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Derisking: Wake Up and Smell the Non-Interest Income - How US Banks Can Solve a Global Crisis

Thursday, June 1, 2017   (0 Comments)
Posted by: Brian Monroe
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*special contributor report*

By Sarah Beth Whetzel
BSA/AML subject matter expert at Palmera Banking Solutions

June 1, 2016

Here are some phrases compliance officers hope to never here from senior managers: “BSA is a black hole of expenses.” And this one: “All of these BSA costs add nothing to our bank.” And of course this little bit of alphabet soup: “There is no ROI on AML.”

If you have ever heard these words uttered by frustrated and befuddled business line managers or senior management, it may be time to take a new look at how anti-money laundering (AML) controls can be viewed as a money maker rather than a profit taker.

Yes, you heard it right: BSA, or the Bank Secrecy Act, can act as a catalyst to boost a bank’s bottom line.

But before budget bean counters start chomping at the bit, there are some caveats to cover to ensure you can add income by helping desperate, high-risk entities enter the global financial system through your institution without tagging along unwanted regulatory scrutiny – or worse, an AML enforcement action or monetary penalty.

To understand how this can work, you need to get a quick lesson on the evolution of AML in America. Maybe 20 years ago, very few people – particularly at smaller banks – knew how to spell AML if you gave them the A and the L.

Go back a decade, after the passage of the Patriot Act, and banks of all sizes are starting to more fully implement the four-pronged program with gusto.

And as regulators pressure larger banks to create controls to deal with a wide array of financial crime risks – giving examiners a glimpse of what a powerful AML program looks like and what one can do – those expectations start filtering down to mid-size and smaller banks, resulting in more diminutive institutions crafting controls on par with the big boys, albeit on a smaller scale.  

Some consultants even believe that small(er) banks in the US have some of the best operational AML experts in the form of their BSA officers.

So that talent, and ability to discern risks, could prod the decision-makers in these U.S. banks to start leveraging their BSA officer’s accumulated acumen to open new avenues of income by taking on higher risk products and customers.

Desperate countries, companies looking for bank accounts

Now here is where there can be opportunities – hopefully coupled with responsibilities – to create a non-interest form of revenue for smaller banks.

There is a world of institutions and regions desperate to access the international financial system, because large banks are shedding all manner of customers, product lines and regions to relieve regulatory pressure and the exposure of AML-related penalties that in recent years have soared into the billions of dollars.

Currently, many foreign banks in countries considered to be at a high risk for financial crime have had their correspondent accounts dropped by large U.S. and international banks. This has included areas in Europe that have suffered financial and political upheaval, roiling regions in the Middle East, countries in the Caribbean and others.

But here is the rub: many of these countries have AML regimes on par with the United States – on paper at least, though implementation and effectiveness is another issue – and are dutifully compliant. While the country’s risk is painted in red with a broad brush, individual companies may have strong compliance controls and savvy officers, if they are just given a chance to shine.

While this piece focuses mainly on the revenue potential of reestablishing vital correspondent financial lifelines for some countries, there are entire business sectors, including money services businesses (MSBs) – this would include money remitters, currency exchangers and others – that are routinely imperiled at their core because they can’t get or keep bank accounts.

Moreover, by bringing these seemingly radioactive entities back into the fold of access to the formal financial system, they are less apt to use illicit organized crime groups to move money, giving vital intelligence to U.S. law enforcement agencies and their foreign partners.

Risky customers represent revenues, with regulatory strings attached

But there are pros and cons to consider when banking higher risk entities.

On one end, which small U.S. bank wouldn’t want an extra hundred thousand dollars a year, or possibly more? The following are some of the top opportunities passed over due to an abundance of perceived risk:

·         trade finance

·         foreign correspondent banking

·         marijuana-related businesses

·         money services businesses

But if a small bank wants to jump into the deep end of the risk pool, they have to realize the broader contextual issues at play and recent AML enforcement actions.

In several AML orders in recent years against banks and MSBs, regulators have chastised and penalized operations of all sizes for banking higher-risk entities without bolting on the required stronger controls.

