In November 2015, CGD published a report titled Unintended Consequences of Anti–Money Laundering Policies for Poor Countries. The product of a CGD working group comprising scholars, policymakers, market practitioners, and other subject-matter experts, the report warned that efforts to curb illicit finance were producing significant adverse side effects, particularly a practice known as “de-risking.” Today we release a follow-up to that report. Policy Responses to De-risking: Progress Report on the CGD Working Group’s 2015 Recommendations takes stock of accomplishments to date, notes where work remains, and recommends concrete actions for international institutions, governments, banks, and others to continue addressing de-risking.
The de-risking dilemma
As the 2015 report explains, partly in response to heightened enforcement of regulations related to anti–money laundering and countering the financing of terrorism (AML/CFT), as well as sanctions, large international banks had begun exiting relationships with countries and market segments they perceived to be high in risk or not worth the rising cost of compliance—a practice that came to be known as “de-risking.”
These pressures sometimes interacted unfavorably with banks’ changing business strategies and heightened cost sensitivity in the wake of the global financial crisis, which put further pressure on low-margin business lines and relationships. As a result of these trends, affected parties could find it harder to access certain financial services, particularly cross-border payments. This situation appeared to pose a risk to international financial integration, financial inclusion, and financial transparency, especially in poor countries.
International correspondent banking (a type of bilateral interbank relationship that is critical to the provision of cross-border payments), money transfer operators (MTOs), and nonprofit organizations (NPOs) are particularly affected by de-risking. The 2015 report warned that the disruption of these sectors could make it harder for small businesses to secure trade finance, for migrants to send remittances back home, and for NPOs to provide lifesaving humanitarian aid abroad.
What’s changed since 2015—and where the work remains
In the three years since we published our report, there has been a robust policy response to de-risking, especially at the international level. International institutions—including the G20 and its member states, the Financial Stability Board, the Bank for International Settlements and its standing committees, the International Monetary Fund, and the World Bank—have devoted significant effort to studying the problem, clarifying regulatory guidelines, supporting technological solutions, and offering technical assistance to government authorities in affected jurisdictions to help them improve their regulatory frameworks and supervisory practices. The G7 ministries of finance, often working behind the scenes, have also been integral to this effort.
But some challenges remain. The new report, coauthored by Jim Woodsome, Clay Lowery, Jody Myers, and myself, argues that there is more work to be done. We recommend that national regulators and international organizations continue to assess and monitor the situation through systematic collection and sharing of data and that regulators continue to clarify regulations around how to implement a risk-based approach.
We are concerned about the treatment of nonprofits. Many continue to experience de-risking and have trouble opening and maintaining a bank account. We ask the Financial Action Task Force (FATF) to consider publishing a consolidated list of indicators for lower-risk nonprofits.
In addition, we make recommendations on developing an internationally recognized, interoperable digital ID system, defining the scope of third party customer identification and due diligence processes, and bridging the gap between technology and regulation with regard to the use of big data and machine learning.
Developing countries must also continue to enhance their own AML/CFT regulatory regimes and supervisory practices. Developed countries and international institutions can assist in these efforts through the targeted delivery of technical assistance. With regard to this, legislation recently introduced in the House, to provide support to the IMF’s work on combatting money laundering, is very welcome.
