A Call for Action on De-Risking – Podcast with US Treasury Under Secretary Nathan Sheets

Summary

Podcast Summary: "A Call for Action on De-Risking" – CGD Podcast with US Treasury Under Secretary Nathan Sheets

Podcast: The CGD Podcast
Host: Center for Global Development (Rajesh Merchandani)
Guest: Nathan Sheets, US Treasury Under Secretary for International Affairs
Date: November 17, 2015
Theme: The impact of anti-money laundering (AML) and combating the financing of terrorism (CFT) laws on financial inclusion and de-risking in developing countries.

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Overview

This episode centers on the unintended consequences of AML and CFT regulations—specifically, their role in driving financial institutions to "de-risk," or withdraw from business relationships deemed high-risk, often affecting developing countries. Nathan Sheets discusses how both financial inclusion and financial system integrity can—and must—coexist, and outlines the responsibilities of banks, policymakers, and regulators in addressing the problem without compromising security.

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Key Discussion Points & Insights

1. The Double-Edged Sword of AML/CFT Laws

• Purpose of AML/CFT: Enacted to prevent money laundering and terror financing, laws have inadvertently led banks to withdraw from risky markets, a process known as "de-risking" ([00:04]–[02:00]).
• Victims of De-risking:
  • Remittance recipients reliant on money from migrant workers
  • Small businesses and banks in developing countries needing access to international finance
  • NGOs and humanitarian groups operating in challenging environments

2. Why the US Treasury Cares

• Treasury’s Mandate: Sheets emphasizes a dual objective:
  • Efficient, global financial intermediation and inclusion
  • Preserving the integrity and security of the system
    "[We want] to ensure that the financial system is able to efficiently intermediate and mobilize resources… and to make sure that the system has integrity and is not abused." — Nathan Sheets ([02:41])
• Long-term Goal: Foster a system that supports growth and access while minimizing illicit activity.

3. The Regulatory Labyrinth

• Complexity for Banks: Confusion arises from overlapping requirements (31 agencies in the US alone).
  "The issue of clarity and of communication is absolutely front and center." — Nathan Sheets ([05:15])
• Need for Clarification: Both regulators and banks share responsibility:
  • Regulators must better articulate expectations
  • Banks must avoid "indiscriminately cutting off" entire classes of clients

4. The Role of Banks

• Expectations for Financial Institutions:
  "We very much expect banks to be playing a role in financial intermediation…not indiscriminately cutting off classes of institutions or counterparties." ([07:19])
• Proper Risk Management: Banks should assess and manage risks case-by-case rather than wholesale account closures.
  • "[Banks should] commit significant resources and take on new responsibilities." — Nathan Sheets ([08:08])
• Historical Role:
  "The role of the banks…is to channel funds from depositors to lenders… they have to manage risk, they have to assess risks, and that's inherent in their business." — Nathan Sheets ([08:33])

5. The Cost of Better Compliance

• Who Pays?: While banks will bear the upfront costs, a safer and more stable system is a long-term benefit.
  • "It wouldn’t surprise me if over time, these kinds of reforms ended up paying for themselves." — Nathan Sheets ([09:42])

6. Data Sharing and Transparency

• Data Bottlenecks: Institutions have data but are reluctant (or unable) to share, hampering effective policy and research.
  • Example: Legal reforms allowing Mexican banks to share data with US banks improved cooperation.
    "It’s important that [information] be collected and regularized so it can be studied across institutions." — Nathan Sheets ([11:03])

7. Risks of Inaction

• Potential Fallout:
  "One [equilibrium is] where financial institutions are backing away and we end up having a less interconnected global financial system. I think that’s at the peril of the global economy." — Nathan Sheets ([12:23])
• Vision for the Future: Collaboration will lead to a balanced, inclusive, and secure global financial system.
  • "We’re looking for…institutions [that] take the necessary steps, where regulators…clarify expectations and this business is able to be brought back on balance sheet in a constructive way." — Nathan Sheets ([12:23])

8. Balancing Inclusion and Security

• Core Challenge: Address the unintended consequences without weakening security objectives.
  • "As systems are put in place…as financial institutions train their staffs, the risks…can be managed and mitigated rather than ones that they have to pull back from entirely." — Nathan Sheets ([13:35])

