April 2017

By Norman Rozenberg

Around the world, international institutions and regulators are increasingly pressuring global banks to implement tougher measures to govern illicit financial flows and crimes, such as money laundering and financing for terrorism. In response, and particularly in volatile and smaller countries with limited financial markets and where local banks may be unable to meet these requirements, their global bank partners are increasingly cutting business ties with local affiliates and departing the market altogether.

In this trend to “de-risk” by exiting volatile markets, large banks may be exposing host countries to a new category of risks.

First, many economies rely on remittances received through banks from abroad. Global banks act as a middle man for remittances flows by providing dollar-clearing and conversion services for their local affiliates. A massive $1.9 billion fine levied by U.S. regulators on HSBC for failure to comply with anti-money laundering regulations caused many global banks to re-evaluate their presence in Mexico, making it difficult for cash sent by migrant workers to reach their families.

Second, de-risking can reduce transparency in the system by forcing legitimate customers into the informal sector and unregulated channels, where money is not easily tracked and may benefit illicit activities. Hawala, a popular method of transferring money across the Middle East, North Africa, and India, operates outside of government regulations and could move funds for money launderers or even terrorists.

Third, when large banks exit a market, governments and foreign lenders lose important insights from correspondent banks on the ground. These relationships provide a deeper understanding of a nation’s economic and political environment.

Finally, de-risking can also negatively impact a government’s ability to implement effective governance and enforce laws. Without a viable alternative to the shadow economy or the presence of banks with a reputation of transparency backed by multinational financial institutions, consumers and local banks have little incentive to follow the rules.

The de-risking trend underscores a pressing issue for global financial markets. Due-diligence standards, such as Know Your Customer (KYC) put pressure on global banks to demand more of their local partners in terms of client verification. However, local banks may not be able to fully comply due to opaque regulations and lack of government oversight in many of these markets.

De-risking has created significant concern among international institutions and developing countries. The World Bank has placed de-risking at the top of its agenda by regularly convening banking leaders and regulators to come to a compromise in order to help struggling developing countries access the international financial market. A consensus is forming among regulators and banking leadership that a compromise is indeed needed. For example, loosening some AML regulations and providing governance assistance to developing countries may help big banks remain in underserved markets.

Fortunately, it is widely agreed that more cooperation between local stakeholders, government regulators, and global banks is needed to solve a problem that can negatively impact smaller markets and much of the developing world.