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Refusal to Supply [Part 2]: a Discussion of Approaches to Mitigate the Impact of Financial De- Risking on Developing Countries

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Refusal to Supply [Part 2]: a Discussion of Approaches to Mitigate the Impact of Financial De- Risking on Developing Countries Refusal to Supply [Part 2]: A Discussion of Approaches to Mitigate the Impact of Financial De- risking On Developing Countries Michael Wechsler1 and Leon Perlman2 Abstract This report is the second of a two-part study on the phenomenon of de-risking, or what we believe is more aptly described as ‘refusal to supply services.’ The trend is mostly associated with large banks and other financial institutions exiting product lines and terminating or restricting relationships with clients or classes of clients who are perceived to be ‘high-risk.’ We find that refusal to supply mostly significantly manifests as the withdrawal or curtailing of critical correspondent bank relationships (CBRs), specifically refusals by large international banks to provide these services to smaller financial entities in predominately developing countries. The key is that world trade and remittances are denominated reserve currencies such as US Dollars (USD), UK Pounds and European Euros, among the most actively traded currencies. The loss of CBRs mean that developing countries are unable to access reserve currencies and thus are cut off from the international financial system. The impact is immediate: business cannot get paid or cannot pay suppliers; remittance flows slow to a trickle; and in many cases, fungible and non-fungible aid provided by aid groups and donors in crises countries is slowed or halted. The refusals by large international banks have a downstream effect for respondent and domestic banks who feel that taking on or retaining certain categories of clients would jeopardize their CBR. It also serves a signaling function within the international financial system as to products, clients, or jurisdictions that are considered high risk, reducing the ability of those entities to retain financial services even domestically. Refusals generally has a chilling effect on economies of affected countries, who have to, but often can’t, find workarounds to the blockages. The impact is particularly acute in those developing countries where remittances represent a significant percentage of Gross Domestic Product (GDP). Most affected by this phenomenon are countries in Africa, Latin America, small island developing states in the Pacific Rim, Caribbean and Asia. Our study determined that reasons for this termination/refusal are complex and the effects profound. In Part 2 of our study, we systematize and devise a taxonomy that categorizes the most prevalent approaches and ostensible solutions to the issue of refusal to supply. It investigates and analyzes some of the issues emanating from refusal to supply that require solving, including the capacity and will to do so, as well as some potential responses – technical solutions and financial mitigants. Many relate to identifying and verifying customers of financial institutions and of recipients of remittances, recognizing that one of the main reasons – amongst many discussed in Part 1 – for refusal are compliance-related money laundering concerns by global correspondent banks (GCBs) as to the ultimate beneficiary of funds sent through their systems to banks and money transfer organizations (MTOs) in and to what these GCBs consider high-risk regions. 1 Michael Wechsler, Associate Research Scholar, Digital Financial Services Observatory, Columbia Institute for Tele- information (CITI), Columbia University, New York. 2 Leon Perlman, Senior Research Scholar, Digital Financial Services Observatory, Columbia Institute for Tele-information (CITI), Columbia University, New York. 1 Refusal to Supply (Part 2): A Discussion of Approaches Mitigating the Impact of Financial refusal on Developing Countries We outline multi-national approaches and initiatives being tried that are policy-based and technology-based; as well as tactile methods such as carrying large amounts of cash (legally) across borders to recipients in Asia, Africa and the Caribbean. It is clear though from an analysis of each of the approaches and ostensible solutions, that there are no ‘silver bullets’ to halting refusal to supply and loss of critical cross-border financial services, but rather that strategies are needed at a supra-national, regional, and/or national level, or even affected entity level as the circumstances require it. Without that leadership, the trend of refusal to supply will increase, and increasingly skew international trade and affect the economic growth of developing countries. Affected countries too should step up their compliance regimes while still investigating alternative methods of cross-border transfer of value that allows their economies not just to survive potentially catastrophic effects of refusals on their GDP, but also to grow. The goal in most cases is to reverse the global decline in CBRs and to break through informational asymmetries that often act as a trigger for CBR terminations or refusal of service. Notably, we find, often what appears to be a ‘stop-gap’ solution acting as band aids to a particular problem of refusal of service in a particular jurisdiction may become the only, and thus permanent solution. ‘Cash Carrying’ is a simple example of the trend. 2 Refusal to Supply (Part 2): A Discussion of Approaches Mitigating the Impact of Financial refusal on Developing Countries Table of Contents Abstract ......................................................................................................................................................................1 Abbreviations .............................................................................................................................................................6 1 Introduction ......................................................................................................................................................10 1.1 Overview of Study ....................................................................................................................................10 1.2 Methodologies and Approaches Used in This Paper ................................................................................10 2 Nature of the Reasons for Refusal to Supply ...................................................................................................11 3 Nature of the Mitigants .....................................................................................................................................13 4 Technology-based Innovation ..........................................................................................................................15 4.1 Overview ..................................................................................................................................................15 4.2 Fintech ......................................................................................................................................................15 4.3 Regtech .....................................................................................................................................................16 4.4 Technologies and Application ..................................................................................................................17 5 Addressing Customer Identification .................................................................................................................19 5.1 Overview ..................................................................................................................................................19 5.2 Electronic Identification (eID)..................................................................................................................19 5.3 National IDs and Country Examples ........................................................................................................20 5.4 Legal, Privacy and Data Protection Considerations in eKYC ..................................................................22 6 Addressing CIV ................................................................................................................................................23 6.1 Overview ..................................................................................................................................................23 6.2 The Evolution of KYC Utilities for Customer Identification and Verification ........................................23 6.3 Private Sector Customer Identify and Verification Solutions ..................................................................24 6.4 National, Multinational and PPP CIV Approaches ..................................................................................25 7 Capacity Building and Technical Assistance ...................................................................................................26 8 Central Bank-Linked Approaches ....................................................................................................................27 8.1 Overview ..................................................................................................................................................27 8.2 Central Bank Accounts for NBFIs and/or Refused Entities .....................................................................27 8.3 Central Bank Accounts at Foreign Commercial Banks ............................................................................27 8.4 Central Bank Digital Currencies ...............................................................................................................28 8.5 Direct Linkage of Central Bank National
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