C a r i b b e a n A s s o c i a t i o n o f B a n k s I n c .

June 2017

Ian R. De Souza

The unintended consequences of regulatory guidelines and the threat to the indigenous banking sector

Correspondent Banking and De-risking in the Caribbean

Correspondent Banking and De-risking in the Caribbean

The unintended consequences of regulatory guidelines and the threat to the indigenous banking sector.

Ian R. De Souza1

1 Ian R. De Souza Chairman, Correspondent Banking Committee, Caribbean Association of Banks Inc. Managing Director & Chief Executive Officer, Republic Bank (Barbados) Limited.Tel: 1-246-431-5907, Email: idesouza@republicbarbados.com

1

Abstract

International regulations for the prevention of money laundering and terrorism financing

have resulted in the withdrawal of correspondent banking services by major international

banks. This is having a deleterious effect on trade and commerce in the Caribbean and it is

threatening the viability of many indigenous banks. It is also resulting in financial activities

that fall outside of the scope of surveillance intended by the regulators and, in certain

respects, rendering the regulations ineffective.

AML/CTF regulations were developed by a number of independent international agencies that

have not consolidated their regulatory regimes. The regulations are onerous and costly to

both correspondent and respondent banks, and they are placing the burden of policing illicit

activity on the banking sector. Reforms are required on the governance and deployment of

regulatory arrangements, and the mechanisms by which regulators work with banks, to solve

the problem of money laundering and terrorism financing.

Research on the impact of de-risking by correspondent banks on banks in sub-regions of the

world and the Caribbean in particular was conducted through dialogue with members of the

Caribbean Association of Banks, participation in conferences and the review of published

articles and regulations. Information was also garnered from the experience of managing the

operations of a subsidiary of a major indigenous bank in the Caribbean region.

For greater effect, regulations used for the monitoring and control of money laundering and

terrorism financing need to be consolidated into one set of comprehensive measures. There is

also need for dialogue and a more collaborative approach to the problem between the

regulators, the correspondent banks and the respondent banks. Coercive activity and punitive

fines used by the regulators to administer the correspondent banks must be removed in

adopting a solution-oriented path to the problem. Law enforcement and intelligence agencies

must also be used as the first line of defense instead of the commercial banking system.

2

The solutions will result in greater efficiency in monitoring the flow of funds associated with

criminal activity. They will also reduce the use of alternative channels for the transfer of

money and they will increase the likelihood of apprehending persons involved in illicit activity.

There will also be a return to a degree of normalcy in the banking system and the reduction of

threats to the indigenous banking sector in the Caribbean.

3

Introduction

Governments and the financial services industry have been seeking to stem the flow of the

proceeds of crime and terrorism financing through the international financial system. As

stated by the Basel Committee on Bank Supervision, the objective is to target criminals,

kleptocrats and others looking to access the financial system anonymously. In response to

the problem, various agencies have established guidelines by which banks are expected to

operate in ensuring that their systems and procedures adhere to the objective, as defined.

Correspondent banks worldwide extend services to banks in sub-regions who do not have

operations in the major world financial centres. Their services to the ‘respondent’ banks

facilitate the flow of payments in major currencies to and from their organizations. Without

correspondent banking, banks in sub-regions will not be able to support their customers’

requirements for transfers and payments in respect of international trade.

Prior to current circumstances, correspondent banks enjoyed a profitable relationship

from the services that they provided to respondent banks. In the Caribbean, local banks

were courted by correspondent banks for their business and the relationships were found

to be mutually beneficial. With the advent of correspondent banking regulations, however,

correspondent banks experienced an increase in the cost of doing business due to the

organizational infrastructure that was required to ensure that respondent banks were in

compliance with new regulatory guidelines. The fines that were being levied on the

correspondent banks for regulatory infractions also assisted in tilting the cost-benefit

relationship away from financial feasibility and they have resulted in correspondent banks

exiting the business by de-risking themselves of correspondent banking relationships. De-

risking, the process of correspondent banks removing circumstances that could result in

financial loss, has adversely impacted the ability of respondent banks to participate in the

international payments system. It has also created a number of negative knock-on effects

on social and economic development in the sub-regions.

Along with de-risking by correspondent banks, the tightening of account on-boarding and

transaction monitoring systems is causing local respondent banks to de-risk themselves of

certain classes of business that would be seen by their correspondent banks to represent a

4

high degree of risk. Those businesses, such as Money Transfer Businesses (MTBs), are

being forced to use ways and means of continuing their trade that may be outside of the

official financial system. The regulations and the reactions of both the correspondent banks

and the respondent banks are therefore resulting in failure of the regulations to do what

they were originally intended to do.

This paper examines the issues around the matter of correspondent banking and de-risking

in the Caribbean. It seeks to identify the causes and effects of regulatory pressures that are

leading to a series of unintended consequences, which include damage to the indigenous

banking sector and actions by customers that are undesirable from a monitoring

perspective. The paper will also present recommendations on measures that must be

adopted to arrest the problems that have arisen and to bring normalcy and stability back to

indigenous banking in the Caribbean.

5

The Regulators

The Financial Action Task Force (FATF) is seen by many as the lead regulator in the

industry. It is an intergovernmental body established in 1989 by the Ministers of the G7

group of countries. The objectives of the FATF are to set standards and promote effective

implementation of legal, regulatory and operational measures for combating money

laundering, terrorist financing and other related threats to the integrity of the international

financial system. The FATF is therefore a policy-making body that works to generate the

necessary political goodwill to bring about national legislative and regulatory reforms in

these areas.

