Fear of Being “Outed”: Why Banks Are Deserting Developing-Country Clients

Summary

The CGD Podcast: Fear of Being "Outed": Why Banks Are Deserting Developing-Country Clients
Date: March 10, 2015
Host: Rajesh Merchandani, Center for Global Development
Guest: Clay Lowry, Chair of CGD Working Group; Former Assistant Secretary of International Affairs, US Treasury

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Episode Overview

In this episode, the CGD Podcast delves into the unintended consequences of international anti-money laundering (AML) and counter-financing of terrorism (CFT) rules. Rajesh Merchandani speaks with Clay Lowry about how well-intentioned regulatory measures meant to curtail crime and terrorism are, paradoxically, shutting out legitimate financial services for people in developing countries—especially those depending on remittances. Their conversation sets the stage for why major banks are “de-banking” entire regions and sectors, and what that means for global development and financial inclusion.

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Key Discussion Points & Insights

1. Background: What Are AML and CFT Rules?

• Origins and Intent:
  • Designed to fight global crime and terrorism by cutting off illicit financial flows, measures include blacklists, naming-and-shaming, and large, escalating fines.
  • "After 9/11, the regime to try to fight this heightened up... All of this made sense in some respects, but it’s had some consequences." – Clay Lowry (01:12)
• Rising Risks for Banks:
  • Compliance costs and potential fines have soared (from hundreds of thousands to billions of dollars), making low-margin services like remittances increasingly unattractive.
  • "The fines for doing something wrong have increased dramatically... the largest one was $9 billion." – Clay Lowry (03:49)

2. The Downside: Withdrawal from Developing Markets

• Double Policy Dilemma:
  • Regulations to fight crime vs. the development objective of encouraging affordable financial flows to developing countries.
  • "As the fines have gone up, that risk has become too much for a lot of financial institutions. And so they stopped doing this." – Clay Lowry (05:35)
• Hard-to-Know Clients:
  • "Knowing your customer" is difficult in poorer or post-conflict countries due to poor information and data.
  • "It is now a risk on top of a risk on top of a risk just to do basic banking services in countries where ... we'd love to see good competitive financial flows." – Clay Lowry (06:51)

3. Scale and Impact

• Major Banks Exiting:
  • HSBC, Barclays, BNP Paribas, Citibank, JP Morgan, and Australian banks have all exited the remittances business due to risk.
  • "About 90% of remittance agencies in the UK [impacted]... It is a kind of a systemic thing." – Rajesh Merchandani & Clay Lowry (07:21)
• Remittances vs. Foreign Aid:
  • Annual global remittance flows are conservatively estimated at $400–450 billion, dwarfing traditional aid which is about one-third that size.
  • "The amount of money that people are sending home... is about $400 billion a year." – Rajesh Merchandani (08:37)

4. Real-World Effects: Somalia Case and Beyond

• Humanitarian Fallout:
  • Citing US senators' letter: "Decreasing remittances will exacerbate Somalia's humanitarian situation... One third of Somali families say they would not be able to afford basic food, medicines and school fees without help from their relatives abroad." (09:56)
  • Cutting these lifelines can boost insecurity and push people toward crime or terrorism as a last resort.
• Going Underground:
  • Pushing regulated players out risks shifting flows to less regulated, opaque, or even criminal channels.
  • "There's one possibility it’s going to go towards the shadows... going to banks that definitely are not as well known and not as transparent." – Clay Lowry (12:03)

5. Who’s to Blame?

• Banks as Victims?
  • Banks follow regulators’ guidance, but as risk outweighs profit, they de-risk to extremes.
  • "It's way too simplistic [to blame banks]. The banks in some respects are doing what is almost natural... It is just in their self-interest to just say we want no part of this anymore." – Clay Lowry (13:16)
• Regulatory Response:
  • The Financial Action Task Force (FATF) cautioned against total withdrawal, urging more nuanced risk management. However, for banks, exiting is often easier and safer than compliance.
  • "If you’re a financial institution, it’s much easier to basically say, how about I just get out..." – Clay Lowry (14:25)

6. Central Banks Speak Up

• Growing Regulatory Awareness:
  • Mark Carney (Bank of England) and Janet Yellen (Federal Reserve) have raised concerns with the G20 and US Congress, acknowledging the seriousness of the problem.
  • Yellen: "It's a difficult problem to deal with ... many [banks] are really very reluctant to want to take risks in their dealings when they may bring them in violation of those rules." (15:59)

