Blog — AML Dictionary

Written by Momen Talaat

De-risking

De-risking refers to the strategic decision made by financial institutions to reduce or eliminate relationships with customers, sectors, or regions that are deemed to pose a high risk of money laundering, terrorist financing, or other financial crimes.

25/05/2023

Definition: De-risking refers to the strategic decision by financial institutions to minimize or eliminate their exposure to high-risk customers, industries, or jurisdictions to mitigate potential legal, regulatory, and reputational risks.

Historical View

De-risking practices have evolved in response to increasing regulatory scrutiny and enforcement actions in the financial industry. In the aftermath of significant money laundering and terrorism financing scandals, financial institutions faced substantial fines and reputational damage.

Historically, banks had a more inclusive approach to customer relationships, providing services to a wide range of clients and industries. However, the heightened focus on anti-money laundering (AML) and counter-terrorism financing (CTF) regulations prompted a shift in risk management strategies.

Financial institutions began to adopt more stringent Know Your Customer (KYC) and due diligence procedures to identify high-risk customers and transactions. This led to de-risking practices, where banks decided to terminate relationships with clients or industries deemed too risky to maintain.

The trend of de-risking gained momentum after the global financial crisis of 2008, as banks faced increased regulatory pressure to strengthen their AML and CTF controls. The fear of potential penalties, legal consequences, and damage to their reputation motivated financial institutions to reevaluate their risk exposure and adopt a more cautious approach.

Practical Examples

1. A bank decides to terminate its relationships with money service businesses (MSBs) due to the perceived high risk associated with these entities’ potential involvement in money laundering activities.

2. An international correspondent bank reduces its exposure to certain jurisdictions known for weak AML/CFT controls and high levels of financial crime by limiting the number of correspondent banking relationships in those regions.

3. A financial institution decides to exit relationships with clients operating in the legal cannabis industry due to conflicting federal and state laws, which create uncertainty and potential regulatory risks.

4. A bank introduces stricter due diligence measures for high-net-worth individuals (HNWIs) and politically exposed persons (PEPs) to ensure compliance with regulatory requirements and mitigate the risk of illicit financial flows.

5. An insurance company decides to discontinue providing services to customers involved in certain high-risk activities, such as online gambling or cryptocurrency businesses, to avoid potential exposure to money laundering or fraud-related risks.

6. A bank imposes additional documentation requirements and enhanced monitoring for correspondent banking relationships to ensure compliance with international AML/CFT standards and reduce the risk of facilitating illicit transactions.

7. An investment firm establishes strict risk criteria to assess potential clients, including industry sectors and geographic locations, to avoid association with businesses or regions known for significant legal or reputational risks.

8. A payment processor terminates relationships with merchants operating in industries prone to fraudulent activities, such as online gaming or adult entertainment, to minimize exposure to potential regulatory and reputational risks.

9. A crowdfunding platform implements stringent screening procedures to verify the legitimacy of fundraisers and beneficiaries, preventing potential misuse of funds and reducing the risk of involvement in illicit activities.

10. An international money transfer operator imposes transaction limits and additional customer verification measures for remittance services to high-risk jurisdictions, aiming to prevent money laundering and terrorist financing.

Statistics

1. According to a survey by the Financial Action Task Force (FATF), approximately 69% of respondent financial institutions reported reducing or terminating correspondent banking relationships as part of de-risking strategies.

2. The World Bank estimated that between 2011 and 2016, approximately 30% of global correspondent banking relationships were terminated, affecting financial access for vulnerable regions and populations.

3. The Global Witness report revealed that between 2009 and 2019, more than 100 international banks were involved in de-risking measures, impacting access to financial services for organizations working in conflict zones and high-risk areas.

4. The Wolfsberg Group, an association of global banks, found that 94% of surveyed banks considered AML/CTF risk as the primary factor driving de-risking decisions.

5. The International Monetary Fund (IMF) highlighted that de-risking practices can disproportionately affect small and medium-sized enterprises (SMEs) in developing countries, limiting their access to global financial services.

6. The Caribbean Association of Banks reported that between 2013 and 2016, regional banks experienced a 75% reduction in correspondent banking relationships, impacting trade, remittances, and economic growth in the region.

7. The World Economic Forum emphasized the potential consequences of de-risking, stating that it may drive illicit financial activities underground and increase financial exclusion for marginalized populations.

8. The Association of Certified Anti-Money Laundering Specialists (ACAMS) revealed that 63% of surveyed AML professionals considered de-risking as a significant challenge in maintaining effective financial inclusion while managing AML/CFT risks.

9. The United Nations Office on Drugs and Crime (UNODC) estimated that up to 2 trillion USD is laundered globally each year, highlighting the ongoing need for robust AML measures without overly restrictive de-risking practices.

10. The Financial Stability Board (FSB) recognized the potential unintended consequences of de-risking, including the emergence of unregulated financial channels and the concentration of risk among a limited number of institutions.