The FATF has developed a series of recommendations that are recognised as the

international standard for combating money laundering, terrorism financing and the

proliferation of weapons of mass destruction. They form the basis for a response to the

threats to the integrity of the financial system and they help to ensure a level playing field

for all operators in the industry. First issued in 1990, the FATF recommendations were

revised and up-dated in 1996, 2001, 2003, 2012, and most recently in 2016.

The Basel Committee on Banking Supervision (the Basel Committee) is a committee of

banking supervisory authorities that was established by the Central Bank Governors of the

Group of Ten countries in 1974. It provides a forum for regular cooperation on banking

supervisory matters. Its objective is to enhance the understanding of key supervisory

issues and to improve the quality of banking supervision worldwide. Through the Bank for

International Settlements, which is the Committee’s governing body, the Basel Committee

published a set of guidelines entitled ‘Sound Management of Risks related to Money

Laundering and Financing of Terrorism’. The guidelines, which were amended in February

2016 to include a general guide to account opening, define how banks should include

money laundering and terrorism financing risks in their overall risk management practices.

Another group participating in the Basel process is the Financial Stability Board (FSB),

which has a separate legal identity and its own governance arrangements. It operates

under a mandate from the G20 heads of state and government, and was originally

6

established in 2009. The FSB monitors and assesses vulnerabilities affecting the global

financial system and it seeks to enhance global financial stability by developing policies and

coordinating the work of national financial authorities and international standard setting

bodies. The FSB, in consultation with the International Monetary Fund (IMF), released its

own recommendations for supervision of financial institutions in November 2010. The FSB

monitors the performance of jurisdictions against their recommendations for regulatory

reform and reports back to the G20 annually.

In the United States (US), the two principal regulators are the Financial Crimes

Enforcement Unit (FinCEN) and the Office of the Controller of the Currency (OCC). Both of

these agencies are governed by the US Department of the Treasury and they enforce the

requirements of the Bank Secrecy Act. FinCEN’s mission is to safeguard the financial system

from illicit use and to combat money laundering by facilitating the detection and

deterrence of financial crimes. According to its website, it seeks to promote national

security through the collection, analysis and dissemination of financial intelligence, and the

strategic use of financial authorities. FinCEN issues guidelines for account on-boarding,

monitoring and reporting on money laundering and terrorism financing activity through its

Anti-Money Laundering Program and Suspicious Activity Reporting framework. Both these

guidelines mirror the FATF guidelines but FinCEN also establishes its own measures which

it considers appropriate.

The OCC is an independent bureau that was established by the National Currency Act of

1863 and serves to charter, regulate and supervise all national banks and thrift institutions,

and the federal branches and agencies of foreign banks operating in the United States. One

of the OCC’s main objectives is to enforce anti-money laundering and anti-terrorism

financing laws that apply to national banks and federally-licensed branches and agencies of

international banks. In regulating national banks and federal thrifts, the OCC has the power

to examine the national banks and thrifts and to take supervisory actions against those that

do not comply with laws and regulations or otherwise engage in unsound practices.

7

The Caribbean consists of a number of independent nations that have their own banking

regulatory regimes. A listing of regulators by country in the region is as follows:

- Anguilla: Eastern Caribbean Central Bank

- Antigua & Barbuda: Eastern Caribbean Central Bank

- Barbados: Central Bank of Barbados

Financial Services Commission

- Belize: Central Bank of Belize

- British Virgin Islands: Financial Services Commission

- Cayman Islands: Cayman Islands Monetary Authority

- Curacao: Central Bank of Curacao and St Maarten

- Dominica: Eastern Caribbean Central Bank

- Grenada: Eastern Caribbean Central Bank

- Guyana: Bank of Guyana

- Jamaica: Bank of Jamaica

- Montserrat: Eastern Caribbean Central Bank

- St Lucia: Eastern Caribbean Central Bank

- St Kitts & Nevis: Eastern Caribbean Central Bank

- St Vincent Eastern Caribbean Central Bank

& the Grenadines:

- Suriname: Central Bank of Suriname

- Trinidad & Tobago: Central Bank of Trinidad & Tobago

The countries that are regulated by the Eastern Caribbean Central Bank are bound under

the Organization of Eastern Caribbean States, which includes a currency union referred to

as the Eastern Caribbean Currency Union.

There is also the Caribbean Financial Action Task Force (CFATF), which is an inter-

governmental organization comprising twenty seven states in the Caribbean and Central

and South America that have agreed to implement common countermeasures to address

8

the problem of money laundering, terrorist financing and the financing of the proliferation

of weapons of mass destruction. The CFATF ensures that its members comply with the

FATF recommendations. It does not issue standards of its own. However, if members do

not comply with the FATF recommendations, they can be sanctioned in accordance with

the CFATF procedures. Sanctions involve inclusion in a public statement of non-compliant

members and they can ultimately result in a country being suspended as a member. The

CFATF’s public statement on non-compliant countries is also copied by the FATF on its

website.

There are, therefore, a number of international regulators setting guidelines for eliminating

money laundering, terrorism financing and the proliferation of weapons of mass

destruction for the financial services industry. However, there is overlap between the

guidelines and it is not clear whether the international regulatory agencies collaborate with

each other in order to unify the guidelines. In this regard, the question as to whether there

is need for as many independent agencies also remains open for discussion and in many

quarters at the industry level, there has been a strong call for unification in order to

standardize application and reporting.

At the Caribbean level, due to the independence of the island states, there is a large number

of regulatory agencies that enforce the guidelines set by the international regulators. While

there is oversight, however, there is need for consolidation of activities as the current

supervisory infrastructure is uncoordinated and therefore inefficient.

