulting from regulatory pressure creates yet another obstacle for economic growth and the alleviation of poverty, especially in poor countries. As the IMF recently put it, “Pressure on correspondent banking relationships could disrupt financial services and cross-border flows, including trade finance and remittances, potentially undermining financial stability, inclusion, growth and development goals.”7 Bureaucratic Complexity and Inconsistency Source: World Bank Migration and Development Brief 24, April 2015 At the international level there has been a significant harmonization of legislation that should be counted as a major Mitigating Unintended Consequences success for the Financial Action Task Force, or FATF, the Money laundering has real consequences for poor countries. international standard setter on terror financing and money Terrorism, organized crime, and theft of public assets have laundering issues. It was established in 1989 by the Group of 7 severe consequences for poverty alleviation.4 Therefore, with a mandate to develop policy and promote effective preventing money-laundering while preserving access to implementation of anti-money laundering and combating the services by non-criminals is critical. Over the last decade, as financing of terrorism. This publication may be reused for noncommercial purposes if the source is cited as IFC, a member of the World Bank Group. While FATF provides overall guidance on these critical issues, The Barclays incident was not an isolated case, as many banks regulations for banks and other financial institutions are made around the world have decided to stop doing business with the at the national level. And it is often national or sub-national remittance sector. In 2012, following a series of “strategic regulators that matter most as they are charged with translating assessments” initiated in the wake of financial settlements with international guidance into national and state regulations. And U.S. and U.K. authorities, HSBC decided to close the accounts these regulations can have far-reaching effects since all US of a number of money transfer organizations in several dollars must be cleared through US banks and are subject to jurisdictions.10 In 2016 banks in the Middle East and North state and local US jurisdictions. As a result, U.S. state Africa surveyed by the IMF and Union of Arab Banks also regulations can affect the behaviour of banks and other financial reported de-banking money transfer organizations. 11 institutions not just within that state but internationally as well. The situation is similar in Australia and New Zealand, the The United States has a complex regulatory environment with primary sources of remittances for most Pacific Island nations, many agencies, both at the national and state level, that are where remittance inflows as a share of GDP are among the relevant to money laundering and terror finance regulation and highest in the world. By December 2015, the Commonwealth enforcement.8 This creates a challenging environment for Bank and National Australia Bank had exited the MTO market financial institutions and other entities that wish to comply. and the other two large banks, WestPac and ANZ had Anecdotal evidence suggests that the European regulatory terminated the majority of accounts held by remittance firms.12 environment is equally or even more complex and (See box on page 5 of this note for a response.) disharmonious, despite concerted efforts to synchronize Regulators have repeatedly noted MTOs’ decreasing access to approaches through EU directives. This problem is particularly banking services. For example, as early as 2005 a joint daunting for smaller financial institutions and especially new statement by the U.S. Financial Crimes Enforcement Network, entrants, creating barriers to entry that undermine competition. the Federal Reserve and several other regulators noted that Figure 3: Number of Anti-Money Laundering Related “money services businesses are losing access to banking Fines by U.S. Regulators, 2000–2015 services as a result of concerns about regulatory scrutiny, the risks presented by money services business accounts, and the costs and burdens associated with maintaining such accounts.” The statement goes on to say that these concerns may stem in part from misperceptions about “the erroneous view that money services businesses present a uniform and unacceptably high risk of money laundering or other illicit activity.” 