As goes correspondent banking, so goes globalisation
The IMF’s Christine Lagarde gave a speech
to the New York Fed last week, lamenting another sign of globalisation
going backwards — the decline of correspondent banking in some of the
world’s most precarious countries:
The perceived problem, as we’ve covered before, relates to heightened banking standards in the wake of the global financial crisis — everything from Know Your Customer (KYC), Anti-Money Laundering (AML) and Combating the Financing of Terrorism (CFT) rules.
They are eating into banks’ cost-benefit rationale for servicing countries such as small island states, war-torn nations or other developing frontiers. At the best of times these areas are only barely profitable for banks. In many cases they’re loss-leading. These days, however, the increased expense is making it an unviable business, causing many banks to withdraw entirely. Banks are not charities, after all.
A significant part of the increased expense relates to the on the ground due diligence processes banks would have to deploy to satisfy know your customers’ customers regulations.
Glaringly, Lagarde didn’t hesitate to link the correspondent reversal to the makings of a new systemic crisis for global finance. Though, really, it’s what she was hinting at between the lines which really mattered.
Take the following statement from Lagarde as an example:
This ties into the speech’s other core message: that the solution to the so-called security-access paradox (i.e. if it’s secure it’s not accessible, if it’s accessible it’s not secure) must also lie in technological innovation. Specifically, it must lie in some sort of international and global KYC framework, encouraging the development of KYC utilities which centralise information on customer due diligence.
So on one hand new technologies are likely to endow opportunists with the tools they need to fill the market chasm left behind by banks, and on the other hand they can and must be used by banks to solve their own cost-benefit problem. With respect to fintech in particular, Largarde’s speech warned:
She added that these technologies are coming whether we like them or not, so it makes sense to deploy them transparently as a force for good (as opposed to, we presume, the offsetting force for bad if deployed by the wrong hands opaquely).
So what’s really going on here? And why does it matter?
The inference, we’d say, is that the global financial system is sitting at a critical juncture beyond which it could easily bifurcate into two competing networks: one transparent, one opaque. As a consequence, the transparent sector has a responsibility to help vulnerable territories raise their standards to those of the international system potentially at a cost to itself, if not in charitable mode. (Think of somewhere like Panama, for example.) Abandoning these territories to the fate of an opaque system, which doesn’t have their long term interests at heart, endangers not just the territories themselves but threatens the sort of global development which we all profit from in the long run.
Things are challenged on this front precisely because charity isn’t an appealing option for a profit maximising market financial system. And yet, if such charity isn’t forthcoming, globalisation and all the expanded profit opportunities which come with it might be up-ended.
It seems increasingly clear, as a consequence, that some sort of permanent “no strings attached” transfer from the rich to the poor must be factored into the framework if globalisation is to keep on track. At the very least, the cost of operating a global transfer and payments system must be factored into the global cost of doing business and be funded, if necessary, on a sunk cost basis.
Opaque systems like bitcoin are equally challenged on this front but their method for coping with the cost-benefit paradox is much more conniving. They use myth-making and cultic indoctrination techniques to convince those with spare capital to invest, to invest it into a reserve stock which funds the global payments float for the long term and without any par value guarantee.
Ingeniously, these myths promise such investments will pay off at some unknown point in the future without any explicit commitment that they must. For as long as the myth remains intact and continues to recruit new capital to compensate for the operating costs of the system (which are substantial) and not too much value is cashed out the whole thing squares.
The system as a consequence courts risk-takers while accumulating a capital buffer which has the capacity to subsidise global remittances on a entirely charitable basis (or for as long as nobody cashes out). But it’s risky and costly for a reason. The lack of a commitment to deploy funds scrupulously on the other side of the delivery point opens the door to the same old tragedy of the commons risk associated with subsidisation systems everywhere.
In short, with chronic subsidisation there is no guarantee precarious states will acquire the sort of behaviours which can deliver them out of poverty or precariousness in the long term. To the contrary, the exact opposite behaviours may be encouraged instead.
