Wednesday, November 23, 2016

AMF Study: Bank De-Risking in the Arab Region -- Big Deal or Not?

AA: As Usual on Top of the Story.  It Looks a Lot Scarier Up Here. 


In an earlier post I outlined why the Hong Kong Monetary Authority's appeals to its banks to "manage correspondent risks" rather than "de-risk" were likely to fall on deaf ears.

Today I’d like to continue exploration of that topic by looking at September 2016 Arab Monetary Fund/IMF/IBRD study Withdrawal of Correspondent Banking Relationships (CBRs) in the Arab Region”.

Context – Survey Coverage
The report is based on a survey of 216 banks in Algeria, Bahrain, Egypt, Iraq, Jordan, Kuwait, Lebanon, Mauritania, Morocco, Oman, Palestine, Qatar, KSA, Sudan, Tunisia, UAE, and Yemen.  One country was excluded from “some analysis” as it is “perceived as a high risk area”. AA is guessing Yemen, though it is not the only “high risk” name in the list.   
  
Details

Apparent Modest Impact
  1. 55% of the banks surveyed did not experience any problems with closure of CBRS.  1% did not respond. 5% reported an increase in CBRs. 
  2. Only 39% (84 out of 216 banks) had CBRs terminated. 
  3. Of this latter group roughly 63% (53 banks) found replacement CBRs, and another 17% (14 banks) developed “workarounds”.  Perhaps an indication that all correspondents are not de-risking?
  4. Only 20% (17 banks or 8% of the 216 banks surveyed) did not find a solution.   
On this basis, it doesn’t seem that de-risking in MENA is a major problem at least at the macro level.

Two caveats.   

First, “limitations” in the survey (see below) preclude making a definitive assessment on impact as well as on the motive(s) for de-risking.  

Second, the number of accounts closed increased over the survey period 2012-2015 (Figure 5), indicating that affected banks are increasingly being disconnected from international finance.         

Primary De-Risking Banks

As expected US banks were the main de-riskers followed by the UK and Germany. Interestingly of the ten countries’ banks named as de-riskers, banks in Saudi were in 4th place and the UAE in 8th place AED and SAR accounts were closed. It’s not clear from the survey if the UAE and Saudi banks are solely responsible for the closures. 

It doesn't seem unreasonable to assume that they were at least partially responsible. If so, an intriguing but unanswered question.  Were their actions motivated by these banks’ own concerns or local regulations? Or are they defensive measures to prevent their foreign correspondents from “de-risking” them?

Survey “Limitations”

As outlined below, these limitations lessen the survey’s utility. Presumably some of this reflects a conscious decision to avoid creating a knock-on effect and potentially worsening the situation by providing too much public information.

Now to the limitations.

The size and location of the affected banks is not disclosed.  If major banks are being de-risked, the impact is likely to be greater than if smaller banks are.  If the de-risking is focused on one or two countries, then what appears to be manageable problem is not –at least for the affected countries.

It’s highly likely that correspondents did not provide a concrete reason for terminating a CBR. But rather used such words as “strategic review of our business”, “change in focus”. If you ever have had to let people go or were on the receiving end yourself, you know that these events are couched in euphemisms like “downsizing”. One doesn’t fire an employee.  Rather his or her position is “eliminated”.  Nothing personal there at all.  We’d love to have you but we don’t have a “position” for you.  The same with closure of accounts. 

If the reason for the firing or closure of an account is not directly “personal” or concrete, it’s hard for the affected party to mount an objection.  How do you argue your case?  Do you really expect the institution to change its board-approved strategy so you get to retain your job or account?    
  
To get around this likely scenario, survey respondents were asked to ascribe motives to the termination of CBRs.  The survey provides 16 possible “drivers” of the decision to terminate CBRs.  Respondents were free to select more than one and were asked to rank them from 1 to 16--which AA takes as an invitation to rank all of them.  Thankfully not every respondent did.  There were some 234 votes from the 84 banks.  Only 17% of the maximum possible number of responses.
  
There are two problems though.   

First, respondents are not only being asked to read their correspondents’ minds, but also to do so with a high degree of precision.

Second, many of the drivers are similar.  One might well need an electron microscope to parse these in any practical sense.  This compounds the dubious first assumption of mind reading skills.

Some examples of similar/duplicative motives.  Note the numbering below follows the rankings on pages 11-12 in the report.
  
