Caribbean Association of Banks Inc.



-3530379-4023360Correspondent Banking and De-risking in the Caribbean The unintended consequences of regulatory guidelines and the threat to the indigenous banking sector Ian R. De Souza June 2017Caribbean Association of Banks Inc.Correspondent Banking and De-risking in the Caribbean The unintended consequences of regulatory guidelines and the threat to the indigenous banking sector Ian R. De Souza June 2017Caribbean Association of Banks Inc.Correspondent Banking and De-risking in the Caribbean The unintended consequences of regulatory guidelines and the threat to the indigenous banking sector.Ian R. De SouzaAbstract International regulations for the prevention of money laundering and terrorism financing have resulted in the withdrawal of correspondent banking services by major international banks. This is having a deleterious effect on trade and commerce in the Caribbean and it is threatening the viability of many indigenous banks. It is also resulting in financial activities that fall outside of the scope of surveillance intended by the regulators and, in certain respects, rendering the regulations ineffective. AML/CTF regulations were developed by a number of independent international agencies that have not consolidated their regulatory regimes. The regulations are onerous and costly to both correspondent and respondent banks, and they are placing the burden of policing illicit activity on the banking sector. Reforms are required on the governance and deployment of regulatory arrangements, and the mechanisms by which regulators work with banks, to solve the problem of money laundering and terrorism financing. Research on the impact of de-risking by correspondent banks on banks in sub-regions of the world and the Caribbean in particular was conducted through dialogue with members of the Caribbean Association of Banks, participation in conferences and the review of published articles and regulations. Information was also garnered from the experience of managing the operations of a subsidiary of a major indigenous bank in the Caribbean region. For greater effect, regulations used for the monitoring and control of money laundering and terrorism financing need to be consolidated into one set of comprehensive measures. There is also need for dialogue and a more collaborative approach to the problem between the regulators, the correspondent banks and the respondent banks. Coercive activity and punitive fines used by the regulators to administer the correspondent banks must be removed in adopting a solution-oriented path to the problem. Law enforcement and intelligence agencies must also be used as the first line of defense instead of the commercial banking system. The solutions will result in greater efficiency in monitoring the flow of funds associated with criminal activity. They will also reduce the use of alternative channels for the transfer of money and they will increase the likelihood of apprehending persons involved in illicit activity. There will also be a return to a degree of normalcy in the banking system and the reduction of threats to the indigenous banking sector in the Caribbean. Introduction Governments and the financial services industry have been seeking to stem the flow of the proceeds of crime and terrorism financing through the international financial system. As stated by the Basel Committee on Bank Supervision, the objective is to target criminals, kleptocrats and others looking to access the financial system anonymously. In response to the problem, various agencies have established guidelines by which banks are expected to operate in ensuring that their systems and procedures adhere to the objective, as defined. Correspondent banks worldwide extend services to banks in sub-regions who do not have operations in the major world financial centres. Their services to the ‘respondent’ banks facilitate the flow of payments in major currencies to and from their organizations. Without correspondent banking, banks in sub-regions will not be able to support their customers’ requirements for transfers and payments in respect of international trade. Prior to current circumstances, correspondent banks enjoyed a profitable relationship from the services that they provided to respondent banks. In the Caribbean, local banks were courted by correspondent banks for their business and the relationships were found to be mutually beneficial. With the advent of correspondent banking regulations, however, correspondent banks experienced an increase in the cost of doing business due to the organizational infrastructure that was required to ensure that respondent banks were in compliance with new regulatory guidelines. The fines that were being levied on the correspondent banks for regulatory infractions also assisted in tilting the cost-benefit relationship away from financial feasibility and they have resulted in correspondent banks exiting the business by de-risking themselves of correspondent banking relationships. De-risking, the process of correspondent banks removing circumstances that could result in financial loss, has adversely impacted the ability of respondent banks to participate in the international payments system. It has also created a number of negative knock-on effects on social and economic development in the sub-regions. Along with de-risking by correspondent banks, the tightening of account on-boarding and transaction monitoring systems is causing local respondent banks to de-risk themselves of certain classes of business that would be seen by their correspondent banks to represent a high degree of risk. Those businesses, such as Money Transfer Businesses (MTBs), are being forced to use ways and means of continuing their trade that may be outside of the official financial system. The regulations and the reactions of both the correspondent banks and the respondent banks are therefore resulting in failure of the regulations to do what they were originally intended to do. This paper examines the issues around the matter of correspondent banking and de-risking in the Caribbean. It seeks to identify the causes and effects of regulatory pressures that are leading to a series of unintended consequences, which include damage to the indigenous banking sector and actions by customers that are undesirable from a monitoring perspective. The paper will also present recommendations on measures that must be adopted to arrest the problems that have arisen and to bring normalcy and stability back to indigenous banking in the Caribbean. The Regulators The Financial Action Task Force (FATF) is seen by many as the lead regulator in the industry. It is an intergovernmental body established in 1989 by the Ministers of the G7 group of countries. The objectives of the FATF are to set