The Downsides of De-Risking

How withdrawal of international financial institutions is harming vulnerable people — and may increase the very risks of financial crimes and terrorism financing that de-risking is meant to solve.

In the fourth article in our partnership with Meridian International Center’s series on The Digital Finance Future, Ann Babe explores the downsides of international trends toward de-risking.

Following 9/11, U.S. authorities suspected al-Barakaat, the biggest money transfer business servicing the predominantly Muslim Somali community, had helped fund al-Qaeda. To protect the U.S. from further threats of terrorism, they shut it down.

In the wave of heightened enforcement, regulators also cracked down on other actors and activities that they deemed to be a danger to international security. Despite ties to terrorism since acknowledged as only tenuous, regulators opened criminal investigations, raided offices and imposed fines. In the years since, many global banks have responded by cutting their risks, or “de-risking.” De-risking means terminating relationships with certain “high-risk” local banking institutions, business sectors (like money services) and regions. Most of these are in the impoverished Global South.

The rest of the al-Barakaat case offers a telling example. The 9/11 Commission eventually cleared al-Barakaat of involvement with al-Qaeda. But the damage was already done: due to the bad publicity, the reputations of al-Barakaat, other Somali money service businesses and the overall money service industry remain tarnished to this day, according to the Global Center on Cooperative Security.

Meanwhile, vulnerable populations in Somalia and other developing nations that lack their own centralized banking scheme suffer the fallout, as one international institution after another declines to serve these communities.

These trends not only hurt disadvantaged people, but they may also, ironically, increase risks of financial crimes — like terrorism financing and money laundering — throughout the global financial system.

The rise of de-risking

Today, with threats of money laundering and terrorism financing still looming, the default strategy for global banks continues to be de-risking’s cut-or-run approach — that is, severing relations with customers or products perceived to be too risky or getting out of high-risk regions entirely.

Chief among the cut-or-runners are big banks in the U.K., U.S. and Australia, which often set the trend in international finance. As Tracey Durner and Liat Shetret put it in their report for the Global Center on Cooperative Security: “A clear herd mentality has emerged. The closure of MSB [money service business] accounts by one major bank has caused other financial institutions to reassess these accounts, which has in turn resulted in closures across the board.” Without money service businesses, which power remittances, people working abroad have trouble sending money to families back home.

Indeed, in 2012, it was reported that HSBC withdrew wholesale from the remittance sector, according to a 2015 paper by the Center for Global Development (CGD). Not long after, in the spring of 2013, Barclays notified more than 140 U.K.-based remittance companies that it would close their accounts within 60 days. Following these closures and a series of others across the U.S. and Australia, notes the CGD, banking access was restricted to only larger money transfer organizations. “Industry bodies report that many smaller players have been forced to close, become agents of larger businesses or even disguise the true nature of their operations in order to remain banked.”

As Vijaya Ramachandran, director of the CGD paper, says in an interview: “Rather than assess case by case, some banks are picking up a very conservative approach: across-the-board de-risking.”

De-banking and the disadvantaged

The global payments landscape that has emerged in recent years is one in which correspondent banking relationships are in sharp decline, with 75 percent of large international banks decreasing such partnerships as of 2015, according to findings by the World Bank. This means local institutions are becoming increasingly disconnected from the global institutions they rely on for international wire transfers, trade finance, check clearing and other cross-border transactions.

In some cases, global banks withdraw from these relationships because they worry, quite legitimately, they put them in jeopardy. But in other cases, according to the Society for the Worldwide Interbank Financial Telecommunication (SWIFT), they might withdraw because they want to minimize costs and avoid added regulatory pressures associated with policies on anti-money laundering and countering the financing of terrorism.

While de-risking may reduce risk for wealthy global financial institutions, it increases risk for already disadvantaged individuals living in or transferring money to the Global South—the risk of financial exclusion. Such exclusion comes in the form of greater difficulties participating in the global economy, which, according to SWIFT, “could affect a wide range of transactions” — from “purchases of consumables” and “payments for medical care and education fees” to, most notably, remittances.

Remittances are crucial to the Global South. Developing countries depend on them, in fact, more than any other form of financial assistance, even foreign aid. In 2015 alone, remittances to the Global South totaled more than $431 billion, the World Bank reported, while all official development aid amounted to just a third of that.

“[De-risking is] a problem for people who are trying to send remittances. It’s a problem for people who are trying to get trade finance,” says Ramachandran. “And it’s a problem for NGOs who are trying to do work in conflict countries.” Ramachandran is referring to banking barriers that stand in the way of important humanitarian and development programs like cash transfer, health, education and other aid initiatives. Even major nonprofits have reported problems accessing banking in de-risked regions.

Examples of these problems abound across the world. Oxfam senior humanitarian policy officer Scott Paul tells me about two in Afghanistan. In one case, an American nonprofit trying to fund a university dormitory for 400 underprivileged students was forced to abandon the project after its wire transfers were denied. In the other, an international nonprofit working to provide tents, blankets and other winterization items failed to deliver the aid because its transfers were delayed.

According to Paul: “It’s become increasingly hard to send money into crisis areas. Remittance companies, humanitarian organizations and key banks are all being pushed out of the financial system or hitting roadblocks with financial transfers.”

Financial exclusion hurts financial integrity

For individuals living in or transferring money to places cut off by de-risking, the absence of official channels also means having little choice but to turn to more dangerous alternative channels for moving their money.

“They tend to shift into mom-and-pop operations,” says Ramachandran. “These are not illegal networks. … They’re not necessarily transferring illicit money, but they are much harder to trace.” Such operations might be money-broker networks like hawalas, used frequently across the Middle East, North Africa, the Horn of Africa and South Asia. Or such operations might involve physically transporting cash across borders in suitcases, which has been reported in Somalia, and on speedboats through waterways.

Cash flows like these are difficult to monitor — another example of how de-risking “ironically,” as SWIFT puts it, may actually lead to other risks. “[F]rom a security perspective, this money is less traceable,” says Ramachandran. “You don’t want that. You want to have money going through formal channels so you know where it’s going and who it’s going to.”

In other words, de-risking is endangering the world’s financial integrity. Writes the World Bank: “Financial integrity and financial inclusion are complementary. Financial inclusion is a necessary precondition to effectively mitigate risks and combat financial crimes. The Financial Action Task Force” — the inter-governmental body founded in 1989 that sets anti-money laundering policies — “recognizes financial exclusion as a risk to financial integrity.”

What lies ahead

With financial integrity at stake, most agree a solution is in order.

“Banks, nonprofits and governments all want the same thing: money flowing into emergencies transparently, legally and without unnecessary impediments,” Paul says. “Policymakers need to make sure that the incentives actually encourage that.”

Measures for mitigating de-risking range from the policy-driven to the tech-enabled, including digitized ledgers, blockchain currencies and biometric IDs. “Some of the most promising stuff is this new technology,” adds Ramachandran.

These solutions will help improve data gathering, knowledge sharing and identification processes, which reduce compliance burdens and foster trust and transparency.

As increasing attention is being paid to the problem of de-risking, it would seem the answers are in sight. But precisely how near in sight? It’s uncertain.