That we live in an interconnected world is nowadays accepted as fact. Every day, nations trade goods, and businesses and individuals send remittances across a multitude of borders. Correspondent banking relationships (CBR) is the unseen foundation of cross-border payments. It enables banks and money-transfer businesses to access financial services in different jurisdictions. CBR is a fundamental cornerstone of cross-border remittances. Remittances play a key role in poverty alleviation and private sector development in recipient countries.
De-Risking: Itself a Risky Business?
However, certain global banks are increasingly reducing the number of relationships through a process known as “de-risking”. In order to meet stringent due diligence and Know-Your-Customer (KYC) requirements, banks are closing accounts that are perceived to be either costly or in high-risk jurisdictions. De-risking inhibits trade finance, reduces the flow of foreign direct investment (FDI), and diminishes the ability of not-for-profit organisations to remit aid to the most vulnerable. The termination of CBRs have widespread, yet uneven, impacts.
Small Is Not (Always) Beautiful
It is especially small states (states with a population of 1.5 million or less) and fragile states, such as Somalia, that are adversely affected by de-risking. According to 2014 World Bank data, remittances constitute 3.8% of GDP in small states on average, compared to the world average of 0.6%. Amongst others, small states struggle to achieve economies of scale in just about anything and are compelled to import more. Foreign trade accounts for almost 80% of the GDP in small states. The openness to foreign trade also implies greater vulnerability. If the rest of the world quivers, small states shake. If openness implies greater vulnerability, then de-risking poses a significant threat to small states.
Banks have gradually been ending its CBRs in the Caribbean region since April 2015. Island small states are even more reliant on remittances: remittances constitute 6.65% and 4.9% of the GDP of the Pacific and Caribbean island small states, respectively. In 2015, Caribbean-based Fidelity Bank suspended the accounts of Western Union in the Bahamas, Turks and Caicos Islands and the Cayman Islands, blaming low margins and perceived high risk for its decision. Customers were unable to use Western Union’s services for several months until a new CBR with Nova Scotia Bank was established. Belize lost several CBRs accounting for over half of its banking assets, with certain customers unable to access funds in closed accounts. Jamaica has also seen a decline in money-transfer operators operating in the country due to de-risking. Recently, the Bahamas has warned that its banking sector faces collapse if de-risking continues. Worryingly, a 2015 banking survey in this country revealed that 35 out of 95 licensed banks lack contingency plans in the event of fewer CBRs[i].
The Need for Clear Criteria
Due to the uneven impact of de-risking on banks and jurisdiction, international payment networks risk becoming more fragmented with an increasingly limited range of options for cross-border transactions, with likely adverse impacts on the cost of remittances as well. One cannot deny that protecting financial institutions from money-laundering is important. Yet the lack of ambiguous criteria surrounding de-risking is merely having unintended damaging consequences, without necessarily fulfilling the original intention of de-risking. Amongst others, correspondent banks should offer adequate and accurate explanations to respondent institutions over why accounts were terminated, as well as provide evidence that all possible actions were taken to assess, and prevent, the true risks.
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