standards and promote effective implementation of legal, regulatory and operational measures for combating money laundering, terrorist financing and other related threats to the integrity of the international financial system. The FATF is therefore a policy-making body that works to generate the necessary political goodwill to bring about national legislative and regulatory reforms in these areas. The FATF has developed a series of recommendations that are recognised as the international standard for combating money laundering, terrorism financing and the proliferation of weapons of mass destruction. They form the basis for a response to the threats to the integrity of the financial system and they help to ensure a level playing field for all operators in the industry. First issued in 1990, the FATF recommendations were revised and up-dated in 1996, 2001, 2003, 2012, and most recently in 2016. The Basel Committee on Banking Supervision (the Basel Committee) is a committee of banking supervisory authorities that was established by the Central Bank Governors of the Group of Ten countries in 1974. It provides a forum for regular cooperation on banking supervisory matters. Its objective is to enhance the understanding of key supervisory issues and to improve the quality of banking supervision worldwide. Through the Bank for International Settlements, which is the Committee’s governing body, the Basel Committee published a set of guidelines entitled ‘Sound Management of Risks related to Money Laundering and Financing of Terrorism’. The guidelines, which were amended in February 2016 to include a general guide to account opening, define how banks should include money laundering and terrorism financing risks in their overall risk management practices. Another group participating in the Basel process is the Financial Stability Board (FSB), which has a separate legal identity and its own governance arrangements. It operates under a mandate from the G20 heads of state and government, and was originally established in 2009. The FSB monitors and assesses vulnerabilities affecting the global financial system and it seeks to enhance global financial stability by developing policies and coordinating the work of national financial authorities and international standard setting bodies. The FSB, in consultation with the International Monetary Fund (IMF), released its own recommendations for supervision of financial institutions in November 2010. The FSB monitors the performance of jurisdictions against their recommendations for regulatory reform and reports back to the G20 annually. In the United States (US), the two principal regulators are the Financial Crimes Enforcement Unit (FinCEN) and the Office of the Controller of the Currency (OCC). Both of these agencies are governed by the US Department of the Treasury and they enforce the requirements of the Bank Secrecy Act. FinCEN’s mission is to safeguard the financial system from illicit use and to combat money laundering by facilitating the detection and deterrence of financial crimes. According to its website, it seeks to promote national security through the collection, analysis and dissemination of financial intelligence, and the strategic use of financial authorities. FinCEN issues guidelines for account on-boarding, monitoring and reporting on money laundering and terrorism financing activity through its Anti-Money Laundering Program and Suspicious Activity Reporting framework. Both these guidelines mirror the FATF guidelines but FinCEN also establishes its own measures which it considers appropriate. The OCC is an independent bureau that was established by the National Currency Act of 1863 and serves to charter, regulate and supervise all national banks and thrift institutions, and the federal branches and agencies of foreign banks operating in the United States. One of the OCC’s main objectives is to enforce anti-money laundering and anti-terrorism financing laws that apply to national banks and federally-licensed branches and agencies of international banks. In regulating national banks and federal thrifts, the OCC has the power to examine the national banks and thrifts and to take supervisory actions against those that do not comply with laws and regulations or otherwise engage in unsound practices. The Caribbean consists of a number of independent nations that have their own banking regulatory regimes. A listing of regulators by country in the region is as follows: - Anguilla: Eastern Caribbean Central Bank - Antigua & Barbuda: Eastern Caribbean Central Bank - Barbados: Central Bank of Barbados Financial Services Commission - Belize: Central Bank of Belize - British Virgin Islands: Financial Services Commission - Cayman Islands: Cayman Islands Monetary Authority - Curacao: Central Bank of Curacao and St Maarten - Dominica: Eastern Caribbean Central Bank - Grenada: Eastern Caribbean Central Bank - Guyana: Bank of Guyana - Jamaica: Bank of Jamaica - Montserrat: Eastern Caribbean Central Bank - St Lucia: Eastern Caribbean Central Bank - St Kitts & Nevis: Eastern Caribbean Central Bank - St Vincent Eastern Caribbean Central Bank & the Grenadines: - Suriname: Central Bank of Suriname - Trinidad & Tobago: Central Bank of Trinidad & Tobago The countries that are regulated by the Eastern Caribbean Central Bank are bound under the Organization of Eastern Caribbean States, which includes a currency union referred to as the Eastern Caribbean Currency Union. There is also the Caribbean Financial Action Task Force (CFATF), which is an inter-governmental organization comprising twenty seven states in the Caribbean and Central and South America that have agreed to implement common countermeasures to address the problem of money laundering, terrorist financing and the financing of the proliferation of weapons of mass destruction. The CFATF ensures that its members comply with the FATF recommendations. It does not issue standards of its own. However, if members do not comply with the FATF recommendations, they can be sanctioned in accordance with the CFATF procedures. Sanctions involve inclusion in a public statement of non-compliant members and they can ultimately result in a country being suspended as a member. The CFATF’s public statement on non-compliant countries is also copied by the FATF on its website. There are, therefore, a number of international regulators setting guidelines for eliminating money laundering, terrorism financing and the proliferation of weapons of mass destruction for the financial services industry. However, there is overlap between the guidelines and it is not clear whether the international regulatory agencies collaborate with each other in order to unify the guidelines. In this regard, the question as to whether there is need for as many independent agencies also