Banks raise concern over shake-up to cut risk

Bankers point to fresh threat to industry as transactions leave system after big lenders end ties with smaller ones to lower compliance costs

PUBLISHED : Sunday, 18 October, 2015, 9:51pm
UPDATED : Monday, 19 October, 2015, 12:57pm

Something has got to give. That is the voice of the small bank in an era when large financial institutions are severing ties with them.

They call it derisking, banker parlance for wiping out relationships with smaller customers in high-risk countries, all with the hope of lowering compliance costs and dodging staggering fines for money laundering, or even the semblance of it.

But some players - smaller banks with international remittance networks, global ones that lend to other banks - are starting to push back against the growing risk of derisking, namely the threat of funds leaving the formal financial system and entering dark, untraceable channels.

"Who are we going to deal with?" Ferry Robbani, the head of international banking and financial institutions at Indonesia's Bank Mandiri, asked of its disappearing correspondent bank network.

Indonesia was removed from the Financial Action Task Force's money laundering blacklist in July. Still, over the past three years, Mandiri, Indonesia's largest bank by assets, had seen global institutions drop some of the most basic services they once provided on cross-border transactions, Robbani said, from cheque clearing and export bill collections to the most basic payments made by customers who walked in off the street.

Those transactions have not stopped despite bigger institutions rejecting the business. Instead, they are moving down the hierarchy of banks to ones that may lack the experience, technology or will to stem money laundering. Many transactions will leave the banking system. The result, Robbani said, was a riskier financial landscape.

"We would be faced with second-tier banks, maybe third-tier banks, which in the end would, in my opinion, bring another set of risk to the industry," he said last week at Sibos, a global conference organised by Swift.

If rapid expansion into high-risk markets defined the run-up to 2012, the year that HSBC Holdings was handed a landmark fine of US$1.9 billion for working with drug cartels in Mexico, then a pullout from those markets would characterise the industry today.

Between May 2013 and November last year, consulting firm Protiviti said regulators levied more than US$10 billion in fines on banks. The annual cost of due diligence and compliance staffing could easy match that in the coming years.

The slash-and-burn brand of derisking would not deliver the end results regulators were looking for, said Alex Manson, the global head of transaction banking at Standard Chartered.

"Flows still happen, they just go underground," he said. "A central bank would go into the system without any of the information that a commercial bank may have been able to gather. This is not a good outcome for the safety of the financial system."

Until now, the bank has been at the forefront of removing itself from riskier segments of the market, notably with the dropping of thousands of small business customers in the United Arab Emirates last year.

Manson told the South China Morning Post he expected far less derisking in future and more active engagement with existing clients with the hope of maintaining relationships.

Standard Chartered recently set up a compliance academy that has so far trained 700 customers on what it needs from them to continue doing business, Manson said on the sidelines of Sibos. The receptive clients might stay on; those asking "why do we need to do this?" were cases for derisking, he said.

Engaging smaller banks on how not to get expunged from the global financial system might very well be an emerging trend of its own, Michael Cho, the head of compliance for global financial institutions at Wells Fargo, told the Post. Banks and regulators might even be finding some common ground.

"I think the banks' concerns and the regulators concerns are similar," Cho said. "The US regulator is clarifying and saying 'our goal is not for you to derisk your customers. Our goal is for you, if you're going to bank a higher risk portfolio, that you have the controls to do it'."

Cultivating those controls had largely played out on the ground with banks around the globe, Cho said. Despite fierce competition, compliance teams at big and small banks have been coming together to share expectations and strategies for catching the transactions that could potentially lead to heavy fines.

As banks begin to get a glimpse of what compliance will eventually cost them, some are making a pitch on profitability to bring smaller banks back into the fold. Smaller banks provided higher returns on equity, higher margins and less management time, said Andrew Yiangou, a managing director for global institutional banking at National Australia Bank.

Still, where billion-dollar fines and long-standing reputational risks were concerned, revenues to be won on banking high-risk markets were not part of Deutsche Bank's strategy, Werner Steinmüller, the head of transaction banking for the German bank told the Post.

Like its peers, Deutsche wants to expand and deepen business with its current customers. For now, Steinmüller said the bank had enough large clients in Asia with a relatively low level of risk.

Deutsche's appetite for picking up smaller clients in higher-risk countries was low despite the potential for higher returns.

"Risk and compliance are the No 1 considerations. Revenues come second," he said.