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Remittances - a regulatory minefield where costs must be cut

Chrisol Correia, LexisNexis Risk Solutions, Director, London, 12 March 2015

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High-net-worth individuals make wire transfer purchases (and, in some countries, hawala purchases) from time to time, but their freedom to do so is being curtailed at every turn. Data analytics might provide some answers.

The Financial Times recently summarised the issue facing remittance services in a single headline: “Crackdown on money laundering threatens to leave parts of developing world cut off from global finance”. The exclusion of customers or the avoidance of business is never an ideal scenario, but one that appears to be increasingly common.

This was demonstrated by the recent move by the Merchants Bank of California to end its money transfer services to Somalia, claiming that it was worried about terrorist finance and money laundering. As an indication of the significance of the closure, and as Somalia has no formal banking system following decades of conflict, Somalis abroad use money transfer companies to send home close to $1.3 billion each year – far more than the vulnerable country’s aid receipts. The Merchants Bank was previously facilitating 80% of all US remittances to Somalia, meaning that this closure is having a significant impact, just two weeks on from the closure, Reuters reports that businesses and families are already short of funds.

The orange suit

The issue facing banks today is that regulatory scrutiny and the need to be 'duly diligent' sometimes make costs outweigh the benefits of offering services such as remittances. As an anonymous European banking chief executive remarked to the Financial Times, the risk/reward ratio of serving parts of the global financial market is now so skewed that “from my point of view, there is an orange suit sitting in the US and the regulator is saying it’s there waiting for me”.

The effect of these pressures is that remittance services, or similar services such as correspondent banking (where a bank in one territory performs non-credit services such as cheque-cashing or access to cash at ATMs for the customers of a bank in another) may be finding it more difficult to operate. The British Bankers’ Association recently noted the loss of “thousands” of correspondent banking relationships in the four years leading up to 2011. The scale of losses indicate that when banks are making difficult decisions about balancing the rewards of serving certain markets, commitments to universal banking and the risk that these relationships may inadvertently expose them to an entire range of regulatory risks – from the funding of terrorism through to international sanctions – they tend to err on the side of regulatory caution. And the result is that relationships across the world are being cut.

Often, it is legitimate businesses and individuals that suffer. Terrorists and others targeted by regulation attempt to keep one step ahead of the regulators and enforcement agencies. They find new ways to operate, such as through shadow banking,  the exploitation of trade and trade finance or perhaps by reverting to older styles of money-laundering techniques such as bulk cash smuggling. Thus the risk to the financial system simply continues. Of course, the average migrant worker attempting to send money home or ordinary business attempting to set up a new supplier relationship does not have these options, leading to financial exclusion.

Hawala banking

One alternative method that those excluded from using banks may turn to as a result is hawala. Hawala is an ancient, informal banking system used to transfer millions between Western countries, the Middle East and South Asia every day. It is trust-based and leaves no paper trail, which is why many people believe it to be the main means by which terrorists receive funds. But back in 2001, when the US froze assets belonging to Barakat, a hawala conglomerate, the collateral damage again was individuals in Somalia – deprived of its only efficient payments system.

Hawala has been banned in some countries, including Saudi Arabia, because it is so difficult to trace and monitor effectively. Pakistan also officially prohibits it while unofficially tolerating it, with the Americans suggesting that it is a conduit for the proceeds of drug smuggling. In South Asia and other labour-exporting countries hawala is outlawed. In some European countries such as Spain and France, no informal mechanism for the transfer of funds is allowed. But the hawala system is a way of life for many businesses and individuals; trying to prohibit it could hurt people more than help combat terrorism or other criminal activity. Indeed, many bankers and regulators reject bans against hawala, claiming that people who misuse the service will simply be driven further underground and become more difficult to trace – something that may well be an unintended consequence of banks’ withdrawal of remittance services.

The issues with both hawala and remittance services are broadly the same; regulators must find a feasible and durable balance between countering money-laundering and terrorist finance and wreaking economic damage by disrupting legitimate flows of capital. At the policy-making level we are beginning to see, despite increasing regulation, wider initiatives to accommodate these services, especially when they involve smaller transactions or individuals who live outside the banking system. The United Kingdom - the capital of European surveillance - is, for example, working with the World Bank on a 'safer corridor' initiative to tighten the scrutiny of Somalian money transfers through the use of biometric identity cards for recipients. The UK has also informed its banks that they will not be prosecuted if a money transfer goes wrong, as long as they can demonstrate a commitment to 'due diligence,' although the US has so far refused to follow suit.

Data analysis

For larger transactions or services such as correspondent banking, data analytics is also opening up opportunities that are profitable and offered in a way that complies with international regulations and that manages a given bank’s reputational risk.

One example of how data analytics can be used is in adverse media monitoring, a cost-effective way of building up an understanding of the risk posed by any given customer or relationship. Things here are shifting away from the 'scattergun' nature of Google searching to a two-step approach that relies first on a search against structured media profiles compiled by an analyst, and secondly the use of a media analysis tool to conduct a search of unstructured news. By moving from a search engine to a specialist, risk-focused, media-analysing piece of software, the searcher not only obtains more accurate results, but also limits his search to influential news sites only – cutting down on the sheer volume of information to process. His money-laundering reporting officer can then make better decisions because he has a better understanding of risk.

This process is cheaper than what went before, but there are other benefits. Data analytics can help build trust amongst banks in correspondent banking relationships and help to reduce reputational risk. It might also help to calm down the 'de-risking' drives at the big banks that are harming so many of these correspondent relationships. This can only be a good thing for the financial health of the industry and the customers it serves.

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