Relations in Banking – Making it Work for Everyone
July 18, 2016
President Dudley, thank you for your kind introduction, and for the opportunity to speak to such a distinguished audience.
I am delighted to be back in New York, the financial powerhouse of the United States. To most people, Wall Street is the hub where the big financial players converge, and where important global issues are at stake on a daily basis.
During my past visits, we have talked about some of these issues, and what they mean for the financial industry. We could easily spend hours on this again, given what has happened in Europe and other places during the last couple of weeks.
Today, however, please allow me to speak about the “smaller” financial players of this world. They include banks and their clients from developing countries, small island economies, and some emerging market economies with small financial systems.
These institutions do not play a big role in the world of global finance. And yet, for their home countries, a well-functioning financial system is just as essential for growth as in the large economies. These countries, too, need to ensure an efficient allocation of capital. And they need ways to empower the poor and the small to participate in the economy.
I am concerned that not all is well in this world of small countries with small financial systems. In fact, there is a risk that they become more marginalized.
This has to do with the fact that large global banks are under pressure to raise capital, streamline their business models, and re-evaluate their risk exposures. As a result, many of them have been in the process of closing business lines that they consider marginal to their bottom line, or detrimental to their risk profile.
So, large banks are withdrawing from smaller countries. This is perhaps most evident in the decline of correspondent banking relationships – a serious concern for those countries that have few avenues for participating in the global payment and settlement systems.
Why should we care about this problem? Because affected countries often are very vulnerable – they include small island economies and countries in conflict. These are countries with minimal access to financial services in the best of circumstances. And there are also larger countries whose economies rely heavily on cross-border flows, such as remittances, and where development is now at risk.
And even if the global implications of these disruptions are not visible so far, they can become systemic if left unaddressed.
So, today I would like to focus on the challenges posed by the withdrawal of correspondent banking relationships and what can be done about it.
1. Disruptions in Banking Relations – Who is Affected and Why
Correspondent banking is like the blood that delivers nutrients to different parts of the body. It is core to the business of over 3,700 banking groups in 200 countries. 1 A global bank like Société Générale, for example, manages 1,700 correspondent accounts and processes 3.3 million correspondent transactions every day. 2
There is a real concern expressed by many of our IMF member countries that their financial lifeline is at risk: in Africa, the Caribbean, in Central Asia, and in the Pacific. The decline in correspondent banking spans several continents.
To be clear, this problem has many dimensions. There are first of all the corresponding banks themselves, mostly private banks that make their own business decisions every day. There are the regulators who are concerned with economic and financial stability, treasuries and finance ministries worrying about tax revenues and money laundering – as well as security agencies that try to limit the abuse of the financial system to finance terrorist activities.
Managing all these dimensions is not an easy task, to put it mildly. A first step for us has therefore been to better understand the concerns of all parties. This is why IMF staff have recently embarked on a fact-finding expedition. They met with representatives from impacted countries, with regulators in key financial centers, and with major global banks.
The outcome of this expedition is documented in a paper that has recently come out. 3 I will give you a flavor of our findings, but I let me first acknowledge the support we received from the authorities in the U.S. and other countries, including from you and your colleagues, President Dudley. Thank you!
Countries affected by disruptions in cross-border banking services
Let me start with examples of countries that are at risk of being cut off from the global financial network.
- In the Caribbean – as of May this year – at least 16 banks across five countries have lost all or some of their correspondent banking relationships.
- In Liberia, global banks have terminated almost half of the existing 75 correspondent relations, severely affecting the ability of local banks to conduct U.S. dollar transactions.
- In the case of Samoa, the decision by banks to terminate accounts of Samoan-linked money transfer services agents increased the fragility of the remittances corridor. Samoa is a small island in the Pacific where remittances account for 20 percent of GDP.
With some of these countries, the decision of larger banks to withdraw was motivated by concerns about lagging efforts in upgrading compliance with international anti-money laundering standards.
In other cases, however, the pull out was driven by low profitability or other considerations.
Some might dismiss this as just an issue for small countries. That would be a mistake. We also heard from bigger countries like Mexico and the Philippines, where remittances play an important role. And it is people in rural and remote regions that are hardest hit by closure of accounts that facilitate the flow of remittances. This is truly a cause for concern.