13 The de-banking of money transfer organizations appears to be a global problem, and it appears to be getting worse. That’s the picture that emerges from the World Bank’s Report on the G20 survey in de-risking activities in the remittance market.14 Nearly half of the transfer organizations surveyed reported that they had at least one bank account closed last year and about half of responding governments indicated that they had received complaints from such organizations about access to bank accounts. Respondents from the United States, the United Kingdom, and Australia appear to be the worst hit. The reduction of services offered by the formal sector may Source: Data compiled from ACAMS reports of enforcement actions. 9 increase the use of services in the informal sector. Remittance flows that are driven through less transparent methods become The De-banking of Money Transfer Organizations substantially more difficult to track and secure from diversion. In the spring of 2013, over 140 UK-based remittance companies This is true whether the channel is informal, like the traditional were notified by Barclays Bank that their accounts would be hawala system of money transfer, or formal, such as the use of closed within sixty days. Barclays reviewed these clients bulk currency exchanges. Anecdotal evidence also suggests that according to its new risk-based eligibility criteria and, as a seizures of cash at major airports such as Heathrow have risen result, the bank decided it would no longer work with them. By during the past decade. The possibility that industry de-risking the autumn of 2014 Barclays had completely withdrawn its might be driving more money into less transparent channels support of the remittance sector. should be of immediate concern. This publication may be reused for noncommercial purposes if the source is cited as IFC, a member of the World Bank Group. Decline of correspondent banking relationships concerns; 40 percent said they had to terminate whole Correspondent banking relationships, in which one bank relationships due to compliance costs in the past year. 22 provides services on behalf of another, are highly valuable to Potential Consequences the global economy, enabling trillions of dollars of cross-border transactions every day in order to facilitate economic activity For many banks, correspondent relationships are crucial for such as remittances, foreign exchange trading, and trade their provision of cross-border services, including payments, finance. Despite this, a number of industry and government foreign exchange, and international trade. Furthermore, if a surveys of banks have suggested that a substantial number of bank wants to settle a transaction in U.S. dollars, it is required links between banks have been severed in recent years. to be based in a country hosting one of the few U.S. dollar clearinghouses or must bank with a correspondent in that A survey carried out by the World Bank in 2015 found that 15 country.23 percent of large global banks are withdrawing from correspondent banking relationships. The World Bank also If banks lose access to their primary correspondent account and found that local banks from around the world reported that the can’t establish a new one through another bank based in their termination of correspondent banking relationships was led by target country, the terminated bank must rely on a third party U.S. banks.15 In the 2016 International Chamber of Commerce with access to a correspondent account to process cross-border Global Trade and Finance Survey, 41 percent of respondents transactions. Such “nested” relationships are inherently less indicated they had recently dropped correspondent transparent and invariably more expensive. relationships.16 Aside from the immediate effects on the transparency and cost A desire by banks to reduce compliance costs and regulatory of financial flows, the degradation of the correspondent banking risk appears to be driving the reduction in the number of network has the potential to hamper global trade, as trade correspondent banking accounts. Correspondent banking links finance often uses correspondent accounts for the processing of have a reputation as potential avenues for money laundering, letters of credit. Over 40 percent of respondents to the ICC and many regulators ask that banks give these accounts special Global Trade Finance survey noted that anti-money laundering scrutiny. In the United States the enhanced regulatory focus on and “know-your-customer” requirements were a “very correspondent banking began with the introduction of the 2001 significant” impediment to trade finance, specifically in Patriot Act. Section 312 of that legislation requires banks to Africa.24 25 perform special due diligence for foreign correspondent This has the potential to hurt trade in both rich and poor accounts. countries: If heavily regulated countries are unable to issue As the onus and costs of compliance and due diligence have letters of credit due to know-your-customer concerns or lack of increased, so have the costs of getting it wrong. In the United