  1. Driver 1 (overall risk appetite) seems to include Driver 4 (change in sovereign risk rating).  As to 4, if indeed it is an accurate assessment, then shouldn’t all banks in Country X be affected more or less at least by the same correspondent? Thus, one would find that all or most banks in Country X had their CBRs terminated.   If that’s not the case (and the AMF has the data), then this Driver should be excluded.    
  2. There are 10 Drivers related to regulatory reasons. Drivers 2, 5, 6, 8, 9, 11, 12, 14, 15, and 16 overlap to a large extent on AML/CFT, though those aren’t the only regulatory issues mentioned. It boggles AA’s mind that the survey constructor thought that participants would be able to provide such granular assessments of what their correspondents’ motives were.      
Third, it also seems (note that caveat) that in ranking drivers no adjustment was made for this overlap.   The summary puts AML/CFT in fifth place.  This seems based Driver 5 being in fifth place by number of “votes” while ignoring the votes for all the other AML/CFT related drivers. 
  
I think it would have been better to have a few very broad primary motives, e.g., credit, profitability, regulatory, refusal/failure to provide requested information.  Participants could have then been asked to ascribe a percentage to each.  This more limited menu probably would be not only easier but more appropriate given the inherent limitations of mind reading. 
  
Follow-up questions could have been used to attempt to parse sub-drivers with economy in options.  For example, was refusal/failure to provide requested information due to regulatory impediments (bank secrecy) or internal bank decision?  Were regulatory concerns focused on AML/CFT, sanctions, or other (e.g. FACTA)? 

Interestingly Driver 16 and part of Driver 8 consist of failures by the respondent bank to provide sufficient AML information, in which case one might argue that the correspondent was obliged by regulation to terminate the CBR or decided failure indicated not only bad faith but probable bad behavior.    The same with Driver 15 imposition of sanctions.  DPAs would be another example.

This is an important point.  If the correspondent is "forced" to withdraw services, this is not "de-risking" but compliance. Focusing a question on this issue would be most helpful.  

The survey noted that banks that found replacement CBRs or developed workarounds faced increased costs, but no data is provided on the relative increase in costs.

All this being said there is useful information in the study. 

Hopefully, it will serve as a basis for further examination of this issue with perhaps answers to some of the above open items as well as a fine tuning of questions.


There's an Occasion Every Day!

One quibble.  There’s always at least one and usually more with AA.
1.3 Hence, the “de-risking” phenomenon involves financial institutions’ practices of terminating or restricting business relationships with clients or categories of clients to avoid rather than manage risks. It is a misconception to characterize “de-risking” exclusively as an anti-money laundering/ combatting terrorism financing issue. In fact, “de-risking” can be the result of various drivers, such as concerns about profitability, prudential requirements, anxiety after the global financial crisis, and reputational risk.
  
The AMF is right to indicate that the motives for “de-risking” don’t relate solely to AML/CFT.  Sanctions and other regulations are important as well.

I’d argue that termination of unprofitable relationships is not “de-risking” nor is restructuring/eliminating lines of business to meet prudential regulations (increases in capital charges).  That’s simply common business sense.  If one can’t make a profit selling a good or providing a service, one stops doing so if there is no way to increase pricing or lower costs sufficiently. 

No doubt many of the small CBRs being tossed do not meet internal ROA targets and would require massive increases in pricing to do so.  At some point too banks like any business need to focus on key LOBs and customers.  “80% of the revenue comes from …”  If you've been around long enough, you know the last bit to that sentence and the business strategy it supports.  "Dabbling" or "hobbies" (my mentor’s descriptive terms) divert resources and attention from more profitable customers and LOBs.

Also it’s not clear to me how anxiety is playing a role.

Clearly any regulatory/prudential anxiety is already covered by those topics. 

If there are concerns about credit quality, then measures theoretically could be put in place to cover these.  Pay against receipt of funds only (no overdrafts), require cash collateral for residual risks (check deposits bouncing, for example), and increase pricing for the additional special handling required. 

But, if a relationship is marginally profitable, what's the point of all of this when the time and effort might be spent on other customers or LOBs where real money could be made?  And when 100% of the risks are unlikely to be covered despite all the elaborate risk management? 

But let's assume a correspondent exerts the effort. At this point, “risk management” might result in making an offer that can’t be accepted, equivalent to withdrawal of CBR. No doubt sparking the argument that “risk management” of this sort was really disguised “de-risking”.    

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