Why de-risking increases risk

And how technology provides a cost-effective alternative

With the heightened burden and increased costs placed on correspondent banks today to ensure compliance across their portfolio, many major institutions have instead resorted to “de-risking” certain segments, markets, and jurisdictions. De-risking largely came about as an unintended consequence of regulations that left banks with limited alternative risk reduction methods, at least at the time.

Ironically, de-risking has not eliminated the risk of illicit flows, but simply reallocated these risks to far less transparent channels, be they overburdened local banks, or the informal market.

This movement of traffic into opaque informal channels has undermined the integrity of the broader financial market, as it exposes the global financial system to unsupervised, non-transparent, high-risk flows (World Bank, 2016). Without adequate monitoring of this traffic, criminals can transact with little risk of being detected.

The growth of de-risking

De-risking is largely a response to the costs of due diligence and risk mitigation exceeding the profits to be gained from a given respondent/correspondent relationship. In such cases, the bank or region is de-risked for fundamentally commercial reasons (Oxfam, 2015). In other instances, banks have undertaken mass de-risking in reaction to increased regulatory scrutiny (Financial Conduct Authority, 2016).

De-risking breeds informal financial channels

Even when a country is de-risked, the monetary flows to and from the region continue. The true change that has occurred is an end to the oversight of these flows; the money still circulates across borders.

Using technology to build an effective risk management strategy

It is clear that banks must rethink their current approach to financial crime risk management. De-risking does not reduce risk. Going forward, banks must adopt new, cost-effective, and efficacious methods of carrying out financial crime risk management across their correspondent relationship portfolios.

While most correspondent banks conduct many of their procedures manually, often compensating for ineffective systems, it is clear that with the rise of machine learning and big data technologies, untapped efficiency gains remain (Financial Stability Board, 2019).

By utilising these new technologies in conjunction with a risk-based approach, banks are now able to leverage a universe of data to assess the probabilistic risk exposure of any given respondent bank on an ongoing basis. Today, the true answer to the rising costs of compliance resides in the untapped technological potential of this data-rich industry.

How Elucidate can help

If banks are to begin effectively managing their correspondent banking risk exposure, they must have the right tools in hand.

At its core, de-risking is a simplistic response to a complex problem, based on a general lack of transparency, limiting banks’ ability to understand financial crime risk and how it should be mitigated.

This is where Elucidate can help. Utilising a hybrid of expert-driven and machine-learning modelling, the Elucidate FinCrime Index (“EFI”) is able to transparently assess the risks a bank and/or its counterparties are facing. It enables both correspondents and respondents alike to swiftly and effectively articulate risk exposures through a holistic assessment of data and control outcomes*. By creating a platform enabling far greater transparency between counterparties in the correspondent banking space, the EFI enables the reversal of de-risking practices in exchange for effective risk management practices across the global financial network.

Elucidate is a financial crime risk management company enabling banks to benchmark and price FinCrime risk through risk assessment, data analysis and scoring.