correspondent connections, exports from these countries will States a number of large fines have been issued to banks for suffer. Conversely, if banks in these countries are unable to failings in anti-money laundering procedures covering confirm letters of credit issued by banks in “high-risk” correspondent banking. In January 2014 JPMorgan Chase was importing countries for the same reasons, exports from poor, fined $350 million for not implementing such programs high-risk countries will also be affected. adequately.17 Responses And more jurisdictions are being labeled as high risk than ever There are four ways to address the unintended consequences of before. Three times a year the FATF adds or removes countries anti-money laundering and anti-terror financing efforts. from its High Risk and Non-Cooperative Jurisdictions list.18 While FATF only recommends active counter-measures in the First, in order to assess unintended consequences rigorously, most extreme cases, merely being added to the list is seen as a the private and public sector efforts should generate more sign of high risk to both banks and regulators. 19 and better data. Evidence from industry surveys and the Committee on  The public and private sectors, including national financial Payments and Market Infrastructures (CPMI) report support the intelligence units, could collaboratively analyze and theory that these factors are causing a drop in correspondent evaluate data available to them around correspondent banking links.20 A European Central Bank report on banking relationships and payment flows in and between correspondent banking specifically mentions compliance costs countries. as a driver of this behavior. 21 The 2016 ICC Global Trade and  SWIFT, the Clearing House Interbank Payment System, Finance survey found that 62 percent of correspondents have the Clearing House Automated Payment System, the Bank had to decline transactions because of money laundering for International Settlements, and other entities could This publication may be reused for noncommercial purposes if the source is cited as IFC, a member of the World Bank Group. consider discussing with their members whether data on financing, and trading in proscribed goods and services. In bilateral payment flows and the number of correspondent seeking to control such potentially harmful applications, it banking relationships between countries could be shared, is imperative that policymakers do not stifle potentially and how the cost of that could be covered. transformative innovations in financial services. Transparent ledgers are desirable, while masked identities  Specific data could be anonymized to protect proprietary are not. information and safeguards put in place by data collectors, so that even anonymous data is only released to parties  The private sector is actively engaging in the development intending to conduct analysis in the public interest. of new technologies, with many large banks making significant investments in blockchain technology.  National governments could make the data that they are Policymakers at both the national and international levels using for risk analyses and regulatory impact assessments could seek to create an enabling environment for the use of available to other jurisdictions and to parties conducting new technology while also minimizing money laundering- analyses that are demonstrably in the public interest. related risk and illicit activity. This is a complex topic and will require setting the right standards on immutability and Second, the use of digital technology could be expanded, transparency. including distributed public ledger-based technology. Third, the risk-based approach could be strengthened.  The technology behind the latest generation of cryptocurrencies has made it possible to have a public,  FATF is making efforts to clarify its definition of money decentralized, secure ledger of all transactions on a laundering and terrorist financing risk and is encouraging payment network. This technology has the potential to banks and other financial institutions to simplify due render transactions over the global payments system more diligence procedures. National governments need to invest secure, almost free, and nearly instantaneous. Such a in supervisory capacity in order to ensure compliance with development could significantly ameliorate some of the FATF recommendations and the Basel Core Principles for negative effect on the cost and speed of cross-border Effective Banking Supervision. They need to invest more transactions from the current approach to money resources to increase exchange of information and ensure laundering and terror financing. 