Caribbean Trade Law and Development

Tag: derisking

  • Will US Financial Deregulation help mitigate the de-risking phenomenon?

    Will US Financial Deregulation help mitigate the de-risking phenomenon?

    Alicia Nicholls

    The exigencies of complying with a complex and often confusing maze of overlapping regulations, coupled with steep fines for compliance breaches, have been identified as principle drivers for United States-based global banks’ restriction and termination of correspondent banking relationships with respondent banks in other jurisdictions. As part of his promise to “Make America Great Again”, US President Donald Trump has pledged to cut the regulatory noose argued to be strangling US enterprise and growth. Will this deregulatory push have the unintended spin-off of mitigating the de-risking phenomenon facing several countries around the world, including Caribbean States?

    President Trump has been adamant that ‘burdensome’ regulations passed during the Obama administration to avert a repeat of the Global Economic and Financial Crisis of 2008, have been fetters on US business activity and prosperity. While most available data point to the contrary, the Trump Administration and Corporate America posit that Obama-era regulations like the Dodd-Frank Wall Street Reform and Consumer Protection Act (2010) have reduced bank profitability and risk appetite, culminating in dampened bank lending to consumers and businesses.

    President Trump has so far signed two executive actions on financial deregulation. The latter, an executive order dated February 3, 2017, sets out seven core principles for regulating the US Financial System. It mandates Treasury Secretary, Steve Mnuchin, to consult with the heads of the member agencies of the Financial Stability Oversight Committee (FSOC) and to submit to the President within 120 days a review of “laws, treaties, regulations, guidance” inter alia, which among other things inhibit regulation in sync with the Core Principles. There has been reportedly a shift towards more ‘pro-business’ regulators. Perhaps most telling, in contrast to his anti-Wall Street rhetoric during the campaign, President Trump has picked several former bankers (notably Goldman Sachs) for key cabinet and administration positions, including for Treasury Secretary.

    Stringent compliance burdens and costs, as well as uncertainty about the interpretation of the regulations, are major drivers for banks’ avoiding, rather than managing risks. Will an unintended consequence of financial deregulation in the US be a mitigation of the de-risking phenomenon? While at first blush this conclusion may appear tempting, I respectfully submit that this may be an overly optimistic view, at least at this early stage, for the reasons which I outline below.

    Firstly, the Trump Administration has set its cross-hairs firmly on the Dodd Frank Act which President Trump termed a “disaster”. This Act, which is hundreds of pages long, was passed in the aftermath of the Great Recession. It includes, for instance, rules against predatory lending, sets measures to deal with banks which become “too big to fail”, prohibits proprietary trading by banks for their own profit (Volcker Rule), inter alia. While Dodd Frank is not perfect and has been blamed for contributing to de-risking, repealing it would not only create an environment for a resumption of the pre-crisis risky behaviours by banks and other financial institutions. It would set the stage for a repeat of 2008, in much the same way that deregulation during the 1990s to early 2000s, including changes to the (now repealed) Glass-Steagall Act, laid the groundwork for the Great Recession, almost a repeat of the Great Depression of the 1930s.

    Secondly, Dodd-Frank is just one aspect of the de-risking problem. There appears to be no indication that the Trump Administration intends to tackle the constellation of other regulations, including international anti-money laundering, countering the financing of terrorism (AML/CFT), tax and banking regulations (Basel III), with which banks, including in the US, must comply.

    In the World Bank’s seminal 2015 global survey on the Withdrawal from Correspondent Banking, some 95% of large banks had cited “concerns about money-laundering/terrorism financing risks” as a driver for withdrawing from correspondent banking relationships. However, it is unlikely that the Trump Administration will try to rollback AML/CFT rules. President Trump’s ‘America First’ ethos has a strong national security undertone. Weakening the US’ AML/CFT rules would likely make him appear ‘soft’ on money laundering and countering the financing of terrorism. International pressure is also a factor as the US’ last Financial Action Task Force (FATF) Mutual Evaluation Report (2016) highlighted some AML/CFT weaknesses, including gaps in timely access to beneficial ownership information.

