The complexity of know your customer (KYC) regulations continues to bite banks and is acting as a severe deterrent to the financing of trade.
A decade after the global financial crisis, which ushered in a new era of banking regulation, 75% of banks say that compliance issues are becoming more complicated. The costs of meeting KYC requirements continue to rise, while most banks (84%) are struggling to justify maintaining relationships with perceived high-risk counterparties.
These are the key takeaways from the Financial counterparty KYC survey, conducted by regtech company Accuity, and covering 100 financial institutions around the world through 2017.
Despite an intense decade of lobbying by industry interest groups, it shows that banks are still living in fear of heavy fines from regulators as a result of not conducting the requisite diligence on trade finance counterparties. In many cases, rather than do the diligence, banks are choosing to play it safe and scrap the deal.
It all feeds into what the Asian Development Bank’s head of trade finance, Steven Beck, recently described to GTR as “the unintended consequences of regulation”. In emerging economies which are heavily underfunded, the problem is exacerbated by the exodus of mainstream – especially western – bank capital.
Of those surveyed, 67% said the priority is avoiding regulatory fines. At the same time, 81% are struggling to adapt to the regulatory system, where banks cannot keep pace with the rate of change.
One-third of banks find it “very challenging” to decipher local interpretation of regulations, with many emerging markets – particularly in Asia – establishing specific registers as a means of fighting financial crime. The ultimate beneficial ownership (UBO) register is becoming a more common tool in the region, with 69% of banks saying that they are finding it difficult to collect the required data to meet these requirements.
While most trade bankers will complain about the scale of regulation and the difficulty in navigating it, they will also (begrudgingly) acknowledge its requirement. Banks such as HSBC, BNP Paribas and Deutsche Bank have been fined heavily for facilitating trade with sanctioned nations, or with illicit organisations such as Mexican drug cartels.
In Asia, many western bankers also bemoan the lack of compliance autonomy they have on the ground: standards are often set in head offices in London or New York, with little consideration of local market conditions.
One trade financier at a European bank says he is unable to deviate from rigid pricing parameters set in accordance with the London market, despite the historically flat margins in Asia in recent years. This leaves him unable to fund perceived “safe” trade deals, while the compliance policy (also set in London) also rules out deals which would carry a higher price, because they’re perceived as being too risky.
It’s clear that many banks’ internal policies are drafted out of fear, meaning frontline staff cannot do the trade lending that they would like to – or that they were able to do in the past.
The policy of de-risking continues, with banks continuing to sever their correspondent banking relationships. Again, this is a trend that accelerated in the years post-financial crisis in response to KYC, anti-money laundering (AML) and anti-terrorist financing legislation.
The pace of de-risking, however, has slowed. In 2014, 58% of respondents to this survey had more than 251 counterparties around the world. In 2016, this fell to 47%. By 2017, it had fallen to 43% which suggests that many banks may have already gutted their counterparty relationships in the years since 2014.
Dalbir Sahota, KYC industry specialist at Accuity, says: “The rising cost of compliance and changing regulatory requirements are driving financial institutions to constantly evolve their systems, but their operations are not designed for continuous change. The laborious processes involved in KYC continue to present hurdles, which can only be overcome with a more comprehensive systems overhaul.”
Other organisations are looking at ways in which this regulatory stalemate can be loosened. Earlier in September, the ADB launched a tool devised to “move the needle” on the effects of AML rules in trade finance.
The Trade Finance Scorecard is designed to help mitigate some of the unintended consequences of regulators’ crackdown on money laundering in trade.
The diagnostic tool gives an industry-wide rating of between one and 10 to assess how a range of “elements of effective regulation” are being deployed to deal with money laundering.
Rather than focusing on individual banks, companies or countries, it is a general rating, derived from discussions with banks, national and multilateral regulators. It was described on its launch by the ADB’s Steven Beck as a “market-sounding” tool, which will provide guidance to banks as to areas in which they may be “over-complying” and to those in which they can improve.