9. The G20’s Role

• Global Policy: The G20 has prioritized financial inclusion and cheaper remittances.
  "The G20 in the area of financial inclusion has a robust agenda…committed to ensuring that these flows continue… and that the cost of these flows remains economic." — Nathan Sheets ([14:32])

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Notable Quotes & Memorable Moments with Timestamps

• On Joint Objectives:
  "[We are] committed to addressing [correspondent banking challenges] in a way that protects our joint goals of supporting financial connectivity and inclusion and maintaining the integrity of the financial system." — Nathan Sheets ([01:23])

• On Banks' Responsibilities:
  "We expect them to play a role in managing risks and not indiscriminately cutting off classes of institutions or counterparties." — Nathan Sheets ([07:19])

• On Data Sharing:
  "To the extent that there are bottlenecks that prevent the sharing of data, steps [must] be taken to eliminate those bottlenecks." — Nathan Sheets ([11:03])

• On the Dangers of De-risking:
  "We end up having a less interconnected global financial system. I think that's at the peril of the global economy." — Nathan Sheets ([12:23])

• On Sustainable Solutions:
  "As financial institutions train their staffs, the risks…can be managed and mitigated." — Nathan Sheets ([13:35])

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Important Segment Timestamps

• [00:04] — Introduction to de-risking and unintended consequences
• [01:23] — Nathan Sheets' speech excerpt on US Treasury’s position
• [02:41] — Sheets outlines Treasury’s dual objectives
• [05:15] — Regulatory confusion and need for clarity
• [08:08] — Direct discussion of banks' responsibilities
• [09:42] — Who should pay for compliance costs?
• [11:03] — Data sharing and regulatory bottlenecks
• [12:23] — Risks to the global system if left unchecked
• [13:35] — Reconciling security and inclusion goals
• [14:32] — Expectations from the G20

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Tone & Final Thoughts

Throughout, both host and guest emphasize that protecting the financial system and supporting global development are not mutually exclusive. Sheets’s approach is practical, collaborative, and optimistic yet clear-eyed about the challenges. He calls for continued regulatory clarity, greater investment from both banks and governments, and ongoing international cooperation, especially from global forums like the G20.

The episode offers a succinct yet nuanced look at how well-intentioned policies can have far-reaching impacts—both positive and negative—on development, security, and the fabric of international finance.

Transcript

[Nathan Sheets]

Foreign.

[Rajesh Merchandani]

Hello, I'm Rajesh Merchandani, and thanks for joining me for the CGD podcast. Recently, CGD launched a new major report into how laws that are designed to prevent money being sent overseas to terrorists or criminals can have unintended consequences for innocent people in developing countries. And let's just stress that these laws were brought in because of very real concern concerns about security. And that's something that's been brought home to us again by the recent terror attacks in Paris. But here's the problem. They're called anti money laundering and combating the finance of terrorism laws AML cft. And they carry huge fines for financial institutions that do not comply because knowingly or not, they've done business with someone who turned out to be dodgy. So to avoid the risk of the potential fine, banks are pulling out of markets they see as potentially risky. And that tends to mean developing countries. It's called de risking. This problem has been recognized at the highest levels of the G20 as well. And recently Dr. Nathan Sheets, who's Under Secretary of Treasury for International affairs, came to CGD to help launch our report with a speech about the problem. I sat down with him afterwards to record an interview. That's today's podcast. Remember, it was recorded before the Paris terror attacks. We'll hear that podcast in a second, but first let's hear a clip of his speech.

[Nathan Sheets]

We take the challenges surrounding correspondent banking relationships and money service businesses seriously, and we are committed to addressing them in a way that protects our joint goals of supporting financial connectivity and inclusion and maintaining the integrity of the financial system. Both of these goals are essential. We realize, however, that to achieve this outcome, not only do banks have to commit significant resources and take on new responsibilities, but policymakers must do so as well.

[Rajesh Merchandani]

That was Nathan Sheets, Under Secretary of Treasury for International affairs, speaking recently at CGD about the problem of de risking. Now here we look at this through a development lens. De risking impacts people who depend on money sent home by foreign migrant workers, remittances. It also impacts small businesses or banks in developing countries that need access to capital and to the international financial system. And it can impact organizations, say, like NGOs operating on the ground doing humanitarian or disaster relief. So that's why it matters to us here at CGD. But when I spoke to Dr. Sheets, I started by asking him why it matters so much to the US Treasury.