Implementation & Monitoring of AML/CTF Guidelines

In response to regulations established by the various international regulatory agencies,

countries around the world have begun to institute legislation and regulations to ensure

compliance with the regulatory guidelines. In the Caribbean, all countries have responded

and the required legislative and regulatory regimes have been instituted. Due to the

complexities of politics in the region, however, some countries have been slower than

9

others in getting legislation through their parliamentary machinery, but all are now

legislatively compliant with international requirements.

A mechanism used by the FATF to ensure that countries are compliant with the guidelines

is ‘blacklisting’. Countries are rated on their compliance with the regulations and those

found to have weak measures to combat money laundering and terrorist financing are

published in two public documents that are issued three times a year. The ‘black listing’ of

countries is very deleterious to business and trade, as correspondent banks immediately

categorize these countries as ‘high risk’ and seek to de-risk themselves of the relationships

in order to protect themselves from home-country regulators. At the political and

legislative levels, therefore, there is keen awareness of the need for compliance and

parliamentarians have instituted the legislation that is required to ensure that their

respective countries are not ‘black listed’ by the FATF. At this time, there are no Caribbean

countries black-listed by the FATF.

The monitoring of implementation and compliance with the FATF regulations has been

provided by the IMF and the World Bank. For the G20 countries, the monitoring has been

provided by the FSB. To ensure compliance, the regulators at the local level have added

specific reviews of AML/CTF policies and procedures to their routine inspection schedules.

Licenced financial institutions are therefore all inspected for compliance and they are

required to provide action plans for remediation where and when found to be deficient

with the guidelines. Quarterly reporting is usually required. Local regulators are therefore

adequately attuned to the need for compliance with international regulations and they are

fully engaged in oversight activities to ensure that licenced financial institutions are

compliant.

Ramifications for Correspondent Banks

Prior to the advent of international regulations for AML and CTF, major US banks courted

the banks in the Caribbean for their cross-border transaction business. Fees were

generated for hosting settlement (nostro) accounts, facilitating wire transfers and

10

confirming international trade payments. Additionally, the correspondent banks offered

‘payable through’ accounts, which afforded customers of the respondent banks access to

chequing accounts drawn on the correspondent banks. In addition to the fees earned,

correspondent banks benefitted from a treasury management perspective on the holding of

deposits on nostro accounts. The cost-benefit equation for the US banks in hosting

correspondent banking accounts confirmed the feasibility of maintaining the service to

banks in the Caribbean region.

The introduction of international AML and CTF regulations, and the attendant regulatory

frameworks and sanctioning mechanisms however increased the cost of correspondent

banking services and changed the cost-benefit equation for the correspondent banks. The

fees generated from correspondent banking were no longer able the cover the operational

costs of extending the services. Additionally, fines and reputational damage inflicted by the

regulatory agencies on international banks for any form of infraction caused the banks to

become more wary of the risk of default in respect of AML/CTF guidelines. What, therefore,

was once a feasible line of business that was deliberately developed by the correspondent

banks became one that was high risk and too costly to maintain, and therefore needed to be

exited.

To adhere to regulatory guidelines in the US, correspondent banks instituted measures

which ensured not only their compliance, but also the compliance by the respondent banks

in the Caribbean with whom they had been conducting business. Correspondent banks

established Compliance Departments and invested in technology to support identity

checking in the on-boarding of customers and the monitoring of transactions on an on-

going basis. To ensure that respondent banks in the Caribbean were also compliant with

AML/CTF regulations and not placing the correspondent banks at risk of having their

systems unwittingly infiltrated by money launderers and financiers of terrorism, the

correspondent banks extended their compliance checks to the respondent banks in the

region. The costs to the US banks of the compliance infrastructure and the investment in

technology were substantial. More importantly, the fee structures that were established for

correspondent banking, which were originally considered reasonable for the service

11

provided, could no longer cover the cost of compliance to the correspondent banks. At an

operational level, therefore, the cost of extending correspondent banking services became

infeasible and formed one of the bases for the decision to discontinue the line of business.

Of note is the fact that the lack of clarity in some of the AML/CTF guidelines resulted in

misinterpretation and second-guessing by the correspondent banks, which in turn led to

additional costs for monitoring and surveillance. As an example, under the ‘Know Your

Customer’ guidelines, the interpretation by the correspondent banks was that they needed

to know not only of their respondent banks’ affairs, but also of the affairs of their

customers.

This interpretation of the guidelines resulted in further investigation and monitoring, and it

added to the cost of confirming compliance. Circumstances of this nature produced

additions to the cost of the compliance infrastructure and added to the overall cost of the

line of business. The cost of compliance therefore tilted the cost-benefit equation away

from the determinant of feasibility.

As justification for the cost of compliance and the related policing activity, FinCEN reported

that between 2010 and 2014, an average of 46,000 cases associated with money laundering

and terrorism financing were prosecuted in the US. The regulator also argued that from an

industry perspective in the US, there was financial breakeven in that the estimated US$287

million per annum spent by the banking sector on computer hardware and software, and

compliance staffing, training and monitoring, was well covered by the estimated saving of

US$300 million in the cost to society that was imposed by illicit activity.

Correspondent banks were also wary of fines levied by the US regulators on banks that

were found to be in breach of regulations or to have engaged in unethical behaviour. Some

of the infractions attracting fines were the rigging of FEX markets, LIBOR manipulation,

creating and dealing in sub-prime mortgages, trading in false mortgage-backed securities

and transacting with countries on sanctions lists.

12

As at October 2015, fines paid by major banks were as follows:

Name No. Settlements US$(Bn)

Bank of America N/A 77

J.P. Morgan Chase 26 40

Citigroup 18 18

Wells Fargo 10 10

BNP Paribas 1 9

UBS 8 7

Deutsche Bank 4 6

Morgan Stanley 7 5

Barclays 7 5

Credit Suisse 4 4

Total 85 185

In addition to fines levied on the banks, executive officers were charged by the US

Securities Exchange Commission (SEC) for their involvement in the infractions. Up to Year

2015, the SEC had collected US$3.6 billion in fines from CEOs and CFOs of some of the

major international banks.

