Derisking poses regulatory quandary for banks

Faced with increased regulatory scrutiny from bank examiners regarding compliance with the Bank Secrecy Act and anti-money laundering rules, many banks are adopting the so-called practice of derisking. This is the process of exiting business lines that are considered to be high risk from a BSA/AML perspective, such as money services businesses and companies in the virtual currency and legal marijuana industries.

However, bank regulators are concerned that derisking could lead to companies in perfectly legitimate industries being unable to obtain access to banking services, including much-needed loans.

Fear of enforcement penalties “should not color the decision-making approach of banks that are carrying out good-faith efforts to abide by the law,” Treasury Department Undersecretary Nathan Sheets said in a speech last November. At the same time, Sheets expressed concern about the practice of derisking and restricting access to credit for many legitimate businesses such as MSBs.

“Financial exclusion and driving people out of the regulated financial system would undermine the integrity of the entire financial sector,” he said in the speech.

More recently, Comptroller of the Currency Thomas J. Curry said in a speech in Washington, D.C., on March 7 that while banks’ concerns about the BSA/AML risks posed by certain kinds of businesses are legitimate, “decisions to terminate relationships can have regrettable consequences.

“Transactions that would have taken place legally and transparently may be driven underground,” Curry said in his remarks. “Customers whose banking relationships are terminated and who cannot make alternate banking arrangements elsewhere may effectively be cut off from the regulated financial system altogether.”

Conflicting messages

Many banks, however, feel like they are receiving conflicting messages from regulators. While they are expected to provide banking services to businesses that are high risk, they also have to deal with enhanced BSA/AML scrutiny from the regulators, not to mention incurring higher compliance costs when banking these high-risk businesses.

Banks also could face large fines if they are deemed to have violated BSA/AML rules, even inadvertently. As a result, some banks are deciding it’s simply not worth the hassle and cost of doing business in certain industries and thus are severing ties with certain types of businesses.

“The regulatory expectations for banks regarding BSA/AML compliance are unclear and inconsistent,” said John Byrne, executive vice president of the Association of Certified Anti-Money Laundering Specialists. “For example, the regulators are saying there is an exam manual for banks and they haven’t issued excessive fines and penalties. But they have issued a tremendous volume of ‘matters requiring attention’ and ‘matters requiring immediate attention’ — these are formal criticisms that must be rectified right away.”

The bottom line is that banks have to perform risk assessments to determine if they can cost-effectively manage the risk involved in banking certain categories of customers. “Even when banks determine that they have adequate risk mitigation policies and transaction monitoring processes in place, they may still decide that it’s not worth fighting the examiners to retain customers that aren’t that profitable anyway,” Byrne said. “In the end, they have to make the best business decision for the bank.”

One strategy is to account for the enhanced BSA/AML risk when pricing loans to these categories of customers. However, that is often easier said than done. Accounting for credit risk is one thing, but accounting for BSA/AML risk when pricing loans tends to more subjective and trickier.

Regulatory guidance

In his recent speech, Curry acknowledged the OCC generally does not direct banks to either maintain or sever account relationships. “The decision to exit a line of business or to terminate a banking relationship with a customer resides solely with the bank, not with the OCC,” he said in the speech. “Institutions must make their own choice about whether to enter into or maintain a business relationship.

“Nonetheless, both hard and anecdotal data show that many such relationships have been terminated, particularly those with foreign correspondent banks. This data has compelled the OCC to take a deeper look at how banks conduct risk reevaluation.”

The OCC is gathering data to get a better picture of these practices and may issue future guidance to banks regarding the issue.

A lack of clear communication or guidance from the regulators regarding their BSA/AML compliance expectations is one of the chief complaints from banks. “There doesn’t seem to be a recognition that the financial sector is, in large part, reacting to the uncertainty of risk,” Byrne said.

However, Byrne said he is encouraged by Curry’s speech indicating that the OCC might consider issuing additional guidance to banks. “This is an opening that wasn’t there before,” he said.

Freelance writer Don Sadler contributed to the writing and research of this article.

By |2019-11-25T08:33:07-06:00May 16th, 2016|Financial Services|0 Comments

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