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.