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Risks associated with de-risking: international creditors consider how to repatriate cash as they move to trade abroad.

About a year and a half ago, Camilo Benzo, CICP, manager of global credit and collections with gaming manufacturer IGT of Reno, NV, began noticing something different was happening in the way international banking relationships were working with customers overseas, in that they weren't working that well.

As Benzos firm started expanding sales to different regions, correspondent banks in the U.S. that are needed to consummate transactions with foreign customers began adopting an aggressive posture of "de-risking [or de-banking, the practice of financial institutions exiting relationships with and closing the accounts of clients perceived to be high risk]" that left his firm scrambling to find ways to get paid and maintain and grow trade relationships abroad.

Tod Burwell, president and CEO of international transaction banking association BAFT in Washington, DC, said that for the past three years the organization has noticed a confluence of two major factors affecting the international banking environment that has come to impact trade. Banks have been hit with increasing capital requirements that have squeezed margins and increased the cost of credit. Also, pressure from global banking authorities to comply with anti-money laundering (AML), countering the financing of terrorism (CFT) and know-your-customer (KYC) regulations have led more large banks and other financial institutions to restrict or end relationships with smaller banks that have customers in targeted industries like gaming or even with banks in countries that pose high risks for these types of violations.

"We didn't know about it until we faced the issue," Benzo said. Suddenly, correspondent banks in the U.S. would no longer accept payment from customers in Honduras, Colombia, Panama and Paraguay--including some who are long-standing, stable customers. Even banks in Latin America actually fired some IGT customers, apparently because there was now

too much risk associated with industries like gaming, he said. "It's beginning to hinder trade a little bit," Benzo said. "It's becoming a real issue to get paid."

The issue has impacted Las Vegas-based gaming machine manufacturer Aristocrat as well, particularly for customers in Panama and Paraguay, said Darreil Horton, CICP, director of credit and accounts receivable for the firm. "In one case, there was a nine-month delay before a customer could get their money here," he said.

The de-risking phenomenon could also lead some customers aware of the situation in these markets to simply delay payment, Horton said. "We don't know sometimes if customers aren't taking advantage of the fact ... it gives them another excuse to possibly delay or slow payment and it's hard to prove."

Aristocrat even had a problem with a branch of its own bank in Canada that no longer wanted to do business with the company, he said. "I understand the need for anti-money laundering, but it's harmed a lot of good businesses as well. It's definitely hurting international trade."

Decline of Correspondent Relationships

Data from the Bankers Almanac compiled by technology provider Accuity demonstrates that from 2013 to 2016, the number of correspondent banking relationships (CBRs) has fallen 38% globally to 233,247, wrote Henry Balani of Accuity in a recent article. Meanwhile, the total number of financial institutions grew 7.5%. North America and Western Europe have seen the largest fall in CBRs during the same time frame, dropping 46% and 39%, respectively.

According to the World Bank, smaller countries with limited financial markets are more vulnerable to de-risking practices, especially those located in the Caribbean. The World Bank, along with the Financial Stability Board and the Committee on Payments and Market Infrastructures, conducted a study in 2015 that found about half of the banking authorities surveyed and slightly more local/regional banks indicated a decline in CBRs. Large international banks saw a decline of about 75%.

The sorts of products and services affected by this drop off in CBRs include: check clearing, clearing and settlement; cash management services, international wire transfer; and trade finance.

"De-risking can frustrate AML/CFT objectives and may not be an effective way to fight financial crime and terrorism financing," the World Bank concluded. "By pushing higher risk transactions out of the regulated system into more opaque, informal channels, they become harder to monitor."

At a conference in October 2016 on the issue of declining CBRs held in the Caribbean, International Monetary Fund Deputy Managing Director Tao Zhang said the problem also extends to countries in Africa, Asia, Europe and the Middle East. The Caribbean Association of Banks said almost 60% of member institutions it interviewed reported a loss of such relationships. For example, banks in Belize that have assets equivalent to half the country's GDP are affected.

"In short, the withdrawal of CBRs is partly a reflection of cost-benefit tradeoffs growing out of increased regulation and enforcement affecting international banks, global banks," Zhang said. Correspondent banking has grown less profitable as regulatory reforms have produced increasing bank capital and liquidity requirements.

Compliance costs associated with AML and other requirements, as well as efforts to promote international banking transparency, are factors as well. Examples of the increasing penalties banks have had to pay for noncompliance with AML regulations abound. BNP Paribas was fined $8.9 billion in 2014, while HSBC was hit with a $1.9 billion fine in 2013 for various alleged money laundering offenses.

"The bottom line is rising expenses, relative to the potential benefits associated with banks' engagement in the region," Zhang said.

Fred Dons, director, head of TCF Netherlands at Deutsche Bank in Amsterdam, said he's seen the de-risking situation escalate in European banks as well, with regulators looking more closely at local branches to ensure they're complying with KYC regulations. "It's a reaction to fines associated with KYC regulations, and all accept it's an exaggeration," he said. In his estimation as well, the situation has had a dramatic impact on world trade. And despite widespread recognition of the problem, he doesn't see much hope of significant relief on the horizon. "There will be some backlash in the market," he predicted.

The Asian Development Bank's (ADB) 2016 survey of international banks on worldwide trade finance gaps found that 90% of respondents said regulatory burdens, including AML provisions, are serving as impediments to trade finance. More than 80% of respondents also said risks associated with sovereign nations and issuing banks also are dampening the sector.