Table 1: Summary of New Recommendations
| Recommendation 1: Rigorously assess the unintended consequences of AML/CFT and sanctions enforcement at the national and the global level | |
|---|---|
| Organization | Recommendation |
| National regulators in international financial centers | Conduct comprehensive regulatory impact assessments of AML/CFT and sanctions regimes |
| Research organizations | Conduct a statistically robust survey of European nonprofits engaged in humanitarian work abroad to determine the extent of their financial access problems |
| FSB or World Bank | Continue to monitor the international remittances market for signs of stress due to the de-risking of MTOs. If necessary, an update to the World Bank’s 2015 survey of remittance service providers should be considered. |
| Recommendation 2: Generate better data and share data to facilitate regulatory impact assessments | |
| Organization | Recommendation |
| National regulators in international financial centers and countries affected by de-risking | Implement systematic monitoring of account and transaction activities in correspondent banking, remittances (including those made through MTOs), and NPOs focused on humanitarian activities |
| FSB and SWIFT | If de-risking has not abated, continue to share and analyze data regarding global trends in correspondent banking relationships and activity |
| Recommendation 3: Strengthen the risk-based approach | |
| Organization | Recommendation |
| National regulators | Provide more training to bank examiners on how to properly assess the risks of MTOs and NPOs. Clarify regulations and bank examination manuals as appropriate to reflect a proportionate RBA. |
| Recommendation 4: improve compliance and clarify indicators of lower risk | |
| Organization | Recommendation |
| National regulators | Continue to conduct outreach and work with affected sectors to ensure they understand regulators’ expectations |
| FATF | Consider whether to publish a consolidated list of indicators of lower-risk NPOs |
| Recommendation 5: Facilitate identification and lower the costs of compliance | |
| Individual identification systems | |
| Organization | Recommendation |
| National governments | Lower or eliminate fees that prevent residents from obtaining IDs |
| Standard-setting bodies and international organizations | Explore what steps are needed to develop an internationally recognized, interoperable digital identification system for natural persons engaging in cross-border financial transactions |
| KYC utilities | |
| Organization | Recommendation |
| National regulators | Give further consideration as to whether and to what degree financial institutions can rely on third parties for customer identification and due diligence, and offer further guidance, if necessary. It is important that banks understand the degree to which they can rely on KYC utilities or other third-party information sharing mechanisms. |
| National regulators | Provide clarity on who bears (or is allowed to bear) liability if CDD information is incorrect |
| National regulators | Consider whether to establish regulatory regimes for regulating and monitoring KYC utilities |
| Standard-setting bodies, international organizations, industry groups, banks, MTOs, and NPOs | Work together to evaluate the utility of Wolfsberg-style standardized due diligence questionnaires for banks to use in the course of onboarding MTOs, and separately, NPOs. Such a questionnaire might help align expectations between banks and MTOs/NPOs (particularly smaller MTOs/NPOs) with regards to what information is required in order to open an account, and also to promote more consistent treatment. If there is broad consensus on the utility of such an approach, identify necessary next steps, possible information requirements, and what type of economic and regulatory support might be necessary. |
| Standard-setting bodies and international organizations | Continue to engage on developing issues related to KYC utilities |
| Standard-setting bodies and international organizations | Explore whether it is possible for third parties also to conduct risk assessments themselves, as opposed to simply providing information for risk assessments |
| Legal entity identifiers (LEIs) | |
| Organization | Recommendation |
| Standard-setting bodies | Determine whether LEIs can be used for customer identification, verification, and due diligence, and provide relevant guidance |
| National regulators in countries affected by de-risking | Look for ways to promote LEI issuance |
| National regulators in countries affected by de-risking | Improve business registries and other relevant information sources that local operating units use to validate information |
| Financial institutions | Help customers obtain LEIs, especially in countries affected by de-risking |
| Banks | Begin modifying IT systems to prepare for adoption of LEIs in payment messages |
| ISO | Continue work on how best to incorporate the LEI into the new payment messaging format |
| Other recommendations | |
| Capacity building and technical assistance | |
| Organization | Recommendation |
| Affected developing countries | Continue to enhance their own AML/CFT regulatory regimes and supervisory practices |
| IMF, World Bank, and Other TA Providers | Conduct efficacy studies of their TA provision and calibrate the delivery of TA based on the studies’ findings |
| FSB | Play a greater role in coordinating TA among the major providers, in order to ensure that TA resources are being allocated efficiently and, to the extent possible, according to the expertise of the provider |
| Big data systems and machine learning | |
| Organization | Recommendation |
| National regulators and international organizations | Determine whether local privacy and data sharing laws pose a challenge to the integration of these data sets and whether these laws can or should be amended without compromising privacy |
| National regulators | Share feedback on SAR submissions |
| National regulators | Allow financial institutions to share data so as to expand the pool that machine learning programs can learn from |
| National regulators | Consider a regulatory sandbox to allow financial institutions to experiment with machine learning solutions |
Disclaimer
CGD blog posts reflect the views of the authors, drawing on prior research and experience in their areas of expertise. CGD is a nonpartisan, independent organization and does not take institutional positions.
