A Dearth of Data in the De-Risking Debate

As readers of this blog are likely well aware, the fight against grand corruption is closely linked to the fight against money laundering. After all, kleptocrats and others involved in grand corruption need to hide the origins of their ill-gotten wealth. While the criminals who seek to launder their illicit cash are sometimes prosecuted for money laundering, much of the burden of the anti-money laundering (AML) regime falls on banks and other financial institutions. These institutions have obligations to perform due diligence on prospective clients—especially those clients with attributes suggesting high risk—and to report suspicious transaction to the government. Financial institutions can be held liable for failing to fulfill these obligations, and in some cases for their complicity in money laundering schemes. Yet many advocates believe that the current AML framework is not stringent enough, and have called for reforms that would impose additional obligations, and potential liabilities, on the financial institutions that handle clients and transactions that pose a high money laundering risk.

Banks and other skeptics often resist these reforms, arguing not only that the various proposals will do little to reduce money laundering, but also that more stringent AML regulations will lead to a phenomenon known as “de-risking.” This piece of industry jargon refers to the practice of ending or avoiding relationships with individuals or businesses perceived as “high risk” for money laundering. Of course, we want banks to eschew an individual client or transaction with characteristics that suggest a high probability of money laundering. But when banks and others warn about de-risking, they are referring to a phenomenon in which banks refuse to do business with broad categories of clients – for instance, those from particular countries or regions, or in specific lines of business – despite the fact that most of the individuals or firms in that category do not actually present a serious money laundering risk. If the monitoring costs and legal risks associated with certain kinds of accounts are too high relative to the value of those accounts, the argument goes, it’s easier for banks to simply close all of the accounts in the “de-risked” category. But this indiscriminate closure of allegedly risky accounts cuts off many deserving people, firms, and organizations from much-needed financial services.

Is de-risking really a significant problem? Skeptics might observe that the financial industry has incentives to resist more stringent AML regulation, and their warnings of de-risking may be, if not deliberately pretextual, then at least self-serving. That said, other actors, including non-profit groups, have alleged that they have experienced account closures due to de-risking. So the concern is likely a real one. Still, to set rational AML policy, we would want to know not just whether de-risking is a potential problem (it is) or whether it occurs sometimes (it probably does); we would want to know whether it is a systematic and serious problem, one that would likely be exacerbated by a significant enhancement of banks’ AML obligations.

So, what do we know about the extent and magnitude of de-risking in response to AML regulations? The short answer is: not much.

            To be sure, there are plenty of anecdotes, as well as a few specific industries where de-risking appears to have occurred. The most cited example concerns money transfer businesses, which specialize in sending cross-border cash transfers between private parties (including remittances sent by migrants to their home communities). A 2015 survey of firms in this sector reported multiple account closures and increased barriers to account opening. In countries perceived as high risk for money laundering, such as Belize, remittance businesses have been shut out of the market entirely, a result that some commentators attribute to de-risking. Another example may come from the semi-legal marijuana industry in the U.S. Although the Financial Crimes Enforcement Network (FinCEN) has repeatedly issued guidance advising banks and credit unions that they can proceed in customer relationships with marijuana businesses operating in states where these business are legal under state law (despite the fact that the operation of such businesses still violates federal law), there is some evidence that concerns about AML risks associated with such clients has led many financial institutions to deny service to those businesses and their employees. That said, on closer inspection these examples may not actually provide clear-cut evidence of widespread de-risking. The market decline of traditional remittance services could be attributable to the high cost of these services, and the emergence of their fintech competitors, rather than to AML regulations. And even if certain services have suspended their business in particular countries or regions, other providers seem to have stepped in to fill the market demand for these services. Likewise, the U.S. recreational marijuana sector has been steadily expanding at a pace that’s inconsistent with the notion that businesses in this sector were losing their bank services.

Outside of these particular sectors, is there quantitative evidence on whether heightened AML requirements—especially the sorts of requirements that might be adopted to target the proceeds of grand corruption—lead to undesirable de-risking? The answer appears to be mostly no. Notwithstanding the occasional one-off study, the evidence on de-risking remains sparse, leading researchers to observe that “little empirical data is available about the extent of relationships being exited and the decision-making processes of financial institutions.” Again, this is not to deny occasional troubling incidents, as when, as Oxfam reported, embassy staff from certain high-risk countries found their accounts closed en masse. But Oxfam also found that in these instances, financial service providers worked to create special accounts for those staff members so that they could continue their work.

Of course, as the saying goes, absence of evidence is not necessarily evidence of absence, and it’s possible that we don’t have more systematic evidence of widespread de-risking because de-risking is an especially difficult phenomenon to measure quantitatively. But it’s not clear why that would be. Banks have access to information on the number of accounts they’ve closed, the types of accounts, and associated account characteristics. The alleged victims of de-risking would also seem to have an incentive to speak out and provide data that could be used to advocate regulatory changes that alleviate de-risking (or to resist regulatory changes in the other direction).

Now, one explanation for why the banks and their affected clients have not provided more systematic evidence of widespread de-risking is that they are reluctant to provide such data, because doing so may have negative reputational consequences. Banks might worry that they’ll get negative press coverage for admitting that they dropped many sympathetic clients just because they were from a particular country or region. And prospective clients might not want to declare publicly that they were denied financial services because they were perceived as a money laundering risk. Maybe. But this seems like an unsatisfying explanation. Banks could provide raw data that would, if anything, underscore a bank’s compliance with AML requirements. And the banks certainly have not been shy about asserting (without quantitative evidence to back up the claim) that stringent AML regulation has already led to the de-risking of sympathetic parties. As for the prospective clients, while it’s true that any one of them might not want to declare that it had been denied financial services on AML grounds, groups that organized on behalf of a sector—especially, say, the nonprofit charity community—would seem to have a strong incentive to provide aggregate anonymized data, and would presumably face little stigma from doing so, especially since this and other sectors already complain publicly about de-risking.

So, while it’s possible that de-risking exists on a large scale, but those who are affected by it either don’t or can’t speak out, this seems unlikely. And that suggests perhaps the reason we don’t have much robust quantitative evidence on widespread de-risking is that it simply doesn’t occur very much. Outside of a handful of industries and a few anecdotes, AML-induced de-risking may be rare enough and small enough that it doesn’t show up in aggregate quantitative data. If that’s the case, then skepticism towards banks’ claims is warranted. Notwithstanding their complaints, it appears that they are able to manage compliance burdens without shutting down accounts in bulk. (Furthermore, in those cases where de-risking may burden identifiable classes of small-value clients that pose little money laundering risk, such as sex workers and international students, regulators could provide special safe harbors, analogous to the reassurances FinCEN provided concerning recreational marijuana businesses.)

To be sure, we should take seriously complaints about de-risking from stakeholders that have little reason to support financial industry talking points; this evidence cuts against the argument that de-risking is a convenient fiction manufactured by the banks. Still, on such an important public policy issue, decisions should be based on more than anecdote and assertion. Given that the banks and their clients are in the best position to supply robust quantitative evidence that de-risking on a wide scale is a genuine problem, the burden should be on them to supply this evidence. Such evidence needn’t be connected to particular named individuals or entities who were cut off from financial services; the evidence can be anonymized and aggregated, and then presented to policymakers. Doing so would bring clarity to this pivotal policy issue. In the absence of such evidence, AML advocates and reformers are within their rights to treat warnings of de-risking with a measure of skepticism.

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