Just a few years ago Lebanese banks were apprehensively awaiting regulations they expected would impact business. These arrived with the United States’ introduction of the Foreign Account Tax Compliance Act (FATCA), alongside international standards for anti-money laundering and counter-terrorism financing (AML/CTF), as well as the implementation of Basel 3 regulations – a framework for basically every aspect of banking, from corporate governance to working capital based on risk profiles, with rules more stringent than previous Basel frameworks. However, irrespective of their compliance in implementing those measures, Arab banks have complained that there have been a high number of closures or interruptions of correspondent banking relations (CBR) with banks in the rest of the world, primarily those in the United States and European Union.
Interruptions of CBRs cause more difficulty in banking relations and transactions, and can make business unprofitable for the banks. The main question is not why, but how much? A September report published by the International Monetary Fund (IMF), along with the Arab Monetary Fund and the World Bank, did not identify which banks in which countries were affected, but in total over 40 percent of banks in the region indicated a significant reduction in correspondent banking relationships. “We’re still trying to understand the true economic impact of this issue,” says Allison Holland, the IMF’s country director for Oman.
From an advocacy standpoint it is of less concern if Arab banks have a reduction in profits since they make enough money. But when the relationship with correspondent banks becomes more difficult, it impacts people’s lives and businesses. “The types of services and clients that have been reportedly most affected are, for example, in the trade and finance sphere, and small and medium enterprises (SMEs); so this could increase the cost of business for small and medium exporters,” Holland told Executive.
It is hard to judge the true scale of the CBR problem, because what the survey does, as much as it can do, is show its magnitude without much comparison to previous closures or interruptions. So while the results of the survey do provide an indication from this period, it does not feel very conclusive.
That more than half of the region’s banks experienced some level of interruption is an indicator that the banks were not lying about the fact that regulations made it harder and more costly for them to conduct transactions, and ultimately impacted services to business and private customers.
The number of banks reporting CBR interruptions has also increased. A 2015 survey by the Union of Arab Banks, in cooperation with the IMF, suggested at that time that the problem was not very significant for the region. The response rate for that survey, Executive reported last year, was not high, though the banks that did respond indicated that CBRs were becoming “more demanding, more time-consuming, more complex and more expensive to maintain.” By comparison, the latest IMF study shows that CBR interruptions are now a significant issue for many of the banks in the region, and that it has become more challenging.
Finding the drivers behind Arab banks’ CBR interruptions is difficult, says Holland. This past June the IMF issued a staff discussion note on the broader issue of correspondent banking relations that found interruptions were generally driven by banks conducting a review of the cost-benefit of different business lines and, based on their own risk perceptions, how they choose which business lines to maintain and which to pull out of. In international monetary policy lingo the IMF stated that: “cost-benefit analyses have been shaped by the re-evaluation of business models post-global financial crisis, including changes in the regulatory and enforcement landscape. The new macroeconomic environment, more stringent prudential requirements and higher compliance costs are putting pressure on banks’ profitability and weighing on their decisions to withdraw CBRs.”
From an operational perspective, it doesn’t matter why CBRs are closing accounts, but as an adjustment to strategy what can be done about it? One might assume that if a CBR becomes more expensive or is closed, customers might look for competitive channels outside the traditional financial system such as FinTech, Bitcoin or underground. The extent that these flows move from the formal financial sector into an informal financial sector raises broader issues of financial stability. “So the question is how do we do this in a way that achieves [stability] without creating too many unintended consequences,” Holland says.