remains open for discussion and in many quarters at the industry level, there has been a strong call for unification in order to standardize application and reporting. At the Caribbean level, due to the independence of the island states, there is a large number of regulatory agencies that enforce the guidelines set by the international regulators. While there is oversight, however, there is need for consolidation of activities as the current supervisory infrastructure is uncoordinated and therefore inefficient. Implementation & Monitoring of AML/CTF Guidelines In response to regulations established by the various international regulatory agencies, countries around the world have begun to institute legislation and regulations to ensure compliance with the regulatory guidelines. In the Caribbean, all countries have responded and the required legislative and regulatory regimes have been instituted. Due to the complexities of politics in the region, however, some countries have been slower than others in getting legislation through their parliamentary machinery, but all are now legislatively compliant with international requirements. A mechanism used by the FATF to ensure that countries are compliant with the guidelines is ‘blacklisting’. Countries are rated on their compliance with the regulations and those found to have weak measures to combat money laundering and terrorist financing are published in two public documents that are issued three times a year. The ‘black listing’ of countries is very deleterious to business and trade, as correspondent banks immediately categorize these countries as ‘high risk’ and seek to de-risk themselves of the relationships in order to protect themselves from home-country regulators. At the political and legislative levels, therefore, there is keen awareness of the need for compliance and parliamentarians have instituted the legislation that is required to ensure that their respective countries are not ‘black listed’ by the FATF. At this time, there are no Caribbean countries black-listed by the FATF. The monitoring of implementation and compliance with the FATF regulations has been provided by the IMF and the World Bank. For the G20 countries, the monitoring has been provided by the FSB. To ensure compliance, the regulators at the local level have added specific reviews of AML/CTF policies and procedures to their routine inspection schedules. Licenced financial institutions are therefore all inspected for compliance and they are required to provide action plans for remediation where and when found to be deficient with the guidelines. Quarterly reporting is usually required. Local regulators are therefore adequately attuned to the need for compliance with international regulations and they are fully engaged in oversight activities to ensure that licenced financial institutions are compliant. Ramifications for Correspondent Banks Prior to the advent of international regulations for AML and CTF, major US banks courted the banks in the Caribbean for their cross-border transaction business. Fees were generated for hosting settlement (nostro) accounts, facilitating wire transfers and confirming international trade payments. Additionally, the correspondent banks offered ‘payable through’ accounts, which afforded customers of the respondent banks access to chequing accounts drawn on the correspondent banks. In addition to the fees earned, correspondent banks benefitted from a treasury management perspective on the holding of deposits on nostro accounts. The cost-benefit equation for the US banks in hosting correspondent banking accounts confirmed the feasibility of maintaining the service to banks in the Caribbean region. The introduction of international AML and CTF regulations, and the attendant regulatory frameworks and sanctioning mechanisms however increased the cost of correspondent banking services and changed the cost-benefit equation for the correspondent banks. The fees generated from correspondent banking were no longer able the cover the operational costs of extending the services. Additionally, fines and reputational damage inflicted by the regulatory agencies on international banks for any form of infraction caused the banks to become more wary of the risk of default in respect of AML/CTF guidelines. What, therefore, was once a feasible line of business that was deliberately developed by the correspondent banks became one that was high risk and too costly to maintain, and therefore needed to be exited. To adhere to regulatory guidelines in the US, correspondent banks instituted measures which ensured not only their compliance, but also the compliance by the respondent banks in the Caribbean with whom they had been conducting business. Correspondent banks established Compliance Departments and invested in technology to support identity checking in the on-boarding of customers and the monitoring of transactions on an on-going basis. To ensure that respondent banks in the Caribbean were also compliant with AML/CTF regulations and not placing the correspondent banks at risk of having their systems unwittingly infiltrated by money launderers and financiers of terrorism, the correspondent banks extended their compliance checks to the respondent banks in the region. The costs to the US banks of the compliance infrastructure and the investment in technology were substantial. More importantly, the fee structures that were established for correspondent banking, which were originally considered reasonable for the service provided, could no longer cover the cost of compliance to the correspondent banks. At an operational level, therefore, the cost of extending correspondent banking services became infeasible and formed one of the bases for the decision to discontinue the line of business. Of note is the fact that the lack of clarity in some of the AML/CTF guidelines resulted in misinterpretation and second-guessing by the correspondent banks, which in turn led to additional costs for monitoring and surveillance. As an example, under the ‘Know Your Customer’ guidelines, the interpretation by the correspondent banks was that they needed to know not only of their respondent banks’ affairs, but also of the affairs of their customers. This interpretation of the guidelines resulted in further investigation and monitoring, and it added to the cost of confirming compliance. Circumstances of this nature produced additions to the cost of the compliance infrastructure and added to the overall cost of the line of business. The cost of compliance therefore tilted the cost-benefit equation away from the determinant of feasibility. As justification for the cost of compliance and the related policing activity, FinCEN reported that between 2010 and 2014, an average of 46,000 cases associated with money