7. The Way Forward: CGD's Working Group

• Seeking Solutions:
  • The CGD working group, including experts from various fields, aims to gather data and develop policy recommendations for both the public and private sectors by the end of 2015.
  • "Our working group... is going to have to try to come forward and think about some of the data problems and data issues and then what are some set of policy recommendations." – Clay Lowry (18:22)

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Notable Quotes & Memorable Moments

• On the scale of the change:
  "What it’s now coming is hundreds of millions of dollars. In fact, actually in a few cases, billions of dollars. I think the largest one was $9 billion."
  – Clay Lowry (03:40)

• On unintended consequences:
  "The irony of the whole thing is... if you cut off some of these well-founded, sound financial institutions... where does that financing go to? ... [It] could actually go towards the exact things that we're most worried about."
  – Clay Lowry (11:29)

• On the regulatory bind:
  "It’s almost an unintended consequence of the unintended consequence."
  – Rajesh Merchandani (13:06)

• On banks' perspective:
  "You have made it very clear to us to stay away. Well, we're really going to stay away."
  – Clay Lowry (13:39)

• On central banks’ view:
  "It's a difficult problem to deal with because BSAAML rules impose heavy sanctions and banks have been penalized for violating those rules. So many of them are really very reluctant to want to take risks."
  – Janet Yellen (15:59)

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Key Timestamps for Important Segments

• [01:12] – Explaining AML/CFT rules and their escalation post-9/11
• [03:40] – Dramatic increase in fines and compliance risks for banks
• [07:21] – Systemic withdrawal of major banks from remittances
• [08:37] – Global scale: $400–450 billion in remittance flows
• [09:56] – Real impact: Quote from US senators on Somalia
• [12:03] – Potential for driving flows towards less-regulated "shadow" systems
• [13:16] – Debunking the myth of "bad banks"
• [14:50] – Central bankers begin to take note (Carney, Yellen)
• [15:59] – Janet Yellen's Congressional testimony
• [18:22] – CGD working group’s mandate and hope for policy solutions

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Summary

This episode exposes a critical policy paradox: measures to block illicit finance have made international banks so fearful of regulatory risk and reputational damage that they are abandoning developing markets, endangering lives dependent on remittances. While regulators and central banks are now acknowledging the problem’s seriousness, real solutions remain elusive. The CGD’s new working group aims to bridge the gap by proposing data-driven, practical policy recommendations in hopes of reconciling the goals of security and development.

Transcript

[Janet Yellen]

Foreign.

[Rajesh Merchandani]

Hello, and welcome to the CGD podcast with me, Rajesh Merchandani. Today we're talking about unintended consequences, and we're talking about them in the context of efforts to prevent international money laundering and the flow of funds to terrorist groups. I'm sure we'd all agree those are good things to prevent. But there are growing concerns that rules designed to stop criminals transferring money around the world are actually hurting people in developing countries. People who are entirely innocent of any crime and who depend on money or remittances sent from their relatives working overseas. CGD recently launched a new working group to look at this problem, and I'm joined by the chair of that group, Clay Lowry, who was Assistant Secretary of International affairs at the U.S. treasury from 2005 to 2009. Clay, welcome to the podcast.

[Clay Lowry]

Thank you very much for having me.

[Rajesh Merchandani]

Roger, let's get you to go back to the beginning of the problem. Just explain to us in your understanding, what are the rules that we're talking about here? They've got strange acronyms. Aml, CFT or bsaaml. Quite a mouthful. What are they actually? What are they meant to do?

[Clay Lowry]

