Regulatory bodies tell banks to stop avoiding risk by eliminating clients categorically

For global banks trying to implement anti-money laundering programs, there is a growing sense of frustration that the regulatory and quasi-governmental bodies issuing guidance and warnings meant to inform and bolster compliance strategies can’t seem to get their stories straight.

Case in point: for more than a decade, federal regulators, like the U.S. Treasury’s Office of the Comptroller of the Currency (OCC), the Financial Crimes Enforcement Network (FinCEN) and more recently, watchdog groups, such as the Paris-based Financial Action Task Force (FATF), have told banks that not all customers carry the same risk, and some areas, such as money service businesses, could be at a higher risk for money laundering.

Not surprisingly, with recent penalties for AML program and sanctions screening failures hitting into the billions of dollars, banks broadly have responded by stating that even higher risk in many instances is simply too high risk – either in terms of ongoing compliance resources, additional examination scrutiny or potential penalty exposure – and are dumping whole swathes of customers, businesses and account types.

Now, these influential bodies seem to be backpedaling, and requesting that banks potentially put themselves at odds with their own regulatory examiners and continue to bank higher risk entities because not doing so actually cuts  off a valuable source of financial intelligence for investigators and prods operations to seek funds and support from less regulated, or even criminal groups.

When banks eliminate, for example, an entire class of customers from a perceived high-risk geographic target, it forces entities and persons to use opaque avenues to move money.

The ability to trace suspicious activity disintegrates, and although on the surface less risk is reported and caught, it may be promoting less transparency to the system altogether, said TTG Consulting Chief Executive Office Peter Moriarty. That approach may be detrimental to the cause.

“It’s parallel to the Ebola issue where some would argue that you should cut off flights to the US, but then people will come across different borders and find an alternative route to what they were going to do anyway,” Moriarty said.

As regulatory authorities continue their demand that financial institutions tighten anti-money laundering and counter-terrorist financing controls, banks have responded with a naturally circumspect reaction.

Institutions worldwide are feeling the mounting threat of rogue actors who look to exploit the legitimate financial system to their own benefit with ever-innovative methods of fooling the ever more complex, but seemingly inadequate, compliance systems currently in place.

Giant penalties a significant deterrent to banking risky groups

Concerned with massive multi-million dollar, and even multi-billion dollar, fines that make investors cringe, a loss of profitability due to increased costs of compliance, and reputational damage for being a recalcitrant institution, banks have simply stopped dealing with high-risk accounts.

Last year, JPMorgan Chase paid more than $20 billion to regulators in settlements relating to compliance failures. Subsequently, the bank closed twice as many accounts in 2013 as it did the year before, according to sources who recently told the Wall Street Journal.

In a Pavlovian move, the bank, like many others large and small, is staying away from hazardous entities to avoid any potentially negative repercussions. The bank won’t approve loans for check cashing companies and won’t process transactions for certain types of payments for around 50 banks, and has even closed the accounts of individual customers who may be associated with foreign leaders.

Banks with significantly smaller budgets than that of JPMorgan Chase are faced with the same challenges, though fewer recourses for meeting compliance requirements and see wholesale termination of high-risk accounts as a money and time-saving panacea.

However, adding to the labyrinth of regulatory expectations, two regulatory bodies have declared their disapproval for this type of categorical cutting-loose of clients.

The fact that FATF and FinCEN have both issued guidance telling financial institutions that eliminating, without identifying and mitigating individual risks, is not the right way to prevent financial crime, has put banks large and small in a quandary, wondering if they should listen to their regulators or ascribe to the higher ideals of getting quality intelligence to federal investigators.

In fact, both regulatory entities agree, it may facilitate financial crime by pushing vulnerable customers into less regulated or virtually underground channels of finance.

It is no secret that financial institutions have been under the gun from national and international regulatory bodies since the financial crisis. Moriarty says that it’s a natural reaction for banks to pull back and avoid the fury of regulators, and in the process save some money.

“With banks, there’s a general complaint or lament about the burden of having to comply with any scrutinized transaction,” Moriarty said.

“It’s extra work,” he said.. “It’s expensive and distracting to the profitable side of the business. It’s a natural reaction.”

However, the FATF October Plenary meeting made it a point to discuss this new trend of “de-risking” – conceding that recent supervisory and enforcement actions have indeed made demands on banks, but that the context of those cases were “banks who deliberately broke the law, in some cases for more than a decade, and had significant fundamental AML/CFT failings,” referring to the broad category of anti-money laundering and countering the financing of terrorism, according to the new guidance issued after the meeting (Read more here).

Problems with wholesale de-risking

The FATF indicated two main reasons for concern regarding  rampant de-risking.

Key to the problem is that it actually impedes the goal of creating a possible physical and electronic paper trail for transactions because they are not occurring in the formal banking system. The main goal of this international governing body is to promote transparency through the global financial system and reduce money laundering and terrorist financing through the implementation of monitoring and reporting methods at financial institutions.

In addition to the concern of transparency, the FATF also pointed to its overall goals of comprehension and collaboration between national governments and their financial institutions, urging those entities to create a supportive network that strives to meet the goal of financial inclusion.

Financial institutions have often pointed to a lack of resources in human capital, time and money as reasons for the categorical divestiture or termination of certain segments of their business.

It’s important to note that FATF says it actually expects financial institutions to take “commensurate measures” which do not imply a “zero failure approach,” though this could be a far cry from how national regulators react to compliance lapses.

FinCEN echoed that approach in  guidance issued on Monday that emphasizes the importance of money services businesses (MSBs), including money transmitters, which have been terminated categorically at several banks for nearly a decade due to the concerns of heightened regulatory scrutiny and federal banking regulators stating they were at a “higher risk” for money laundering.

In the release, the governmental body said it “does not support the wholesale termination of MSB accounts without regard to the risks presented or the bank’s ability to manage the risk.”

Some banks have adapted to growing concerns of money laundering and terrorist financing by applying a blanket policy to prohibit fund transfers for foreign MSBs. Barclays PLC closed the accounts of 250 MSBs which accounted for about 75 percent of all MSB customers.

The closures, in some cases tied to remitting operations in Somalia, caused an international uproar, with groups stating they would have no way to send money to impoverished foreign family members.

FinCEN highlighted that MSBs often provide financial services to vulnerable entities who are less likely to use traditional banking services, making it even more crucial to keep them within the regulated financial system.

The Treasury Under Secretary for Terrorism and Financial Intelligence, David Cohen, said Monday at a conference that banks should not be de-risking.

HSBC Holding’s Bob Werner,  the bank’s global head of financial crime compliance, questioned whether cutting off risky customers would actually curtail financial crime. HSBC closed accounts in certain high-risk segments, following the pattern of safety by avoidance.

“We’re passing them around. It’s like a game of Old Maid. That’s got to stop. We’ve got to figure out how to deal with that,” said Werner last month, at an accounting conference in New York. “Chances are the risk is still coming back to us, it’s just less transparent.”