laundering and terrorism financing were prosecuted in the US. The regulator also argued that from an industry perspective in the US, there was financial breakeven in that the estimated US$287 million per annum spent by the banking sector on computer hardware and software, and compliance staffing, training and monitoring, was well covered by the estimated saving of US$300 million in the cost to society that was imposed by illicit activity. Correspondent banks were also wary of fines levied by the US regulators on banks that were found to be in breach of regulations or to have engaged in unethical behaviour. Some of the infractions attracting fines were the rigging of FEX markets, LIBOR manipulation, creating and dealing in sub-prime mortgages, trading in false mortgage-backed securities and transacting with countries on sanctions lists. As at October 2015, fines paid by major banks were as follows: Name No. Settlements US$(Bn) Bank of America N/A 77 J.P. Morgan Chase 26 40 Citigroup 18 18 Wells Fargo 10 10 BNP Paribas 1 9 UBS 8 7 Deutsche Bank 4 6 Morgan Stanley 7 5 Barclays 7 5 Credit Suisse 4 4 Total 85 185 In addition to fines levied on the banks, executive officers were charged by the US Securities Exchange Commission (SEC) for their involvement in the infractions. Up to Year 2015, the SEC had collected US$3.6 billion in fines from CEOs and CFOs of some of the major international banks. Of note, however, is the fact that the fines levied on international banks did not feature breaches of AML/CTF guidelines in any significant way. This notwithstanding, the general threat of fines and the potential damage to their image weighed against the benefits in the cost-benefit equation and became a major disincentive for correspondent banks. The correspondent banks therefore began to exit the business where jurisdictions were deemed to be high-risk by virtue of the lack of legislation or adherence to regulatory guidelines. Correspondent banks also appeared to use the burden of regulatory arrangements to de-market low-value accounts. Several indigenous banks from the Caribbean region have reported that notwithstanding measures taken to conform to the regulatory regimes, including investment in technology at considerable expense and the introduction of compliance functions with supporting policy and procedure, they were still de-risked by their correspondent bankers, as the volume of their transaction activity appeared not to justify maintenance of the relationship. The issue therefore has not only been one of risk associated with dealing with respondent banks but the profitability of the relationship to some correspondent banks in the context of the cost of compliance. It is therefore apparent to some banks that AML/CTF compliance has been surreptitiously used by some correspondent banks to discontinue relations. Based on March 2017 statistics from the Caribbean Association of Banks (CAB), 45% of the correspondent banks exited the market entirely. The remaining correspondent banks withdrew their services from some countries and from some banks, resulting in 55% of CAB’s 41 members experiencing complete or partial de-risking. Of note is the fact that five banks were given an ultimatum by one major correspondent bank to close their accounts by the end of August 2016. Due to CAB’s intervention, an extension was granted to the end of November and, subsequently, to the end of January 2017. Despite this intervention, however, all 5 of those banks have since been de-risked by that correspondent bank. CAB statistics indicate that 8 of its member banks now have no direct correspondent banking arrangements, 17 have only one relationship and 9 have two to three correspondent banking accounts. The banks that have retained multiple correspondent accounts are larger in size and operate in jurisdictions deemed to be safer. Due to their size, the volumes of business generated from those banks weigh in favour of the cost-benefit equation. There has therefore been no ebbing of the de-risking trend and the Caribbean region continues to be stripped of its correspondent banking services and all related forms of business. Consequences of De-risking in the Caribbean Banking in the Caribbean has been severely impacted by the withdrawal of correspondent banking services and the threat thereof by the international banks. The cost of compliance has placed a heavy burden on the industry and the related funding requirements have added to the challenges faced by smaller indigenous banks, in particular. Where banks have been de-risked, many of the services that are relied on by customers for day-to-day living and the conduct of business have been lost. In order to continue to satisfy customers’ needs, banks have had to find alternative means of facilitating international payments. This has impacted the cost of doing business and it has also affected the quality of services to banks’ customers. Additionally, transactions are being driven into new channels, which either fall outside of the regulated sector or are difficult to monitor. These emerging trends are unintended consequences of the regulatory regimes and they are working against the intent of the regulators. The threat of loss of correspondent banking arrangements with international banks has caused many respondent banks in the Caribbean to terminate relationships with MTBs such as Western Union and Moneygram. Because of the ‘know your customer’ requirements, respondent banks have been unwilling to take the risk of relying on the on-boarding arrangements used by the MTBs for their customers. The de-risking of the MTBs by the respondent banks has interfered with the flow of international remittances from persons resident in the diaspora to their friends and relatives in the Caribbean. This has been very disruptive to life for many people who depend on foreign remittances for day-to-day living and it has negatively impacted GDP for many countries in the region. Persons transferring funds into the Caribbean are now faced with the inconvenience and higher cost of arranging wire transfers through the formal banking sector, and recipients of the transfers, who largely operate at the lower end of the income scale, are also faced with higher bank charges for the transactions. In order to satisfy the customer on-boarding and transaction screening requirements that are embedded in the AML/CTF regulations, banks have had to invest in technology and introduce compliance functions at a significant increase to their capital and operating costs. The on-boarding of customers calls for screening against criminal databases and sanctions lists. To be effectively managed and ensure thoroughness and accuracy, technological solutions that are hardware and software intensive have had to be employed. These solutions are extremely