Of note, however, is the fact that the fines levied on international banks did not feature

breaches of AML/CTF guidelines in any significant way. This notwithstanding, the general

threat of fines and the potential damage to their image weighed against the benefits in the

cost-benefit equation and became a major disincentive for correspondent banks. The

correspondent banks therefore began to exit the business where jurisdictions were

deemed to be high-risk by virtue of the lack of legislation or adherence to regulatory

guidelines.

Correspondent banks also appeared to use the burden of regulatory arrangements to de-

market low-value accounts. Several indigenous banks from the Caribbean region have

13

reported that notwithstanding measures taken to conform to the regulatory regimes,

including investment in technology at considerable expense and the introduction of

compliance functions with supporting policy and procedure, they were still de-risked by

their correspondent bankers, as the volume of their transaction activity appeared not to

justify maintenance of the relationship. The issue therefore has not only been one of risk

associated with dealing with respondent banks but the profitability of the relationship to

some correspondent banks in the context of the cost of compliance. It is therefore apparent

to some banks that AML/CTF compliance has been surreptitiously used by some

correspondent banks to discontinue relations.

Based on March 2017 statistics from the Caribbean Association of Banks (CAB), 45% of the

correspondent banks exited the market entirely. The remaining correspondent banks

withdrew their services from some countries and from some banks, resulting in 55% of

CAB’s 41 members experiencing complete or partial de-risking. Of note is the fact that five

banks were given an ultimatum by one major correspondent bank to close their accounts

by the end of August 2016. Due to CAB’s intervention, an extension was granted to the end

of November and, subsequently, to the end of January 2017. Despite this intervention,

however, all 5 of those banks have since been de-risked by that correspondent bank.

CAB statistics indicate that 8 of its member banks now have no direct correspondent

banking arrangements, 17 have only one relationship and 9 have two to three

correspondent banking accounts. The banks that have retained multiple correspondent

accounts are larger in size and operate in jurisdictions deemed to be safer. Due to their size,

the volumes of business generated from those banks weigh in favour of the cost-benefit

equation. There has therefore been no ebbing of the de-risking trend and the Caribbean

region continues to be stripped of its correspondent banking services and all related forms

of business.

Consequences of De-risking in the Caribbean

14

Banking in the Caribbean has been severely impacted by the withdrawal of correspondent

banking services and the threat thereof by the international banks. The cost of compliance

has placed a heavy burden on the industry and the related funding requirements have

added to the challenges faced by smaller indigenous banks, in particular. Where banks have

been de-risked, many of the services that are relied on by customers for day-to-day living

and the conduct of business have been lost. In order to continue to satisfy customers’

needs, banks have had to find alternative means of facilitating international payments. This

has impacted the cost of doing business and it has also affected the quality of services to

banks’ customers. Additionally, transactions are being driven into new channels, which

either fall outside of the regulated sector or are difficult to monitor. These emerging trends

are unintended consequences of the regulatory regimes and they are working against the

intent of the regulators.

The threat of loss of correspondent banking arrangements with international banks has

caused many respondent banks in the Caribbean to terminate relationships with MTBs

such as Western Union and Moneygram. Because of the ‘know your customer’

requirements, respondent banks have been unwilling to take the risk of relying on the on-

boarding arrangements used by the MTBs for their customers. The de-risking of the MTBs

by the respondent banks has interfered with the flow of international remittances from

persons resident in the diaspora to their friends and relatives in the Caribbean. This has

been very disruptive to life for many people who depend on foreign remittances for day-to-

day living and it has negatively impacted GDP for many countries in the region. Persons

transferring funds into the Caribbean are now faced with the inconvenience and higher

cost of arranging wire transfers through the formal banking sector, and recipients of the

transfers, who largely operate at the lower end of the income scale, are also faced with

higher bank charges for the transactions.

In order to satisfy the customer on-boarding and transaction screening requirements that

are embedded in the AML/CTF regulations, banks have had to invest in technology and

introduce compliance functions at a significant increase to their capital and operating costs.

The on-boarding of customers calls for screening against criminal databases and sanctions

15

lists. To be effectively managed and ensure thoroughness and accuracy, technological

solutions that are hardware and software intensive have had to be employed. These

solutions are extremely costly at the acquisition and installation stages, and on-going

licencing and maintenance costs form a major component of operating costs.

Banks have also had to establish Compliance Departments for monitoring and control of

day-to-day banking activity. These departments are independent of executive management

and are required to report directly to Boards of Directors. They are staffed by specially-

trained legal and compliance professionals, who, with their on-going need for training, add

another layer of expense to a bank’s operating cost structure. The combined technological

and operating costs that arise from the AML/CTF compliance function are significant and

place a notable burden on smaller indigenous banks in the Caribbean, whose financial

circumstances are already challenged by the on-going economic pressures of the region.

Another increase to the cost structure of many indigenous banks is the use of ‘down

streamers’ for international business. Many banks who have lost correspondent banking

services, or who are at risk of having their options for correspondent banking reduced, are

turning to ‘down streamers’. ‘Down streamers’ are medium-sized, intermediary banks that

use their own correspondent banking relationships to facilitate transactions on behalf of

smaller respondent banks. This activity was previously referred to as ‘nesting’. It was

considered to be an undesirable practice by the international correspondent banks, as it

represented a means of entry into the international financial payments system by

respondent banks that were using other banks’ correspondent banking relationships.

