The financial landscape changes constantly and, as new regulations and criminal trends affect global regulatory compliance, banks sometimes act to reduce the amount of risk they face through de-risking policies. While de-risking is a way to protect banks from criminal risk, it often represents a controversial compliance option since it can result in the exclusion of certain businesses from financial markets.
What is de-risking?
De-risking is the practice of declining or limiting financial services based on prevailing regulatory compliance requirements. More specifically, under a de-risking policy, a bank or financial service provider may adjust, end, or choose not to enter into a business relationship with a customer based on the compliance demands that doing so would present.
Since anti-money laundering regulations require banks to put policies and procedures in place to identify, prevent, and report financial criminal activities (such as money laundering and terrorism financing), de-risking represents an alternative option for those that cannot comply effectively with the rules. In most cases, de-risking is a commercially-motivated decision: a bank may decide that it is necessary to de-risk in order to be able to afford satisfactory financial compliance in other areas of its services.
There are no regulatory requirements for the way de-risking policies should be implemented. Financial institutions may apply de-risking measures broadly by restricting their services to entire categories of customer, or assess each customer’s risk level individually. Similarly, de-risking does not always mean that a financial institution limits their financial services: in some cases de-risking may be achieved by increasing compliance spending to boost performance. Some banks devote resources towards ongoing de-risking programmes which constantly assess the commercial viability of certain customer relationships and inform de-risking decisions.
Why is de-risking problematic?
While de-risking has regulatory and commercial benefits for banks, its exclusionary effects mean that many customers lose or are unable to gain access to the financial system. The de-risking process particularly affects organisations that are viewed as presenting a high money laundering risk, including money transfer businesses, non-profits, charities, correspondent banking services, and fintechs.
Many of the financial services affected by de-risking policies involve customers and clients that are located overseas, and so the practice disproportionately affects foreign customer groups, which may include vulnerable persons such as immigrants, refugees and asylum seekers, or legitimate businesses in developing countries that need access to international financial markets to grow. Studies by the World Bank have shown that de-risking takes place around the world but affects certain regions disproportionately, especially those with smaller countries or countries with only limited access to financial markets. With that in mind, the consequences of de-risking include:
- Negative effects on financial inclusion. Customers that are unable to access financial markets are likely to remain in poverty and are less able to contribute to the economic growth of their country.
- Humanitarian organisations may lose access to crucial financial services and be unable to provide aid to people and areas in need.
- Customers that are unable to access higher quality banking services may be forced to use less-regulated banks. Similarly, criminals may resort to money laundering methodologies outside the scope of traditional AML/CFT controls.
- When one bank de-risks, others may follow suit out of competitive necessity, creating significant knock-on effects for the financial system and undermining confidence in the wider financial sector.
- De-risking can be a complex administrative process and may not be entirely effective in reducing a bank’s risk exposure. High risk customers that are declined services may be able to access others via a different branch of the same bank.
What are the alternatives to de-risking?
De-risking policies work against Financial Action Task Force (FATF) guidance that banks should take a risk-based approach to AML/CFT. In practice, the risk-based approach means that banks should assess the compliance risk that individual customers pose, and then adjust their compliance response accordingly. This approach enables banks to balance their compliance obligations with customer service considerations, and offer their services to as broad a customer base as possible.
With that in mind, banks may address some of the cost concerns that drive de-risking policies by implementing automated software solutions designed to streamline the compliance process. By automating customer data collection and analysis, for example, firms may build accurate risk profiles for their customers quickly and in large volumes, and use that information to make compliance decisions. Similarly, automated software enables firms to conduct transaction screening in seconds, establishing money laundering risk without compromising customer experiences.
Ripjar’s Labyrinth Screening platform is capable of screening customers against thousands of structured and unstructured data sources in real time, including sanctions and watchlists, and adverse media stories in 21 languages. Rather than declining services to customers as part of a de-risking strategy, Labyrinth Screening enables you to enhance customer safety and regulatory compliance, in a challenging financial landscape, and adapt quickly when new methodologies or regulatory responsibilities emerge.