costly at the acquisition and installation stages, and on-going licencing and maintenance costs form a major component of operating costs. Banks have also had to establish Compliance Departments for monitoring and control of day-to-day banking activity. These departments are independent of executive management and are required to report directly to Boards of Directors. They are staffed by specially-trained legal and compliance professionals, who, with their on-going need for training, add another layer of expense to a bank’s operating cost structure. The combined technological and operating costs that arise from the AML/CTF compliance function are significant and place a notable burden on smaller indigenous banks in the Caribbean, whose financial circumstances are already challenged by the on-going economic pressures of the region. Another increase to the cost structure of many indigenous banks is the use of ‘down streamers’ for international business. Many banks who have lost correspondent banking services, or who are at risk of having their options for correspondent banking reduced, are turning to ‘down streamers’. ‘Down streamers’ are medium-sized, intermediary banks that use their own correspondent banking relationships to facilitate transactions on behalf of smaller respondent banks. This activity was previously referred to as ‘nesting’. It was considered to be an undesirable practice by the international correspondent banks, as it represented a means of entry into the international financial payments system by respondent banks that were using other banks’ correspondent banking relationships. ‘Down streamers’ however base their business on the rigour with which they conduct their on-boarding and compliance activity. The practice is therefore now being accepted by some international correspondent banks, as it provides a layer of compliance checking that reduces the level of accountability on their part. While the use of ‘down streamers’ is an option that is available to respondent banks, the threat of de-risking remains, and both the cost and quality of service extended by the indigenous banks are being negatively affected. As indicated, down streaming as a business is based on the thoroughness with which intermediary banks that offer the service conduct their on-boarding and compliance checks. If these checks are intentionally or otherwise breached by respondent banks and illicit transactions make their way into the international payments system, the ‘down streamers’ themselves could lose their correspondent banking relationships. In the event of an occurrence of this nature, all respondent banks in their portfolios would be affected. In addition to the residual risk that remains, the use of ‘down streamers’ adds to both the cost of doing business and the length of time for processing transactions on behalf of respondent banks. Due to necessity and the risk of the service, the charges levied by down streamers for their service are significant. The screening process also lengthens the time taken for transactions to be approved and processed. The charges, which are passed on to respondent banks’ customers, and the longer transaction times result in an adverse variation in the efficiency of respondent banks’ service relative to competitors who do not need to use ‘down streamers’. Invariably, international banks and large indigenous banks do not use ‘down streamers’, so it is the smaller indigenous banks that suffer a competitive disadvantage in respect of their cost structures and service standards. AML/CTF regulations have also been attributed to the physical movement of US cash between countries in the Caribbean and the use of alternative, technology-based payment systems for international and inter-personal transactions. Media and other reports have it that large sums of US currency are being transported by sea and air as a ‘work-around’ to the difficulties in transferring money through the formal banking sector. Some of these cash movements are believed to be in support of illicit transaction activity, but due to the very nature of the enterprise, little credible information is available. The issue from a regulatory standpoint is that notwithstanding the regulations that now pervade the entire banking system, money is still being moved internationally to satisfy transaction activity. Some Latin American countries, including the Dominican Republic, have also established a closed-loop clearing system to facilitate the settlement of trade and remittance transactions in US dollars between themselves. Transactions are cleared and settled through the Central Banks of the various countries using their respective US dollar accounts. This mechanism averts the need for commercial banks to settle through their correspondent banks in the US. It has been suggested that Caribbean indigenous banks either seek to join the Latin American closed-loop or set-up a similar arrangement with their Central Banks. The clearing of US dollar transactions outside of the US financial system in this manner precludes oversight of the use US dollars for payments and transfers intended by the international regulators, and represents a consequence of the regulations that was not intended. Another mechanism that is being used as an alternative means of payment or funds transfer is internet-based crypto currency. Crypto currency is a medium of exchange involving transfers and settlements between anonymous, internet-based accounts. Operationally, traditional currency, which is fiat or commodity money, is converted into units of crypto currency that is stored in internet ‘wallets’ or accounts. The currency is used for settlement of transactions with other holders of internet accounts who are prepared to transact in that form of currency. The system of transfers is based on distributed or shared ledgers in a synchronized peer-to-peer network of computers that is geographically spread across multiple sites, countries or institutions. Like traditional currency, crypto currency has a trading value that is based on demand and supply. With crypto currency, there is no central administrator, such as a Central Bank. Transactions are instead proven on an instantaneous basis by interconnected computers that validate them as a block of data. Blocks of data are added to an existing chain of transactions referred to as a ‘block chain’ and they are accounted for on the distributed ledger network. Transactions in the block chain are permanent and unalterable, and they can be tracked. However, the owners remain anonymous. While crypto currency was not developed as a means for facilitating illicit activity, the anonymity has made it attractive to criminals and it has gained in popularity as a method of transferring funds derived from illicit activity. Ransomware, for