‘Down streamers’ however base their business on the rigour with which they conduct their

on-boarding and compliance activity. The practice is therefore now being accepted by some

international correspondent banks, as it provides a layer of compliance checking that

reduces the level of accountability on their part.

While the use of ‘down streamers’ is an option that is available to respondent banks, the

threat of de-risking remains, and both the cost and quality of service extended by the

indigenous banks are being negatively affected. As indicated, down streaming as a business

is based on the thoroughness with which intermediary banks that offer the service conduct

16

their on-boarding and compliance checks. If these checks are intentionally or otherwise

breached by respondent banks and illicit transactions make their way into the

international payments system, the ‘down streamers’ themselves could lose their

correspondent banking relationships. In the event of an occurrence of this nature, all

respondent banks in their portfolios would be affected.

In addition to the residual risk that remains, the use of ‘down streamers’ adds to both the

cost of doing business and the length of time for processing transactions on behalf of

respondent banks. Due to necessity and the risk of the service, the charges levied by down

streamers for their service are significant. The screening process also lengthens the time

taken for transactions to be approved and processed. The charges, which are passed on to

respondent banks’ customers, and the longer transaction times result in an adverse

variation in the efficiency of respondent banks’ service relative to competitors who do not

need to use ‘down streamers’. Invariably, international banks and large indigenous banks

do not use ‘down streamers’, so it is the smaller indigenous banks that suffer a competitive

disadvantage in respect of their cost structures and service standards.

AML/CTF regulations have also been attributed to the physical movement of US cash

between countries in the Caribbean and the use of alternative, technology-based payment

systems for international and inter-personal transactions. Media and other reports have it

that large sums of US currency are being transported by sea and air as a ‘work-around’ to

the difficulties in transferring money through the formal banking sector. Some of these

cash movements are believed to be in support of illicit transaction activity, but due to the

very nature of the enterprise, little credible information is available. The issue from a

regulatory standpoint is that notwithstanding the regulations that now pervade the entire

banking system, money is still being moved internationally to satisfy transaction activity.

Some Latin American countries, including the Dominican Republic, have also established a

closed-loop clearing system to facilitate the settlement of trade and remittance

transactions in US dollars between themselves. Transactions are cleared and settled

through the Central Banks of the various countries using their respective US dollar

17

accounts. This mechanism averts the need for commercial banks to settle through their

correspondent banks in the US. It has been suggested that Caribbean indigenous banks

either seek to join the Latin American closed-loop or set-up a similar arrangement with

their Central Banks. The clearing of US dollar transactions outside of the US financial

system in this manner precludes oversight of the use US dollars for payments and transfers

intended by the international regulators, and represents a consequence of the regulations

that was not intended.

Another mechanism that is being used as an alternative means of payment or funds

transfer is internet-based crypto currency. Crypto currency is a medium of exchange

involving transfers and settlements between anonymous, internet-based accounts.

Operationally, traditional currency, which is fiat or commodity money, is converted into

units of crypto currency that is stored in internet ‘wallets’ or accounts. The currency is used

for settlement of transactions with other holders of internet accounts who are prepared to

transact in that form of currency. The system of transfers is based on distributed or shared

ledgers in a synchronized peer-to-peer network of computers that is geographically spread

across multiple sites, countries or institutions. Like traditional currency, crypto currency

has a trading value that is based on demand and supply.

With crypto currency, there is no central administrator, such as a Central Bank.

Transactions are instead proven on an instantaneous basis by interconnected computers

that validate them as a block of data. Blocks of data are added to an existing chain of

transactions referred to as a ‘block chain’ and they are accounted for on the distributed

ledger network.

Transactions in the block chain are permanent and unalterable, and they can be tracked.

However, the owners remain anonymous. While crypto currency was not developed as a

means for facilitating illicit activity, the anonymity has made it attractive to criminals and it

has gained in popularity as a method of transferring funds derived from illicit activity.

Ransomware, for example, is a computer malware that attacks systems and devices,

18

encrypts files and holds the data hostage until owners pay a ransom for retrieval. The

ransom must be paid using crypto currency.

Regulators have no direct means of control over crypto currency and the distributed ledger

system. At this time, controls are indirectly derived through the refusal by many banks to

deal with crypto currency companies due to the fact that the system is used for illicit

activity. The conundrum for the regulators, however, is that crypto currency is deemed to

be a currency of the future and it will eventually have to be accepted by the banking

system. The issue is with acceptance of it as an official payment mechanism with its

anonymity when regulators are adamant on the banking system ‘knowing its customers’.

In the Caribbean, most banks do not deal with crypto currency, as to do so would possibly

threaten their relationships with their correspondent banks. However, digital currency

companies are active in the region and there does exist the risk of them being used for

illicit activity.

Other forms of peer-to-peer activity are also fast gaining popularity and are being used as

work-arounds to the traditional banking and clearing systems. An example would be peer-

to-peer lending, where holders of surplus funds are matched with borrowers on

technology-based platforms. Use of funds in this manner is a means of laundering money if

the platform is not proficient in its background checks on the funders. Similarly, internet-

based clearing systems have been developed that allow suppliers and purchasers to

transact and clear payments on a network of cyber accounts. These systems are not being

developed to facilitate illicit activity. They are instead being developed to exploit the

efficiency of technology and the internet, and as a means of affording users a more

convenient and efficient means of transacting business than that which exists in the

traditional banking sector. However, their existence and the means by which they operate

are attractive to and being exploited by persons engaged in nefarious activity.

The off-shore banking and international business sectors have been particularly hard hit by

AML/CTF regulations and de-risking. Both sectors are integral to the economies of several

19

Caribbean islands and they are in fact significant contributors to GDP where they operate.

