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Unwarranted de-risking is having a detrimental effect, the European Banking Authority (EBA) has warned, as it publishes new advice for competent authorities on dealing with the phenomenon.
De-risking has come under increased focus recently across Europe. It occurs when a decision is taken by financial institutions not to provide services to customers in certain risk categories.
While it can be a legitimate risk management tool, it can also be a sign of ineffective money laundering and terrorist financing procedures leading to what the EBA’s new guidance report deems are “severe consequences,” for the bank’s customers.
“Providing access to at least basic financial products and services is a prerequisite for participation in modern economic and social life and de-risking when unwarranted, can cause the financial exclusion of legitimate customers,” the Paris-based watchdog said in a statement, noting that it can also affect competition and financial stability.
In particular, the EBA found that certain categories of customers struggle due to de-risking. For example, asylum seekers that come to the trading bloc from high-risk jurisdictions, as well as many not-for-profit organisations, can face significant challenges caused by de-risking by banks.
Also, specific segments of the financial sector are at risk of being frozen out - including both payments institutions and electronic money institutions.
“While one can justify that financial institutions have a right to set different risk appetites, however, we cannot deny the fact that there are still cases when the risk is simply avoided rather than mitigated,” said Ruta Bajarunaite, financial crime specialist at the Lithuania-based AML Centre For Excellence.
Very often crypto service providers and gaming operators are denied access to financial services as not every financial institution is in possession of sufficient knowledge to understand and mitigate risks properly, according to Bajarunaite. “Therefore, a conservative approach is usually followed.”
“The impact of de-risking is detrimental, especially when legitimate customers who are individuals are financially excluded and thus prevented from accessing financial services,” she pointed out.
In its guidance, the EBA has called on competent authorities to take “necessary steps” to promote financial inclusion.
The EBA has also called on the EU’s financial regulators to engage more actively with institutions that de-risk and with users of financial services that are particularly affected by de-risking to raise awareness of the rights and responsibilities of both institutions and their customers and set out in practical terms what each can do to facilitate legitimate customers’ access to financial services.
This includes filling information gaps to reign in unwarranted de-risking. For example, this could be made possible by leaflets indicating what information can be provided by groups, such as asylum seekers, when they are being onboarded to a financial institution.
Similarly, where innovative financial solutions firms are being de-risked, the EBA advises that competent authorities could work with the sector to strengthen institutions’ understanding of those solutions, while at the same time taking steps to ensure those solution providers that are themselves obliged entities are in compliance with their AML/CFT obligations.
The EBA has also indicated that if the termination of a customer relationship is warranted by the outcome of their assessment of ML/TF risk, they can opt to offer only basic financial products and services in order to restrict the ability of users to abuse these products and services for financial crime purposes. This is made possible by the EU’s Payments Accounts Directive (PAD).
The EBA recommends that the EU do more to deal with the interaction between AML/CFT obligations and the PAD, as well as the EU’s revised Payments Services Directive (PSD2).
For example, consideration should be given to ensuring, through changes to the PAD or through guidelines, that a review process or complaint mechanism is in place within institutions to ensure a transparent and fair process for customers, the EBA has proposed.
The EBA has also suggested that de-risking is covered in the upcoming PSD2 review to contribute to mitigating significantly the risk of unwarranted impediments to competition and clarify the application of Article 36 of the directive.
Article 36 dictates that member states need to ensure that payment institutions have access to credit institutions’ payment accounts services on an objective, non-discriminatory and proportionate basis.
Such access should be sufficiently extensive as to allow payment institutions to provide payment services in an unhindered and efficient manner, while the credit institution shall provide the competent authority with duly motivated reasons for any rejection, the recital continues.
“The Commission may wish to consider mandating the EBA to develop technical standards to ensure the consistent application of Article 36,” the EBA suggests.
In doing so, the EBA could create a template that credit institutions would be required to use when notifying competent authorities that they are rejecting an account.
“Regulators at EU level could gain more robust insight on the most common reasons for rejection and take targeted steps to address those reasons if necessary,” the EBA suggests.
While the EBA report provides at least several potential initiatives that could be taken in order to address de-risking issues, there are also options beyond regulatory guidance suggests Bajarunaite.
“I believe that multi-stakeholder dialogue to mitigate financial exclusion can bring valuable results by bringing all relevant stakeholders around the table.”
Clarity and assurance can be given to institutions that the application of a risk-based approach does not mean refusal or termination of business relationships with entire categories of customers that are considered to present a high ML/TF risk, Bajarunaite advised.