26 greater cooperation among national supervisors. Sharing information across borders and greater harmonization of  Distributed ledgers can store, secure, and maintain Legal regulatory frameworks would help reduce the level of Entity Identifiers, which are unique IDs associated with uncertainty faced by banks. The World Bank Group and corporate entities. Smart contracts are another useful the IMF can provide technical assistance and financial application built on distributed ledger technology. resources to achieve this objective.  Greater clarity of regulations may enable the emergence of De-Banking of Money Transfer Organizations: a private sector insurance market to cover some types of The response by Tonga Development Bank anti-money laundering risk. In Tonga, the World Bank Group is supporting the Tonga Development Bank in piloting a fully compliant remittance Fourth, identification could be facilitated and the costs of facility, the ‘Ave Pa’Anga Pau Voucher. compliance lowered. This product has now been designated in New Zealand. It is  Banks and other financial institutions could redouble their purchased online in New Zealand and redeemed or remitted efforts, with encouragement from the Financial Stability to a bank account in Tonga. This approach significantly Board and national regulators, to develop and adopt better reduces the need for international settlements between messaging standards and implement “Know Your Tonga and New Zealand. The Tonga Development Bank Customer” documentation repositories. will receive the funds only via electronic payments in New  Banks and other financial institutions could accelerate the Zealand before disbursing them in Tonga using the liquidity global adoption of the Legal Entity Identifier scheme. obtained by the importers of goods, thereby avoiding a  National governments, banks, and the World Bank could constant use of international settlements with its accelerate the adoption of new and existing technologies to correspondent bank. facilitate lower-cost customer identification, know-your- customer compliance, and due diligence.  However, distributed ledger technology can facilitate an  National governments could provide citizens with the anonymous payments system with very serious means to identify themselves in order to make the reliable implications for the ease of money laundering, terrorist This publication may be reused for noncommercial purposes if the source is cited as IFC, a member of the World Bank Group. identification of clients possible for financial institutions system has the potential to greatly reduce AML-related risk and other organizations. while improving financial inclusion worldwide.  National governments could ensure that appropriate Conclusion privacy frameworks and accountability measures support De-risking is a challenge that can be addressed through these identification efforts while also ensuring the free flow regulations that allow clear risk-reward calculations by banks of information related to identifying money laundering and and other participants in the remittances chain and by terrorist financing. supporting emerging innovative solutions developed by banks  Finally, governments might consider moving to a cashless and other financial institutions, money service businesses, and economy where firms and individuals are clearly identified fintech companies. using biometric identification, Legal Entity Identifiers, or Vijaya Ramachandran, Senior Fellow, Center for Global other technology, along with a digital currency. This Development (vramachandran@cgdev.org)  1 This note draws from findings of an earlier report by the Center for Global 90224b083395501/3_0/Rendered/PDF/Withdraw0from000what0to0do0about0it. Development (2015), Unintended Consequences of Anti-Money Laundering pdf Policies for Poor Countries – A CGD Working Group Report, as well as from 16 ICC, “2016 Rethinking Trade and Finance: An ICC Private Sector additional data and conversations with regulators, banks and other stakeholders. Development Perspective.” Paris: International Chamber of Commerce. 2016. 2 We use the term “poor countries” to describe the countries that the World Bank http://www.iccwbo.org/Products-and-Services/Trade-facilitation/ICC-Global- classifies as “low-income economies” and “lower middle-income economies.” Survey-on-Trade-Finance/ These are countries with gross national income per capita of less than $4,125. 17 “OCC Assesses a $350 Million Civil Money Penalty Against JPMorgan Chase 3 “De-risking” is sometimes used in this way, and sometimes in a more general for Bank Secrecy Act Violations.” Office of the Comptroller of the Currency, sense, to refer broadly to the process of reducing exposure to risk. We employ U.S. Department of the Treasury. 2014. http://www.occ.treas.gov/news- the more restrictive definition of “de-risking” for clarity, in order to avoid issuances/news-releases/2014/nr-occ-2014-1.html confusion between “good” and “bad” de-risking. 