However, they are based to a large extent on the privacy of the relationship between the

bank and the client, and in the case of numbered accounts, the customers are anonymous.

These arrangements are at direct variance with ‘know your customer’ requirements, which

call for full disclosure and identification of beneficial owners of accounts. The tightening of

disclosure requirements by commercial banks has resulted in the closure of accounts and

the contraction of off-shore and international business sectors. Local economies that have

been dependent on these lines of business have been adversely affected as a result.

AML/CTF regulations have also placed a heavy administrative burden on commercial

banks in the Caribbean and the quality of banking services in general has been adversely

affected by the new compliance arrangements. In order to satisfy ‘know your customer’

requirements, banks are now required to update file information on all of their customers.

The task has proven to be an arduous one, and with most banks having had to employ

additional staff for the purpose, it has added to the cost of doing business. Customers have

also been disaffected by the additional information requirements, particularly as they do

not relate to the issues of money laundering, counter terrorism financing, correspondent

banking and de-risking. Banker-client relationships have therefore become strained and

the business as a whole has been negatively affected by AML/CTF regulations.

In summary, AML/CTF regulations have been producing opposite effects to their original

intent. In some cases, they are driving transactions into alternative channels that are more

difficult to trace. The regulations are also damaging business sectors that have been

integral to the economies of some Caribbean countries, and they are therefore affecting

economic performance and development in the region. At the operational and service ends,

the entire banking industry has been negatively affected due to the retrospective due

diligence requirements on customers and the frustrations being put on the banker-client

relationships. Most importantly, the indigenous banking sector is being put at a

disadvantage relative to the international banks, as they are faced with additional costs for

staying in business at a time when circumstances have remained strained in the overhang

of the 2008 world financial crisis and the continuing struggle for economic development.

20

Solutions and the Way Forward

Banks in the Caribbean continue to work on measures to ensure compliance with

international AML/CTF regulations. Technological solutions for transaction monitoring and

background screening in the on-boarding process continue to be introduced, and

information on existing customers is being remediated under the ‘know your customer’

requirements. Training of all staff from Board members through to non-clerical employees

is on-going and being repeated on an annual basis. To confirm the tenacity of their

AML/CTF systems and procedure, some banks have introduced the use of independent

professional assessors to test and report on their internal programs. The assessment

reports are used to support requests for the establishment or maintenance of

correspondent banking accounts.

At an industry level, measures are being considered that would provide for the

establishment of information databases on banks and customers in the region. These

databases, which are referred to as KYC utilities, are intended to support transaction hubs

that would screen banks and customers seeking to enter the international financial

payments system. For example, SWIFT, the Society for World Interbank Financial

Telecommunication, which is used by banks worldwide for international payments, is

introducing a secure, shared platform for exchanging standardized and validated KYC data

using mechanisms such as ‘legal entity identifiers’. The industry has also agreed on

enhanced wire transfer instructions so that the bona fides of transactions can be more

easily verified.

While work continues to be done at the regional level in the Caribbean, work on

improvements to the regulatory regimes is also required at the international level.

International regulators appear not to have envisaged the negative consequences of the

regulations that have been occurring. The withdrawal of correspondent banking and the

de-risking of respondent bank relationships by major international banks was not

expected, or at least so the industry believes. The regulators also did not foresee the degree

21

of impact on industries such as the MTBs and the international business sectors. Most

importantly, they did not anticipate the secondary and underground money transfer

arrangements that have come into being. The issue that has emerged is that the regulations

have begun to work against themselves and they are resulting in activity that makes

monitoring of the flow of funds in respect of illicit activity even more difficult. It is

therefore now necessary for the regulators to make adjustments to the regulations and the

manner in which they are implemented so that they can achieve the objective of arresting

the flow of the proceeds of unlawful enterprise and monies bound for the financing of

terrorist activity.

In reviewing the regulations and the methods of implementation, the FATF, the Basel

Committee, the FSB and the US Department of Treasury, along with its agencies, FinCEN

and the OCC, all need to collaborate to assess the effectiveness of their respective

regulations. Most importantly, they need to consolidate the regulations into one standard

that would be more easily deployed and governed. There is very little efficiency and

justification in having three major international bodies and various country-level agencies

establishing individual sets of regulations, all for the same purpose. Apart from the

dysfunctionality that this produces, it is a costly and administrative burden for regulators

at the country level. Regulators in the Caribbean also have to undergo regular reviews by

the World Bank, the IMF, the FSB and the CFATF, all on the same issue of adherence to the

various international regulations. Conversion of the regulations to one common standard

will allow for greater ease in implementation and it will provide for more focused

monitoring of the activities of the banks and other financial services entities that they

supervise.

In reviewing the regulations and guidelines for their application, international regulators

also need to detach from the thinking of the entire universe of bank customers as potential

criminals and kleptocrats, particularly if this thinking is based on preconceived notions

about specific regions such as the Caribbean. This level of thinking is having a very

damaging effect on the quality of banking services in the Caribbean and bank customers are

being frustrated in the conduct of normal banking business for reasons that play a very

small part of daily life in their societies. Specifically, while there are no doubt flows of funds

22

affiliated with persons involved in illicit activity, this is no different to any other economy

or society in the world and, in relative terms, flows of funds associated with criminal

activity in the Caribbean are much lower than those in major world centers such as New

York, Miami, Toronto and London. Therefore, rather than disrupt the entire banking

industry and the lives of persons across the Caribbean region in the attempt to identify and

capture a few perpetrators of criminal activity, more incisive and effective methods need to

be used to achieve the purpose.