example, is a computer malware that attacks systems and devices, encrypts files and holds the data hostage until owners pay a ransom for retrieval. The ransom must be paid using crypto currency. Regulators have no direct means of control over crypto currency and the distributed ledger system. At this time, controls are indirectly derived through the refusal by many banks to deal with crypto currency companies due to the fact that the system is used for illicit activity. The conundrum for the regulators, however, is that crypto currency is deemed to be a currency of the future and it will eventually have to be accepted by the banking system. The issue is with acceptance of it as an official payment mechanism with its anonymity when regulators are adamant on the banking system ‘knowing its customers’. In the Caribbean, most banks do not deal with crypto currency, as to do so would possibly threaten their relationships with their correspondent banks. However, digital currency companies are active in the region and there does exist the risk of them being used for illicit activity. Other forms of peer-to-peer activity are also fast gaining popularity and are being used as work-arounds to the traditional banking and clearing systems. An example would be peer-to-peer lending, where holders of surplus funds are matched with borrowers on technology-based platforms. Use of funds in this manner is a means of laundering money if the platform is not proficient in its background checks on the funders. Similarly, internet-based clearing systems have been developed that allow suppliers and purchasers to transact and clear payments on a network of cyber accounts. These systems are not being developed to facilitate illicit activity. They are instead being developed to exploit the efficiency of technology and the internet, and as a means of affording users a more convenient and efficient means of transacting business than that which exists in the traditional banking sector. However, their existence and the means by which they operate are attractive to and being exploited by persons engaged in nefarious activity. The off-shore banking and international business sectors have been particularly hard hit by AML/CTF regulations and de-risking. Both sectors are integral to the economies of several Caribbean islands and they are in fact significant contributors to GDP where they operate. However, they are based to a large extent on the privacy of the relationship between the bank and the client, and in the case of numbered accounts, the customers are anonymous. These arrangements are at direct variance with ‘know your customer’ requirements, which call for full disclosure and identification of beneficial owners of accounts. The tightening of disclosure requirements by commercial banks has resulted in the closure of accounts and the contraction of off-shore and international business sectors. Local economies that have been dependent on these lines of business have been adversely affected as a result. AML/CTF regulations have also placed a heavy administrative burden on commercial banks in the Caribbean and the quality of banking services in general has been adversely affected by the new compliance arrangements. In order to satisfy ‘know your customer’ requirements, banks are now required to update file information on all of their customers. The task has proven to be an arduous one, and with most banks having had to employ additional staff for the purpose, it has added to the cost of doing business. Customers have also been disaffected by the additional information requirements, particularly as they do not relate to the issues of money laundering, counter terrorism financing, correspondent banking and de-risking. Banker-client relationships have therefore become strained and the business as a whole has been negatively affected by AML/CTF regulations. In summary, AML/CTF regulations have been producing opposite effects to their original intent. In some cases, they are driving transactions into alternative channels that are more difficult to trace. The regulations are also damaging business sectors that have been integral to the economies of some Caribbean countries, and they are therefore affecting economic performance and development in the region. At the operational and service ends, the entire banking industry has been negatively affected due to the retrospective due diligence requirements on customers and the frustrations being put on the banker-client relationships. Most importantly, the indigenous banking sector is being put at a disadvantage relative to the international banks, as they are faced with additional costs for staying in business at a time when circumstances have remained strained in the overhang of the 2008 world financial crisis and the continuing struggle for economic development. Solutions and the Way Forward Banks in the Caribbean continue to work on measures to ensure compliance with international AML/CTF regulations. Technological solutions for transaction monitoring and background screening in the on-boarding process continue to be introduced, and information on existing customers is being remediated under the ‘know your customer’ requirements. Training of all staff from Board members through to non-clerical employees is on-going and being repeated on an annual basis. To confirm the tenacity of their AML/CTF systems and procedure, some banks have introduced the use of independent professional assessors to test and report on their internal programs. The assessment reports are used to support requests for the establishment or maintenance of correspondent banking accounts. At an industry level, measures are being considered that would provide for the establishment of information databases on banks and customers in the region. These databases, which are referred to as KYC utilities, are intended to support transaction hubs that would screen banks and customers seeking to enter the international financial payments system. For example, SWIFT, the Society for World Interbank Financial Telecommunication, which is used by banks worldwide for international payments, is introducing a secure, shared platform for exchanging standardized and validated KYC data using mechanisms such as ‘legal entity identifiers’. The industry has also agreed on enhanced wire transfer instructions so that the bona fides of transactions can be more easily verified. While work continues to be done at the regional level in the Caribbean, work on improvements to the regulatory regimes is also required at the international level. International regulators appear not to have envisaged the negative consequences of the regulations that have been occurring. The withdrawal of correspondent banking and the de-risking of respondent bank relationships by major