The regulatory environment has seen significant growth in the wake of the global financial crisis. The resulting effect is that ‘risk avoidance’ appears to have replaced ‘risk management’ and banks have embarked upon a wholesale culling of customers deemed to be ‘outside of risk appetite’.

The phrase given to this practice is ‘de-risking’ and, while many regulatory authorities insist it is not in line with international guidelines, the unfortunate reality is it has become a recognised problem within the global financial services sector and one which has been termed a large-scale market failure.

The increase in regulatory activity means increased costs to banks – either in the face of sanctions imposed by the regulators or in the face of mandatory standards of risk and compliance – and the figures in this respect speak for themselves.

To highlight just three examples, JP Morgan confirmed in 2013 it employed 4,000 additional compliance staff and spent an extra $1bn (£760m) on controls; Deutsche Bank’s 2014 results included €1.3bn (£1.12bn) in extra regulatory-related spending; and in April 2015 Citigroup confirmed about half of the bank’s $3.4bn efficiency savings were being “consumed by additional investments … in regulatory and compliance activities”.

This has not gone unnoticed and the World Bank’s 2015 report on de-risking points to low profitability of a customer base as one of the key, if not the most important, driving factors behind de-risking practices. Banks are now frequently left in a situation where they lack both “market and regulatory incentive” to maintain a wide range of customer accounts, with the preferred approach being to ‘off-board’ high-risk, low-profit customers.

Impact Of AML Legislation

Alongside the ‘profit-cost analysis’ assessment, the risk of falling short of existing anti-money laundering (AML) legislation is frequently referred to as a major cause for the cut-and-run approach that is being adopted. In the UK, a prime example of this is the application of the Money Laundering Regulations 2007 and, specifically, the concept of a ‘politically exposed person’ or ‘PEP’.

A PEP status could apply not only to heads of state, members of parliaments, members of supreme courts – and more – but also any of a PEP’s “close associates” and “immediate family members”. This concept therefore has an extensive application across a wide range of customers.

Moreover, once a PEP has been identified, banks are then under an obligation to conduct enhanced customer due-diligence and monitoring. Rather than adhering to these ongoing obligations, which ultimately entail heightened costs to the business and dedicated management time for doing so, the more financially viable and risk-averse option for a bank is often simply to close the customer’s account.
The offence of “tipping off” under section 333A of the Proceeds of Crime Act 2002 also puts banks in a difficult position. Tipping off occurs when a relevant individual – for example, the person suspected of laundering money or a close associate of his – is alerted that an investigation into suspected money laundering is either in progress or pending.

Under this offence, therefore, a bank that freezes, or closes, a customer’s account upon suspicion of illegal activity (in compliance with applicable AML legislation) is then restricted from providing reasons for its actions to the customer or risk facing criminal sanctions.

Not only does this result in high levels of stress and a lack of clarity on the part of the customer, but the banks suffer reputational blows when details of such incidences become public – the most recent high-profile example of this resulted in a claim being issued against Barclays Bank by the billionaire Iranian philanthropist, Wafic Saïd.

Clarification Of Regulation

It has been suggested the de-risking trend could actually have the opposite effect to what AML legislation is trying to achieve – for example, the Financial Action Task Force has observed de-risking has the potential to force entities and persons into less regulated or unregulated channels.

This is something with which Gloria Grandolini, senior director of finance and markets global practice at the World Bank Group, agreed when she stated: “There is a real risk that turning away customers could actually reduce transparency in the system by forcing transactions through unregulated channels.” So what are the UK regulators doing to counter-balance these adverse affects?

A report recently commissioned by the Financial Conduct Authority (FCA) on the impacts of de-risking recognises the need for banks to “retain flexibility in setting up appropriate systems and controls to ensure they comply with legislation as well as in making commercial decisions on whether to provide banking facilities that are consistent with their tolerance of risk”.
Many hope the Financial Services Act 2016, which came into force on 6 July this year, will go some way to achieving this. The act makes provision for the FCA to issue guidance on the meaning of a PEP for the purposes of the Money Laundering Regulations, going so far as to suggest compensation might be owed to the customer concerned if the banks effectively ‘over-comply’ with the regulations and refuse to bank with a customer solely on the basis of their PEP status.

This latter proposal appears to address the ‘one size fits all’ approach by introducing an element of accountability for any de-risking decisions and encouraging a more active management of risk portfolios.

In addition to this, the arrival of the Basic Payment Accounts Regulations 2015 on 18 September this year will, subject to certain conditions, make it mandatory for banks to offer a basic payment account to any consumer who applies for one on or after 18 September. It will also restrict banks’ termination rights over those basic payment accounts, thereby providing a buffer to across-the-board de-risking practices.

Whether these new initiatives will eradicate the problem is difficult to say. What is promising, however, is that UK regulators appear at least to have realised the current regulatory environment is close to being unworkable.

Banks need more clarity on what risks they actually face, and an improved dialogue between the financial services sector, the regulators and the consumers will prove essential in achieving this.