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Jason Malcolm

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Jason Malcolm - Capco

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De-Risking Banking: The Decrease or Transfer of Risk?

05 March 2015  |  2803 views  |  0

The term “derisking” has been used in the financial services industry for quite some time, most recently, due to increased regulations.  Financial institutions and their boards are discussing how they can further derisk themselves from certain high risk divisions. Businesses such as money transmitters, casinos, certain foreign banks and derivative and prop trading are all under the micro-scope.  Fear over new risk is also causing banks to refuse taking on new profitable businesses, such as virtual currencies as well as the cannabis industry.  With ever mounting regulation, and unclear agendas, financial institutions have become very sensitive to the level of risk each particular line of business represents.  

Since the financial crisis in 2008, heavy bank regulation by government agencies has sought to prevent the explosion of toxic assets, curb manipulation, and increase the sense of awareness to, and monitoring capabilities of, aberrations in financial markets.  But with renewed scrutiny of bottom-line and risk adjusted returns, just which markets will be deemed unprofitable for banks and how will that affect the greater economy.  Take the Money Services Business.

The Money Service Business (MSB) is defined as persons or entities dealing or exchanging currency, check cashiers, issuers of money orders – basically money transmitters and third party processors for the unbanked.  As FinCEN (Financial Crimes Enforcement Network) continues to beef up their regulations on MSBs, costs mount for financial institutions forced to spend money and resources on enhancing AML controls, such as Know Your Customer (KYC) and Enhanced Due Diligence (EDD).   These processes can be extremely expensive and return very little upside.  In the new business of banking, and with the incessant need to push ROEs higher, the question becomes, Are these sectors just too much risk and not enough return for my bank?  And, do I want these customers?

Most of the MSBs clientele are low income individuals and families that use the technology to send relatives money overseas.  Most of the business derived from these families is not lucrative and the financial institutions do not see the service offering as profitable relative to the risk it carries. Additionally, controls are very weak and often are not robust enough to capture the small sums of money being transferred at one time. The lack of technologic controls attracts individuals and organizations that focus on financial crime, such as human trafficking, financial fraud, drug cartels, and terrorist organizations.  Can you blame the banks for wanting out?

And yet what about the unbanked?  One out of every four households in America use some sort of MSB*.  And as banks reject more of this type of business, that number could grow.  The unbanked will be turning more toward third party new entrants that will be eager to capitalize on the void in service left by the bigger banks.  But will smaller institutions be able to manage the risk of this risky population?  The unbanked spent $89 billion dollars, on interest and fees, for alternative financial services in 2012 alone*.  Will third party provider be able to charge ever higher prices of those ousted from traditional banking channels, and at the mercy of other options?

The conundrum left?  Is regulation having the inadvertent effect of transferring risk from the country’s financial institutions, best suited to manage risk and protect consumers – to the unbanked themselves?  And should the net effect of public policy, and financial regulation, be to transfer risk to the country’s population least able to absorb its potential harm? 

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TagsRisk & regulationTransaction banking

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De-Risking Banking: The Decrease or Transfer of Risk?

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job title Principal Consultant
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Management Consultant for Capco focusing on Risk and Compliance, change mgmt & run the bank strategies & initiatives.

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