The ADB's estimate of the global trade finance gap is $1.6 trillion, with $692 billion of this impacting developing Asia. Small- and medium-size businesses are the only client segment that's more likely to have a transaction rejected than supported.

Meanwhile, companies report that the primary cause of their high rejection rate is an inability to fulfill standard bank requirements, including collateral, documentation and valid company records, the ADB said. Firms that don't find trade financing through banks then turn to informal financial providers, with some 47% of African and 37% of Asian companies doing so. In Latin America, companies are more likely to find formal alternatives to financing trade deals.

According to Michael Imeson, owner of Financial & Business Publication and contributor to Wolters Kluwer's Compliance Resource Network, national governments and their regulatory bodies, as well as institutions like the Financial Stability Board, the Financial Action Task Force (FATF) and others "... are so worried about the consequences of their rigorous approach to combating financial crime that they are beginning to backtrack. They are pleading with the global banks not to interpret their AML, CFT and KYC rules so literally, in correspondent banking and in other areas too."

Getting Paid and Other Next Steps

In October 2016, the intergovernmental policymaking body FATF released new guidance for global correspondent banks and asked that they soften their approach when carrying out due diligence checks on AML and CFT standards, especially for respondent banks in developing nations, Imeson said. "The FATF understands [de-risking] to mean situations where financial institutions terminate or restrict business relationships with entire countries or classes of customer in order to avoid, rather than manage, risks in line with the FATF's risk-based approach (RBA)," the FATF wrote in the introduction to its guidance. "This is a serious concern for the FATF and the FATF-style regional bodies (FSRBs) to the extent that de-risking may drive financial transactions into less/nonregulated channels, reducing transparency of financial flows and creating financial exclusion, thereby increasing exposure to money laundering and terrorist financing (ML/TF) risks."

The FATF also clarified that its AML and CFT recommendations "... do not require financial institutions to conduct customer due diligence on the customers of their customer (i.e., each individual customer)." Also, the organization's recommendations don't "... require correspondent institutions to perform CDD [customer due diligence] on the customers of their respondent institutions when establishing correspondent banking relationships or in the course of the relationship."

The IMF is also attempting to aid banks and countries to better understand regulatory expectations and to help impacted countries update and enhance their own regulatory and supervisory roles to comply with AML and CFT, as well as tax transparency issues, Imeson said.

While global and local banking authorities figure out a way to mitigate the negative impacts on legitimate business transactions blocked by the de-risking umbrella, trade creditors need to maintain and grow their own trading relationships.

"There is no silver bullet to this," said Burwell of BAFT. A possible silver lining, though, is that the conversations he's seen between banks and regulators have shifted over the past three years from talking past one another to being on the same page in terms of working collectively for a solution.

From an exporter's point of view, Burwell suggested that firms strengthen their relationships with their U.S. banks and try to establish more than one banking relationship in order to grow their network of institutions that have correspondent relationships.

Benzo at IGT said some of the firm's customers, particularly those that are corporate conglomerates, are able to transfer funds to the company through accounts in Europe that don't pass through an American correspondent. The money is sent to IGT in euros and then converted to dollars.

Another way--the most costly and inefficient option--is to send money (U.S. dollars) through local exchange houses in Latin America that have their own corresponding partners in different places directly to IGT, he said. "It's just ridiculous at this point. At the end of the day, if enough industries are affected by this, eventually we're going to see some sort of solution or at least a conversation around the issue," Benzo said. "I can't trade if I can't get paid."

For Horton, it's meant having customers wire funds to Europe or Australia first and then on to Aristocrat's bank in the U.S. so that it's able to clear its receivables on the books, he said. He's considering a variety of other payment options that can provide some type of security, from letters of credit to credit insurance. Horton is not alone. According to the International Credit Insurance & Surety Association's Yearbook 2016-2017, its members say that the credit insurance premium grew by 5% in 2015 from the prior year and was more than 41% higher than in 2007. The insured exposure for 2015 of 2.3 trillion [euro] was 35% higher than in 2007.

But, "it's expensive for us to do that, and it puts customers off as well," he said, at a time when more and more of his customers, who are involved in hundreds of thousands to millions of dollars worth of transactions, are seeking terms and open lines of credit.

In one case, Dons at Deutsche Bank said he's seen some transactions that turned into offshore barter trades when cash couldn't be taken out of the country.

Meanwhile, Horton said, keeping a close eye on news coverage and staying in close contact with sales people on the ground in the affected areas to better understand the latest trends remains a big part of his strategy to address the issue. "It's word of mouth and street smarts in a lot of ways."

Dons agreed with this strategy. He suggested trade creditors reach out to a local accountant or local branch of an international bank in the locales of their customers to learn about some of the payment solutions that may be available.

Also, before a deal is finalized with a potential customer in a high-risk country, credit professionals should inquire about said customer's local bank and find out whether it has a correspondent network as part of their due diligence work.

Benzo suggested setting up a test payment as a sort of proof to ensure the customer can send the funds before carrying out the full transaction. "And make sure it's under the name of the actual business. You don't want to be an accomplice in trying to cheat the system because that's dangerous territory," he said.

Nicholas Stern, senior editor, can be reached at
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Author:Stern, Nicholas
Publication:Business Credit
Date:Apr 1, 2017
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