Understanding Bank De-Risking and its Effects on Financial Inclusion: An exploratory study | Banks

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‘De-risking’ refers to financial institutions closing the accounts of clients perceived as high risk for money laundering or terrorist financing abuse, namely money service businesses, non-profit organizations, correspondent banks and foreign embassies. This report explores the linkages between bank de-risking and the ascendance of the risk-based approach to anti-money laundering and countering the financing of terrorism (AML/CFT). It presents a nuanced examination of the driving factors and influences behind de-risking, and its potential impact on financial inclusion for vulnerable communities. The report includes case studies from other sectors facing financial access challenges, and provides actionable recommendations for key stakeholders. This joint agency report was led by the Global Center on Cooperative Security.
  RESEARCH REPORT NOVEMBER 2015 UNDERSTANDING BANK DE-RISKING AND ITS EFFECTS ON FINANCIAL INCLUSION  An exploratory study TRACEY DURNER AND LIAT SHETRET Global Center on Cooperative Security “De-risking” refers to financial institutions exiting relationships with and closing the accounts of clients considered “high risk.” There is an observed trend to-ward de-risking of money service businesses, foreign embassies, nonprofit or-ganizations, and correspondent banks, which has resulted in account closures in the US, the UK, and Australia. Low profit, reputational concerns, and rising  AML/CFT scrutiny contribute to de-risking, which can further isolate communi-ties from the global financial system and undermine AML/CFT objectives. This paper explores the drivers of and responses to de-risking, highlights case stud-ies of financial access, and provides recommendations to banks, regulators, and bank customers. This research report was written to share research results, to contribute to public debate and to invite feedback on development and humanitarian policy and practice. It does not necessarily reflect the policy positions of the organizations jointly publishing it. The views expressed are those of the authors and not necessarily those of the individual organizations.   CONTENTS Executive Summary 3   1   Introduction 5   2   Drivers of de-risking 7   3   Mapping the existing narratives 13   4   Impacts of de-risking 19   5 Instructive learning: case studies 24   6   Conclusion and recommendations 30   Bibliography 34   Notes 49    Acknowledgements 56   2 Understanding Bank De-risking  EXECUTIVE SUMMARY This report is based on a four-month exploratory study on the impacts of bank de-risking practices on financial inclusion, carried out between November 2014 and February 2015. “De-risking,” or “de-banking,” refers to the practice of financial institutions exiting relationships with and closing the accounts of clients perceived to be “high risk.” Rather than manage these risky clients, financial institutions opt to end the relationship altogether, consequently minimizing their own risk exposure while leaving clients bank-less. This exploratory study was designed to identify the core drivers of this practice and its implications for financial inclusion goals, particularly as they affect vulnerable communities. It provides a number of relevant case studies highlighting innovative approaches to, and lessons learned from, addressing de-banking challenges across six different sectors with varying degrees of banking incentives, as well as a set of recommendations about how invested stakeholders can better address de-risking challenges. De-risking practices have not been localized in any particular population, community, or industry. However, in recent years there has been an “aggregation of results” best described as a trend toward de-risking of sectors, including money service businesses (MSBs), foreign embassies, nonprofit organizations (NPOs), and correspondent banks. Those closures have had a ripple effect on financial access for the individuals and populations served by those businesses. Regulatory authorities continue to emphasize that de-risking is not in line with international guidelines, and in fact is a misapplication of the risk-based approach. Yet in the absence of clear instructions or an incentive to bank these clients, account closures continue across the United States, the United Kingdom, and Australia. These closures have significant humanitarian, economic, political, and security implications, effectively cutting off access to finances, further isolating communities from the global financial system, exacerbating political tensions, and potentially facilitating the development of parallel underground “shadow markets.” Unfortunately, little empirical data is available about the extent and nature of the client relationships being exited and the decision-making processes of financial institutions. This presents challenges to assessing the scale and scope of the problem, identifying vulnerable communities affected by the reduction in services, and developing effective responses. Nevertheless, this study endeavors to illuminate a number of existing trends and themes relating to the issue and provides some insight into likely factors behind de-risking practices. Below is a summary of the key findings: 1. The goals of financial inclusion, and anti-money laundering and countering the financing of terrorism (AML/CFT), are not inherently in conflict; however, tensions do emerge in practice. Overly restrictive AML/CFT measures may negatively affect access to financial services and lead to adverse humanitarian and security implications. 2. Rather than reducing risk in the global financial sector, de-risking actually contributes to increased vulnerability by pushing high-risk clients to smaller financial institutions that may lack adequate AML/CFT capacity, or even out of the formal financial sector altogether. 3. A lack of empirical data about the extent and nature of the client relationships being exited and the decision-making processes of financial institutions impedes an assessment of the scale and scope of the problem as well as the development of effective responses. 4. De-risking represents a market failure. All invested stakeholders (banks, regulators, and bank customers and clients) appear to be acting rationally and in their own best interest, but in so doing have created unintended consequences for financial inclusion goals. 5. In such clear instances of market failure, either government or the public sector must intervene to re-align market factors, either through incentive programs or through enhanced regulatory guidance. 6. Regulatory authorities have been unable to keep up with prevailing market trends in this area. 7. Policymakers, regulators, banks, and other stakeholders have not shown the necessary accountability and leadership to address de-risking from a structural and systemic position. The ambiguity of regulatory frameworks, coupled with a lack of empirical information about de-risking criteria, has allowed responsibility for addressing the problem to shift continually Understanding Bank De-risking 3  among stakeholders. De-banked customers are left without clear expectations and unable to anticipate and protect themselves against impending account closures. 8. Communication among relevant stakeholders is improving, but it is still limited at practical levels, which results in information stovepipes and siloed, ad hoc efforts to address the issue across institutions, departments, industries, and jurisdictions that do not adequately and comprehensively address market factors. 9. Regulatory authorities across jurisdictions must cooperate and coordinate more fully in order to develop streamlined definitions, standards, and policies that reduce compliance burdens and improve accountability. 10. Already suffering reputational harm following the 2008 financial crisis, financial institutions incur additional reputational damage due to AML/CFT enforcement actions. However, de-risking also has public relations repercussions, since banks are seen as cutting off crucial funds to vulnerable populations. There may also be the potential for reframing the issue as one of corporate social responsibility and for highlighting the potential “reputational returns” of continuing to cater to underserved communities.   4 Understanding Bank De-risking
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