Regulators also need to discontinue the use of the banking system for policing of activity

that belongs with law enforcement and intelligence agencies. The AML/CTF operating

regulations are not unlike the case of Foreign Account Tax Compliance Act, where banks

around the world have been forced to engage in activity involving the identification of

American citizens who are liable to the US Internal Revenue Service for payment of taxes, a

matter having nothing to do with banks outside of the United States. Similarly, FinCEN sees

itself as both regulator and financial intelligence unit and it therefore bases its information

requirements from the commercial banking sector on support for this activity.

Banks are commercial entities that that have as one of their primary objectives, the

maximization of shareholder returns. AML/CTF regulations are increasing the costs of

doing business for commercial banks and they are therefore reducing profitability and

returns to the shareholders. In some cases, the additional costs are affecting the very

viability of small indigenous banks in the Caribbean and threatening their ability to stay in

business. The control of money laundering and terrorism financing are not primary

banking functions and regulators need to instead use law enforcement and intelligence

agencies to police criminal activities. In today’s world, there are physical and technological

surveillance mechanisms that are available to law enforcement to identify and monitor

criminals and illicit activity. Rather that rely on banks as the first line of defense and impair

the business in the way that is now occurring, information gained by law enforcement from

policing activity should be used to direct banks on the handling of accounts belonging to

persons who are suspected of or guilty of money laundering or terrorism financing.

23

In order to address the problems that have been emerging as a result of AML/CTF

regulations and, in particular, the unintended consequences that have been described,

there is need for public-private consultations between the regulators and the commercial

banking sector. By necessity, these consultations must include both the correspondent and

the respondent banks, whose businesses have been severely affected as a consequence of

the regulations. They must seek to identify the negative impact of the regulations on

banking services globally and they must focus on means for improving effectiveness in the

measures for prevention of money laundering and terrorism financing.

Public-private consultations must specifically seek to correct the damages that are being

done to the banking sector and the economies in the Caribbean, as well as other similarly-

affected sub-regions around the world. The objectives of these consultations must be to

remove or substantially reduce the factors that are causing the business of correspondent

banking to be unattractive and uneconomical for the international banks. In this regard,

rather than using regulations in a coercive manner and applying fines that are extremely

punitive, the aim must be to have joint, on-going, solution-oriented collaboration between

all parties, including law enforcement, that provides for more effective monitoring of illicit

activity while providing for the continuation of business at reasonably normal levels.

Unless there is change, the manner of administration of regulations and use of fines by the

regulators at the levels noted will not result in any change in direction by the

correspondent banks and the negative consequences of the regulatory regime will persist.

In the Caribbean, there is also need for consolidation of supervisory activity on the part of

the regulatory agencies. As noted, there are 11 regulatory bodies across 17 countries in the

region. These supervisory arrangements are inefficient, as they are largely uncoordinated

and they do not provide for consolidated and unified oversight of banking activity across

the various jurisdictions. They are also cost-ineffective for a regional banking sector whose

net earnings streams are already challenged. Additionally, for regional and international

banks with operations in multiple countries, there is the inefficiency of having to satisfy the

requirements of numerous regulators. The move by the Eastern Caribbean Central Bank to

consolidate supervision within the Eastern Caribbean Currency Union as a coordinated

24

oversight measure is noted and welcomed. This initiative will assist with the centralization

of activity that is needed. The strategy however now needs to be extended to and adopted

by other regulatory agencies across the region.

There is also a significant role for elected politicians in bringing relief to the problem of

burdensome regulatory oversight. The regulatory bodies, the FATF, the Basel Committee,

the FSB and FinCEN, were all established by Ministers of Government and Central Bankers

of the G7 and G20. To effect change on the work of the regulators, there is need to address

the issues at political level where there would be broader concerns for human and social

development, and the consequences of international regulations on the development of the

sub-regions of the world. Regional politicians therefore have a responsibility to lobby for

change at the level of the G7 and the G20 so that reform can be effected at the regulatory

level. In this regard, with the number of independent regulatory agencies that are

overseeing the AML/CTF matter, it would be difficult for any one regulator to initiate

change without the other regulators being in alignment. Governments therefore need to

agree to consolidate regulatory arrangements under one international body so that

activities could be unified and more effectively applied.

Conclusion

Bankers in the Caribbean are conscious of the need to prevent money laundering, terrorism

financing and the proliferation of weapons of mass destruction due to the damage that

these activities are having on societies in parts of the world. The measures that are

required to be compliant with international AML/CTF regulations are being put in place,

not only for purposes of compliance and to protect correspondent banking relationships,

but also because of their sense of responsibility for protection of the world financial

system. However, the weight of the current regulatory regime is too heavy and it is

negatively affecting the cost of operations, the service to customers and the overall

financial performance of respondent banks. For the correspondent banks, the costs and

risks of reputational damage are also very onerous and they are therefore being forced to

discontinue correspondent banking as a line of business. The loss of correspondent

25

banking is severely affecting the ability of respondent banks in sub-regions of the world to

fully service their customers and it is retarding economic development.

AML/CTF regulations are also driving financial transactions and money transfers into

alternative channels that are unregulated and cannot be monitored. The regulations are

therefore beginning to work against themselves and they are losing effectiveness. In order

to correct the negative circumstances that have developed, international regulators need to

rethink the approach to regulating the AML/CTF provisions for the industry. They must

consolidate their activities and collaborate in a more purposeful manner with both

correspondent and respondent banks in order to achieve greater effectiveness in their

roles. In so doing, regulators also need to be mindful of the fact that the banking system is

commercially oriented and it therefore cannot be used for policing and intelligence

activities that belong in the domain of law enforcement and governmental agencies. In this

regard, commercial banking should respond to intelligence and law enforcement activity

rather than being directly responsible for those roles.

