General / Miscellaneous

The Risks of De-Risking by Molly Sterns

At the 22nd annual West Coast Anti-Money Laundering Forum, held May 7 to May 9 in San Francisco, representatives from across the field gathered to discuss current trends and issues in the industry. In this candid, closed-door setting—no journalists are admitted and recordings are expressly prohibited—few issues were off limits, as experts tackled everything from the latest in sanctions activity to the financial impact of “hacktivists”.

Even with so many lively topics on the agenda, no issue was more hotly debated than the cross-cutting theme of de-risking. The term refers to the practice by which banks strip their portfolios of riskier clients, rejecting or exiting these relationships rather than engaging in the enhanced due diligence and sweeping know-your-customer requirements that make these customers costly to bank.

The de-risking trend is especially pronounced at larger banks that have found themselves the targets of heightened regulatory scrutiny and record-breaking fines in recent years. Indications from various government agencies that key bank personnel may soon be held personally liable for oversights only increases the pressure to choose customers wisely, erring ever further on the side of caution.

On the surface, de-risking seems a sound reaction to the tightening compliance standards that characterize the field today. But customers who are terminated from a relationship with larger banks still need to bank somewhere, and may turn to smaller institutions whose resources do not allow them to be as thorough in conducting their due diligence—or as discriminating in selecting their clients.

An unfortunate consequence of de-risking, then, is to drive risk further to the fringes of the financial system, outside the purview of the regulatory machinery designed to keep it in check. This effect is particularly notable in industries where anti-money laundering protocols have yet to adapt to the rapid pace of technological and legislative change. Take, for example, businesses working in the emerging landscapes of virtual currencies or online payment processing, or those hovering in legal limbo between state and federal laws, such as marijuana businesses in Colorado. Barred from bigger banks, players in these industries may seek out banks with lax controls and limited reporting capabilities, making it more difficult for authorities to track their activity and distinguish the legitimate actors from the less law-abiding sort.

The policies that engendered this de-risking response may still be the right ones. Raising the standards for combating money laundering and increasing the incentives to comply is a step in the right direction. But even the best policies can lead to unintended outcomes. If the de-risking trend continues, policy makers may be inclined to take another look to be sure that risky business does not slip too far out of sight.

Molly Sterns  is a a student in the joint MBA/MA in International Policy Studies program at the Monterey Institute of the International Studies. where she focuses on Anti-Money Laundering. She recently became a Certified Financial Crimes Specialist. Prior to graduate school, Molly spent three years in an international education start-up, building out its recruitmen, admissions, and training progras. She also spent a year in Cambodia as a Communications Advisor to a local NGO.