    Thirdly, replacing existing regulators with so-called pro-business regulators does not necessarily mean that there will be a more lenient approach to fines imposed on banks for compliance breaches. Unlike popular belief, most of the large banks which have been made to pay record fines had indeed knowingly committed serious AML/CFT breaches.

    Fourthly, even if financial deregulation in the US eases the regulatory pressure on US global banks, it does not affect two core problems which appear to be driving the de-risking of regional banks, namely the perceived unprofitability of providing correspondent banking services to indigenous Caribbean banks, and the Caribbean region’s unjustified characterisation as a ‘high risk’ region for conducting financial services. In the previously mentioned World Bank 2015 Survey, some 80% of large banks cited “lack of profitability of certain foreign CBR services/products” as a driver of exiting correspondent banking relationships.

    Further to the latter point, Caribbean countries, particularly international financial centres (IFCs) are consistently and unjustifiably placed on US government lists deeming them as money laundering threats, despite the fact that no Caribbean IFC is currently on any CFATF list of ‘high-risk and non-cooperative jurisdictions’. The most notorious example of this unfair practice is the US’ annual International Narcotics Control Strategy Report, the latest edition of which listed 21 Caribbean jurisdictions without providing (as usual) any evidence to support the conclusions drawn.

    Caribbean countries are consistently branded as tax havens in spite of the fact that all Caribbean countries have signed intergovernmental agreements (IGAs) with the US Government pursuant to the extra-territorially applied US Foreign Account Tax Compliance Act (FATCA) passed in 2010. Most Caribbean governments have already passed implementing legislation to bring their IGAs into force. In addition, while the US has opted not to be a part of the OECD’s Common Reporting Standard, several Caribbean countries have elected to be early adopters!

    Added to this is that compliance officers in overseas banks usually view the Caribbean as a “collective” and not as individual countries; any perceived risks in one country are transposed to the Region as a whole.

    Granted, it is still early days of the Trump Administration and the findings of the Treasury Secretary’s report on which regulations may possibly be earmarked for axing would not be known for some time. What does help, however, is where there is clarification of the rules through clearer guidance. For instance, for a long time it was unclear how far banks’ due diligence requirements were to go. In addition to knowing their customer (KYC), there appeared to be a growing consensus that banks were also supposed to know their customer’s customers (KYCC).  Definitive guidance through the FATF Guidance in October 2016 showed that KYCC was not required. Turning to the US, that same month the US Office of the Comptroller of the Currency (OCC) released guidance to assist banks in the periodic risk reevaluation of foreign correspondent banking relationships.

    However, the Region would be well-advised not to expect any serious mitigation of the de-risking phenomenon stemming from US financial deregulation. Despite being a ‘pro-business’ administration, it should be remembered that the overriding goal of the Trump Administration’s regulatory rollback is to “Make America Great Again”, point blank. Any spill-over positive benefits to the Caribbean from Trumpian financial deregulation would be welcomed but unintended, and it is more likely that the regulatory rollback may perhaps be more harmful than helpful to the region.

    There is no panacea for the de-risking phenomenon as it is caused by a multiplicity of factors. Regional governments and private sector stakeholders should continue their lobbying and advocacy efforts, including engagement with key US administration officials, regulators and the banking sector. Given the Trump Administration’s ‘America First’ disposition, lobbying efforts which emphasises the implications that possible derisking-related economic and social destabilisation in the Caribbean may have on the US’ homeland security would be more impactful than pure moral suasion.

    These advocacy efforts should also highlight to US officials and to US correspondent banks Caribbean countries’ own efforts at continuously improving their AML/CFT frameworks and the compliance efforts of Caribbean banks. Regional banking stakeholders should also continue to explore the possibility of investing in technologies such as Know Your Customer (KYC) utilities and legal entity identifiers (LEIs) to assist in customer due diligence (CDD) information sharing between themselves and their US correspondents.

    These were part of the remarks I gave as a panellist at the Barbados International Business Association (BIBA) International Business Forum 2017. 

    Alicia Nicholls, B.Sc., M.Sc., LL.B., is a trade and development consultant with a keen interest in sustainable development, international law and trade. You can also read more of her commentaries and follow her on Twitter @LicyLaw.