[Nathan Sheets]

I articulated a framework in my remarks that emphasize these joint goals of on the one hand, we want to do everything we possibly can to ensure that the financial system is able to efficiently intermediate and mobilize resources to their most efficient use across the globe, wherever that may be. A related objective that I would put in that cone of efficiency is continue to allow people across the world to have access to the system. So this objective of financial inclusion is crucial and central for us, along with thinking about generating a financial system that's able to support growth over the medium to long run. And then the second core value that I articulated that I think is important because we want to make sure that the system has integrity and it and is not abused. So it's this joint pursuit of these various objectives. And I think all of them are crucial and all of them are right at the heart and core of Treasury's mandate.

[Interviewer from CGD]

And there's almost an irony here, isn't there, that anti money laundering and combating the finance of terror laws, aml, CFT are designed to make international financial flows more transparent. But is there a risk that de risking is driving these transactions underground, making the system more opaque?

[Nathan Sheets]

My feeling is the point you make underscores how important it is for the policy community to get this right. We want to see these flows occur and to the extent possible, we want to see them occur in the conventional regulated banking system.

[Interviewer from CGD]

Let's pick up on a few things that you talked about. It's banks that are doing the de risking. Banks are often portrayed as the bad guys, but they're the ones who are saying, and we've got examples of this in the report, that the rules are confusing. You talked about this in your comments. In fact, in our report we document 31 different agencies with jurisdiction in this area in the US alone. And then that's not even getting into the complexities in Europe. How are you trying to clarify that or how important is it to kind of wade through that sort of labyrinth?

[Nathan Sheets]

The issue of clarity and of communication is absolutely front and center. My sense is that if there is one challenge for us in the official sector, it's to continue the efforts we've started. And I think that in recent years we've made progress, but there's clearly more work to be done to articulate what is expected of banks, what it means from our perspective as official sector and from the perspective of the regulators, what it means to manage the risks and to underscore that these requirements don't envision zero tolerance or zero error.

[Interviewer from CGD]

So there's work to be done both by the regulators and by the banks. Let's come on to the banks in a sector, in a Second, what more do you think, or what would you like to see in terms of the regulatory landscape on this if you could change it now?

[Nathan Sheets]

Right. So in my remarks I articulated a very rich work program that is occurring in the official sector under the umbrella of the fsb, which is including this whole set of issues. I achieve a better data collection that I think will allow us to better define and banks to better understand what is happening and to make better decisions. Further clarification of what's expected, an increased technical assistance to support compliance. I think all of these things are necessary. The FSP has been vital in this role. And in addition, we've also seen a range of constructive contributions from the enforcement.

[Interviewer from CGD]

Side through fas, so greater technical assistance. So actually the regulators saying to banks, this is what you need to do and this is how you need to do it.

[Nathan Sheets]

I would think that this would be more technical assistance in various jurisdictions where this is happening, where the de risking has been observed in order for those institutions, institutions and counterparties in those jurisdictions to take steps that would make them less risky in the eyes of the banks. But it's also imperative for the banks to do their part. And this is the key point that we very much expect banks to be playing a role in financial intermediation. We expect them to play a role in managing risks and not indiscriminately cutting off classes of institutions or counterparties.

[Interviewer from CGD]

That is exactly the quote from your remarks that I wrote down. In fact, let me just, let's not.

[Rajesh Merchandani]

Let the banks off the hook entirely here. You said, I see de risking as.

[Interviewer from CGD]

A situation in which financial institutions indiscriminately terminate customer relationships without a careful assessment of the risks and tools available to manage and mitigate those risks. And then you also say, what should they do? They should commit significant resources and take on new responsibilities.

[Nathan Sheets]

Nicely said.

[Interviewer from CGD]

It was written. Well, what's your message to the financial institutions about their responsibilities, about taking them seriously?

[Nathan Sheets]

So as I underscored and as that remark indicated, that the role of the banks, and I think that this is a historical role that's well established, is the banks are there to intermediate and to channel funds from depositors to lenders. And in order for that to happen, they have to manage risk, they have to assess risks, and that's inherent in their banks business. So the bottom line that I would have is to think carefully on a case by case basis about the various relationships they have and to think carefully about the scope that they have to manage and to mitigate risks and not to make decisions about a broad class of customers. And I think, I'm not saying necessarily that the banks have done this, but we have seen a lot of account closures.

