Sangeeta Goswami is Advocacy and Communications Officer at the Human Security Collective
Derisking is defined as the practice of financial institutions exiting relationships with and closing the accounts of clients considered ‘high risk’. Nonprofit organisations (NPOs), unfortunately, seem to fall within this ambit – along with certain others such as money-service businesses, foreign embassies and correspondent banks. This has led to NPOs around the world being unable to carry out their mandate, affecting aid and relief, as well as the campaigning for political and social change. It has also, in some cases, led to funds being transferred through unregulated channels. Why is this happening? Why is banking nonprofits considered risky? And what can be done about it?
Principle driver: AML/CFT regulation
In theory, the goals of financial inclusion and anti-money-laundering (AML)/countering the financing of terrorism (CFT) are aligned. Less leakage and misuse of financial resources coupled with enhanced due-diligence should only strengthen the formal banking sector and help in meeting financial inclusion goals. However, things look very different in practice. AML/CFT regulation, codified by bodies such as the Financial Action Task Force (FATF) and transposed into rules and laws at the national level, have led to financial exclusion instead and created whole new categories of the ‘de-banked’ and ‘un-bankable’. And civil society is a prime example.
One of the FATF’s 40 Recommendations (Recommendation 8) specifies a broad requirement to regulate the nonprofit sector as a whole for greater transparency and accountability. Nonprofit organisations (NPOs) were viewed as being ‘particularly vulnerable’ to abuse for the financing of terrorism – till the wording and discourse were altered in June 2016 to apply to those ‘non-profit organisations which the country has identified as being vulnerable to terrorist financing abuse’ and to emphasise ‘focused and proportionate measures, in line with the risk-based approach’. But the damage had been done. An entire sector had been tarred with a broad brush without an adequate evidence base.
This has, over the years, had numerous unintended consequences and led to cases of overregulation, including infringements of the basic democratic rights of association, assembly and expression. Several governments have issued tighter rules and restrictions for NPOs over the past few years based, in many cases, on the FATF Recommendations. And many an ill-intentioned government has found it convenient to misuse the spirit of these regulations to crackdown on civil society organisations that are inconvenient to its agenda (e.g., those that speak truth to power, those that campaign for human rights, land rights, minority rights or environmental rights, etc.), leading to the shrinking of the financial, operational and political space of civil society.
The shrinking financial space for nonprofits has been marked by derisking. Banks are now required to carry out extensive due-diligence on their clients to fulfil AML/CFT compliance requirements and face large fines if they are found to be in contravention of any of these regulations. Many NPOs, especially those that work in or around conflict zones, have fallen foul of these stringent requirements. And this, coupled with the fact that NPOs are not banks’ most profitable customers, has led to banks terminating or refusing to take on the relationship with many NPOs.
This has been further aggravated by a decline in correspondent banking relationships. Correspondent banks have been withdrawing from relationships with respondent banks in many parts of the world. This has been prompted by increased due-diligence and Know Your Customer (KYC) requirements stemming from AML/CFT regulations, with the correspondent bank lacking confidence in the respondent bank’s ability to effectively manage AML/CFT risk. Profitability concerns also play an important role. For banks taking a steely-eyed look at the risk/return ratio of such relationships, risk averseness (financial and reputational) and a fear of fines wins out most times over servicing customers in far-flung corners of the world.
Additionally, the parts of civil society most affected by this are likely to consist of those organisations working in high risk areas on development, conflict transformation and human rights. This, ironically, is counterproductive to mitigating terrorist threats. One of the potential factors contributing to a greater risk of terrorist abuse of NPOs is certainly these restrictive measures, which causes NPOs to potentially go underground or use less formal channels to get their work going.
There is plenty of evidence to show that NPOs are adversely impacted by derisking.
- The Charity & Security Network and Schar School report on Financial Access for U.S. Nonprofits is an empirical study on the derisking phenomenon as it relates to nonprofits in the US. Financial access difficulties faced by nonprofits include delays in wire transfers (affecting 37% of the nonprofits surveyed), requests for unusual additional documentation (26%), increased fees, account closures and account refusals. Two-thirds of all US nonprofits that work abroad are faced with financial access difficulties. Transfers to all parts of the globe are impacted; the problem is not limited to conflict zones or fragile and failing states. When money cannot be transmitted in a timely manner, 42% of nonprofits report that they carry cash.
- A report by the International Human Rights Clinic at Duke University School of Law and the Women Peacemakers Programin the Hague analyses, through interviews, surveys, and statistics, how countering terrorism financing rules impact women’s rights organising, women’s rights organisations, and gender equality, including through derisking.
- The World Bank and the Association of Certified Anti-Money Laundering Specialists (ACAMS) published a report in 2016 reflecting the findings of multiple stakeholders (regulatory and law enforcement officials, financial institutions, NPOs, IOs, government, academics, and policymakers) on derisking.
