July 12, 2018

Testimony before the Subcommittee on Financial Institutions and Consumer Credit Committee on Financial Services

International and Domestic Implications of De-Risking

Submitted Written Testimony

Chairman Luetkemeyer, Ranking Member Clay, and distinguished members of the subcommittee, thank you for the opportunity to testify today on the international and domestic implications of derisking.

I applaud your efforts to call attention to the critically important phenomenon of de-risking, something that is not well understood but which has profound impacts on some of the most vulnerable populations. It is particularly disconcerting as it directly affects humanitarian assistance to those most in need, and at a time when those needs are growing. The U.S. has a unique role to play in addressing de-risking globally, as the dominance of the U.S. dollar and American regulatory policies set the stage for other countries.

My comments today, focused primarily on the impact of de-risking on charities and nonprofit organizations (NPOs) are based on the research I conducted for the February 2017 report, Financial Access for U.S. Nonprofits, commissioned by the Charity & Security Network (C&SN) and supported by the Bill and Melinda Gates Foundation. While I am currently affiliated with the World Bank/ACAMS Initiative on Financial Access for NPOs, the views I express today are my own.

Financial tools, in particular, Anti-Money Laundering (AML), Countering the Financing of Terrorism (CFT), and international sanctions policies, have become essential instruments in protecting the integrity of the global financial system and promoting international security. In recent years, however, the unintended consequences of these policies on some developing countries and certain sectors such as money service businesses (MSBs) and humanitarian organizations have become apparent. Anecdotal examples abound regarding the significant challenges charities face when financial institutions terminate or restrict business relationships to avoid rather than manage risk. Without the ability to transfer funds internationally, NPOs are unable to deliver vital humanitarian and development assistance. 

Drivers of de-risking

De-risking is a complex phenomenon driven by multiple considerations and calculations by financial institutions. Among these various drivers are concerns for reputational and liability risk, profitability, business strategy, the cost of implementing AML/CFT/sanctions and other regulatory requirements, and exposure to penalties by supervisory and law enforcement authorities. 

Compliance-related concerns and regulatory expectations are among the most frequently cited reasons for de-risking by banks. For many financial institutions, decisions to decline to provide financial services relate to perceptions that certain customers such as NPOs are high-risk, and certain countries (subject to sanctions or where non-state armed groups such as ISIS and alShabaab are active or exercise territorial control) are high-risk jurisdictions. Such locations are often the places where humanitarian and development NPOs operate, creating compliance challenges for banks in facilitating transactions to these regions. Regulatory requirements and expectations, as well as routine second-guessing by examiners of financial institutions’ decisions require banks to undertake extensive and expensive efforts to mitigate risks and justify decisions, frequently tipping the risk reward scale toward exiting such relationships. Despite statements from government officials, financial institutions perceive a clear disconnect between what policy officials say and what happens at the individual bank examination level. This reluctance has been fueled by a fear of penalties.

In recent years, several major banks have had large fines levied for AML/CFT/sanctions violations; many financial institutions are still under deferred prosecution agreements or consent orders requiring substantial compliance reforms and costly monitoring. In the aftermath of the 2008 financial crises, U.S. regulators (on both the federal and state levels) cracked down on regulatory violations, imposing unprecedented fines. Over the last 15 years, both the number and value of AML-related fines have increased in both the U.S. and the U.K. 

The upward trend in U.S. enforcement actions and penalties against banks, along with the complexity in AML/CFT/sanctions regulatory requirements, result in increased compliance costs for financial institutions. Bank representatives consistently note decreased profitability resulting from the increased monitoring and compliance costs of AML/CFT regulations as a key driver of de-risking. Some reports place the additional burden at upwards of $4 billion annually. One bank reportedly employed 4,000 additional compliance staff in one year, at a cost of $1 billion. According to a 2016 survey by the Association of Certified Money-Laundering Specialists (ACAMS), three-fifths of respondents cited enhanced regulatory expectations as the greatest AML compliance challenge. Supervisory actions including personal liability of compliance officers for regulatory violations further contribute to escalating costs and challenges. This trend is not limited to the U.S.; a 2015 survey of Commonwealth members identified decreased profitability resulting from the increased monitoring and compliance costs of AML/CFT requirements as a key driver of de-risking. Added to this is the fact that NPO accounts are not  3 usually hugely profitable.

Countries base their AML/CFT frameworks on international standards established by the Financial Action Task Force (FATF). Central to the 40 recommendations issued in 2012 is the risk-based approach that calls for financial institutions to establish systems to assess client risk and adopt measures to mitigate those risks. Financial institutions need to take appropriate steps to identify and assess their money laundering and terrorist financing risk (for customers, countries or geographic areas; and products, services, transactions or delivery channels), and put into place policies, controls, and procedures enabling them to effectively manage and mitigate identified risks. Since the introduction of the risk-based approach, however, regulations have not fully
incorporated it and the current system remains a hybrid of rules-based and risk-based approaches. Lack of regulatory clarity has resulted in termination or restrictions on relationships with countries and customer categories perceived to be high-risk. Numerous studies have shown that de-risking has impacted correspondent banking, MSBs, and NPOs’ transactions, among others, posing a threat to financial connectivity, financial inclusion, and financial transparency. 

Significant analysis has been undertaken on the decline in correspondent banking relationships by the World Bank and the Financial Stability Board (FSB); such reports confirm related pressures on NPOs and MSBs. In 2017, the FSB collected information on the motives behind respondent banks’ decisions to terminate services to customers, including NPOs, money transfer operators, payment service providers, Politically Exposed Persons, and other financial institutions. The main drivers reported were the perceived risk (35%) or the “additional KYC (Know Your Customer) or CDD (Customer Due Diligence) measures” associated with these customers (34%) and therefore presumably related to AML/CFT deficiencies, whether detected or apparent.

  1. The term nonprofit organization (NPO) has been defined by FATF as: “A legal person or arrangement or organisation that primarily engages in raising or disbursing funds for purposes such as charitable, religious, cultural, educational, social or fraternal purposes, or for the carrying out of other types of “good works.”

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