A U.S. government watchdog group is pushing federal banking regulators to review the after-effects of de-risking in the Southwest Border region, as institutions more aggressively shed customers due to perceived financial crime risks, compliance costs or examiner pressure.
The eagerly-awaited Government Accountability Office (GAO) report tackled an enduring anti-money laundering (AML)-related problem that has only accelerated since the 2012 financial crisis: banks dropping customers, products and ties to regions considered by examiners to be at a higher risk for financial crime – a trend called “de-risking.”
As it stands now, AML regulations meant to detect and prevent money laundering, fraud and uncover ties to terror groups have also resulted in “concerns about the unintended effects, such as de-risking,” according to the report. “We have found that reduced access to banking services can have consequential effects on local communities.”
The issue is a vexing one with global repercussions. If banks carry more risk than their examiners believe can be mitigated adequately with controls, they can be exposed to major enforcement actions. Likewise, regulators that allow institutions to take on risky business are themselves at risk of scrutiny and critiques by their overseers in the U.S. Congress.
Conversely, if broad swathes of customers are dropped, law enforcement intelligence trails can go dark. De-risked groups could potentially retreat from the formal financial sector, seeking unlicensed or illegal avenues to move funds instead, and causing suspicious activity reporting to dry up.
The dynamic can also lead to risky groups migrating to smaller banks unaware of how to properly monitor them – and in some cases fraudulent entities banking on that naivety.
But the de-risking dilemma has a history well known to the key players in the game.
For more than a decade, banks, regulators and the U.S. Treasury’s Financial Crimes Enforcement Network (FinCEN) have engaged in a delicate dance where, publicly, top government officials said they were not pressuring banks to drop risky customers – for example domestic or foreign money services businesses – even putting out guidance and statements that banks should only make such decisions after careful, data-driven analyses.
Privately, however, compliance officers around the country – and those particularly in border regions near Mexico – recounted tales of intense federal regulatory pressure to not bank certain customers, like cash-intensive businesses that had even the faintest whiff of money laundering risk.
In essence, some federal examiners tacitly told banks their compliance programs could be graded harshly if they didn’t comply by pruning risk.
Report confirms de-risking due to examiner fears
The more than 100-page GAO report confirmed this climate of uncertainty, stating that “an estimated 80 percent of banks in Southwest border communities terminated customer accounts over Bank Secrecy Act and anti-money laundering concerns.”
Further, according to the survey, “an estimated 80 percent limited or did not offer accounts to customers that are considered high risk for money laundering because the customers drew heightened regulatory oversight.”
Banks also tried to cover themselves for the customers they did bank in border regions, according to GAO.
For example, in 2016, bank branches in the Southwest border region “filed 2-1/2 times as many reports identifying potential money laundering or other suspicious activity (SARs), on average, as bank branches in other high-risk counties outside the region.\
GAO recommends more analysis, potential easing of AML pressure
GAO surveyed more than 400 banks, which included 115 banks operating in the Southwest border region; analyzed SAR filings; developed an econometric model on the drivers of branch closures; and interviewed banks operating in the region. The survey period ran from January 2014 to December 2016.
The report defined the Southwest border region as “all counties that have at least 25 percent of their landmass within 50 miles of the U.S.-Mexico border.” Thirty-three counties in Arizona, California, New Mexico, and Texas fell within this definition, according to the GAO.
GAO recommended that FinCEN and the federal banking regulators “conduct a retrospective review of AML regulations and how banks are implementing them,” with the goal to see where examiners are being inconsistent in their approach and oversight, resulting in pockets that are too prescriptive or heavy-handed.
The review “should focus on how banks’ regulatory concerns may be influencing their willingness to provide services,” according to the GAO.
The federal banking regulators agreed to the recommendation, in letters attached to the report, while the U.S. Treasury’s Office of the Comptroller of the Currency (OCC), the chief regulator of the nation’s largest and most complex banks, chafed at some of the report’s wording.
OCC criticizes report, insinuation de-risking due solely to regulators
In its response, the OCC stated GAO’s definition of de-risking is “flawed” because other groups only use the term when banks drop ties to entire countries or whole classes of customers.
The regulator also criticized the report for only looking at dropped accounts due to AML risks, without putting any figures or context to overall trimmed relationships due to other reasons, such as profitability, changing business models or dormant accounts.
FinCEN did not provide written comments.
GAO noted that while regulators, and government agencies, have reviewed AML regulations broadly for adequacy and overall compliance burden, they have not done an analysis with a focus on the nuances, drivers and aftershocks of de-risking.
The reviews, however, “have not evaluated how banks’ BSA/AML regulatory concerns may influence them to derisk or close branches. GAO’s findings indicate that banks do consider BSA/AML regulatory concerns in providing services,” according to the report.
“Without assessing the full range of BSA/AML factors that may be influencing banks to derisk or close branches, FinCEN, the federal banking regulators, and Congress do not have the information needed to determine if BSA/AML regulations and their implementation can be made more effective or less burdensome,” the report concluded.
The meaning: Legislators, if armed with concrete data on U.S. de-risking practices, could nudge examiners to ease pressure on banks, creating opportunities for new law enforcement intelligence streams.
“While it is important to evaluate how effective BSA/AML regulations are in helping to identify money laundering, terrorist financing, and other financial crimes, it is also important to identify and attempt to address any unintended outcomes,” the report stated. “We have found that reduced access to banking services can have consequential effects on local communities.”