Incidents

1. The closure of correspondent banking relationships in the Caribbean region has affected the ability of local banks to process international transactions and receive foreign currency, leading to economic challenges and financial exclusion.

2. The de-risking actions by major banks in Mexico following increased regulatory scrutiny resulted in difficulties for Mexican businesses and individuals to access international financial services, impacting trade and remittances.

3. The termination of correspondent banking relationships in Somalia, driven by de-risking concerns, limited the country’s ability to receive remittances from the Somali diaspora, affecting the livelihoods of many families.

4. The closure of MSB accounts by banks in the United States has led to financial exclusion for legitimate MSBs, hindering their ability to provide remittance services and impacting communities that heavily rely on these services.

5. The withdrawal of international banks from certain jurisdictions in Africa due to de-risking concerns has had adverse effects on trade finance, foreign investment, and economic development in the region.

6. The termination of banking relationships for nonprofit organizations (NPOs) engaged in humanitarian work has hindered their ability to access financial services, affecting their ability to deliver aid to vulnerable populations.

7. The closure of correspondent banking relationships in the Pacific Islands has resulted in challenges for local economies, hindering trade, tourism, and financial inclusion for remote island communities.

8. The de-risking actions taken by banks in response to the Panama Papers scandal have impacted offshore financial centers, resulting in reputational damage and reduced access to global financial services for legitimate businesses.

9. The termination of correspondent banking relationships in the Middle East and North Africa (MENA) region has disrupted trade finance and cross-border transactions, impacting economic growth and financial stability in the region.

10. The closure of bank accounts for charities and nonprofit organizations involved in conflict-affected areas has created obstacles in delivering essential humanitarian assistance, impeding the response to humanitarian crises.

The Future

1. Regulatory authorities are working to address the unintended consequences of de-risking and develop guidelines that balance risk management objectives with financial inclusion goals.

2. Technology advancements, such as distributed ledger technology (DLT) and blockchain, may offer potential solutions to enhance transparency and reduce the compliance burden, easing de-risking concerns.

3. Enhanced collaboration between financial institutions, regulators, and industry associations can facilitate dialogue and the development of risk-based approaches to prevent excessive de-risking.

4. Increased use of artificial intelligence (AI) and machine learning (ML) in AML compliance processes can improve risk assessments, helping institutions better differentiate between high-risk and low-risk customers and transactions.

5. The emergence of regulatory sandboxes and innovation hubs provides an opportunity for financial institutions to test new technologies and approaches to address de-risking challenges while ensuring compliance.

6. The focus on building stronger public-private partnerships can promote information sharing, capacity building, and collaboration to address de-risking concerns collectively.

7. Proactive engagement with regulators and ongoing dialogue between financial institutions and policymakers can help align regulatory expectations with practical risk management strategies, reducing the need for excessive de-risking.

8. Continued advocacy for standardized risk assessment methodologies and clearer regulatory guidance can provide more certainty for financial institutions in managing their risk exposure and navigating de-risking challenges.

9. The integration of advanced AML technology solutions, such as Kyros AML Data Suite, can assist financial institutions in effectively managing risk while maintaining financial inclusion and ensuring regulatory compliance.

Kyros AML Data Suite

With the increasing complexity of AML regulations and the challenges associated with de-risking, financial institutions can leverage Kyros AML Data Suite to enhance their risk management capabilities and compliance processes.

Kyros AML Data Suite offers advanced AML solutions powered by artificial intelligence and machine learning algorithms, enabling institutions to efficiently and effectively detect, investigate, and mitigate financial crime risks.

By leveraging Kyros, institutions can streamline their customer due diligence processes, improve transaction monitoring, and enhance their overall risk assessment frameworks. The software provides comprehensive analytics and reporting capabilities, enabling institutions to make informed decisions and meet regulatory obligations.

Explore the Power of Kyros AML Data Suite

Visit kyrosaml.com to learn more about Kyros AML Data Suite and schedule a demo or book a call with our experts. Discover how Kyros can assist your organization in effectively managing AML risks, enhancing compliance efforts, and addressing de-risking challenges.

Conclusion

De-risking is a risk management strategy adopted by financial institutions to mitigate potential legal, regulatory, and reputational risks associated with high-risk customers, industries, or jurisdictions. While it aims to ensure compliance and protect institutions from financial crime, de-risking practices can have unintended consequences, such as financial exclusion and hindered economic development.

As the regulatory landscape continues to evolve, it is crucial for financial institutions to strike a balance between managing risks and promoting financial inclusion. By leveraging advanced technologies and comprehensive AML solutions like Kyros AML Data Suite, institutions can enhance their risk management capabilities, maintain compliance, and navigate the challenges associated with de-risking effectively.

Together, we can build a robust and resilient financial ecosystem that addresses financial crime risks while fostering economic growth, inclusion, and trust.

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