Okay, so the policy one, which creates the problem of policy two, which are in total conflict. Policy one stems out of trying to fight against anti money laundering and against the financing of terrorism. So as you can imagine, this was a problem back in the 1990s, but after 9 11, it became a problem of which became a huge issue, which is how do we starve the beast? And the beast being those that are willing to put bombs on airplanes and do horrible things. But also, obviously, we were worried about lots of different things around the world. So how do you find a way to get at them? And one way is to stop the financing. And so financial flows have to go through certain areas. A lot of it goes through the dollar, it turns out, because the dollar is the biggest currency in the world, particularly on trade flows and on remittance flows. So after 9 11, the regime to try to fight this heightened up and a series of steps over, frankly the next 10 years made it increasing, increasingly difficult to try to do financing. So it was things like blacklisting individuals, countries, industries, et cetera. It was naming and shaming using a multilateral system, not just the United States. And it was follow the money and do it as best as you possibly can. All of this made sense in some respects, but it's had some consequences because of probably a few other things that have happened since then, which is the techniques in legal Regime did a few things that were quite helpful, but probably the primary thing they were trying to do hurt the reputation of financial institutions. So if financial institutions were going to be doing banking with bad people, we were going to out you, so to speak. And that reputational risk became something that banks worried about a lot. There's probably one more step in my sequence, which is the fines for doing something wrong have increased dramatically. So before when you violated a sanction or a money laundering rule, your fines were significant. I mean, hundreds of thousands of dollars. But for a bank or a financial institution, you can handle that. What it's now coming is hundreds of millions of dollars. In fact, actually in a few cases, billions of dollars. I think the largest one was $9 billion. That that's correct. And it was being sanctioned for dealing, doing work with sanctioned countries from the United States, but also from UN sanctioned countries such as Iran, such as Sudan. Some of the stuff that they were doing, it's not my judgment on what they did, but it wasn't good stuff. And so trying to stop that, it was probably a very good policy thing. Now we run into conflict with the second policy.

[Rajesh Merchandani]

Yeah, so something is going wrong with those bona fide attempts to cut off the supply of funds.

[Clay Lowry]

Exactly. The second policy issue we all talk about, especially at a place called the center for Global Development, is how do you help facilitate finance into developing countries? How do you create a competitive environment so that you can get finance to flow in an efficient manner and as low cost as possible? And what are some of those areas that you work on? There are things like trade, finance, remittance flows, as you mentioned in your opening question. And those are businesses that are very low margin businesses. And so what do I mean by that? If you are a financial institution and you are doing correspondent banking in, in a country, a small country, a poor country, making sure that those flows happen so that there's a competitive environment, you make a little bit of a profit off it, but it's not very much. And so as the fines have gone up, that risk has become too much for a lot of financial institutions. And so they stopped doing this.

[Rajesh Merchandani]

The risk that the businesses that they're providing banking services to might be involved or might be funneling dodgy money. Right.

[Clay Lowry]

And so it's basically you're doing funding. And what the worry is is that so again, going back to 9, 11 and forward, banks set up fairly significant compliance operations to make sure that they could try to live by the rules on anti money laundering, countering, financing, terrorism as the fines have Gone up, the compliance costs have gone up. And setting up these compliance regimes usually gets into how do you know your customer, knowing your customer, are they involved in anything nefarious and so forth. It's hard to do. It's really hard to do in poorer countries where information flow is not as great, data is not as available. And it's even more difficult in post conflict countries which almost by definition have these concerns. So as banks have figured out, it is now a risk on top of a risk on top of a risk just to do basic banking services in countries where from a policy perspective, we would love to see good competitive financial flows going and banks are just saying, not today, I'm leaving because I do not want to take on the risk of having this huge fine on a margin business in which I can only earn a few thousand dollars.

[Rajesh Merchandani]

And this is not one or two banks. I mean, Barclays did it in 2013. They shut down services. About 90% of remittance agencies in the UK, HSBC did it, BNP Paribas got fined and then did it. They were also frozen out of the US banking system, which is one of the potential penalties that no bank wants to incur. The Merchants bank of California did it this year. Westpac of Australia, the last big bank in Australia still in this business, is getting out of it as well. So they're major banks with major dealings in remittances, which means that more and more of these money transfer organizations, MTOs, are getting squeezed out of the banking sector. But just give us a sense of how important are MTOs for people trying to send money home.

[Clay Lowry]

So one way of thinking about that is, by the way, on top of that, Citibank has been getting out of this business, JP Morgan's been getting out of this business. I think that it is a kind of a systemic thing, the remittance flows. I mean, rough estimates on official remittance flows are somewhere in the 400, $450 million billion dollars, excuse me, range, which I believe last time I looked was around three times the amount of development assistance aid that goes around the world.

[Rajesh Merchandani]

So let's just get that exactly clear. So the amount of money that people are sending home, migrant workers are sending home to largely developing countries is about $400 billion a year.

[Clay Lowry]

Yes. I mean, to get you. I want to be, I want to be as precise as possible. I've read 400, I've also read 450. So it's somewhere in that range, which.

