Correspondent Banking and De- Risking. Hans-Peter Bauer Stockholm October 5 th 2017

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1 Correspondent Banking and De- Risking Hans-Peter Bauer Stockholm October 5 th 2017

2 De-Risking and Correspondent Banking Taking and transferring risk is the core of banking Banks have increased and decreased risk for ages Too much risk taking was identified as a main reason for the 2008 banking crisis Banks were encouraged to reduce risks across all portfolios Correspondent banking was defined as a high risk area Counter terrorism finance and sanctions added new dimensions with the focus on tail risk Regulatory risk because of enhanced regulatory rules and fines was identified as a new source of eminent risk Regulatory requirements and risk changed the economics in correspondent banking

3 De-Risking Definition Making financial loss less likely by reducing, minimizing or excluding risk in a Business Portfolio with respect to one or more risk categories Reducing risk can refer to Individual risk Overall exposure or portfolio Exposure to tail risk Volatility of Income stream Capital requirements

4 Risk Categories Credit Risk Market Risk Operational Risk Financial Crime Risk AML Risk Regulatory Risk Reputation Risk

5 Risk Factors Client Risk - related to the individual client Industry Risk - related to the industry he operates in or is related to Country Risk - domicile, nationality, business activities Product Risk - selection of products related to customer Distribution Channel Risk

6 High Risk Client Relationships (Examples) Shell banks Arms traders Casinos Dealers in precious metals and stones Trust companies and service providers Money Service Bureaus Embassies Correspondent banks Charities Non Profit Organizations International Private Banking Politically Exposed Persons (PEPs) US-Persons Sans Papiers Immigrants

7 Correspondent Banking Definition (Wolfsberg) Correspondent Banking is the provision of a current or other liability account, and related services, to another financial institution, including affiliates, used for the execution of third party payments and trade finance, as well as its own cash clearing, liquidity management and short-term borrowing or investment needs in a particular currency. A Correspondent Bank is effectively acting as its Correspondent's agent or conduit, executing and/or processing payments or other transactions for the Correspondent's customers. These customers may be individuals, legal entities or even other financial institutions. A correspondent relationship is characterised by its on-going, repetitive nature and does not generally exist in the context of one-off transactions. AUTHOR 22. JANUARY 2014

8 Drivers of De-Risking for CB Overall, reduced risk appetite after 2008 Perceived or assessed risk, Increased compliance cost for high risk clients Insufficient DD information available Lack of confidence in respondent bank s ability to manage risk Nested relationships Lack of client profitability Sanctions on countries or individual banks Regulatory pressure Rising fines and penalties Enhanced corporate and personal accountability Growing reputational concerns

9 Recommendations FATF 2014 De-risking should never be an excuse for a bank to avoid implementing a risk-based approach, in line with the FATF standards. The FATF Recommendations only require financial institutions to terminate customer relationships, on a case-by-case basis, where the money laundering and terrorist financing risks cannot be mitigated. This is fully in line with AML/CFT objectives What is not in line with the FATF standards is the wholesale cutting loose of entire classes of customer, without taking into account, seriously and comprehensively, their level of risk or risk mitigation measures for individual customers within a particular sector.

10 Recommendations FinCEN 2014 Refusing financial services to an entire segment of the industry can lead to an overall re-duction in financial sector transparency that is critical to making the sector resistant to the efforts of illicit actors. This is particularly important with MSB remittance operations. FinCEN does not support the wholesale termination of MSB accounts without regard to the risks presented or the bank s ability to manage the risk. As noted, MSBs present varying degrees of risk, and not all [MSBs] are high-risk. Therefore, when deciding whether to provide services to an MSB customer, financial institutions should assess the risks associated with that particular MSB customer.

11 Recommendation JMLSC UK 2014 There is no requirement in the ML [money laundering] Regulations that a firm must close an account that is the subject of a suspicious activity report. Firms are therefore not expected automatically to terminate existing accounts of MSBs based solely on the discovery that the customer is an MSB that has failed to comply with registration requirements (although continuing non-compliance by the MSB may be an indicator of heightened risk). In these circumstances, further enquiries ought to be made.7

12 Initiatives on Correspondent Banking The Financial Action Task Force (FATF) Anti-money laundering and terrorist financing measures and Financial Inclusion (June 2011) Correspondent Banking Services (October 2016) Financial Stability Board FSB Correspondent Banking Data Report (2017) FSB Action plan to assess and address the decline in correspondent banking:progress report to G20 (July 2017) The World Bank The World Banks Data Collecting Efforts: De-Risking? (2017) International Monetary Fund Recent Trends in Correspondent Banking Relationships (2017) The Basel Committee on Banking Supervision Sound management of risks related to money laundering and financing of terrorism (3 rd revised edition June 2017) BIS Committee on Payments and Market Infrastructures (CPMI) Working Group on Correspondent Banking Correspondent Banking (July 2016) FSB Correspondent Banking Coordination Group

13 FSB Correspondent Banking Coordination Group Action Plan Further examining the dimensions and implications of the issue; Clarifying regulatory expectations, as a matter of priority, including guidance by the Financial Action Task Force (FATF) and the Basel Committee on Banking Supervision (BCBS); Domestic capacity-building in jurisdictions that are home to affected respondent banks; Strengthening tools for due diligence by correspondent banks.

14 FSB Open Issues 2017 The monitoring of trends at the global level and of the impact on jurisdictions still needs to be improved The new FATF and revised BCBS guidance should be followed up by statements at the national level by national regulators to clarify expectations at the national level, Technical assistance providers need to continue to coordinate help to affected jurisdictions to improve their AML/CFT frameworks, and strengthen their supervisory capacity. Technical solutions such as Know Your Customer (KYC) utilities have the potential to assist in conducting due diligence and reduce compliance costs Despite efforts by the international community, difficulties for remittance providers in accessing banking services persist.

15 Private Initiatives SWIFT international KYC Utility for financial institutions SWIFT Sanctions Screening for member banks SWIFT Compliance analytics to monitor channels Wolfsberg Revised Due Dilgence Questionaire Training banks and regulator

16 Thank you Basel, October 2017 Hans-Peter Bauer Member of the Board Basel Institute on Governance Basel/Switzerland AUTHOR 22. JANUARY 2014