In recent years, de-risking has become a common practice among financial institutions worldwide. Some institutions take on the role of withdrawing funds, while others are left with limited leverage and resources to ensure the continuity of their client’s international operations.
For decades, globalisation has forced smaller banks to depend on and collaborate with major players. However, due to various reasons such as high costs of maintaining relationships, prudential requirements, concerns related to anti-money laundering (AML) and countering the financing of terrorism (CFT), and the possibility of reputational risk, a de-risking tendency has emerged.
This tendency has become particularly noticeable with the onset of the COVID-19 pandemic, followed by the Russia-Ukraine war. The negative effects of this trend have been especially harsh on the financial sector and related areas of developing economies, such as Armenia.
The economic consequences of declining correspondent banking relations are another major setback for world trade and the global economy. It must be noted that trade finance is particularly vulnerable to de-risking.
Once the global players leave an emerging market, the infrastructure is recalled leaving the connection between the local and cross-border counterparties on unfavourable terms. This eventually poses a real threat of disruption in commodity markets and supply chains, which in turn will have a negative impact on financial stability and progress worldwide.
As a working alternative to termination of any relationship, we see open communication aimed at the mitigation of detected or presumed risks, for instance:
- In cases where the termination of a partnership is motivated by profitability concerns, the partner bank could be afforded an opportunity to cover the relevant charges and costs. This can be achieved by increasing their business volumes or paying higher maintenance fees.
- If concerns are for prudential requirements, then direct communication with central banks aimed at the review of underlying legislation and regulations may overlay the way out;
- If KYC/AML/CFT measures are still found to be insufficient, conducting an external compliance audit may be necessary.
- This can be carried out by a big four, or other specialised entity that can identify fundamental gaps in the field and provide targeted recommendations to address the findings. Such an audit can be helpful not only for the specific relationship in question but can also establish an aspirational compliance benchmark for all local players, promoting the reorganisation and heightening of predetermined standards in the market.
The key remains with communication, once the communication starts counterparties can often find an agreeable solution.
However, it is necessary to remember that any situation has also its reverse side. And as history has often shown necessity is the mother of innovation and can often provide new opportunities for all parties. With the aforementioned, we can detect two basic upshots of de-risking in emerging markets.
The first trend we observe is the rapid growth and expansion of fintech and payment platforms, which fill the void left by the withdrawal by large players. These platforms often offer lower maintenance fees and operational charges, which is advantageous for local players seeking access to global remittances and the ability to conduct their business uninterrupted.
However, a major challenge is whether these platforms are able to ensure sufficient implementation of KYC, AML and CFT measures for proper procedural reviews during onboarding and constant due diligence of activities. Insufficient controls in these areas may lead to fraudulent transactions, money laundering, and breaches of sanctions, resulting in lawsuits, heavy financial penalties, and even imprisonment.
And secondly, in today’s digital age, we anticipate an emergence of a special category of fintechs that not only automate the trade processes, but also implement smart tools. These tools will conduct initial KYC procedures based on the provision of standard documentation, AML screening and checks, and adverse media monitoring. Outsourcing this function to a trustworthy fintech partner can assist in building a resilient and robust KYC, AML, and CFT compliance system that is adaptable to rapidly evolving market conditions.
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