Their mentality is clear: if a bank is going to inculcate and interweave higher risk entities, there must be a corresponding bump in AML controls, including more staff with stronger expertise, more rigorous and finely tuned transaction monitoring systems and deeper due diligence on these customers and, going a rung lower, understanding and gauging the cumulative risks of their customers.

But while the four areas listed above do present increased money laundering/ terrorist financing (ML/TF) risk exposure, regulators have provided guidance for banks willing to take on these riskier products or customers, giving some sense of comfort, there is no impenetrable shield if a regulator feels the added controls are not enough.

At the heart of the guidance is for banks to engage what is called the risk-based approach. In short, this means banks must put more compliance resources, monitoring and scrutiny to areas representing a greater risk of financial crime.

Sounds simple enough, but the effort can have few bright line boundaries and is very subjective when viewed through a regulatory lens as to what truly is enough resources to mitigate high-risk areas.

But some believe risk-based approaches are essential, not only to satisfy the regulators, but also to truly recognize the ML/TF risks and tailor intentional mitigants appropriately.

As we mentioned, one particular area, foreign correspondent banking (FCB), is in critical need of some smaller U.S. banks to step in and add this product to their suite. But part and parcel of such an initiative should be getting to know the actual and perceived risks of the country, company and institution at hand.

Foreign respondents (non-US banks) that are customers of US correspondents (US banks) are being de-risked, their account relationships closed, and subsequently cut-off from the US banking system.

Who’s at fault for de-risking?

As for the real reasons, one can only guess. But it seems regulatory bodies are throwing up their hands saying they never told these US banks to exit relationships and US banks are pointing the fingers at the regulators saying they told them to exit the relationships. It’s the AML version of he said, she said.

At this point, who is actually at fault is of little consequence.

At issue is that as a result of this risk-weighted pullback, there are areas of the world that have lost more than 40 percent of their foreign correspondent relationships. This means that these largely compliant foreign banks have no entry into the U.S. financial market at a time when their business customers are dependent on transacting with U.S. businesses.

Specifically, the Caribbean market has been one of the hardest hit, with some regions experiencing a more than 60 percent loss of FCB relationships according to the International Monetary Fund (IMF). The Caribbean, rightly or wrongly, is still battling the stigma that some countries are major drug transit routes and AML compliance is mere window dressing.

But this dynamic, as we mentioned, has repercussions beyond de-risked bank accounts. Not only are we driving these legitimate funds into the underground market, but we are actually making our global fight against money laundering and terrorist financing that much harder.

Not only can smaller US banks step in and close this gap, but by doing so, these US banks can take part of the non-interest income revenue stream that is an intrinsic advantage of a correspondent banking product. 

Why Not?

With so much apparent high-risk income for the taking, one major question rises to the fore: Why are US banks hesitant to venture into the arena of higher risk products or customers? Why not embrace the dark side when the risk factors can be controlled, identified, and ostensibly mitigated with the net risk exposure being a safe, even comfortable, level?

Part of the answer, in speaking with community banking leadership, is fear of regulatory criticism.

Another concern for bank leadership is fear of the unknown. For US community banks that have the manpower and some regulatory “cushion” to pursue FCB connections, the case can be made by looking at the results of a cost/benefit analysis.

The new fees from correspondent transactions could be dubbed non-interest income. And let’s face it, with most small banks, this side of the house could use some sustainable income. In foreign correspondent relationships, the income stems from fees paid by the foreign bank for transactions on behalf of their customers.

Some foreign correspondent relationships may be simple, requiring only wires and deposit accounts and others may be more in-depth, with the offering of letters of credit or foreign exchange services.

But if you want to add these services, you better consult the oracle of AML, the FFIEC interagency manual, to see how you measure up and get a glimpse of what examiners will be expecting.

The FFIEC's interagency AML Exam Manual describes additional services under the FCB umbrella – one example is nested accounts, where your correspondent is doing business on behalf of other banks or parties – that could exponentially increase the risk, and make it essentially unappealing for certain US banks.