[Rajesh Merchandani]

Is much more than aid flows, much.

[Clay Lowry]

More than aid flows, which is understandable. And a lot of it is done in dollars, not just because it's coming from the United States, just because the dollar is an easier way to do transactions around the world. And that's remittance flows. That doesn't even get into trade finance, which is just basic type of banking services where. And that's done in most countries around the world. In fact, in the financial crisis in 2008, 2009, one of the biggest things that dried up really fast was trade finance. So you saw all the development institutions move into a trade finance posture now as they move back out and allow the private sector to move back in. Private sector is not moving back into a lot of these countries. And one of the primary reasons is because this is just, it's a nice business, but it's very, very low margin, low profitability, and it's not worth the financial risk that they're taking on the sanctioning side.

[Rajesh Merchandani]

So the results for people in developing countries who have found that they can't send money, can't receive money from relatives abroad is pretty drastic. And we know that this is a pretty current issue. Several U.S. senators have been thinking about this. They wrote a letter to the Secretary of State, John Kerry recently. Here's a couple of excerpts from it. They wrote, decreasing remittances. They were talking about Somalia. Decreasing remittances will exacerbate Somalia's humanitarian situation. One third of Somali families say they would not be able to afford basic food, medicines and school fees without help from their relatives abroad. The senators went on, Decreased remittances would also present greater security risks. Cutting off money could significantly strengthen the appeal of terrorism and piracy for young Somali men. Would you say that's a fair assessment?

[Clay Lowry]

I think, I mean, given what I have read about Somalia, I think that might be a fair assessment now. It is. There's some. There's another irony here. So it's not just Somalia. Somalia is the one that everybody's talking about. Because as far as I can tell, almost every financial institution that is considered a western financial is basically just cut off all remittance flows and all, which is a huge amount of percentage of GDP in Somalia. In fact, actually Barclays, which you mentioned earlier, actually got sued to continue to keep flows into Somalia. And the UK government put them. I've almost never heard of something like that where you basically, the regulator is saying, you must keep financing. Now, that will only last for a certain amount of time because Barclays has said, look, we're getting out because you're killing us on this other side. I mean killing is a little strong, but then, but I want to be clear that I think that it's great that the senators are raising this. It is more, it's a bigger problem than just Somalia. Somalia's obviously got a lot of issues. And the irony of the whole thing is they mention the problem of you could be leading people towards less hope and so that could lead them towards more extremist measures and so forth. A different irony is if you cut off some of these well founded, sound financial institutions that usually have pretty good reputations around the world about trying to know their customers and so on. If you cut them off, where does that financing go to? Because people still need to get financing to run businesses, to trade operations, what have you. There's one possibility is it's going to go towards the shadows and, and there's a term in financial regulations of shadow banking. I don't mean that. I mean going to banks that definitely are not as well known and not as transparent about how they do their businesses and not as well regulated, which suggests that it could actually go towards the exact things that we're most worried about, which is how do you finance terrorism, how do you finance anti money laundering? Well, what if you make the banks that actually do that stronger because you've made the, that area less competitive? I'm not saying I don't know if that's happening, but it's something that people should be worried about.

[Rajesh Merchandani]

It's almost an unintended consequence of the unintended consequence.

[Clay Lowry]

Exactly, exactly.

[Rajesh Merchandani]

You make the whole system less transparent. Is it too simplistic to say that the banks are the bad guys here?

[Clay Lowry]

Very way too simplistic. The banks in some respects are doing what is almost natural, which is you've told us to be very, very careful in this area. We tried to do that. We have received fine upon fine and some of them are enormous. Sometimes it is totally the bank's fault, but sometimes it may not be. Rules can be a little vague, but it is just in their self interest to just say we want no part of this anymore. It is too big of a risk for us. You have made it very clear to us to stay away. Well, we're really going to stay away. And so now that's where regulators are struggling because they're actually. So there's a group called the Financial Action Task Force, fatf. FATF is basically a international grouping of the different regulators to try to think through anti money laundering. And so they came out last year with kind of a statement saying you're not supposed to get out of banking services. You're basically supposed to be much more careful about your risk management. The problem is that those are easy words to say, but if you're a financial institution, it's much easier to basically say, how about I just get out, I'm not making that much money off this, and it's just not worth it. And so I think that. So banks being the villain is just incorrect. I think that's why we have to find solutions that involve financial institutions. But obviously the regulators are going to have to stay step up a lot more too.

