Regulation

Is ‘De-Risking’ Waning?


By Krishna Srinivasan, Deputy Director, International Monetary Fund’s Western Hemisphere Department (01/05/2018)

Caribbean countries were blindsided about two years ago by a serious threat to their economies from the loss of correspondent banking relationships (CBRs), more colloquially termed as ‘de-risking’. There was a serious risk that, without US correspondent banks, Caribbean banks would find it extremely difficult to mediate US dollar transactions on behalf of their clients, tourists would not be able to use credit cards to make purchases while vacationing, Caribbean nationals living abroad might not be able to send remittances back home, and settling payments for imports and exports would become problematic.

To be clear, the Caribbean was not the only region to be affected by the withdrawal of CBRs.  This was a global phenomenon affecting several regions and countries around the world, but given that most Caribbean economies are heavily dependent on tourism and tourism-related activities, there was a clear and present danger that the adverse economic impact from a loss of CBRs could be catastrophic.  

While there are several interrelated factors responsible for US banks’ withdrawal of CBRs from the Caribbean, they generally reflected changes in correspondent banks’ assessment of the profitability and risks associated with these relationships. This, in turn, emanated from changes in the regulatory and enforcement landscape, notably pertaining to prudential requirements, economic and trade sanctions, anti-money laundering and combating the financing of terrorism (AML/CFT) and tax transparency standards. The problem had a varying impact across Caribbean countries depending on the size of the affected banks and the level of foreign presence in affected countries’ banking systems, with offshore financial sectors reporting larger losses in CBRs than the onshore sector.

With a view to addressing the problem, Caribbean authorities stepped up their reform efforts to address the factors responsible for the loss of CBRs, including improving the supervisory and regulatory frameworks, notably on AML/CFT. For instance, the Eastern Caribbean Central Bank (ECCB) members decided to consolidate their national AML/CFT supervision into a regional operation under the ECCB. At the same time, they urged the International Monetary Fund (IMF) to use its global reach to help foster a shared understanding among the key stakeholders of the drivers behind the withdrawal of CBRs, with a view toward finding durable solutions to the problem.

The IMF responded by convening a periodic Caribbean Roundtable on CBRs, bringing together regional bodies and authorities, as well as global correspondent and respondent banks from various Caribbean islands, to explore industry and regional solutions to address the problem.

And progress has been made. At the end of the latest consultative event, held in November in Jamaica, there was consensus among participants that the worst fears have not come to pass – there had been no further erosion in access to CBRs in the region since the first of the IMF–organized events (held in Barbados in February 2017) and  the macroeconomic effects of CBR withdrawals had been contained. Indeed, available data points to a recovery in the value of cross-border transactions across the Caribbean since the second half of 2016, with some global banks beginning to reengage with the region, albeit cautiously, and new correspondent banks entering to fill the gap. For example, while local banks in Belize had lost two-thirds of their CBRs in early 2016, every Belizean bank now has at least two CBRs and can process transactions in a timely manner.

Progress is attributed to three key initiatives mutually agreed to by the banks at the first IMF event held in Barbados. First, communication has greatly improved. When the problem of CBR withdrawal first arose, there was little communication between global and respondent banks, with the latter receiving letters indicating accounts were to be closed without any explanation. In contrast, communication is now taking place in a two-way stream, with correspondent banks providing written statements to respondents describing the risk management practices they expect from respondent banks. Respondent banks, in turn, are making a stronger effort to improve the quality and timeliness of information in response to requests from correspondents. Second, correspondent banks are providing targeted training to help improve Caribbean banks’ capacity to manage risks. Third, in response to concerns by correspondent banks of the low profitability of CBRs with Caribbean banks, owing to the typically small volume of business, there has been meaningful progress in consolidation of transactions via a global intermediary bank that has onboarded more than 20 respondent banks in the region. 

Where Do We Go From Here?

Despite encouraging improvements, the situation is still fragile. Several banks are working with fewer CBRs and any further loss could be catastrophic to commerce; and costs of cross-border transactions have already increased substantially, bearing negatively on competitiveness, growth and financial inclusion. Moreover, new risks have appeared, such as US sanctions on Venezuela, which has prompted several correspondent banks to refuse the handling of Petrocaribe-related transactions. These developments suggest a need for additional measures. In particular:

•           Increasing dependence on fewer correspondent banks means that Caribbean respondents could be seriously affected if any of the remaining correspondents were to no longer provide correspondent banking services. Could a large regional bank also take on the consolidation role? At this stage, no regional bank has yet positioned itself as such. The possibility of establishing or acquiring a regional bank in the US to serve as a correspondent bank deserves careful consideration.

•           More progress is needed on the consolidation of banks. In the Eastern Caribbean, where 20 licensed banks serve a population of just 600,000, banks are typically too small to efficiently implement the tighter risk management protocols required by correspondent banks. Encouragingly, regional policymakers acknowledge the need for consolidation and a white paper is expected to be issued by the Eastern Caribbean Central Bank on this topic in early 2018.

•           Durable solutions are needed for risky but, nevertheless, legitimate activities. Certain sectors or activities, such as the offshore financial sector, gaming and casinos, and money transfer companies, that often support the tourism sector and boost employment, social welfare, and financial inclusion, continue to see their access to correspondent banking restricted.

What is the Solution?

The Caribbean must find efficient ways to reduce the use of cash in US dollar transactions. Cash, while a convenient means of exchange, does not allow adequate tracking of the underlying transactions, something that has become crucial in today’s world where the fight against money laundering, terrorism financing, and tax evasion, is rightly prioritized. Financial technologies, such as mobile banking or blockchain, could provide helpful alternatives and should continue to be explored.

Offshore centers can also enhance their position by implementing robust AML/CFT and tax transparency regimes, reconsidering high-risk business lines, and engaging in effective international cooperation. However, ongoing international initiatives to promote transparency may call into question the sustainability of offshore banking in the long term.

Meanwhile, the IMF will continue its ongoing engagement with members to promote needed action by various stakeholders. Additional effort is needed to ensure the effective implementation of the updated international standards on anti-money laundering and combatting the financing of terrorism. The IMF will continue to provide technical assistance and training in this area. Regulators in advanced countries and international standards setters should continue to clarify their regulatory expectations for the correspondent banks. In the Caribbean context, this has once again become important with respect to the banks’ uncertainty surrounding the appropriate reaction to the US sanctions against Venezuela.

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