Greater financial inclusion is vital for economic diversity and growth in the Middle East and North Africa (MENA). How can banks ensure their due diligence processes do not end up stifling entrepreneurship and innovation?
In the global fight against financial crime, banks are under great pressure to meet their obligations under laws on Anti-Money Laundering (AML) and Countering the Financing of Terrorism (CFT).
Worldwide, the financial services industry is shouldering a US$80 billion compliance burden. This cost is expected to increase by as much as 50 percent over the next five years.
In this environment, many banks have opted to take a broad-based “de-risking” approach rather than assessing business relationship risk on a case-by-case basis.
As a result, some financial institutions are cutting off entire countries or categories of customer.
The impact of financial exclusion
While risk and compliance processes can be a challenge for any financial institution, especially smaller banks with limited resources or skills, regulatory authorities have made it clear that they do not advocate the blanket de-risking approach.
One of the major dangers of de-risking is that it can exclude entire communities and business sectors from the global, regulated financial system.
This not only erodes financial security, but also impacts local economies.
In this environment, the domestic SME sector often finds it more difficult to access banking services than larger corporates. This, in turn, stifles entrepreneurship and innovation.
Correspondent banking sector
One sector that has been affected significantly in certain regions is correspondent banking.
As an industry that moves funds across borders, correspondent banking plays a critical role in supporting international trade, commerce, non-profit and charitable activities, and economic development.
This means that the negative impacts of de-risking reach far beyond the firms that are facing financial exclusion themselves.
When cautioning against broad-based de-risking practices, regulators have expressed concern that a weakening of the correspondent banking sector may redirect payment flows into less-regulated channels.
This poses a significant threat to the stability and integrity of the broader financial system.
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Ramifications of de-risking
MENA is perceived to be a high-risk region in terms of correspondent banking relationships (CBRs).
Even major regional banks are losing some of the CBRs they have, with banks in certain countries finding it challenging to establish any partnerships at all.
According to a recent study by the IMF, CBRs have been under pressure in several nations and there’s been a dip in the number of CBRs globally.
In the MENA region specifically, countries under economic and trade sanctions are most vulnerable; as are jurisdictions where non-profit organizations play a key socio-economic role (in Somalia, for example).
A similar study focusing on the Arab region conducted in 2016 by the Arab Monetary Fund, the IMF and the World Bank, found that the decline in local CBRs has affected banks’ ability to:
- provide services to certain client segments;
- offer solutions such as trade finance, letters of credit, documentary collections, and clearing and settlement;
- carry out foreign-currency-denominated capital and current-account transactions.
This study, based on 216 banks in 17 Arab countries, found that around 39 percent of the participant banks have experienced “a significant decline in the scale and breadth of CBRs”, while 55 percent reported no significant change.
Among those banks that have experienced a withdrawal of CBRs, a noteworthy portion — 20 percent — have been unable to find replacement CBRs or suitable alternatives.
In this landscape, domestic businesses may be unable to utilize clearing, remittance and cross-border transaction services, which effectively means they are cut off from the global market.
What can banks in the region do?
One way for MENA-based banks to manage the risk of losing correspondent relationships is to improve internal policies, processes and controls to meet international standards.
They also need to be able to prove their competencies, systems and procedures in a clear and auditable manner.
This involves stepping up their customer due diligence and third-party risk programs to include best practices in the following areas:
KYC (Know Your Customer)
In the current regulatory environment, the onus is on banks to interpret AML/CFT legislation and develop relevant KYC processes. This can be a daunting task for firms with limited resources, especially considering that they need to demonstrate to both auditors and regulators that they know their clients, with step-by-step evidence showing they’ve made sound decisions based on accurate and up-to-date data.
UBO (Ultimate Beneficial Ownership)
The need for accurate and up-to-date information about past, present and ultimate beneficial owners is critical, as many criminals hide their identities behind corporate structures.
However, this information can be difficult to source, due to multiple levels of ownership, different jurisdictions with unique corporate frameworks, and a lack of supporting documentation to prove ownership. Fortunately, there are technology platforms available on the market that can help with both KYC and UBO obligations, especially when the firm’s stretched resources make in-depth research difficult.
Transaction monitoring goes beyond the essential requirements of a traditional compliance program, to help reveal unusual patterns of customer activity.
With well-designed software in place, organizations can continually monitor transactions in real-time, and screen these against historical activity, customer profiles, and other risk intelligence to quickly identify areas of concern.
Ongoing AML/CFT training for all relevant staff helps to ensure that the firm has the competencies required to run an effective risk and compliance regime, at every level of the organization.
It’s advisable to adopt a structured learning management system that provides a full audit trail, including training records, evidence of the escalation path, and consequences for those not completing training.
Harnessing risk intelligence
While there’s no doubt that MENA’s banks and financial institutions have work to do, it is possible to harness risk intelligence and compliance management technology to ensure due diligence processes and transaction monitoring stand up to scrutiny.
It’s also advisable to seek expert help with training, if required.
If MENA is unable to stem the tide of financial exclusion in the region, households will struggle to find safe and affordable financial services such as savings solutions, remittances, loans, insurance, and pensions.
At the same time, businesses will lack access to working capital and other offerings from regulated sources, which will negatively impact these organizations’ ability to trade, invest, innovate, seize market opportunities, create jobs, and more.
Ultimately, enhanced financial inclusion is required for greater economic diversity and growth across MENA, and this needs to be a key area of focus for both policy makers and the region’s key financial players going forward.
Hosted by Thomson Reuters, under the patronage of the Central Bank of Bahrain, the 12th MENA Regulatory Summit has become the Middle East and North Africa’s leading forum for the Governance, Risk and Compliance (GRC) community.
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