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Evaluating
the Impact and Barriers for De-Risking Strategies (A Case Study Of Diamond Bank
Plc)
CHAPTER ONE
INTRODUCTION
Background
of the study
In recent
years, the international community has begun to focus on financial inclusion as
part of a broader strategy to reduce poverty, encourage economic development,
and promote stability and security. For the purposes of this paper, the term
“financial inclusion” refers to the provision of accessible, usable, and
affordable financial services, either through the formal or informal financial
sector, to underserved populations. This includes the estimated 2.5 billion
“unbanked” individuals worldwide who lack access to a formal bank account, the
vast majority of whom reside in developing countries.
1. Financial
inclusion also applies to “underbanked” communities, where people lack reliable
access to or are unable to afford the associated costs of financial services.
In the US alone, 50.9 million adults are considered underbanked and have relied
on alternative financial services in the past 12 months, including payday
lenders, pawn shops, or check-cashing services.
2. The
international focus on financial inclusion has coincided with increased
attention to anti-money laundering and countering the financing of terrorism
(AML/CFT) frameworks as crucial tools for advancing stability and security
objectives and for curbing criminal and violent extremist activity.
The focus on
AML/CFT has resulted in regulators’ increased scrutiny of the formal and
informal financial sectors, as well as international pressure on low-capacity
countries to develop and implement effective AML/CFT frameworks. Although
overly strict approaches to AML/CFT may inadvertently limit financial access,
their respective aims do not inherently conflict. Proportionate and calculated
implementation of AML/CFT measures can help to advance financial inclusion
goals, drawing more economic activity into the formal banking sector and
consequently enhancing transaction monitoring and customer due diligence, which
in turn help advance AML/CFT goals. However, with risk appetites declining in
the wake of the 2008 financial crisis, many financial institutions have opted
to exit relationships assessed as being high risk, unprofitable, or simply
“complex,” such as those with money service businesses (MSBs), foreign embassies,
international charities, and correspondent banks. Closures of these entities’
bank accounts affect financial access for the individuals and populations those
businesses serve. MSBs and other financial service providers, often referred to
as “alternative money transfer services,” hold accounts with formal financial
institutions (banks), which allow them to perform transactions and serve as an
access point and gateway for their traditionally underserved client bases. They
fill an important gap, particularly in jurisdictions with nascent financial
systems where the informal sector is in fact the main provider of formal and
traditional banking services. Such relationships also exist internationally.
Financial
institutions in developing economies often rely on correspondent banking
relationships to provide access to the global financial system and underpin
trade finance. Charities operating in conflict and other sensitive environments
rely on all of these channels to move much needed resources internationally.
Although some non-bank financial service providers are noted for their
traditionally low fees— including the remittance sector—others have been
described as predatory, due to their staggering fees and disproportionate
targeting of vulnerable communities.3 For example, annualized payday loan fees
can amount to three- or even four-digit interest rates,4 which represent
significant costs to the 80 percent of US borrowers who renew or roll over
their initial loans.5 Unbanked or underbanked communities, particularly in the
developing world, are also vulnerable to private lenders. These “loan sharks”
offer no legal customer protection measures and have anecdotally been linked to
extortion and even threats of violence.6 As banks close the accounts of non-bank
financial service providers, underserved communities may be forced to increase
their reliance on these types of costlier and less-regulated options. As
financial institutions re-calculate risk appetites and decide to exit
relationships, they directly and negatively affect these sectors and the
populations they serve. For example, in August 2014, Westpac Banking Corp.
followed other major Australian and UK banks and announcedthe closure of
numerous money transfer operators’ accounts over concerns about AML/CFT and
rising compliance costs.7 This followed the precedent set in the wake of
Barclays’ May 2013 decision to close money transmitter accounts and the
subsequent temporary injunction filed by Dahabshiil, one of the largest Somali
remittance companies in the UK. 8 The closure of these bank accounts not only
threatens these businesses but also jeopardizes the vital flow of remittances
to Somalia from diaspora populations, which constitute an estimated 25 to 45
percent of the country’s GDP and serve as a key source of income for more than
40 percent of its vulnerable population.9 Financial exclusion is a huge barrier
for disadvantaged populations. On an individual level, financial exclusion
limits the ability of vulnerable populations to manage cash flows, build
capital and savings, and mitigate economic shocks. 10 On a macroeconomic level,
financial inclusion is linked to economic and social development, and
improvements in financial access have been shown to contribute to reductions in
extreme poverty and wealth inequality.11 Additionally, expanded access to the
financial sector helps finance small business and microenterprise: a positive
correlation has been found between financial inclusion and employment
opportunities, and it is generally believed to positively affect economic
growth.12 Women and other vulnerable groups are disproportionately affected by
limited financial access. For example, in developing countries, 46 percent of
men have a bank account, compared to 36 percent of women.13 Immigrants are another
heavily affected population: factoring out socioeconomic and demographic
considerations, immigrants are six percent less likely to have a checking
account and eight percent less likely to have a savings account in the US than
their American-born counterparts. 14 Without formal bank accounts, these
underserved populations commonly rely on the remittance sector to send money to
their families back home, and women have increasingly emerged as a key sending
demographic. Although they remit about the same amount as men, women are shown
to remit higher percentages of their income, more frequently, and for longer
durations than their male counterparts.15 Reductions in the remittance sectors
due to MSB account closures stand to further isolate these communities from the
global financial system, exacerbating existing financial inclusion challenges.