  • CARICOM countries continue fight against bank de-risking

    CARICOM countries continue fight against bank de-risking

    Alicia Nicholls

    The countries of the Caribbean Community (CARICOM) are continuing their fight against bank de-risking practices which are resulting in the restriction, threat of, or outright termination of correspondent banking relations with banks and wire transfer providers in the Caribbean region.

    Onerous global and national regulatory requirements (such as anti-money laundering and combating the financing of terrorism standards), burdensome compliance costs and the stringent sanctions for breach of these regulations are increasingly leading banks in metropolitan countries, particularly in the United States, to de-risk, that is, avoid risk by discontinuing business with whole classes of customers without taking into account their levels of risk, as opposed to managing and mitigating risk. While other countries are also experiencing this disquieting phenomenon, the Caribbean appears to be the most affected region according to a World Bank survey conducted last year.

    There are a number of other factors influencing de-risking decisions. Besides risk and reward considerations, added to the mix is the growing perception of the Caribbean as a “risky” place for financial transactions. The unwarranted attacks against legitimate offshore financial centres in the Caribbean in the wake of the Panama Papers scandal will no doubt unfortunately add fuel to the fire. The net result is an increasing unwillingness of international banks to continue correspondent banking relationships with banks and wire transfer providers in the region.

    Belize has been the hardest hit so far by bank de-risking, but other Caribbean countries are also being affected. In the International Monetary Fund (IMF)’s Caribbean Corner publication of September 2015, it was reported that “[a]lready at least 10 banks in the region in five countries have (as of June 2015) lost all or some of their CBRs, including two central banks.” This number has grown.

    At the meeting of the Financial Stability Board in Tokyo in March this year, Barbados’ Central Bank Governor, Dr. Delisle Worrell, reporting in his capacity as co-Chair of the Financial Stability Board’s Regional Consultative Group for the Americas, highlighted that eight correspondent banking relationships in Barbados’ international business sector have already been severed. He further warned that the lack of correspondent banking services could lead individuals to utilise unregulated channels, thereby limiting transparency and adding further risk to international transactions.

    The loss of correspondent banking relationships disrupts the processing of financial instruments, such as credit card transactions and cheques,  needed for trade, investment, tourism and remittance flows, and would effectively de-link regional economies from the international financial system. It also has humanitarian and poverty eradication consequences as well. Remittances are the “bread and butter” for many poor families who depend on earnings made by breadwinners abroad. In light of the serious threat posed to the region’s economic, financial and social stability by de-risking, CARICOM heads of government took the decision to raise the issue not just bilaterally but in multilateral fora.In March Caribbean countries sought the Organisation of American States’ support.

    Last week, Prime Minister of St. Kitts & Nevis, Dr. Timothy Harris took the lead during an important consultation with officials from the US State and Treasury Departments in Washington DC raised the serious impact de-risking was having on regional economies. The issue was also raised at the recently concluded Ninth UK-Caribbean Forum. The Ministers noted at paragraph 9 of the Communique:

    The Caribbean therefore called on the UK to continue to work with international
    partners to address this global phenomenon, and to encourage banks which
    provide correspondent banking services, and regulatory authorities, to take
    into account the efforts being made by Caribbean countries and financial
    institutions to implement international regulations and to mitigate risks.

    The full communique from that meeting may be viewed here.

    The Caribbean Association of Banks has also been playing a critical role in lobbying efforts. At the Association’s recently held CEO Forum on May 3rd, parties came together “to explore potential solutions and develop a set of actions in response to this threat”. According to the press release, the Forum “discussed and agreed” on the following possible solutions:  the establishment of a clearing institution in the US, alternative Payment Methods and alternative Correspondent Banking Relationships. The forum also established a six member committee to advance these recommendations. The full press release from the CAB’s CEO Forum may be viewed here.

    Alicia Nicholls, B.Sc., M.Sc., LL.B. is a trade and development consultant with a keen interest in sustainable development, international law and trade. You can also read more of her commentaries and follow her on Twitter @LicyLaw.