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De-risking in the Caribbean

De-risking in the Caribbean

Financial Crime Compliance,
14 September 2016

Risk mitigation, standardisation and transparency, the future of the Caribbean financial community

In the last few years, the correspondent banking industry has been increasingly impacted by the trend of de-risking – in other words, the decision taken by banks to rationalise their correspondent banking relationships. Such decisions are typically driven by concerns about money laundering and terrorist financing, as well as by cost and regulatory pressures.

While this trend has affected banks around the world, research published by the World Bank in November 2015 found that the Caribbean was the region most significantly affected. According to the report, a majority of the region’s banking authorities reported a significant decline in foreign correspondent banking relationships.

Why de-risking?

Centrale Bank van Curaçao en Sint Maarten (CBCS) reports that the general view of the local banking sector is that banks are being de-risked for a number of reasons. These include increasing regulatory requirements, strategic decisions to stop offering correspondent services in particular markets, and insufficient business to justify the risks and due diligence costs associated with correspondent banking relationships.

The implementation of global regulatory standards has meant that banks face increased compliance costs in providing correspondent banking relationships. “In addition, tax information-sharing agreements that also result in more costs for the correspondent banks have added to the de-risking trend,” notes CBCS.

Indicating the scale of the issue, CBCS reports that 14 de-risking events have occurred in the last year in relation to local general banks and international banks in Curaçao and Sint Maarten. Other research has shown that in the Eastern Caribbean, one correspondent bank terminated all accounts involved with downstream correspondent or third party intermediary activities, as well as closing accounts of several legal professionals and local charities.

The implications of de-risking are particularly significant given that the region’s correspondent banking relationships tend to be concentrated on a small number of banks. “A 2015 CAB survey of members indicates a heavy reliance on one or two US correspondent banks to provide key services, such as payment processing, third party payments and cash clearing,” says Mary Popo, General Manager of the Caribbean Association of Banks (CAB).

We would like correspondent banks to implement measures to mitigate risk, rather than de-risking.

General Manager of the Caribbean Association of Banks (CAB)

Impact of de-risking

This trend has significant implications for the region’s banks and their end customers. CBCS notes that correspondent banking relationships are crucial for financial institutions – especially for smaller standalone banks and international banks – given the limited access to foreign financial markets.

Where end customers are concerned, the impact of de-risking could include making it difficult for people to pay for consumables imported from the US, according to Trevor Brathwaite, Deputy Governor of the Eastern Caribbean Central Bank (ECCB). “In addition, a number of our citizens send their children to universities in the United States,” he says. “If fees and accommodation costs cannot be paid, children will not be able to advance their education.”

For some, the consequences of this type of disruption could be even more severe. People seeking medical attention in the US could suffer – or, indeed, die – if they are unable to pay for the services they need.

For banks which have been on the receiving end of a de-risking exercise, there is a clear and urgent need to put replacement correspondent banking relationships in place. This may not be straightforward. Brathwaite says that some second-tier banks in the US have indicated a willingness to provide services to Caribbean banks – although these arrangements have yet to be finalised.

“It is not easy for the banks to establish new correspondent banking relationships,” adds CBCS. “Most respondents that experience a de-risking event have not been able to establish new relationships due to the significant and time-consuming due diligence process prior to entering into a new relationship.”

Overcoming the challenges

It is clear that these issues need to be addressed. A number of different options are under consideration. Brathwaite says that actions being taken include “diplomatic discussion at the highest political level” as well as making sure that robust legislation is in place. “We are also exploring the possibility of having our own clearing bank in the US,” he says. “Some see that as far-fetched, but we are working on a proposal in conjunction with the Caribbean Development Bank.”

CBCS reports that Curaçao has adopted several pieces of i.a. AML/CFT legislation in order to comply with international standards and execute the action plan recommended by the Caribbean Financial Action Task Force (CFATF). Sint Maarten is in the process of reviewing the draft of its AML/CFT legislation in order to comply with international standards and execute the action plan recommended by the Caribbean Financial Action Task Force (CFATF). “CBCS hopes that FATF draft guidance on correspondent banking services will increase the likelihood that US banks will maintain correspondent banking relationships, assuming that the main reason for the US banks to currently end the correspondent banking services is the perceived risks involved,” CBCS commented.

Brathwaite adds that the ECCB is recommending that banks use The KYC Registry, SWIFT’s repository for KYC information. With over 2,500 financial institutions already signed up, the Registry gives banks a means of providing validated information to their correspondents in a standardised way.

At an individual bank level, there may be other actions that banks can take to avoid being de-risked. By providing greater transparency over their activities, business lines and behaviour, banks can share information more effectively with counterparties, provide greater levels of comfort and reduce due diligence costs for their correspondents. While there are no guarantees of success, banks may be able to reduce the likelihood that they will be de-risked, or increase their chances of securing alternative arrangements.

Finally, for correspondent banks which may be considering a de-risking exercise, Popo says that alternatives actions should be considered. “We would like correspondent banks to implement measures to mitigate risk, rather than de-risking,” she explains. “They should also provide timely communication of compliance gaps, enabling the respondent bank to address the issues, while working with respondent banks to enhance collaboration, trust and transparency.”