De-Risking: The ‘Perfect Hurricane’ Threatening Caribbean IFCs

De-risking in this context refers to the practice by some global banks of indiscriminately restricting or terminating business relationships with customers or entire classes of customer without a careful case-by-case analysis of the risks or consideration of mitigation strategies. Indiscriminate de-risking runs contrary to the risk-based approach advocated by the Financial Action Task Force (FATF) since 2012, which requires financial institutions to identify, assess and understand anti-money laundering/countering the financing of terrorism (AML/CFT) risks and to take the appropriate measures to mitigate the assessed risks.

Like a hurricane, formed by winds rotating inward to an area of low atmospheric pressure, a swirl of interrelated factors has lowered banks’ risk appetites. Regulatory scrutiny has increased in the aftermath of the Great Recession. In 2013 the US Department of Justice initiated ‘Operation Choke Point’, which pressured US banks to terminate relationships with businesses deemed to be high risk to prevent their access to banking and payment systems. A Congressional Report by the House Committee on Oversight and Government Reform in 2014, however, found that the initiative was denying access to legitimate businesses.

The low interest rate environment, coupled with higher compliance costs and higher reserve capital and liquidity requirements, has narrowed banks’ profitability margins. Moreover, providing correspondent banking services, while essential, is inherently risky. The correspondent bank is processing transactions for a respondent bank and is therefore reliant on the respondent’s due diligence. No wonder banks have started to consolidate their networks of CBRs to reduce their costs and risk exposure.

Risk Management Guidance released by the US Treasury Department’s Office of the Comptroller of the Currency (OCC) in October 2016 suggested that US banks consider the extent to which account closures may have an adverse impact on entire customer groups or geographic locations’ access to financial services, while also suggesting sufficient time be given to permit respondents to establish alternative banking relationships. While a good step, these are just guidelines and banks will choose profit over costs unless they are incentivised.

The hefty fines imposed on some of the world’s biggest banks for AML/CFT breaches have been wrongly interpreted to suggest a zero-tolerance approach by regulators to any breach, even if unwitting. In fact, the penalised banks had been guilty of egregious wrongdoing and not simple mistakes. Banks also fear the reputational damage and stock market fall-out if they are placed under investigation, even if no wrongdoing is found. In many cases, global banks have decided that the reputational risks and compliance costs do not justify providing accounts to unprofitable customers. All of these factors have conspired to create the ‘perfect hurricane’.

Caribbean IFCs come out on the losing end of this ‘high costs, low profitability’ equation. They are deemed to be ‘high risk’ jurisdictions, while their small market size reduces their profitability for banks. Let me hasten to highlight, however, that although the seminal World Bank Survey published in 2015 found that Caribbean jurisdictions appeared to be the most affected by the loss of CBRs, it was not suggested, nor would it be fair to say that de-risking is a Caribbean-specific problem. Several countries throughout Africa, Asia, the Pacific and the Middle East have also felt the headwinds of the de-risking hurricane.

What Impact on Caribbean IFCs so far?

Caribbean-based banks’ CBRs are the arteries which connect Caribbean IFCs to the heart of the global financial system. These relationships facilitate not just cross-border payments for goods and services, but the repatriation of funds and a slew of other services essential for any IFC to serve the needs of its clients.

While the de-risking hurricane has not yet made landfall, it has already sent warning swells on the shores of Caribbean IFCs. A 2016 survey conducted by the Bahamas Central Bank found that some stand-alone international banks in that jurisdiction had lost their CBRs. Several other territories have seen their standalone banks lose CBRs, usually with little explanation of the reason for termination.

The storm waters have been contained so far and the problem is not yet systemic. Replacement relationships have been found, usually at much higher costs. Even where relationships have been maintained, fees have in some cases increased and respondents have been subject to increased due diligence.

A few international business companies (IBCs) in Barbados have encountered difficulty in opening bank accounts with local branches of global banks unless they have an existing relationship with the parent bank, are a subsidiary of a listed company or have revenues over a certain amount. This has implications for the ease of doing business. Industry insiders have also highlighted instances of account closures and increased scrutiny of international wire transfer requests.

Barbados, which has traditionally relied heavily on Canadian business thanks to a favourable tax treaty relationship, has sought to diversify its sources of business as changes to Canadian legislation have eroded the island’s margin of preference vis-à-vis other Caribbean IFCs. The island’s pivot towards emerging markets, including those in Latin America and Africa, may be impacted by the inability to open accounts.  There is also the possibility of business diversion from the well-regulated, transparent and substance-based Caribbean IFCs to the less scrutinised onshore jurisdictions in metropolitan countries.

The workforce in Caribbean IFCs includes expatriates who not only require wire transfers to make cross-border payments but rely on money services businesses (MSBs) to remit monies to their families. Banks, unfortunately, have also been reducing their risk exposure to MSBs, as these are deemed to be high risk businesses for AML/CFT purposes. MSBs rely on accounts with local banks to offer their services. Fidelity Bank ended its association with Western Union in the Cayman Islands, the Bahamas and Turks and Caicos in July 2015, forcing Western Union branches in those jurisdictions to close for several months until GraceKennedy Money Services took over the Western Union operations later that year.