In an effort to ensure AML/CFT measures do not unduly limit financial access,
international standards urge financial institutions to adopt a risk-based
approach (RBA). Financial institutions are advised to assess their money
laundering (ML) and terrorist financing (TF) vulnerabilities and to formulate
policies and allocate resources according to their unique risk profiles and
risk exposure. Although this approach is designed to allow for flexibility, it
also introduces ambiguity and immense subjectivity around which actions are in
fact required to meet international AML/CFT standards. High- and low-capacity
jurisdictions alike struggle in implementing the RBA, and those perceived as
being deficient in their implementation have been publicly listed by the
Financial Action Task Force (FATF) and subjected to its ongoing global AML/CFT
monitoring process—potentially dissuading international investors and hindering
economic growth and trade relations. For financial institutions, concern over
ambiguity in the RBA has been compounded in recent years by the imposition of
large fines and enforcement actions related to inadequate AML/CFT compliance
procedures.
1.2 Statement of the problem
De-risking
practices have not been localized in any particular population, community, or
industry. However, in recent years there has been an “aggregation of results”
best described as a trend toward de-risking of sectors, including money service
businesses (MSBs), foreign embassies, nonprofit organizations (NPOs), and
correspondent banks. Those closures have had a ripple effect on financial
access for the individuals and populations served by those businesses.
Regulatory authorities continue to emphasize that de-risking is not in line
with international guidelines, and in fact is a misapplication of the
risk-based approach. Yet in the absence of clear instructions or an incentive
to bank these clients, account closures continue across the United States, the
United Kingdom, and Australia. These closures have significant humanitarian,
economic, political, and security implications, effectively cutting off access
to finances, further isolating communities from the global financial system,
exacerbating political tensions, and potentially facilitating the development
of parallel underground “shadow markets.” Unfortunately, little empirical data
is available about the extent and nature of the client relationships being
exited and the decision-making processes of financial institutions. This
presents challenges to assessing the scale and scope of the problem,
identifying vulnerable communities affected by the reduction in services, and
developing effective responses. Nevertheless, this study endeavors to
illuminate a number of existing trends and themes relating to the issue and
provides some insight into likely factors behind de-risking practices.
1.3 Significance of the study
This report
is based on an exploratory study on the impacts of bank de-risking practices on
financial inclusion. “De-risking,” or “de-banking,” refers to the practice of
financial institutions exiting relationships with and closing the accounts of
clients perceived to be “high risk.” Rather than manage these risky clients,
financial institutions opt to end the relationship altogether, consequently
minimizing their own risk exposure while leaving clients bank-less. This
exploratory study was designed to identify the core drivers of this practice
and its implications for financial inclusion goals, particularly as they affect
vulnerable communities. It provides a number of relevant case studies
highlighting innovative approaches to, and lessons learned from, addressing
de-banking challenges across six different sectors with varying degrees of
banking incentives, as well as a set of recommendations about how invested
stakeholders can better address de-risking challenges
1.4 Objectives of the study
The research
is aimed at evaluating the impact and barriers for de-risking strategies. To be
concise, these objectives are:
To know
whether de-risking strategy have any significant impact on Nigerian Banks.
To identify
the barriers to de-risking strategies in Nigerian banks.
1.5 Research questions
In order to
have a thorough grasp of the understanding of this research, certain questions
need to be asked. These are:
Does
de-risking strategy have any significant impact on Nigerian banks?
Is there a
barrier to de-risking strategy in Nigerian banks?
1.6 Research hypotheses
Ho:
De-risking strategy has no significant impact on Diamond Bank Plc.
Hi:
De-risking strategy has significant impact on Diamond Bank Plc.
Ho: There is
no barrier to de-risking strategy by Banks in Nigeria.
Hi: There are barriers to de-risking strategy by
Banks in Nigeria.
1.7 Limitations of the study
The study
was carried out to evaluate the impact and barriers for de-risking strategies.
The study is limited to Diamond Bank Plc. This is because of her representative
nature of all the banks in Nigeria, proximity to the researcher, time and
financial constraints.
1.8 Scope of the study
The study
focuses on the impact of de-risking on previously banked populations, whether
those services are accessed directly or through an alternative financial
service provider, and does not seek to assess the extent to which de-banking
has affected populations that do not currently have access to financial
systems.
1.9 Definition of terms
Evaluation:
An appraisal of something to determine its worth or fitness.
Impact:
Tohave a strong effect on someone or something.
Barrier:
Anything that prevents or obstructs passage, access, or progress.
De-risk:
This means to make something safer by reducing the possibility that something
bad will happen and that money will be lost:
Strategy: A plan of action designed to achieve a
long-term or overall aim.
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