This study examines and unpacks the concept of ‘de-risking,’ a term now entrenched in the financial ecosystem lexicon to describe the increasing trend of major financial entities refusing to provide services to mostly smaller financial entities in a number of jurisdictions around the world, ostensibly because of regulatory compliance and money laundering risks potentially associated with such interactions.
Mostly this manifests as the withdrawal or curtailing of critical correspondent bank relationships (CBRs). The almost immediate effect of this withdrawal is to disrupt or even halt trade finance flows between countries and to block remittances. It generally has a chilling effect on the economies of affected countries. Most affected by this phenomenon are countries in Africa, Latin America, small island developing states in the Pacific Rim, Caribbean and Asia. Affected countries have to, but often can’t, find workarounds to the blockages. The impact once the money flows are turned off is immediate: business cannot get paid or cannot pay suppliers; remittance flows slow to a trickle; and in many cases, fungible and non-fungible aid provided by aid groups and donors in crisis countries is slowed or halted.
The de-risking trend is mostly associated with large banks and other financial institutions exiting product lines and terminating or restricting relationships with clients or classes of clients who are perceived to be ‘high-risk.’ The impact is particularly acute in those developing countries where remittances represent a significant percentage of Gross Domestic Product. The key to this stark impact is that much of the world’s trade and remittances are denominated reserve currencies such as US Dollars (USD), UK Pounds and European Euros, among the most actively traded currencies. With especially USD, there is a need to touch the US banking system and as such financial entities doing so through a presence in the US are subject to strict US laws on anti-money laundering. Often regulators require financial entities to engage in proper risk management to deal with such risks. From the perspective of those doing the de-risking, the need to cut off flows is obvious: the risk of money sent to countries where there is seen to be lax or purposely aberrant money laundering controls.
In this, the first part of our two-part study, we investigate here the genesis and ostensible reasons for ‘de-risking,’ the actors involved and their roles and reasons for doing so; the effect and then the impact thereof on affected countries and regions, entities and individuals.
While there are copious amounts of studies from standard setting bodies and think tanks, there is not much academic writing on the ‘de-risking’ subject, though possibly because it is still an evolving issue and affects primarily developing countries which, we postulate, omnibus funding for academic research on finance-related issues may not necessarily cover.
Our contribution to the academic literature shows that the causal connection – risk - of the observed trend of ‘de-risking’ activity is speculative and not covalent, such that we question whether ‘de-risking’ is the most suitable term to describe this phenomenon. We find that the term ‘de-risking’ is outdated and, given the non-risk related reasons we find for the phenomenon, suggest that the phenomenon should rather be styled as ‘refusal to supply.’ These other reasons encompass profit and other business-related reasons, many of which may have nothing to do with apparent compliance and money laundering risks posited. With competition related reasons also found, appropriating the term ‘refusal to supply’ from its embedded use in aspects of competition law seems especially apt, and also captures the essence of the evolution of the phenomenon.
That the phenomenon and its constituent parts is now more accurately described does not however change the fact that there is still a risk-related component to the refusals, nor that in many cases, a refusal to supply services to an entity, individual or jurisdiction based on identifiable money laundering or similar risks may be wholly justified.
We further find that refusal based on perceived compliance-based risks are derived from the unintended consequences of risk-based management approaches to anti-money laundering and counter terrorist financing that have been mandated by national financial integrity/anti-money laundering regulators and global standard setting bodies. The genesis then is the lack of guidance to financial institutions on how to implement these mandated compliance approaches. A fear of sanctions from these regulators had led many financial institutions to rather employ a risk avoidance approach by simply terminating or refusing relationships they feel could trigger regulatory oversight and any associated sanctions. That is, the topology of risk management anticipated by the regulatory mandates has instead morphed into risk avoidance, whereby it is simply easier to avoid the risk than provide services. The effect is the same though: a refusal that results in halting of financial flows. Therefrom, we create a taxonomy of reasons for the termination and refusal.
In the Part 2 of this study, we provide a compendium and taxonomy of approaches being employed to mitigate or even solve these refusals, alongside companion recommendations on which approaches or solution could or should be employed.