Regulators in key financial centers
Now let us turn our focus to our discussions with the regulators. One question we had was whether the cutback in banking relationships was the result of tighter regulation after the global financial crisis – or whether it is the collateral damage to the imposition of stricter rules related to Anti-Money Laundering and Combating the Financing of Terrorism (AML/CFT) in recent years.
The regulators were of course very aware of both issues, and we all agreed strongly on the need for adequate financial supervision and curbing money flows into criminal activities.
Undoubtedly, bank regulators have also made significant efforts to disseminate to the public information on regulations and enforcement actions. The U.S. Treasury Department, for example, has put considerable resources into educating financial institutions on the precise nature of transactions and individuals that are subject to sanctions. 4 [ [i] ]
Our conversations also revealed that bank supervisors have not asked financial institutions to terminate specific relationships or business lines. Nor did regulators feel that there were excessive demands on banks to “know your customers” or “know your customers’ customers,” which is where some of the violations occurred that led to large fines in the past. 5
Indeed, high-profile enforcement actions have focused on cases where the violations were repeated, systematic, and egregious. They were not aimed at pursuing accidental one-off episodes due to insufficient information or lapses in judgment.
Our overall takeaway from the discussions has been that regulators are following a generally reasonable approach. It is of course based on proper implementation of domestic regulations and designations of sanctions, albeit using a risk-based approach to enforcement. In other words, ensuring compliance with greater efforts where the risks are highest.
So what about global banks themselves? What has been shaping their decisions on cross-border services?
There are several intertwined factors. But what affected countries may perceive as a knee-jerk reaction by global banks may in the end simply reflect rational business decisions.
One such factor is the broader re-assessment of business lines based on cost-benefit considerations. Global regulatory reforms have effectively raised the cost of capital for banks. As a result, high-volume, low-return businesses – such as correspondent banking – have become less appealing.
Another factor quoted to us has been the considerable uncertainty among banks concerning their regulatory obligations. The possibility of large penalties and reputational risks associated with enforcement on sanctions, tax transparency, and anti-money laundering seems to increase the costs of compliance for global banks in significant ways.
Since these are the very issues where regulators have tried to provide clarity, this suggests that both sides still have some work to do in order to reach a better understanding.
I should note that this was particularly a concern for European banks in the context of U.S. regulations – which is important as they all have dollar-based operations here in the United States.
Some of these banks have undertaken to examine normative documents, so-called Deferred Prosecution Agreements, for guidance on the level of compliance expected of them. 6 There are a few cases where banks committed to end correspondent banking relationships for risk reasons in these agreements. 7
This has now have taken on broader importance; other banks’ views of regulatory expectations are influenced by such agreements. This may also have contributed to the pull-out from correspondent banking.
2. Collective Action to Mitigate a Breakdown in Banking Relationships
So where does our fact-finding exercise leave us today?
It seems clear that all parties involved pursue rational objectives, but don’t quite see eye-to-eye with each other. It is a collective action problem that calls for a collective solution.
Or, as the famous philosopher Aristotle once wisely noted:
“In the arena of human life, the honors and rewards
fall to those who show their good qualities. ” 8
I understand Aristotle as saying that the responsibility cannot just be on one individual group of actors to show their good qualities. There is a need for action on the part of the countries affected, the regulators, and the global banks. All three have a stake in addressing this issue.
Clearly, the affected countries themselves need to be called to task. They need to upgrade their regulatory and supervisory frameworks to enhance compliance with international standards, especially in the areas of AML/CFT and tax transparency.
The case of Mexico is illustrative of how such action has led to improvements in correspondent banking relations. The authorities issued regulations to increase AML/CFT controls, especially for institutions involved in high-risk activities, and required the use of what is called Legal Entity Identifier for banks and large firms involved in certain transactions.
These steps were taken in coordination with the home authorities of major global banks. They reduced the risk of disruption in correspondent banking, and improved the robustness of the domestic regulatory framework at the same time.
In other jurisdictions, efforts may need to go beyond improving compliance, however. Business models that depend on opaqueness, offshore structures, and a lack of transparency clearly need to be reassessed going forward.
