Understanding the risk exposure of PEPs on the local banking sector and correspondent banking relationships

-in the context of PEPs who have been recently subjected to U.S Sanctions

Introduction

In the previous column, this thematic issue was introduced where the potential implications were examined. The article concluded that if the commercial banks do not exercise extreme caution in the handling of the accounts of PEPs, then the risk exposure of the local financial system is such that the local banks stand to lose correspondent banking relationships and it was contended that the effects can be equal to that of economic sanctions without the imposition of actual economic sanctions by virtue of simply being cut off from the international financial system.

The author is cognizant that persons may not fully understand how the expressed views presented last week is possible to the extent where it is believed that no such risk exist. It is in this view that today’s piece seeks to address such concerns and provide a deeper understanding of these inherent risks. Firstly, one has to understand the full context of this issue and the very constructs that embodies the fragility of not just the local economy in this regard, but the regional financial system as well from the perspective of “de-risking” in the Caribbean Region.

Discussion and analysis

The termination or loss of correspondent banking relationships (CBRs) in the Caribbean became a cause for concern for the financial sector around 2015. In fact, a fact-finding de-risking survey conducted by the World Bank (WB), which examined the extent of world withdrawal from correspondent banking, its drivers and implications for financial inclusion/exclusion, the Caribbean was found to be the region to be the most affected by declining CBRs.

The Caribbean Financial Action Task Force (CFATF) issued a CFATF perspective report on “De-Risking in the Caribbean Region”, published in November, 2019. Based on the findings of the CFATF report, it was noted importantly that “de-risking is a multi-dimensional challenge that consists of operational, financial, and supervisory/regulatory issues that are detrimental to both Central Banks and Financial Institutions.”

The report also highlighted measures adopted at the supervisory and institutional levels to address de-risking and which represents important progress within jurisdictions to mitigate the effects of de-risking. Notwithstanding, the report also highlighted specific gaps that are in need of more targeted measures. Further, although there were minimal restrictions / termination of CBRs, the perception of de-risking threat is almost equal on both sides – that is, Central Banks (CBs) and Financial Institutions (FIs). Despite the relatively small number of FIs reporting the effects of de-risking and loss of CBRs, the scope of these are crucial enough to warrant them to implement comprehensive measures to mitigate de-risking as well as substantial assistance from CFATF (CFATF, 2019).

According to the Financial Action Task Force (FATF), PEPs are classified as high risk because of their position and influence, where many PEPs are in positions that potentially can be abused for the purpose of committing money laundering (ML) offenses and related predicate offenses, including corruption and bribery, as well as conducting activities relating to terrorist financing. This has been confirmed by case studies and analysis (FATF Guidance, 2013).

The International Finance Corporation (IFC) in its report on Anti-Money Laundering (AML) and Countering Financing of Terrorism (CFT) Risk Management in Emerging Market Banks, noted that correspondent banking relationships are reduced in number, especially for respondent banks that:

  • are located in jurisdictions perceived to be too risky;
  • offer products or services or have customers that pose higher risks of AML/CFT and therefore are more difficult to manage; and
  • more so, some correspondent banks are increasingly reluctant to provide correspondent banking services in certain foreign currencies in which the perceived risk of economic sanctions, the regulatory burden related to AML/CFT, or the uncertainties related to the implementation of these requirements and the potential reputational risk in case of noncompliance seem to be higher. This is certainly applicable to the case of Guyana within the context of the current political crisis. (Note: these are just a few selected reasons cited from the report to corroborate the argument presented).

Conclusion

Against these backgrounds, it would be a grave error for anyone to believe that the risks and implications articulated in last week’s column are non-existent. The fact that the U.S has again announced another set of visa restriction on more officials, is a clear indication that the U.S is now in action mode following the developments in Guyana’s political crisis, and other countries may soon follow. Sanctions are imposed in stages, and therefore, at this point in time these risks on the financial sector are very real and moderate if not considered high at this time – especially since the names of those officials are not publicly announced. This naturally complicates the situation wherein commercial banks would now have to exercise great caution and intensify the application of enhanced due diligence for transactions emanating from all PEPs.

Additionally, within the framework of the de-risking issue within the Caribbean Region as well, there is another layer of contagion risk wherein the entire regional financial system is now exposed because of the situation in Guyana.

As such, if the political impasse is not resolved in Guyana and it worsens, then regional bankers as well as local bankers and regional regulators would have to start considering approaches to mitigate the contagion risk that Guyana now poses to the entire region’s financial system and institute safeguards to prevent and / or minimize further de-risking since the region is already regarded a high risk region for de-risking.

Next week the author will examine these other dimensions in more depth.

About the Author:

    JC.Bhagwandin is a macro-finance and research analyst, lecturer and business & financial consultant. The views expressed are exclusively his own and do not necessarily represent those of this newspaper and the institutions he represents. For comments, send to jbbankingadvice@gmail.com.