international banks was not expected, or at least so the industry believes. The regulators also did not foresee the degree of impact on industries such as the MTBs and the international business sectors. Most importantly, they did not anticipate the secondary and underground money transfer arrangements that have come into being. The issue that has emerged is that the regulations have begun to work against themselves and they are resulting in activity that makes monitoring of the flow of funds in respect of illicit activity even more difficult. It is therefore now necessary for the regulators to make adjustments to the regulations and the manner in which they are implemented so that they can achieve the objective of arresting the flow of the proceeds of unlawful enterprise and monies bound for the financing of terrorist activity. In reviewing the regulations and the methods of implementation, the FATF, the Basel Committee, the FSB and the US Department of Treasury, along with its agencies, FinCEN and the OCC, all need to collaborate to assess the effectiveness of their respective regulations. Most importantly, they need to consolidate the regulations into one standard that would be more easily deployed and governed. There is very little efficiency and justification in having three major international bodies and various country-level agencies establishing individual sets of regulations, all for the same purpose. Apart from the dysfunctionality that this produces, it is a costly and administrative burden for regulators at the country level. Regulators in the Caribbean also have to undergo regular reviews by the World Bank, the IMF, the FSB and the CFATF, all on the same issue of adherence to the various international regulations. Conversion of the regulations to one common standard will allow for greater ease in implementation and it will provide for more focused monitoring of the activities of the banks and other financial services entities that they supervise. In reviewing the regulations and guidelines for their application, international regulators also need to detach from the thinking of the entire universe of bank customers as potential criminals and kleptocrats, particularly if this thinking is based on preconceived notions about specific regions such as the Caribbean. This level of thinking is having a very damaging effect on the quality of banking services in the Caribbean and bank customers are being frustrated in the conduct of normal banking business for reasons that play a very small part of daily life in their societies. Specifically, while there are no doubt flows of funds affiliated with persons involved in illicit activity, this is no different to any other economy or society in the world and, in relative terms, flows of funds associated with criminal activity in the Caribbean are much lower than those in major world centers such as New York, Miami, Toronto and London. Therefore, rather than disrupt the entire banking industry and the lives of persons across the Caribbean region in the attempt to identify and capture a few perpetrators of criminal activity, more incisive and effective methods need to be used to achieve the purpose. Regulators also need to discontinue the use of the banking system for policing of activity that belongs with law enforcement and intelligence agencies. The AML/CTF operating regulations are not unlike the case of Foreign Account Tax Compliance Act, where banks around the world have been forced to engage in activity involving the identification of American citizens who are liable to the US Internal Revenue Service for payment of taxes, a matter having nothing to do with banks outside of the United States. Similarly, FinCEN sees itself as both regulator and financial intelligence unit and it therefore bases its information requirements from the commercial banking sector on support for this activity. Banks are commercial entities that that have as one of their primary objectives, the maximization of shareholder returns. AML/CTF regulations are increasing the costs of doing business for commercial banks and they are therefore reducing profitability and returns to the shareholders. In some cases, the additional costs are affecting the very viability of small indigenous banks in the Caribbean and threatening their ability to stay in business. The control of money laundering and terrorism financing are not primary banking functions and regulators need to instead use law enforcement and intelligence agencies to police criminal activities. In today’s world, there are physical and technological surveillance mechanisms that are available to law enforcement to identify and monitor criminals and illicit activity. Rather that rely on banks as the first line of defense and impair the business in the way that is now occurring, information gained by law enforcement from policing activity should be used to direct banks on the handling of accounts belonging to persons who are suspected of or guilty of money laundering or terrorism financing. In order to address the problems that have been emerging as a result of AML/CTF regulations and, in particular, the unintended consequences that have been described, there is need for public-private consultations between the regulators and the commercial banking sector. By necessity, these consultations must include both the correspondent and the respondent banks, whose businesses have been severely affected as a consequence of the regulations. They must seek to identify the negative impact of the regulations on banking services globally and they must focus on means for improving effectiveness in the measures for prevention of money laundering and terrorism financing. Public-private consultations must specifically seek to correct the damages that are being done to the banking sector and the economies in the Caribbean, as well as other similarly-affected sub-regions around the world. The objectives of these consultations must be to remove or substantially reduce the factors that are causing the business of correspondent banking to be unattractive and uneconomical for the international banks. In this regard, rather than using regulations in a coercive manner and applying fines that are extremely punitive, the aim must be to have joint, on-going, solution-oriented collaboration between all parties, including law enforcement, that provides for more effective monitoring of illicit activity while providing for the continuation of business at reasonably normal levels. Unless there is change, the manner of administration of regulations and use of fines by the regulators at the levels noted will not result in any change in direction by the correspondent banks and the negative consequences of the regulatory regime will persist. In the Caribbean, there is also need for