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How compliance regulations are hurting the Caribbean’s indigenous banks

With international banks withdrawing from correspondent banking with small states, the threat to the Caribbean’s indigenous banks and the private sector is dire

IMAGINE THIS. You, a partner or family member is working overseas. You have been sending money home to support an aging relative or to make a regular payment on a mortgage. You go to the Caribbean money transfer business that you have always used, only to be told your money can no longer accepted because there is no intermediary bank in Europe or the US willing to work with it despite its absolute reliability and positive track record.

Although oversimplified, this scenario is not impossible as changing international regulations and risk aversion are having the effect of disconnecting Caribbean financial institutions from the international correspondent banking services that are necessary for them to clear or transfer money.

In the last year the issue has become a significant problem that potentially threatens to touch significant numbers in the Diaspora who send money home, or small businesses that need to make international payments.   It is also a development that has much broader significance for many economies in the region, as Central Banks and Governments for reasons of macro-economic and social stability have come to rely on the a constant flow of remittances.

The origin of the problem lies in relatively new international regulations intended to address money laundering and the financing of terrorism, known as AML/CFT.

This requires that all financial service providers, including the big banks and those working with low-income communities, enhance their internal controls; undertake customer due diligence procedures on all new and existing clients; introduce higher levels of surveillance of suspicious transactions; keep transaction records; and report suspicious transactions to national authorities. It also requires international banks and financial institutions to know that their correspondent bank, for example in Jamaica, the Dominican Republic or Guyana, is also undertaking the same level of due diligence and knows its customers.

This has had the unintended consequence of seeing increasing numbers of international banks withdrawing their correspondent banking facilities either on the basis of the cost of compliance with the AML/CFT rules, or the perceived possibility that they may be placing themselves in jeopardy with their own supervising financial body; with the possibility they may face huge fines.

So serious has this matter become, that the World Bank recently asked banking authorities and banks worldwide about the extent to which there had been a withdrawal from correspondent banking, what was driving this trend, and what the implications were for financial exclusion and inclusion.

Its subsequent November 2015 report, ‘Withdrawal from Correspondent Banking – Where, Why and What to do about it’, makes clear that the Caribbean is the region most severely affected.

The report observes that about half the banking authorities it surveyed, and slightly more local and regional banks, indicated they were experiencing a decline in correspondent banking relationships, with a much greater number, some 75 per cent of large international banks, saying the same.

Particularly affected are the clearing (typically by cheque) and the settlement of payments, cash management services, international wire transfers, and according to banking authorities and local and regional banks, trade finance. The issue was particularly serious when it came to transactions denominated in US dollars, Euros, the Pound sterling, and the Canadian dollar.

According to the World Bank, the banking authorities surveyed indicated that those most affected were money transfer operations, followed by small and medium domestic banks and then small and medium sized exporters.

Uncertainty about regulatory obligations, the World Bank said, was leading large banks to err on the side of caution with the consequence that correspondent relationships with financial institutions in regions like the Caribbean were being abandoned, sometimes with no notice period. This then led to a situation where indigenous banks were finding that it was increasingly difficult to locate correspondent banks, and that the business costs for all involved had become significant.

The report also showed that the situation was particularly acute in the locations where the majority of the Caribbean Diaspora reside: the US and the UK.

It also made a number of recommendations, some of which are internal to the way correspondent banking operates, while identifying a number of hard-to-address issues relating to the way in any commercial enterprise can decline to undertake business on the basis of cost, policy or risk.

AML/CFT rules are a classic example of regulation with unintended consequences.

“Although seemingly remote from everyday life, correspondent banking is central not just to the global flow of currency and trade, but in the case of the Caribbean to social sustainability through remittances, which in 2014 were, according to the IDB, worth US$9.9 billion, but probably significantly more if flows into Cuba were included.”

De-risking by correspondent banks is not only driving illegal money to less transparent channels, but if not addressed will have the effect of damaging the contribution that remittances make to GDP, and touch social stability by excluding the unbanked at the poorest levels of society.

Few would oppose rules that halt money laundering, funding for terrorists, or tax evasion; yet it seems that these well intended international objectives have led to a situation that particularly discriminates against the Caribbean, enabling either the nervous, bureaucratic or cost-conscious who run international banks to end their relationship with indigenous banks and financial institutions.

During 2015, the issue was raised by Caribbean Central Banks with the IMF, and by private sector bodies in countries from Belize to Guyana. More recently such concerns were incorporated into the final communiqué of the annual meeting between Britain and its overseas territories, with the UK agreeing to work to maintain viable banking and financial sectors there.

However much more needs to be done, and in a coordinated way by Government, Central Banks and the private sector, as the matter is at the interface between international relations, government regulation, the commercial, the individual and the criminal.

The issue has the capacity to diminish the regional private sector, and restrict the flow of remittances which provide liquidity, consumer led growth and stability in many Caribbean economies. It is also an issue on which the Diaspora requires leadership and direction to articulate politically the region’s case in Washington, London and elsewhere.

The issue of correspondent banking for small nations needs addressing rapidly at the highest levels of the World Bank, the OECD and the G20, if regions like the Caribbean are ever to develop strong indigenous financial institutions and not see their economies marginalised.

Expert Contributor

David Jessop is the Executive Director of the Caribbean Council. In a forty-year career, he has provided high level support and advice to industries, associations, governments and companies on investment, trade policy and political issues in the Caribbean, the UK and continental Europe

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