Correspondent banks and deglobalisation
All this links into how and why the decline of correspondent banking is stirring the forces of deglobalisation. Currently, as the discussion noted, a lack of private sector confidence has forced central banks to take on the responsibility of lubricating the global financial system mostly by way of FX swap lines. These swap lines were supposed to be a temporary post-crisis measure, but have instead become a permanent feature of the global banking system — in some ways substituting the private swap lines usually provided by correspondent banks.
Asked if the IMF was in a better positioned to provide these sorts of ‘at cost’ global banking mechanisms, Lagarde noted it wasn’t a bad idea and that she would certainly consider it. Nevertheless her initial instinct was the IMF would need an enhanced structure from a technology point of view and from a market capacity point of view.
But ultimately the key takeaway point is this. For as long as the private sector remains reluctant to fund the global payments systems, public bodies in developed nations will be required to fill the void in a manner which socialises the costs, impacting their own prosperity. If they are stopped from doing this before the private sector can be wooed back, globalisation could be threatened. Hence, getting the private sector to fund these operations is critical.
This, however, is much more likely if value creating behaviours can be encouraged in areas currently deemed high risk. To ensure that, however, active and responsible supervision by western institutions must also be part of the course. Yet the cost of that currently is too high to make it worthwhile. Thus, the reasoning goes, if the costs can be brought down with the cunning use of technology then we can all have our cake and eat it.
Which is all very nice.
Except, as we’ve recounted before, the view neglects that such costs aren’t necessarily linked to supervision as much as to enforcement. More so, that simply adding everyone’s name to an almighty blockchain in the sky does little to encourage positive-sum behaviours let alone the private sector to underwrite risk in areas where there is a general contempt for the rule of law.
So unless a global blockchain comes complete with a robotic enforcement division or a new way to of encouraging rich countries to transfer capital permanently to poor countries with no strings attached, we suspect we’ll find ourselves back at square one (or living in a global panopticon system). None of which is all that encouraging.
Related links:
Fintech paradoxes, blacklist edition – FT Alphaville
Dollar re-shoring risk and fintech panaceas – FT Alphaville
Correspondent banking is like the blood that delivers nutrients to different parts of the body. It is core to the business of over 3,700 banking groups in 200 countries. A global bank like Société Générale, for example, manages 1,700 correspondent accounts and processes 3.3 million correspondent transactions every day.And to see how much the issue is preying on the minds of officials at the IMF, you only have to look at its recent Article IV country reports, everywhere from Panama, to the Marshall Islands and — as an example of a country encouraging its own banks to end these relationships — the US itself.
There is a real concern expressed by many of our IMF member countries that their financial lifeline is at risk: in Africa, the Caribbean, in Central Asia, and in the Pacific…
The perceived problem, as we’ve covered before, relates to heightened banking standards in the wake of the global financial crisis — everything from Know Your Customer (KYC), Anti-Money Laundering (AML) and Combating the Financing of Terrorism (CFT) rules.
They are eating into banks’ cost-benefit rationale for servicing countries such as small island states, war-torn nations or other developing frontiers. At the best of times these areas are only barely profitable for banks. In many cases they’re loss-leading. These days, however, the increased expense is making it an unviable business, causing many banks to withdraw entirely. Banks are not charities, after all.
A significant part of the increased expense relates to the on the ground due diligence processes banks would have to deploy to satisfy know your customers’ customers regulations.
Glaringly, Lagarde didn’t hesitate to link the correspondent reversal to the makings of a new systemic crisis for global finance. Though, really, it’s what she was hinting at between the lines which really mattered.
Take the following statement from Lagarde as an example:
Although not yet having macroeconomic consequences this issue if not addressed could be of systemic nature. And I have not deliberately addressed what I regard as the weak link that could result from very strange alternatives being put in place in order to facilitate the flow of movement between certain countries which are effectively cut out of the legitimate circuits and channels whereby finance has to flow.Lagarde’s point is that as legitimate banks pull out of vulnerable areas, less scrupulous actors will not hesitate to rush to take their place. Unlike the regulated banking network , however, these actors will be inclined to operate below the supervisory radar, thus potentially exposing the entire system to risk again. Many of these ‘strange alternatives’, meanwhile, will hail from the technological sector. (And while Lagarde didn’t explicitly mention cryptocurrency or bitcoin, it’s certainly the case that such systems would qualify as ‘strange alternatives’.)