[Rajesh Merchandani]

Well, central banks are thinking about this. The governor of the bank of England, Mark Carney, recently signed a letter to G20 regulators calling on them to look into the problem of what he called the withdrawal from correspondent banking facilities. And then the chair of the Fed, the Federal Reserve, Janet Yellen, she was giving evidence before Congress recently and she was asked about this by Representative Keith Ellison of Minnesota. He has a large Somali population in his district and he talked about the importance of. Of remittances sent to Somalia. Let's hear a little excerpt of this interchange between the two.

[Keith Ellison]

I believe this helps to stabilize Somalia as a country. They send way more remittances than we do foreign aid over there. And when you. And it's already a fragile state. It does have a government. It's not a failed state anymore, but it's a fragile one. And if we pull that rug out, I fear for national security issues. We just heard threats by Al Shabaab to our homeland, which is something that I'm very much concerned about. And as we destabilize that country, I think it's bigger than just the humanitarian needs of individuals. We're now dealing with a real serious problem. So what can be done first?

[Janet Yellen]

But I agree with you, it is a very serious problem and it's causing a great deal of hardship. And we're meeting with interested congressmen, including yourself, and with other banking agencies, the controller of the currency and the treasury, to see what we can do to try to address this problem. It's a difficult problem to deal with because BSAAML rules impose heavy sanctions and banks have been penalized for violating those rules. So many of them are really very reluctant to want to take risks in their dealings when they may bring them in violation of those rules. And as banking supervisors, we can't insist or force them to do that.

[Rajesh Merchandani]

That was Janet Yellen giving testimony before Congress on the issue, the problem of debanking she was saying it was a problem there, but she didn't really seem to have much to offer there. So what can be done?

[Clay Lowry]

So this is what first of all, it's very good to hear that Chairwoman Yellen has recognized this problem, as well as Mark Carney, who's not only the bank of the England governor, but also the chairman of the Financial Stability Board. For your audience, the Financial Stability Board is made up of finance ministries, regulators, financial regulators and central bank governors, as well as standard setters in different types of regulations. So it is actually a very good thing to hear that the Financial Stability Board, the regulators are worried about this. I actually think that this largely comes from their regional outreaches. The regional outreach to Africa has uncovered this problem. And so it's good to hear that some of the emerging market countries who sometimes don't have as much voice on these issues are being able to are being given some voice that your regulations are creating these consequences. And it's also good to hear that the chairman of the Fed, chairwoman of the Fed, excuse me, is doing is also on top of this. You asked the big question, which is so what do we do?

[Rajesh Merchandani]

And this is something that in the CGD working group.

[Clay Lowry]

And that's what the working group. So the working group is looking at, I think the same issue that the regulators are going to look at. The regulators are going to look at. I mean, part of the issue is trying to figure out the data, also figure out some of the definitions that are involved that we've been talking about. I think that our working group, which is made up of practitioners as well as academics that think about development, finance, banking, aml, CFT issues. This group is going to have to try to come forward and think about some of the data problems and data issues and then what are some set of policy recommendations that could become that we could make most likely to the public sector, but probably some to the private sector even. I think that that is what the FSB, the G20, the Federal Reserve are also trying to think about. So I think that the timing of this working group is very well done and hopefully we'll be able to come up with some practical ideas. But it's going to be difficult because again, these are two policies that are totally in conflict with each other and it's two very sound policies. So that's a tough thing to overcome.

[Rajesh Merchandani]

And as we've been hearing, this is a very current issue at the moment. The working group plans to report when.

[Clay Lowry]

Clay so I think that the idea is to we'll be working for the next this calendar year, 2015. I think that the idea is to try to have a report out by the end of the year or early next year.

[Rajesh Merchandani]

Okay. Well, Clay Lowry, thank you very much for being on the CGD podcast.

[Clay Lowry]

I appreciate you taking me and also thinking about this issue in advance because we have a lot of work to do.

[Rajesh Merchandani]

You can find out much more about the issues we've been discussing. Debanking, anti money laundering rules, the unintended consequences of those on our website, www.cgdev.org. you can search on Clay's name or just search on unintended consequences and you'll get to the right page. I'm Rajesh Merchandani. Join us next time for another podcast from cgd, the center for Global.