Insight archive for David Howes | Standard Chartered

Cracking the remittance challenge

David Howes — Mon, 05 Mar 2018 09:57:35 +0000

In many emerging economies, remittance payments are not simply a financial service; they are a financial lifeline. For millions of families who rely on remittances for large portions of their day-to-day costs, they are a critical source of income. For local businesses, flows from 150 million migrant workers underpin domestic consumption. And for the broader economy, they have come to represent a vital engine for growth and development. To put this into context, according to a report published by the IFC last year, remittances to developing countries account for more than three times foreign aid (US$432 billion in 2015) and close to 10 percent of GDP in one in five countries.

Access to remittance payments and Remittance Service Providers (RSPs) matters. But they also represent an elevated risk for financial crime. RSPs have been exploited by organised crime and terrorist organisations as conduits to move and launder money, and finance some of today’s most damaging crimes. The top three areas for fines are breaches of Sanctions requirements, Correspondent Banking, and RSP activity. Many global banks have responded by exiting – also known as ‘de-risking’ – customers in this space, and this has led to reduced access to banking for RSPs as well as correspondent banking remittances.

As a result, we have seen the cost of remittance flows rise, which in turn can push financial flows underground with potential adverse impacts on trade and economic stability. In one extreme case in a region where RSPs have been significantly de-risked, physical movement of cash (via ships) has become cheaper and easier than trying to access the international financial system. The number of ships used for this cash-in-transit, in some areas of the Pacific, outnumbers the local navy and so far, exceeds their ability to supervise it. And this physical movement of cash (and so transfer of value) reduces transparency and thus increases exposure to financial crime risk and exacerbates the challenge for developing economies.

This goes to a central tension between safeguarding financial inclusion and protecting the integrity of the financial system. Increasingly, larger RSPs are aware of the expectations of the banks and those leaders among them are defining compliance programmes consistent with standards in place among international banks. These include identification and verification of its clients, payments transparency, responsiveness to information requests, and the ability to restrict future transactions when put on notice

Driving a wedge

The challenge comes when smaller institutions don’t have the knowledge, capabilities or financial resources to meet essential regulatory standards designed to safeguard the system from abuse by criminals.

This is driving a wedge between those who have the capabilities, knowledge and skills to comply with standards and those who can’t, because they don’t. That’s why a fresh look at the problem is needed.

Recently I was invited to take part on behalf of the Wolfsberg Group in the Financial Stability Board’s Roundtable on Remittance Service Providers. There, I shared an example from a parallel de-risking challenge that has resulted in a decline in correspondent banking. As the leading bank in many of the emerging markets we serve, correspondent banking is in our DNA.

And so, over the past two years we have been pioneering a new approach to helping Respondent Banks who have the right intentions but not yet the right tools, knowledge or experience to build robust controls for financial crime risks. This has crystallised in a unique strategy called ‘De-Risking Through Education’. It comprises three elements: correspondent banking academies, regional workshops, and e-learning portals.

"Our approach offers a good blueprint for partnering with institutions in other sectors to drive commerce and prosperity within the regulatory frameworks designed to keep society safe"

So far over 3,600 participants from over 1,100 correspondent banks, across 71 countries, have taken part. We have experienced huge pull from national banks determined to strengthen their controls and keep pace with evolving threats. By involving our client relationship managers, the programme is transformed from being just another training session into an important part of our customer relationships.

Our approach offers a good blueprint for partnering with institutions in other sectors to drive commerce and prosperity within the regulatory frameworks designed to keep society safe.

Supporting NGOs and charities

We have already adapted the Correspondent Banking Academy model to the NGO and charity sector, and the learnings from these two programmes could provide the foundations for improving the financial crime compliance capabilities of RSPs.

I believe three additional things need to happen alongside strengthening RSPs’ capabilities to manage financial crime risk:

1. Payment transparency is necessary but not sufficient in and of itself. RSPs should be drawing on the standards set out in the opens in a new windowWolfsberg Payment Transparency Principles. Where on investigation, banks need a richer understanding of the profile, purpose, provenance, and destination of the transaction, RSPs should be responsive to information requests.

2. There needs to be agreement on what good standards look like – including creating greater alignment between national regulations and global standards. An analogue is the work of the Wolfsberg Group to create a unified Client Due Diligence questionnaire for respondent banks. In doing so, we need to ensure that the expectations of RSPs are reasonably attainable, that RSPs are given time to enhance their financial crime control frameworks, and help in understanding and in reaching these standards in a cost-effective manner. And countries with large concentrations of RSPs should ensure that their local regulations outline clearly expectations, which in turn should be aligned to global standards. It’s encouraging that the larger RSPs are working to develop an industry view on appropriate standards and the banking sector should engage with the RSPs on expectations.

