United States: The Regulatory Pendulum: When Is De-Risking By Financial Institutions Too Much?

In the environment of increasingly aggressive regulatory and criminal enforcement of anti-money laundering (AML) violations, concerns about de-risking – when financial institutions close accounts or restrict access to new clients because of high AML or counter-terrorist financing (CFT) risks – have risen to the fore. Regulators and policy groups are concerned that "wholesale" de-risking restricts financial inclusion and may violate competition laws. It goes without saying that financial institutions must appropriately manage their AML risks in light of the increased enforcement and civil liability exposure. Nevertheless, in lieu of wholesale exclusion of large segments of commerce, financial institutions should develop enhanced diligence protocols during the customer account opening process and monitor account activity to manage these risks effectively. By doing so, financial institutions can ensure continued banking access to the communities these alternative money service businesses (MSBs) serve.

The Financial Action Task Force (FATF) has cautioned that de-risking may unintentionally "drive financial transactions underground, which creates financial exclusion and reduces transparency, thereby increasing money laundering and terrorist financing risks."¹ As urged by the U.K. Financial Conduct Authority (FCA), financial institutions should take a proportionate approach, not a "blanket approach," to their AML/CFT compliance responsibilities.² In a recent speech discussing this issue, the Deputy Director of FinCEN, Jamal El-Hindi, called for federal and state cooperation in creating transparency in the industry to combat the wholesale de-risking of MSBs, "especially considering the potential economic impact of money transmission to developing countries and MSBs to financial inclusion generally."³ Regulators in the U.K. and the U.S. have recently issued reports concerning the potential for excessive de-risking policies by financial institutions that will have the unintended effect of pushing money laundering and terrorist financing further underground.

The Financial Conduct Authority's De-Risking Probe

On May 24, 2016, the FCA released a report, Drivers & Impacts of Derisking, expressing concern that financial institutions are violating U.K. competition law by wholesale closing accounts in certain segments of commerce. The FCA analyzed the reasons financial institutions have engaged in aggressive de-risking, the types of individuals or sectors involved, and whether "wholesale derisking" is occurring within the U.K.

The report noted that banks are adopting aggressive de-risking practices in reaction to the widespread enforcement actions and increased regulatory capital requirements for higher-risk portfolios.⁴ De-risking is disproportionately affecting certain sectors, including correspondent banking, MSBs, charities, defense and Financial Technology (FinTech) companies, which are perceived to pose higher AML/CFT risks.⁵ Recognizing that there is no precise quantifiable method for implementing a risk-based approach, the FCA recommended that banks identify risk factors based on geography, sector, type of business, political risk and distribution channels, among others, in making these determinations. Financial institutions should then consider enhanced due diligence and ongoing monitoring correlated to the institution's risk appetite and the heightened risk posed by the customer.

De-Risking's Effect on the MSB Industry

In the same month the U.K.'s FCA released its report, the Conference of State Bank Supervisors and the Money Transmitter Regulators Association in the U.S. issued a white paper, The State of State Money Services Businesses Regulation & Supervision, which highlights a similar concern regarding the wholesale exclusion of MSBs from the U.S. banking system.

Noting that over one-quarter of households in the U.S. use non-bank financial institutions, including MSBs and other money transmitters, the Association observed that banks are "indiscriminately terminating the accounts of all MSBs, or refusing to open accounts for any MSBs, thereby eliminating them as a category of customers."⁶ The state regulators advise financial institutions to assess client risks on a case-by-case basis. By implementing a risk-based approach informed by their clients such as MSBs and the supervisory framework regulating the industry, financial institutions can manage risk and still facilitate access to these customer accounts by the communities they serve.

The De-Risking Dilemma

As the FCA commented, there is no "silver bullet" to the de-risking dilemma faced by global financial institutions.⁷ Regulators continue to grapple with AML enforcement, particularly in the higher-risk segments including MSBs, new technologies and payment methods. The FATF has recognized the challenges financial institutions face when applying a risk-based approach, and has urged law enforcement and regulators to not view it as a "zero failure" approach.⁸ Financial institutions must know their customers and monitor their transactional activity to best manage those risks without denying access to the traditional and emerging MSBs that will service increasingly larger segments of the global population.

Financial institutions may also face scrutiny and potential civil litigation for de-risking practices from excluded customers. In March 2016, a billionaire and longtime Barclays account holder stated his intention to sue the bank after his account was purportedly closed as a part of a de-risking program implemented by the bank.⁹ While there are legal hurdles to that type of action and the plaintiff recently dropped his case, it is a warning of the scrutiny to come on these de-risking policies. It is important for financial institutions to apply a case-by-case, risk-based approach to their de-risking decisions and to appropriately document those decisions in the context of the increased regulatory and customer scrutiny.  

Footnotes

1 FATF takes action to tackle de-risking (Oct. 23, 2015), http://www.fatf-gafi.org/publications/fatfrecommendations/documents/fatf-action-to-tackle-de-risking.html.

2 FCA to Probe if Customers Are Being Denied Banking, Financial Times (May 20, 2016), http://www.ft.com/intl/cms/s/0/8422b0c0-1e9b-11e6-a7bc-ee846770ec15.html#axzz4AWXYrcjC.

3 Remarks to the CSBS State Federal Supervisory Board, Jamal El-Hindi (May 26, 2016), https://www.fincen.gov/news_room/nr/html/20160606.html.

4 The Drivers & Impacts of Derisking (Feb. 2016), http://fca.org.uk/static/documents/research/drivers-impacts-of-derisking.pdf.

5 Id. at 28.

6 The State of State Money Services Businesses Regulation & Supervision (May 2016), at 3, https://www.csbs.org/regulatory/Cooperative-Agreements/Documents/State%20of%20State%20MSB%20Regulation%20and%20Supervision%202.pdf (citing FinCEN Statement on Providing Banking Services to Money Services Businesses, FinCEN (Nov. 10, 2014)).

7 The Drivers & Impacts of Derisking, at 16.

8 Effective Supervision and Enforcement by AML/CFT Supervisors of the Financial Sector and Law Enforcement, FATF (Oct. 2015), http://www.fatf-gafi.org/media/fatf/documents/reports/RBA-Effective-supervision-and-enforcement.pdf.

9 Wafic Said drops Barclays Suit Over Cutting Banking Ties, Financial Times (June 2, 2016), http://www.ft.com/intl/cms/s/0/164f94ba-28ea-11e6-8ba3-cdd781d02d89.html#axzz4AWXYrcjC.

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