Regulators also have an important role to play. They should continue their outreach and dialogue with global banks and affected jurisdictions to clarify – and consistently communicate – regulatory expectations.
There is also room to collaborate further with other public authorities to improve compliance and mitigate disruptions in key business categories such as remittances.
In the United States, for example, the Federal Reserve Bank of Atlanta set up an automated clearing house for cross-border payment services. This has been vital in securing remittance flows to more than 25 countries in Central and South America. 9
Countries where large global banks are situated could further help improve clarity by fostering a common domestic understanding of the regulatory perimeter between the different actors that are involved. This includes the government, bank regulators, other financial supervisors, as well as judicial agencies that are involved in supervising and enforcing relevant legislation.
Finally, the financial industry, too, needs to step up to the task.
Looking beyond short-term risks and profitability concerns, there clearly is a business case that can be made for banking in small countries. The challenges to overcome in the payment and correspondent banking business are not limited to these countries. And as technology confirming the authenticity and legitimacy of transactions moves forward – effectively reducing compliance costs for global banks – I would expect that smaller countries can be brought into the fold.
So I would encourage banks to work collectively on reducing compliance costs and maintaining the financial lifeline for those who need it most. Innovative solutions like “Know Your Customer” utilities to centralize information on customer due diligence is one example.
Similarly, industry efforts to support the training of bankers on implementing AML/CFT regulations in remote jurisdictions can go a long way in furthering a common vision. And I would pledge support to initiatives that bring regulators and banking representatives together in helping smaller countries raise their game.
If these and other avenues are not pursued and smaller countries are left to fend for themselves, new entrants to the payments sphere emerging from the fintech boom will surely step in. This may not be a bad outcome for consumers, who could benefit from increased efficiency.
The outcome may be less positive for society, however, if the banking sector leaves the field to informal – and sometimes illegal – channels of remittances that provide less security. It may even make it more difficult for banks to generate legitimate business.
3. How Can the IMF help?
This brings me to my final topic: how can the IMF help?
Many people probably do not know that one of our most important activities is providing extensive support to our member countries in improving their regulatory frameworks to meet international standards. The Financial Stability Assessment Program introduced in 1999 has been instrumental in identifying weaknesses and guiding remedial training and technical assistance programs, including in the area of AML/CFT.
Over the past decade, technical assistance on AML/CFT has been provided to 118 countries already, and we currently have 37 ongoing projects in 29 countries. By now, almost all member countries have had at least one AML/CFT assessment. This assistance helps countries identify gaps in their AML/CFT frameworks, and are key to the effective implementation of the risk-based approach to regulation.
In some cases, IMF efforts have gone beyond assessments. For example, Samoa is now part of a pilot exercise where we are facilitating a dialogue with relevant stakeholders, including different agencies in Australia and New Zealand – central banks, regulators, bankers and money transmitters associations. The objective is to find options to safeguard the flow of remittances without undermining compliance with AML/CFT requirements.
The IMF can also invoke its convening power. We have organized a series of discussions with our partners at the Financial Stability Board and the World Bank, bringing together policymakers and the private sector to develop a shared understanding of the drivers of the phenomenon.
And finally, through our membership in the Financial Stability Board, we will support further clarification of international standards and contribute to their implementation.
Let me conclude.
A strong and open international financial system is key to restore momentum in the global economy. Enhancing financial inclusion in many parts of the world can pay big dividends for countries themselves but also for global banks. It is critical that financial stability does not come at the expense of access.
But all actors have a part to play: countries need to upgrade their regulatory frameworks; regulators in key financial centers need to clarify regulatory expectations and ensure consistent application over time; and global banks need to avoid knee-jerk reactions and find sensible ways to reduce their costs.
There is a lot stake. For both the big and the small. For all of us.
5 See Box 7 of IMF (2016), The Withdrawal of Correspondent Banking Relationships: A Case for Policy Action . Though not very comprehensive or detailed, also see survey by American Banker.
6 Deferred Prosecution Agreements are normative instruments that involve foregoing enforcement actions in exchange for cooperation by the individual or company. For more detail, see IMF (2016), The Withdrawal of Correspondent Banking Relationships: A Case for Policy Action .
8 Aristotle, Nicomachean Ethics.
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