18 The HNRC process has replaced the NCCT Initiative. That initiative started in 4 ADB, Manual on Countering Money Laundering and the Financing of 2000 and listed countries deemed to have significant deficiencies and to be Terrorism, March 2003. IMF, The IMF and the Fight Against Money Laundering “noncooperative” in the context of FATF recommendations. The last country and the Financing of Terrorism, September 2015. was de-listed in October 2006. The HNRC process is more 5 Some of the apparent growth in recorded remittances may be due to discriminatory/specific in its classification of jurisdictions’ strategic deficiencies, improvements in measurement (Clemens, Michael A., and David McKenzie. distinguishing between jurisdictions to which countermeasures apply, 2014. “Why Don’t Remittances Appear to Affect Growth?” Policy Research jurisdictions that have not made sufficient progress or committed to an action Working Paper 6856, World Bank, Washington D.C. http://www- plan, and jurisdictions that have made a “high-level political commitment” and wds.worldbank.org/external/default/WDSContentServer/ action plan to address their issues. The International Cooperation Review Group WDSP/IB/2014/05/06/000158349_20140506090632/Rendered/PDF/WPS6856.p (ICRG) monitors and reviews these countries, issuing two public documents df/.). Nevertheless, the relative recent totals still understate remittances more three times a year. than ODA, reinforcing the importance of remittances compared to ODA. 19 “Aspects of Financial Transactions Indicative of Terrorist Funding.” SAR 6 For the purposes of this section “AML” is used as an umbrella term, in its Bulletin 4, Financial Crimes Enforcement Network. 2002. broadest possible sense. https://www.sec.gov/about/offices/ocie/aml2007/sarbull0102.pdf 7 Erbenová, Michaela, Yan Liu, Nadim Kyriakos-Saad, et al. “The Withdrawal of 20 Committee on Payments and Market Infrastructures, Correspondent Banking, Correspondent Banking Relationships: A Case for Policy Action.” IMF. 2016. Bank of International Settlements (BIS), July 2016. http://www.imf.org/external/pubs/ft/sdn/2016/sdn1606.pdf http://www.bis.org/cpmi/publ/d147.pdf 8 “Guide to U.S. Anti-Money Laundering Requirements: Frequently Asked 21 Keatinge, Tom. Uncharitable Behaviour. London: Demos. 2014 Questions, 5th ed.” Protiviti Inc. 2012. http://www.protiviti.com/en- http://www.demos.co.uk/files/DEMOSuncharitablebehaviourREPORT.pdf?1419 US/Documents/Resource-Guides/Guide-to-US-AML-Requirements-5thEdition- 986873 Protiviti.pdf 22 “ICC, 2016 Rethinking Trade and Finance: An ICC Private Sector 9 Although not a branch of government, the Financial Industry Regulatory Development Perspective.” Paris: International Chamber of Commerce. 2016. Authority, or FINRA, fulfills a regulatory function. It is a self-regulatory http://www.iccwbo.org/Products-and-Services/Trade-facilitation/ICC-Global- organization overseen by the Securities and Exchange Commission that writes Survey-on-Trade-Finance/ 23 and enforces rules governing the activities of more than 4,000 securities firms. This includes the U.S., Tokyo, Hong Kong, Singapore, and Manila. 10 Flint, Douglas J “Evidence Submitted By Douglas Flint, Group Chairman, 24 “2014 Rethinking Trade and Finance: An ICC Private Sector Development HSBC, About Access to Banking Services,” February 2015. See also BBC, Perspective.” Paris: International Chamber of Commerce. 2014. “Somalia fears as US Sunrise banks stop money transfers,” December 30, 2011; http://www.iccwbo.org/Data/Documents/Banking/General-PDFs/ICC-Global- Trindle, Jamila “Terror Money Crackdown Also Complicates Life for Ordinary Trade-and-Finance-Survey-2014 Somali-Americans,” April 23, 2014. 25 AML/CFT requirements can also restrict trade finance directly by leading banks 11 IMF and Union of Arab Banks 2015. to deny letters of credit for which they cannot do sufficient due diligence on the 12 Buckley, Ross P. and Ken C. Ooi 2014. listed beneficiary, an issue also covered in the ICC trade survey. 13 FinCEN, “Joint Statement on Providing Banking Services to Money Services 26 See for a recent report about costs of remittance services: World Bank, Businesses,” March 30, 2005. Remittance Prices Worldwide – An Analysis of Trends in Cost of Remittance 14 World Bank 2015. Services, Issue No. 19, September 2016. 15 “Withdraw from Correspondent Banking: Where, Why, and What to do About https://remittanceprices.worldbank.org/sites/default/files/rpw_report_sept_2016. It.” World Bank Group. 2015. http://www- pdf wds.worldbank.org/external/default/WDSContentServer/WDSP/IB/2015/11/24/0 This publication may be reused for noncommercial purposes if the source is cited as IFC, a member of the World Bank Group.