According to Kem Warner of KAW Management Services Ltd, an AML consultant in the Caribbean, many banks are not looking for high-risk services within their FCB relationship. They simply need access for Caribbean businesses to pay their suppliers and vendors in the US.

As an example, most “available” banks in the Caribbean are looking for simple wire services, deposit services and in limited cases, letters of credit or foreign exchange services.

So what’s in it for my bank?

Fee income can range from $50,000/year to upwards of $500,000/year, per foreign bank relationship.

If your bank is new to this type of risk, start out with one relationship and after the growing pains have subsided, try to capitalize on those efficiencies and lessons learned, hopefully garnering the approval of regulators, or at the very least not incurring their wrath, then slowly try adding more relationships.

Eventually, your bank will compare the efforts (cost) and income (benefits) of FCB ties with the drip-drop of income gained from dropping an interest rate a fraction of a point and more readily appreciable income from a FCB relationship, for some banks, it will be a no-brainer in the affirmative.

There is nothing illegal or “too risky” that would prevent any US bank from offering a foreign correspondent product, at least at the outset of the relationship. US regulators have the same guidebook BSA Officers have – the aforementioned AML exam manual.

There are more than a dozen pages in the manual that provide step-by-step guidance for identifying risk factors, implementing mitigating actions and audit guidelines.

Some guidelines and best practices include getting copy of the foreign correspondent’s AML policies and procedures, finding out the kind of customers they cater and regions of the world they are connected, looking to see if they ever were the subject of a formal AML enforcement action or monetary penalty in their home country and get a list of the countries the foreign bank has correspondent ties.

In addition to this US resource, global regulatory bodies, such as The Wolfsberg Group and the Paris-based Financial Action Task Force (FATF), the arbiter of global AML standards, have published multiple resources outlining practical instructions for assessing and documenting risks associated with FCBs.

US banks interested in offering FCB can be selective in the area of the world they want to target. A critical need at this point is the Caribbean market and they are held to the same, if not higher standards, than US banks. With some believing that in some areas, the Caribbean even exceeds the U.S. in some areas of AML/CTF.

Most Caribbean banks are under a country compliance regime that has long enforced FATF recommendations in the areas of know your customers (KYC), customer due diligence and enhanced due diligence (CDD/EDD) and politically-exposed person (PEP) risk.

According to Mr. Warner, the region's audit standards are the same as US standards with some areas experiencing overregulation due to the standards required by some tier 1 US correspondent banks.

With an abundance of opportunity and limited risk exposure, why is FCB seen as something only the big banks can handle?

Next Steps

Will it take work? Absolutely! FCB is not a plug-and-play program. Risk assessments are essential, with the mindset that the ultimate goal is not to show "0" or "low" risk in all areas. A risk-based approach, according to Mr. Warner, will satisfy FATF requirements and provide opportunities to both US and Caribbean banks.

The biggest drain of resources when starting an FCB program comes from the digestion of global regulatory guidance, extraction of the various risk factors, operationalization of those risk factors, and design of FCB risk assessments.

Fortunately, most of this heavy lifting has been done if your bank is genuinely interested in providing foreign correspondent banking. (not a sales pitch… free FCB program templates for US banks interested in correspondent banking)

If your bank is interested in stepping into this new long-term revenue stream that FCB offers – evaluation of these areas is required:

o   Review and assess your bank’s appetite for this additional risk exposure

o   Assess your BSA staffing levels and skills

o   Review recent audit reports (looking for indicators that regulators see unidentified areas of risk)

o   Perform cost v. benefit analysis

o   Connect with Respondent Banks*

Additional public and private resources include:

The interagency AML manual.

U.S. Treasury and federal banking agencies 2016 guidance on correspondent banking from the vantage point of AML compliance and sanctions enforcement.

U.S. Treasury Office of the Comptroller of the Currency (OCC) 2016 guidance on correspondent banking risks.

FATF 2016 guidance on correspondent banking.

Wolfsberg Group 2014 guidance on correspondent banking.



For more information on this story or a for a list of Caribbean respondent banks interested in US correspondent relationships, please contact 

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