Caribbean IFCs’ small economies are no strangers to the destructive forces of non-metaphoric hurricanes. In a similar vein, the de-risking hurricane’s landfall can have high economic and even human costs. The international business and financial services sector is not only a generator of foreign exchange inflows, but an important source of corporate tax revenues and employment, with spill-overs in other economic sectors. Any loss of business because of the difficulties caused by de-risking will undermine the long-term viability and macroeconomic stability of Caribbean IFCs, with implications for employment and poverty alleviation. 

What is being done by Caribbean IFCs?

Caribbean IFCs have sought to raise global awareness of the potentially disastrous consequences of the impending de-risking hurricane. A high-level advocacy initiative by the Caribbean Community (CARICOM) has been targeting high-ranking US government officials. A Stakeholders Conference was hosted in October 2016. Caribbean leaders have also tabled and raised the issue at a plethora of hemispheric and international meetings. The Caribbean Association of Banks has also contributed significantly to the research and advocacy efforts. The Association’s survey of its members conducted in August 2016 found that 55 per cent of survey respondents had lost at least one CBR.

Caribbean IFCs have also found support from several regional and international organisations, including the World Bank and the International Monetary Fund, which have also contributed to the growing corpus of research on the impact of de-risking and possible solutions. The Financial Stability Board (FSB) also established the Correspondent Banking Coordination Group in March 2016 to coordinate its four-element action plan aimed at assessing and addressing the decline in CBRs.

One of the factors identified in several of the studies has been the misinterpretation and misapplication of the FATF Recommendations. In 2014, FATF sought to dispel confusion about the risk based approach by clarifying that assessments must be done on a case by case and not wholesale basis. Additionally, until recently there appeared to be the growing norm that banks were required to know their respondent customer’s customers (KYCC). The FATF Guidance note released in October 2016 has since clarified that KYCC is not required.

Concerns about AML/CFT deficiencies are frequently cited as one of the major contributing forces to the de-risking hurricane. Caribbean countries are currently undergoing their fourth round of Mutual Evaluation by the Caribbean Financial Action Task Force (CFATF). Currently, none of the major Caribbean IFCs are included on the CFATF’s list of high risk or non-cooperative jurisdictions.

A key factor is the unfamiliarity of some global banks’ compliance officers with the AML/CFT frameworks in Caribbean OFCs. Moreover, the unfounded characterisation of Caribbean IFCs as high risk jurisdictions for financial services has caused global banks to feel, rightly or wrongly, that they will be subject to increased scrutiny if they conduct business in the region. RBC Wealth Management closed many of its operations throughout Latin America and Caribbean, reportedly, due to regulatory concerns.

The US Department of State’s International Narcotics Control Strategy Report (INCSR) 2016 listed several Caribbean IFCs as jurisdictions of primary concern for money laundering and other financial crimes. This is despite peer reviews of the major Caribbean IFCs conducted by the Organisation for Economic Cooperation and Development (OECD)’s Global Forum in which they have been found to be largely compliant. For example, in its most recent OECD peer review, Barbados was upgraded from partially compliant to largely compliant. Caribbean authorities have also been working assiduously to address any identified gaps, including with the help of technical assistance.

Caribbean IFCs have been supportive of global tax transparency initiatives, despite the high administrative costs and the possible preference erosion vis-à-vis less regulated jurisdictions. Two of these initiatives include the OECD Base Erosion and Profit Shifting (BEPS) initiative and the Common Reporting Standard (CRS) to which several Caribbean IFCs have committed as early adopters. Interestingly, the United States, which started the ball rolling with its Foreign Account Tax Compliance Act (FATCA), has not committed to adopting the CRS. Caribbean countries have also made commitments under FATCA.

De-risking is a complex issue and there is no panacea. While it is outside the scope of this article to explore the possible solutions, blockchain technology, shared data repositories and legal entity identifiers (LEIs) have been among those proffered. What is clear, however, is that information deficiencies have been a contributor to the de-risking problem and any solution must involve increased cooperation, information-sharing and dialogue among regulators, standard setting bodies, banks and other stakeholders, as well as continued clarification of regulatory expectations.

The twin goals of maintaining the integrity of the global financial system and ensuring financial inclusion are not mutually exclusive but complementary. By reducing access to legitimate financial channels, indiscriminate de-risking can have the opposite effect of reducing competition in the global financial system and encouraging the use of informal channels.

The de-risking hurricane has not yet made landfall but it has the potential of making Caribbean IFCs unwitting casualties. While Caribbean IFCs are nothing if not resilient, sustained global cooperation on finding solutions to the de-risking issue will be urgently needed to avoid a direct hit by what could possibly be a category-five hurricane.

Alicia Nicholls
Alicia D. Nicholls is an international trade consultant with over a decade of experience providing bespoke trade research and advisory services to a variety of clients. She is currently a research fellow and part-time lecturer with the University of the West Indies. Miss Nicholls is the founder of the Caribbean’s leading trade policy and development blog, www.caribbeantradelaw.com, since 2011. She also presents regularly at both regional and international academic and industry-related conferences and webinars. While she maintains an interest in all issues affecting Caribbean trade and trade policy, her specific research focuses primarily on global financial regulation and small States, foreign investment law and policy and international business.