Anti-corruption in the North but anti-growth in the South

In Asia, indeed in any of the markets where the financial crisis was a matter of contagion not primary infection, there's a prevailing view not all the doctor's orders are sensible.

Most notably bankers in Australia, Japan, Singapore, Canada and elsewhere have argued new rules on capital and leverage in banking designed in Basel ignore the reality of both the crisis and the structure of institutions outside the developed northern hemisphere.

"The intention of the regulation is clear. But the collateral damage is immense."

There are, they argue, unintended consequences, most notably in restricting financial growth due to a throttling of finance provision in their economies.

But that, literally, is a first world problem. For the third world there is another risk: that new regulation and particularly measures designed to choke off money laundering and cauterise the financial arteries financing terrorism will have the unintended consequence of strangling the financial systems of emerging economies.

These are not just the economies the world is relying upon for revitalisation but they are also ones where the real world impact of financial exclusion can actually increase the risk of unsettled societies, providing the environment for potentially more radicalism, social unrest and ultimately the kind of anarchy and terrorism the original measures were designed to upset.

Yet in the developed world, the political headlines of money laundering and terrorism trump the more mundane development concerns in developing economies.

It is akin to all too frequent and simplistic responses to high profile crime in western societies where politicians launch campaigns and spend money on policing and punishment rather than the more complex and protracted task of addressing the root causes of crime – whether that is poverty, lack of mental health services, domestic violence, economic duress or other challenging social ills.

The B20's Financing Growth Taskforce identified this multi-layered issue in its final communique for last year's G20 meeting in Australia.

“Many emerging markets are dealing with multiple macro-economic challenges. Three in particular deserve mention,” the B20 said. “First, emerging markets' central banks have to deal with the after effects of the withdrawal of extraordinary monetary stimulus by advanced economies. Second, emerging market economies are dealing with lower growth prospects. Third, banks and financial services companies in emerging market economies have to implement the global financial regulatory agenda at an uncertain time.”

The taskforce argued emerging markets were being forced to deal with lower global growth while implementing – and suffering the repercussions of – the impact of regulatory uncertainty which was further lowering growth expectations.

The deeper challenge is while the regulatory agenda is well intentioned and needed in the wake of a catastrophic crisis which will endure for years, the uncertain impact and implementation of new rules continues to create uncertainty.

In emerging economies, these multiple impacts increase the danger of financial exclusion.

One of the most notable impacts has been on correspondent banking and the provision of remittance services.

Correspondent banking is as old as banking systems themselves and it is where a bank in one country will use the services of a bank in another. In its simplest form, a customer of a bank in say Australia may want to do business in a country like Bolivia where no Australian bank has representation. However, the customer's Australian bank may well have a correspondent relationship that allows the business to be undertaken under what amounts to an airline “code share”.

Click image to zoom Tap image to zoom

The intention is to facilitate cross border finance, obviously trade and investment, but equally in financial service activities which help deepen the economies of emerging markets. That is often the provision by more advanced banks of sophisticated products which are sold to banks in emerging markets.

The remittance market is a more specialised and consumer focussed area and it facilitates the repatriation of money by individuals back to their local societies, for example Pacific Islanders working in Australia sending money back to their families.

The intention of both these businesses is to increase financial flows. Obviously both can also be corrupted and legitimate channels can be used for illegitimate purposes such as money laundering or financing crime.

However, global regulation has now severely impacted both.

Australian banks have effectively closed their remittance businesses in the Pacific largely because of the danger they would be culpable if a remittance was ultimately found to be illicit – under new regulation the primary bank is responsible not just for the intermediary it deals with, which may be a local shop, but the final beneficiary of a transaction.

The penalties can be huge and global banks have already paid fines totalling billions of dollars for transgressions on money laundering or sanctioned countries.

Again, the intention of the regulation is clear. But the collateral damage is immense.

Somewhere around 80 million remittances worth nearly $A50 billion were originating from Australia annually. The intermediary was typically some form of money services business whose client was an individual or small business.

Banks must “know their client” – but increasingly they must now know their client's client and even their client's client's client.

Another consequence of course is that the financing ultimately won't stop. Illicit funds will find another channel, legitimate transfers will become more difficult and more expensive.

As the B20 noted “well-intentioned rules, designed for sophisticated markets, can have powerful unintended effects, particularly when combined with other rigorous standards around new capital and liquidity rules”.

“The three key examples of this impact are small to medium-sized enterprise financing, correspondent banking and remittances.”

In particular: “The combination of Basel III prudential rules, in relation to SME lending, and the manner in which the array of conduct of business regulations are enforced, including AML/CTF, selling standards, and bribery and corruption, are, in some instances, restricting the provision of finance to certain client segments, which are increasingly difficult to service cost-effectively.

“A small cross-border SME will get pushed into accessing finance from the informal sector. Our concern is that this issue is impacting a variety of marginal and underrepresented sectors of society, most commonly higher risk segments in higher risk jurisdictions.”

Even regulation not directly linked to restricting illicit activity is having an impact.

New Basel intra-day liquidity reporting, designed to ensure banks are soundly funded and going concerns, has had an impact on key instruments used in correspondent banking.

This has resulted in many global banks severely culling the number of the correspondent relationships. JP Morgan for example cut ties to over 500 foreign lenders in its 2013 financial year alone, Citi too has announced a major review.

The result inevitably will be more impediments to finance in emerging markets. That means less new business development, less economic growth, less employment. These are not just unfortunate consequences, they potentially contribute to an environment where crime and radicalism are more likely to flourish as economic opportunity diminishes.

One of the contributing factors to weaker financial activity globally is the lingering uncertainty around regulation. There has been growing recognition that the interaction of new measures is not understood and a stock take is necessary.

This is critical. What is happening in the correspondent banking, remittance and SME financing sectors demonstrates collateral impacts are enormous. If they do stifle economic growth and shift finance to unregulated and riskier realms, they will be particularly damaging.

The question then will be whether the cure is worse than the disease.

Photo: Roger Bragg, Personal and Business Banker, ANZ New Zealand.

The views and opinions expressed in this communication are those of the author and may not necessarily state or reflect those of ANZ.

editor's picks

14 Apr 2015

Four ways to safeguard business from financial crime

Mark Evans | Managing Director Transaction Banking, ANZ

Imagine being offered a job which promises excellent money in exchange for very little work. It sounds like a dream.

03 Mar 2015

Too big to fail or too big to manage?

Andrew Cornell | Past Managing Editor, bluenotes

“Too big to fail” is the moral hazard conundrum at the centre of the debate about the future of financial services, anchoring issues such as how the sector should be structured, regulated, financed. More than two dozen global banking behemoths have been officially designated too-big-to-fail or in regulator-speak “globally systemically important banks”.