3. Further work is required to achieve more effective supervision. Many regulators have increased focus on RSPs in order to drive control improvements over the past five years, but the perception and I think the reality remains that the due diligence banks undertake will be called into question when there are failures of an RSP irrespective of the fact that the RSP is subject to regulation in the same country as the bank. This remains a sector widely described by regulators as high-risk and that places on banks a set of expectations in relation to their controls.

In summary, to arrest the decline in access to banking for RSPs and the associated costs for remittances, there must be clear risk-based standards that are reasonably attainable, commitment by the RSPs themselves to meet these standards, improved supervision, capability building to attain those standards, and international regulatory support.

The unintended consequence of tackling financial crime

David Howes — Tue, 20 Sep 2016 11:45:40 +0000

Correspondent banking has been a cornerstone of transaction banking for many years, facilitating the cross-border flow of goods and services, and connecting banks and their customers from around the world.

However, as banks, regulators, policymakers and law enforcement agencies address the challenge of tackling money laundering and the financing of terrorism, one outcome is that some banks are choosing to de-risk their business by exiting correspondent banking in certain markets, with very real implications for the global economy.

With companies of all sizes now involved in global trade – and given the complex nature of supply chains – the ability to make and receive international payments is essential to doing business. No bank has a global network that can facilitate cross-border payments and collections across all currencies, so correspondent banking fulfils a vital role.

"Increasingly stringent regulation is resulting in some banks choosing to reduce their correspondent banking activities"

However, there is growing evidence that increasingly stringent regulation, together with the cost and risk of compliance with these regulations, not to mention the potential for reputational risk, is resulting in some banks choosing to reduce their correspondent banking activities from specific client segments or entire markets.

This particularly applies to regions where banks believe that the potential risks and costs of associated controls outweigh the strategic benefits of serving those markets, with the Caribbean, East Asia Pacific, Eastern Europe and Central Asia most affected.

Access problem

Banks are committed to the fight against financial crime and have invested billions of dollars to reduce access to the banking system for its perpetrators. However, the complexity of compliance with diverse regulations across markets, the uncertainty around interpretation and implementation, and the risk of significant penalties in case of non-compliance is having unintended consequences.

Specifically, the impact of banks’ decisions to de-risk their business is that local and regional banks, and remittance providers, are finding it more difficult, if not impossible to access international services. This, in turn, affects cross-border payments and collections and trade finance, endangering already fragile trade and posing a threat to financial inclusion.

IMF concerns

This issue are now being discussed at the top table of international finance. Managing Director of the International Monetary Fund (IMF) Christine Lagarde recently emphasised that regulators in both developed and emerging countries had a role to play in halting the decline and helping banks to maintain their correspondent banking relationships.

Lagarde pointed to the fact that at least 16 banks in five countries in the Caribbean had lost all or some of their correspondent banking relationships by May of this year, and that countries such as Belize have been particularly hard-hit, stressing that ‘even if the global implications of these disruptions are not visible so far, they can become systemic if left unaddressed.’

She added that smaller countries need to upgrade their regulatory and supervisory frameworks to enhance compliance with international standards, particularly in areas such as anti-money laundering and anti-terrorism finance compliance.

Positive steps

Despite the perceived challenges, the good news is that banks and key international bodies such as the Financial Stability Board (FSB) are united in their recognition and desire to maintain access to the international financial system for businesses and individuals in many of the world’s most vulnerable regions.

The FSB is working in partnership with the Basel Committee for Banking Supervision, the Committee on Payments and Market Infrastructures (CPMI), the Financial Action Task Force (FATF), the IMF, the Legal Entity Identifier Regulatory Oversight Committee and the World Bank to address this issue.

In July 2016, for example, a report released by the CPMI emphasised that banks’ network of correspondent relationships appears to be shrinking, with the risk that cross-border payment networks could fragment, resulting in a narrower choice of options for payment users.

The CPMI proposes three next steps:

First, a focus on further data collection and examination to understand the current situation more fully and the implications, with a number of bodies having undertaken studies
Second, clarify regulatory expectations, including more guidance from FATF, which is working to outline in more detail customer due diligence expectations for correspondent banks when working with respondent banks
Third, continued support for domestic capacity building in the most affected locations is important, including assessments and technical assistance to help identify and address deficiencies before they result in a reduced access to the global financial system

Banks also have a role to play by recognising the wider implications of their commercial and regulatory decisions to exit specific markets or activities. There are undoubtedly challenges. However, banks have an important role in collaborating to build consensus over controls such as ‘know your customer’.

How to continue supporting economic development

At Standard Chartered, we take our responsibility for managing financial crime risk very seriously. We have developed a strategy for correspondent banking called ‘de-risking through education’, focusing increasingly on how we partner with those clients who have the right intent but not yet the right tools or experience to build robust controls for financial crime risks. For example, we are actively promoting training and workshops for our clients through our ‘Correspondent Banking Academy’, as well as continuing to invest in due diligence and oversight.