- The quantitative Correspondent Data Report from the Financial Stability Board looks at the decline in correspondent banking worldwide between 2011 and 2016 (using SWIFT data).For both the US dollar (USD) and euro (EUR), the number of active correspondents decreased by around -15%. On average small economies are the most affected by the reduction in the number of foreign correspondent banks serving banks in these countries.
Civil society is a vital partner for governments in delivering the Sustainable Development Goals (SDGs). Reduced access to the formal banking sector for nonprofits imperils the entire 2030 Agenda. Additionally, the existence of civil society is critical for a health democracy and for development. The CIVICUS Monitor findings show a clear correlation between open civic space and human development, as well as showing that the more open civic space is, the less income inequality there is. Constraining this space through financial exclusion would therefore be antithetical to the goals of progress and development.
Engagement, Advocacy and Redress
As is evident, NPOs are having to navigate an increasingly complex regulatory landscape. At the moment many NPOs and funders are dealing with the situation on a case-by-case basis. The larger NPOs, often household names, find solutions and ways around the system more easily than the smaller NPOs, who are also often the NPOs advocating for matters that are a thorn in the side of the establishment.
Given the systemic nature of the issue, however, what is needed is a cross-sectoral (development/humanitarian) and multi-stakeholder approach (funders, NGOs, INGOs, banks, regulators, governments, local authorities) in order to develop possible and sustainable responses to the shrinking of civic space. While AML/CFT rules were developed to curb the risk of turning dirty money clean and making clean money dirty in and through the financial system, the evidence to date shows that the interpretation and implementation of the rules have been counterproductive.
- Advocacy towards the FATF and on FATF at the national and regional level
The Global NPO Coalition on FATF (of which Human Security Collective and the European Foundation Centre are core members) works to respond to, shape and mitigate the impact of the FATF’s policies on the operational, financial and political aspects of civic space. The FATF Secretariat and members have acknowledged that the FATF Recommendations have had unintended damaging consequences on the NPO sector and its legitimate and much-needed activities, which ought to now be mitigated. Advocacy and engagement have led to the revision of the claim that the NPO sector is ‘particularly vulnerable’ to terrorist abuse, and the formalisation of a risk-based approach, which means more proportionate and context-specific implementation of FATF standards. The coalition continues its work on awareness-raising, coalition-building and multi-stakeholder dialogue at the global, regional and national levels.
- World Bank/ACAMS
The World Bank’s Financial Markets Integrity group along with ACAMS (the Association of Certified Anti-Money Laundering Specialists, an individual network of members working on AML/CFT risk assessment within their institutions) have been facilitating a set of multi-stakeholder dialogues on derisking and NPOs. While the focus has been on supporting financial access for humanitarian organisations and charities, there seems to be scope and agreement among the participants to include other nonprofits (development, human rights, anti-corruption, etc.) whose financial access also needs to be guaranteed. Work streams have been set up to address the three main focus areas as pertain to derisking and NPOs:
- Fostering the NPO–bank relationship
- Improving the regulatory and policy climate
- Building coalitions
Though still largely a US-driven initiative, both the World Bank and ACAMS are interested in broadening the scope and including diverse initiatives in the work streams. Additionally, the IMF is working on the effects of derisking on correspondent banks.
The G-20 is concerned about derisking and the decline in correspondent banking relationships. It has charged both the Financial Stability Board (FSB) and the FATF to report to it on the matter. But the G20 is currently looking at it from a ‘financial inclusion’ point of view. Derisking has to be linked to shrinking civic space, and civil society stakeholders have to advocate to make that link. There is also need to advocate, at the G20 level, for an assessment of the impact, legitimacy and effectiveness of the AML/CFT system as a whole given its role in derisking/shrinking civic space.
- Safe-corridor approach for humanitarian NPOs
In a number of countries, e.g. the UK, large humanitarian NPOs, government authorities such as the Finance, Foreign Affairs and Interior Ministries, the Banking Association and the bank and charity regulators have agreed to facilitate cash transfers to high-risk countries or countries on the sanctions list.
While there are advocacy and redressal initiatives afoot, NPOs need more capacity around awareness, resilience and response. And while there has been some promising response from governments and regulators, it has been patchy at best. There will need to be a more concerted effort on all sides to tackle this issue head on. In the Netherlands, an effort to re-start a conversation with all relevant stakeholders to find practical and hopefully rule-based solutions is underway, facilitated by Human Security Collective, commercial banks and the Ministries of Foreign Affairs and Finance. In the UK, a similar dialogue has begun, spearheaded by DfID. These type of conversations, where relevant and committed stakeholders want to seek solutions together, are critical for finding a way forward. Given the multi-faceted nature of the derisking/shrinking-civic-space beast, it is time that policymakers, financial institutions and regulators take ownership of the problem and, together with civil society, look at the issue structurally and systemically to find sustainable and long-term solutions.