Government officials and industry professionals have long stressed the importance of regulatory compliance for their firms and for the wider financial services industry in the Cayman Islands.
But in places like the Caribbean, the stakes are even higher than that: One non-compliant firm or individual can tar the entire region with the same bad reputation, according to Adrian Sanchez, the director of LexisNexis’ financial crime compliance solutions in Latin America.
That has indeed been the case in the banking sector, with the region’s reputation for drug trafficking and money laundering leading to major international banks limiting their operations here or pulling out altogether – a phenomenon known as “de-risking.”
De-risking has been on the increase in recent years, impacting the Cayman Islands and other Caribbean financial jurisdictions.
Government officials here attribute the continued decline in the number of Cayman-registered Class B banks – which are restricted to conducting business offshore with non-residents – to the fact that they are unable to secure correspondent banking relationships with global banks. The problem has been reported in the British Virgin Islands, too, with at least 11 Panamanian trust firms having their BVI offices’ accounts closed by a major international bank after the Panama Papers scandal.
In total, about 75 percent of the world’s largest banks have engaged in de-risking in the Caribbean, Sanchez said at the 13th annual Anti-Money Laundering/Compliance and Financial Crime Conference on Oct. 2-3.
This has had a widespread negative impact on regional trade, remittances, charity, and other services that require the use of the banking sector, he said.
By limiting credit to potential entrepreneurs, it is also hampering innovation, added the financial crime expert.
“Many financial institutions have been turning away customers because of their KYC policies, and this has been particularly affecting small businesses because they are not able to comply with strict KYC policies, and therefore they’re being denied access to credit needed to expand their businesses,” he said.
Moreover, the irony of de-risking is that by limiting access to reputable international banks, it has made the region more susceptible to money laundering.
“If de-risking goes to an extreme, we could have a surge of cash-flowing activities, because all that money still needs to be moved somehow. And we could see a return of foreign currency and exchange black markets,” he said, adding that potential wrongdoers could also seek “other options such as smaller banks or credit unions, which don’t have the same infrastructure as large banks, and don’t have the same oversight. All these high-risk customers will be moving into less-regulated entities.”
But for all the handwringing over de-risking, Caribbean government have put forth few suggestions on how to solve the problem. At the conference, however, Sanchez said that the banking industry is working to come up with a solution.
However, such an initiative would require changes to international regulations in order to allow banks to share their clients’ information.
“We need to work with regulators and lawmakers,” said Sanchez.
In the meantime, a global bank that figures out an efficient and inexpensive way to manage risk could capture markets like the Caribbean and rake in huge profits, he said.
Right now, the profit incentive is not strong enough for banks to devote significant resources to examine risk in the region on a case-by-case basis.
However, banks are coming under increased pressure from regulators to resist engaging in de-risking.
“They’re telling them de-risking is not in line with international standards. So banks are being torn between conflicting expectations,” said Sanchez. “On the one hand, regulators are telling them to scrutinize their clients, but on the other hand, they’re also urging them to completely walk away from high-risk areas or industries.”
Along with regulatory pressure, banks are also receiving negative feedback, and could be risking a class-action lawsuit or a discrimination claim by those who are excluded from the banking system. If those risks become serious enough, banks will have the proper incentive to find ways to manage their risk.
“There are no silver bullets, this is a very complicated topic,” said Sanchez. “But if we can work together – banks, regulators and lawmakers – the cooperation between stakeholders can clarify regulatory expectations and what the current needs of a specific region are, and we can work towards a specific solution.