De-Risking for Dummies: A Very Simple Explanation


What is de-risking?

computer-moneyDerisking: “The phenomenon of financial institutions terminating or restricting business relationships with clients or categories of clients to avoid, rather than manage, risk.” (as defined by The World Bank)

A simple way of understanding de-risking is to think of it in terms of a friendship. When a friendship goes bad, and starts being more to your detriment than your benefit, or even if you start getting bad reports about that friend, you may be forced to stop talking to or dealing with the offending, or ‘bad’, friend. That’s you de-risking your life. You are minimising the level of risk the friend poses to your life by not talking to or dealing with that person.

Banks and financial institutions do the same thing sometimes. For them, de-risking means cutting ties and lessening relationships with categories of customers that are considered ‘high-risk’. The bank may stop offering financial services to ‘high-risk’ customers (termination of services), and may choose to close their existing accounts. The bank may also choose to restrict the services provided to ‘high-risk’ customers, carefully monitoring them and subjecting them to special stipulations. Such customers may be companies, persons, whole countries, or other banks themselves.

Photo Courtesy: Investopedia
Photo Courtesy: Investopedia

Why do banks de-risk?

When you end a friendship, it is usually because you no longer consider that person to be a friend. You no longer see how you benefit from a relationship with that person, and may even believe that that person poses a threat to your well-being. Banks de-risk for similar reasons. They de-risk when there are:

  • Security concerns: If a bank suspects that a customer is using their services to break the law, they will sever their relationship with that group. In today’s economic climate, financial institutions are especially careful to avoid money launderers, and to ensure that they are countering the financing of terrorism (CFT).
  • Reputational concerns: Banking is based on people’s perception of the organisation. A bank’s will de-risk to protect its reputation, which will be damaged if people perceive the bank as not unsecure, or engaged in and susceptible to criminal activity.
  • Low profits: When the bank does not see the financial benefit of continuing a relationship with a particular entity.
  • Excessive scrutiny: When a relationship with a particular entity causes the bank to be scrutinised by national, regional or international regulatory bodies, the bank may find it easier to sever its relationship with that entity.

4121035876illegaltrademoneyResults of de-risking

Consider this: If your ‘bad’ friend wanted to continue a friendship with you, then he/she would see your decision to end it as a negative. But you would see things differently. You would probably think that ending the friendship was a positive move that would benefit you in the long run. De-risking is seen in a similar way. Depending on where you are, de-risking can be seen in both a positive and negative light.

“Money transmitters, charities and fintech companies are among the sectors particularly affected by banks de-risking, and we understand that some banks are also withdrawing from providing correspondent banking services. Banks have told us that this helps them comply with their legal and regulatory obligations in the UK and abroad. However, we are clear that effective money-laundering risk management need not result in wholesale de-risking. (Quote from the UK’s Financial Conduct Authority)

The proponents: Proponents for de-risking are usually large banks and financial institutions. They will argue that they must de-risk to remain secure, and to minimise the risk of money laundering and the financing of terrorism.

The opponents: Opponents of de-risking are usually small- to medium-size money transmitters, charities, fintech companies, and banks that hold correspondent banking status with larger banks. They will argue that wholesale de-risking encourages financial exclusion, casting aspersions on smaller banks that cannot afford to be as competitive as larger groups, and which rely on larger groups to offer certain services or complete certain transactions.