[Interviewer from CGD]

Who's going to pay for the extra responsibilities that banks should take on board? I mean, they're going to pay for it, but ultimately, who's going to pay for it?

[Nathan Sheets]

Ultimately, it will require some investment for the sake of institutions. My sense is that it contributes to stronger, safer financial institutions and a stronger, safer financial system. It wouldn't surprise me if over time, these kinds of reforms ended up paying for themselves. But I think that in any event, it's consistent with the regulatory initiatives and regulatory agenda that the policy community has pursued in the aftermath of the financial crisis that capital standards, liquidity, stand leverage standards have all been raised. And there might be some costs associated with that in the near term, but over time, I think when you factor in particularly potential social costs that occur at the time of financial crisis, that it makes the system safer and these institutions safer.

[Interviewer from CGD]

One thing you called for was better data, more and better data. Absolutely echoed in the recommendations in the report. But actually our team is saying that a lot of the institutions have data, but they're not sharing it. So is there a way to make them actually share the data? And can we have some of it as well so we can research it better?

[Nathan Sheets]

So certainly more data is positive and constructive. That's very much where we think that this discussion should go. A related point is that individual institutions have this information. It's important that it be collected and that it be regularized so it can be studied across institutions. And it's also important that to the extent that there are bottlenecks that prevent the sharing of data, that steps be taken to eliminate those bottlenecks. An example of this is in some of the conversations with Mexican banks. Mexican banks couldn't share certain kinds of data with US Banks because of the Mexican bank secrecy laws. Laws were modified so that bottleneck was removed, which has facilitated increased discussions with the Mexican banks and has moved in a meaningful direction toward addressing the problems that were occurring in Mexico.

[Interviewer from CGD]

If this problem is left unchecked, do you worry about its effects on, say, the U.S. banking system? I mean, you mentioned in your remarks your responsibility to safeguard the integrity of the dollar. I mean, that's quite a leap almost to me.

[Nathan Sheets]

So in the remarks, I sketched out these three equilibriums. One where financial institutions are backing away and we end up having a less interconnected global financial system. I think that's at the peril of the global economy. It's at the peril of the U.S. economy and the global system. That is clearly, clearly not the outcome that we're looking for. We're looking for the outcome in the third case where institutions take the necessary steps, where regulators, enforcement agents take the steps to clarify expectations and this business is able to be brought back on balance sheet in a constructive way.

[Interviewer from CGD]

Let's look at this as we come to a close. Let's look at this from a slightly alternative perspective. If you want to kind of close these gaps between what banks think they should be doing and what regulators want them to be doing and get rid of these unintended consequences that we've identified in the report. How do you address that without appearing to be soft on security? Because AML CFT laws were put in place for justifiable and real national security reasons.

[Nathan Sheets]

So that's of these two goals of on the one hand, efficiency and inclusion, and on the other hand, safety, soundness, integrity. That's, that's the other leg of it. And I'm comfortable that as systems are put in place, as the investment occurs, as financial institutions train their staffs, that the risks associated with this kind of business are risks that can be managed and mitigated rather than ones that they have to pull back from entirely. So I'm reasonably comfortable that over time, as this continues to evolve, as we move, as I mentioned, to the new equilibrium, there will be one that is characterized by financial inclusiveness.

[Interviewer from CGD]

Now, finally, G20 leaders are discussing this issue. They're looking at it through the lens of attempts to make remittances cheaper. It's high on the agenda. What do you want to see come out of the G20 on this issue?

[Nathan Sheets]

My feeling is that the G20 in the area of financial inclusion has a robust agenda and it's one that's very much committed to ensuring that these flows continue in the global system and that the cost of these flows remains economic. So I think that it would be constructive and it's what I expect to hear. The G20 leaders continue endorse the continued work on this. I think we're on a good trajectory and we just need to keep moving forward with it.

[Rajesh Merchandani]

That was Nathan Sheets, Under Secretary of Treasury for International Affairs Secretary, speaking with me recently here at CGD. Video of the whole event where Dr. Sheets took part to launch our report on the unintended consequences of anti money laundering policy is available on our website. So is the report. That's cgdev.org and I'm Rajesh Merchandani. Please do. Join me again for the next podcast from the Centre for Global Development.