"We are collaborating through industry bodies such as the Wolfsberg Group"

The value of this approach is not simply to strengthen compliance, but also to build strong, open and pragmatic relationships with clients. We are also collaborating through industry bodies such as the Wolfsberg Group to engage in the discussion as to what constitutes an appropriate level of transparency, how the regulators can support correspondent banking, and law enforcement derive benefit from financial intelligence. These measures will help to make the financial system a hostile environment for criminals and terrorists, whilst supporting the economic development that is important for the societies we serve.

China’s debt turned a corner (and no-one noticed)

David Howes — Thu, 19 Mar 2015 11:08:29 +0000

Much of the negativity about world growth prospects at the moment seems to stem from the absence of a credit boom in any major market and worries over the consequences of higher US interest rates for the first time since 2006.

The lack of a credit boom means that growth is more subdued than it was in the run-up to the global financial crisis.

Positive signs

In particular, there are fears about China’s growth prospects, given the recent bad news concerning weak credit demand, high real interest rates and tight liquidity. However, we see three reasons for at least some optimism:

First, China’s debt-to-GDP ratio stabilised as of mid-2014, albeit at a relatively high 251 per cent of GDP.

While China’s dramatic debt increases of the past five years grabbed headlines worldwide, as the ratio leapt nearly 100 percentage points from 155 per cent of GDP, the fact the ratio has begun to stabilise has not yet received much attention.

This is an important milestone in China’s debt turnaround, following years of excess. Over the past five years, total credit growth in China was on average 8 percentage points faster than nominal GDP growth – way beyond the point at which credit growth becomes inefficient for any economy.

"Since mid-2014, China’s credit has been growing in line with GDP"

However, since mid-2014, China’s credit has been growing in line with GDP. Essentially, this means China is now getting more ‘bang for its buck’ for every new unit of borrowing. Also, attitudes to debt have changed, with loan officers in China much more averse now to taking the risk of a loan going bad than previously.

While this doesn’t mean that China’s leverage risks have been resolved, as the excessive debt accumulation of prior years still needs to be dealt with, it does mean that debt challenges are no longer escalating, which is good news.

Resuming past excesses is not an option. China’s debt-to-GDP ratio is still relatively high compared with other economies at a similar stage of development, so debt cannot be used to boost growth significantly in the near future without risking even more solvency issues later.

The official non-performing loan ratio is set to keep rising through 2015 and beyond. Most likely not all of the bad debt will be recognised immediately, which comes with both benefits and potential costs.

On the upside, we are unlikely to see a sudden jump in China’s non-performing loan ratio, which could have led to a possible market panic.

On the downside, those unrecognised bad loans may mean that interest costs are turned into principle and count towards new credit growth. Unfortunately, by definition this part of credit growth is not going to generate new GDP.

A careful watch

We will need to watch carefully whether this ‘evergreening’ of bad loans becomes too large a share of new credit growth. Importantly, this does not appear to be the case so far.

The second reason to be a bit more upbeat about China is the sign of positive sentiment among property developers. Results of our recent property market survey of 30 companies in five major cities around China – which we have been running twice a year since 2010 – indicate that the industry will be in better shape by the second half of 2015, which bodes well for China’s growth.

Developers believe the excessive amount of inventory in lower-tier cities will be worked through by the second half of 2015. They also anticipate better appetite for land investment among their peers before the end of this year. This is good news, given the drag on GDP growth from the sector recently.

"While we all should be getting used to China’s ‘new normal’ of slower growth we should not be worried about the slowdown deepening even further"

Finally, our SME survey of over 600 companies across China showed a slight improvement in sentiment in January from a low in December.

The results indicate that this optimism is being supported by broad-based policy easing in China. And, as we expect to see more monetary easing in the form of at least two more reserve requirement ratio cuts and a further lowering of policy rates, business confidence could continue to improve.

While we all should be getting used to China’s ‘new normal’ of slower growth we should not be worried about the slowdown deepening even further in 2015 and 2016.

Reforms will drive growth

There are many reasons to be less bearish on China than the present consensus, and the fact that there is no unsustainable credit booming taking off again in China, or anywhere else in the world’s major economies, should be a source of relief.

Growth of 7 per cent annually means that GDP doubles every 10 years – a very respectable rate for any economy at China’s present stage of development. While by no means guaranteed, we are also waiting for potential growth-boosting measures over the longer term from structural reform of rural land, the ‘hukou’ system and the state owned enterprise sector.

We are also encouraged by the planned CNY 1 trillion debt swap initiative, which aims to convert more than 50 per cent of the local government due for re-financing in 2015 into lower interest cost bonds.

In the meantime, expect financial reforms from China in 2015 to help shift its allocation of capital even more towards being determined by market forces – making growth more sustainable.

A version of this article was first published in beyondbrics on 19 March 2015

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