International regulators need to be more mindful of the fact that societies in developing

regions are fragile and often vulnerable to the smallest of adverse economic events.

Indigenous banks in these regions are integral to economic development and the

advancement of these societies. They often play role that international banks are not

interested in performing or that do not fit their operating mandate. It is therefore

important that the indigenous banking sector be supported and allowed to prosper.

The US Office of the Controller of Currency states on its home page that it recognises the

important role that minority banks and savings associations play in providing financial

services to the communities they serve. The agency also states that it is committed to the

success of these financial institutions. While the institutions referred to in the statements

are US based, the same commitment and principles should apply to indigenous banks in

regions such as the Caribbean, as they too play an important role in providing financial

services to the communities they serve. Such commitment would be met by ensuring that

international banks in the US that have provided correspondent banking services to

26

respondent banks in the sub-regions of the world are allowed to continue do so in manner

that satisfies the need for protection of the financial system while allowing respondent

banks to carry on their business in a successful manner.

*******

27

References

1. Shehu, A, Y 2010, ‘Promoting financial sector stability through an effective AML/CFT

Regime’, Journal of Money Laundering Control, vol 13, no. 2.

2. ‘International Standards on Combating Money Laundering and the Financing of

Terrorism & Proliferation’, Financial Action Task Force, 2016.

3. Artingstall, et al 2016, ‘Drivers & Impacts of De-risking’, John Howell & Co. Ltd.

4. Durner, T, Shetret, L 2015, ‘Understanding Bank De-risking and its effects on

Financial Inclusion’, Global Centre on Cooperative Security.

5. Worrell, et al 2016, ‘De-risking in the Caribbean: The Unintended Consequences of

International Financial Reform’, Central Bank of Barbados Working Paper G21; F36.

6. ‘Mitigating the effects of de-risking in emerging markets to preserve remittance flows’,

International Finance Corporation, Note 22, 2016.

7. ‘Fact finding summary from De-risking Surveys: Withdrawal from Correspondent

Banking – Where, Why, and What to do about it and Report on the G20 Survey on De-

risking activities in the Remittance Market’, The World Bank Group 101097, 2015.

8. ‘The Caribbean Association of Banks Applauds IMF Managing Director Christie

Lagarde’, Caribbean Association of Banks Inc. 2016.

9. Stabile, C 2014, ‘De-risking: Does one bad apple spoil the bunch?’ ACAMS Today.

10. ‘Report on the G20 Survey on De-risking Activities in the Remittance Market’, The

World Bank Group 101017, 2015.

11. ‘World Bank Surveys Confirm Concerns over Reduced Access to Banking Services’, The

World Bank Group Press Release no. 2016/186/FMGP, 2015.

12. Luetkemery, et al 2016, ‘Members of US Congress write on the banking risk’, Kaieteur

News Letters.

13. Charles, J 2016, ‘Advocacy: Correspondent Banking’, Caribbean Association of

Bankers Bulletin.

14. Worrell, D ‘De-risking strategies of Canadian and American banks discussed at

Montreal meeting’.

15. Popo, M 2016, ‘Report on the Caribbean Association of Banks Inc. CEO’s Forum on

Correspondent Banking’.

28

16. ‘Solving the Caribbean’s Correspondent Bank Problem’, Sidley Austin LLP, 2016.

17. Wright, A, Kellman, B 2017 ‘De-Risking in the Barbados Context’, Inter-American

Development Bank, Policy Brief no. IDB-PB-263.

18. Williams, R, C 2017, ‘Prospects for blockchain-based settlement frameworks as a

resolution to the threat of de-risking to Caribbean financial systems’, United Nations,

Economic Commission for Latin America and the Caribbean.

19. El-Hindi, J 2016, ‘Remarks to the CSBS State Federal Supervisory Forum’, United

States Department of the Treasury, Financial Crimes Enforcement Network.

20. Boyce, T 2016, ‘Strategic Solutions to ‘De-Risking’ and the Decline of Correspondent

Banking Relationships in the Caribbean’, Caribbean Development Bank Discussion

Paper.

21. ‘Withdrawal from Correspondent Banking – Where, Why, and What to do about it ’,

The World Bank Group 101098, 2015.

22. ‘CAB Update, Facing the Correspondent Banking Challenge,’ Caribbean Association of

Bankers, Bulletin 2017.

23. Carney, M, Badré, B 2015, ‘Keep finance safe but do not shut out the vulnerable’,

Financial Stability Board, Article 2015.

24. ‘Report to the G20 on actions taken to assess and address the decline in correspondent

banking’, Financial Stability Board, Report 2015.

25. ‘FSB publishes progress report and 2017 workplan to assess and address the decline in

correspondent banking’, Financial Stability Board, Report 2017.

26. Basel Committee on Banking Supervision, Consultative Document, Guidelines,

Revised annex on correspondent banking, Bank for International Settlements 2016.

27. ‘High-Level Conference on Correspondent Banking Relationships: Policy Responses and

Industry Solutions’, International Monetary Fund, 2016.

28. ‘OCC Releases Risk Reevaluation Guidance for Foreign Correspondent Banking’, Office

of the Comptroller of the Currency - U. S. Department of the Treasury, NR 2016-123,

2016.

29. ‘Risk Management Guidance on Periodic Risk Reevaluation of Foreign Correspondent

Banking’, Office of the Comptroller of the Currency - U. S. Department of the

Treasury, OCC Bulleting 2016-123, 2016.

29

30. ‘Customer Due Diligence Requirements for Financial Institutions’ Federal Register.

31. ‘FinCEN Publishes Final Customer Due Diligence Rules Introducing New Measures to

Control Money Laundering and Other Financial Crimes’, 2016.

30