consolidation of supervisory activity on the part of the regulatory agencies. As noted, there are 11 regulatory bodies across 17 countries in the region. These supervisory arrangements are inefficient, as they are largely uncoordinated and they do not provide for consolidated and unified oversight of banking activity across the various jurisdictions. They are also cost-ineffective for a regional banking sector whose net earnings streams are already challenged. Additionally, for regional and international banks with operations in multiple countries, there is the inefficiency of having to satisfy the requirements of numerous regulators. The move by the Eastern Caribbean Central Bank to consolidate supervision within the Eastern Caribbean Currency Union as a coordinated oversight measure is noted and welcomed. This initiative will assist with the centralization of activity that is needed. The strategy however now needs to be extended to and adopted by other regulatory agencies across the region. There is also a significant role for elected politicians in bringing relief to the problem of burdensome regulatory oversight. The regulatory bodies, the FATF, the Basel Committee, the FSB and FinCEN, were all established by Ministers of Government and Central Bankers of the G7 and G20. To effect change on the work of the regulators, there is need to address the issues at political level where there would be broader concerns for human and social development, and the consequences of international regulations on the development of the sub-regions of the world. Regional politicians therefore have a responsibility to lobby for change at the level of the G7 and the G20 so that reform can be effected at the regulatory level. In this regard, with the number of independent regulatory agencies that are overseeing the AML/CTF matter, it would be difficult for any one regulator to initiate change without the other regulators being in alignment. Governments therefore need to agree to consolidate regulatory arrangements under one international body so that activities could be unified and more effectively applied. Conclusion Bankers in the Caribbean are conscious of the need to prevent money laundering, terrorism financing and the proliferation of weapons of mass destruction due to the damage that these activities are having on societies in parts of the world. The measures that are required to be compliant with international AML/CTF regulations are being put in place, not only for purposes of compliance and to protect correspondent banking relationships, but also because of their sense of responsibility for protection of the world financial system. However, the weight of the current regulatory regime is too heavy and it is negatively affecting the cost of operations, the service to customers and the overall financial performance of respondent banks. For the correspondent banks, the costs and risks of reputational damage are also very onerous and they are therefore being forced to discontinue correspondent banking as a line of business. The loss of correspondent banking is severely affecting the ability of respondent banks in sub-regions of the world to fully service their customers and it is retarding economic development. AML/CTF regulations are also driving financial transactions and money transfers into alternative channels that are unregulated and cannot be monitored. The regulations are therefore beginning to work against themselves and they are losing effectiveness. In order to correct the negative circumstances that have developed, international regulators need to rethink the approach to regulating the AML/CTF provisions for the industry. They must consolidate their activities and collaborate in a more purposeful manner with both correspondent and respondent banks in order to achieve greater effectiveness in their roles. In so doing, regulators also need to be mindful of the fact that the banking system is commercially oriented and it therefore cannot be used for policing and intelligence activities that belong in the domain of law enforcement and governmental agencies. In this regard, commercial banking should respond to intelligence and law enforcement activity rather than being directly responsible for those roles. International regulators need to be more mindful of the fact that societies in developing regions are fragile and often vulnerable to the smallest of adverse economic events. Indigenous banks in these regions are integral to economic development and the advancement of these societies. They often play role that international banks are not interested in performing or that do not fit their operating mandate. It is therefore important that the indigenous banking sector be supported and allowed to prosper. The US Office of the Controller of Currency states on its home page that it recognises the important role that minority banks and savings associations play in providing financial services to the communities they serve. The agency also states that it is committed to the success of these financial institutions. While the institutions referred to in the statements are US based, the same commitment and principles should apply to indigenous banks in regions such as the Caribbean, as they too play an important role in providing financial services to the communities they serve. Such commitment would be met by ensuring that international banks in the US that have provided correspondent banking services to respondent banks in the sub-regions of the world are allowed to continue do so in manner that satisfies the need for protection of the financial system while allowing respondent banks to carry on their business in a successful manner. *******References Shehu, A, Y 2010, ‘Promoting financial sector stability through an effective AML/CFT Regime’, Journal of Money Laundering Control, vol 13, no. 2. ‘International Standards on Combating Money Laundering and the Financing of Terrorism & Proliferation’, Financial Action Task Force, 2016. Artingstall, et al 2016, ‘Drivers & Impacts of De-risking’, John Howell & Co. Ltd. Durner, T, Shetret, L 2015, ‘Understanding Bank De-risking and its effects on Financial Inclusion’, Global Centre on Cooperative Security. 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Department of the Treasury, NR 2016-123, 2016. ‘Risk Management Guidance on Periodic Risk Reevaluation of Foreign Correspondent Banking’, Office of the Comptroller of the Currency - U. S. Department of the Treasury, OCC Bulleting 2016-123, 2016. ‘Customer Due Diligence Requirements for Financial Institutions’ Federal Register. ‘FinCEN Publishes Final Customer Due Diligence Rules Introducing New Measures to Control Money Laundering and Other Financial Crimes’, 2016. ................
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