Big global banks freezing smaller operators out of correspondent banking on tough regulation, viability

Many big global banks are inadvertently promoting financial exclusion as they are increasingly freezing smaller operators and money transfer businesses out of correspondent banking network due to much stricter laws and regulation to curb financial crimes, including money laundering and terrorist financing, businessamlive has learnt.

Anurag Bajaj, Global Head of Banks, Transaction Banking, Standard Chartered, in an article – Promoting financial inclusion in correspondent banking, published in The Economist, said global banks have been reducing correspondent banking clients, either because they are commercially unviable or they fail today’s higher financial crime prevention standards.

He said that financial exclusion usually regarded as a problem confined to the most disadvantaged sections of society – poor people and struggling small businesses – who find it expensive or difficult to access banking and associated financial services, has recently become a concern for smaller banks and money transmission businesses, some of whom are finding themselves frozen out of the correspondent banking network because global correspondent banks no longer want to do business with them.

He, therefore, posited that the development is frightening and serious, as correspondent banking remains the lifeline of commerce, facilitating and financing trade and cross border financial flows.

“There are two main reasons for this. First, many global banks are pulling out of smaller markets because they are no longer economically viable. Second, global banks today have to comply with much stricter laws and regulations to curb money laundering, terrorist financing, and other financial crimes.

“Many small banks and money transmission businesses are unable to meet or prove that they operate to acceptable standards, so the global banks deem them too risky and cease their relationships with them – a phenomenon is widely known as de-risking,” he stated.

Businessamlive learnt that policy making institutions like the International Monetary Fund (IMF), Financial Stability Board (FSB), Financial Action Task Force (FATF) and the Basel Committee on Banking Supervision, as well as national regulators, governments and the global correspondent banks themselves, have recognised this as a form of financial exclusion that presents a serious threat to the integrity of the financial system.

Specifically, in a staff discussion note entitled The withdrawal of correspondent banking relationships: A case for policy action, published in June 2016, the IMF described what has been happening and made some recommendations.

The IMF paper noted that in recent years, several countries have reported a reduction in correspondent banking relationships (CBRs) by global banks, adding that smaller emerging markets and developing economies in Africa, the Caribbean, Central Asia, Europe and the Pacific, as well as countries under sanctions, are the worst affected.

“Individual banks may decide to withdraw CBRs based on a number of considerations,” it explains. “Generally, such decisions reflect banks’ cost-benefit analysis, shaped by the re-evaluation of business models in the new macroeconomic environment and changes in the regulatory and enforcement landscape, notably with respect to more rigorous prudential requirements, economic and trade sanctions, anti-money laundering and combating the financing of terrorism (AML/CFT) and tax transparency.”

The IMF said: “coordinated efforts by the public and private sectors are called for to mitigate the risk of financial exclusion and the potential negative impact on financial stability.”

One of the IMF recommendations is that national regulators should encourage the banks they regulate not to de-risk too hastily or indiscriminately. Another is that in countries facing severely reduced access to the correspondent-banking network, governments should consider setting up “temporary mechanisms ranging from regional arrangements to public-backed vehicles to provide payment clearing services.”

Bajaj noted that the exclusion of smaller banks from the correspondent banking network is a serious problem because the smaller banks are most reliant on international correspondents for facilitating their cross border flows, adding that financial flows underpin trade and commerce which is chiefly responsible for the economic growth of the weaker sections of society.

He said education is key to improving financial inclusion. If global banks simply refuse to deal with smaller banks, it not just excludes those smaller banks from the financial system, it also encourages a lack of transparency as financial flows will start finding alternate channels that potentially go completely under the radar.

“It is far more beneficial for as many transactions as possible to remain mainstream, subject to tighter compliance controls,” he said, adding, however, that there is not much any bank can do for correspondent banking clients that fall short of risk tolerance and are unwilling to improve their processes and systems.