This ties into the speech’s other core message: that the solution to the so-called security-access paradox (i.e. if it’s secure it’s not accessible, if it’s accessible it’s not secure) must also lie in technological innovation. Specifically, it must lie in some sort of international and global KYC framework, encouraging the development of KYC utilities which centralise information on customer due diligence.
So on one hand new technologies are likely to endow opportunists with the tools they need to fill the market chasm left behind by banks, and on the other hand they can and must be used by banks to solve their own cost-benefit problem. With respect to fintech in particular, Largarde’s speech warned:
If these and other avenues are not pursued and smaller countries are left to fend for themselves, new entrants to the payments sphere emerging from the fintech boom will surely step in. This may not be a bad outcome for consumers, who could benefit from increased efficiency.The outcome may be less positive for society, however, if the banking sector leaves the field to informal – and sometimes illegal – channels of remittances that provide less security. It may even make it more difficult for banks to generate legitimate business.In the Q&A session which followed, Lagarde predictably referenced our old favourite the blockchain as the technology most likely to make a difference. She added that her IMF teams were now looking into it as a potential solution to the cost-benefit problem.
She added that these technologies are coming whether we like them or not, so it makes sense to deploy them transparently as a force for good (as opposed to, we presume, the offsetting force for bad if deployed by the wrong hands opaquely).
So what’s really going on here? And why does it matter?
The inference, we’d say, is that the global financial system is sitting at a critical juncture beyond which it could easily bifurcate into two competing networks: one transparent, one opaque. As a consequence, the transparent sector has a responsibility to help vulnerable territories raise their standards to those of the international system potentially at a cost to itself, if not in charitable mode. (Think of somewhere like Panama, for example.) Abandoning these territories to the fate of an opaque system, which doesn’t have their long term interests at heart, endangers not just the territories themselves but threatens the sort of global development which we all profit from in the long run.
Things are challenged on this front precisely because charity isn’t an appealing option for a profit maximising market financial system. And yet, if such charity isn’t forthcoming, globalisation and all the expanded profit opportunities which come with it might be up-ended.
It seems increasingly clear, as a consequence, that some sort of permanent “no strings attached” transfer from the rich to the poor must be factored into the framework if globalisation is to keep on track. At the very least, the cost of operating a global transfer and payments system must be factored into the global cost of doing business and be funded, if necessary, on a sunk cost basis.
Opaque systems like bitcoin are equally challenged on this front but their method for coping with the cost-benefit paradox is much more conniving. They use myth-making and cultic indoctrination techniques to convince those with spare capital to invest, to invest it into a reserve stock which funds the global payments float for the long term and without any par value guarantee.
Ingeniously, these myths promise such investments will pay off at some unknown point in the future without any explicit commitment that they must. For as long as the myth remains intact and continues to recruit new capital to compensate for the operating costs of the system (which are substantial) and not too much value is cashed out the whole thing squares.
The system as a consequence courts risk-takers while accumulating a capital buffer which has the capacity to subsidise global remittances on a entirely charitable basis (or for as long as nobody cashes out). But it’s risky and costly for a reason. The lack of a commitment to deploy funds scrupulously on the other side of the delivery point opens the door to the same old tragedy of the commons risk associated with subsidisation systems everywhere.
In short, with chronic subsidisation there is no guarantee precarious states will acquire the sort of behaviours which can deliver them out of poverty or precariousness in the long term. To the contrary, the exact opposite behaviours may be encouraged instead.
Correspondent banks and deglobalisation
All this links into how and why the decline of correspondent banking is stirring the forces of deglobalisation. Currently, as the discussion noted, a lack of private sector confidence has forced central banks to take on the responsibility of lubricating the global financial system mostly by way of FX swap lines. These swap lines were supposed to be a temporary post-crisis measure, but have instead become a permanent feature of the global banking system — in some ways substituting the private swap lines usually provided by correspondent banks.
Asked if the IMF was in a better positioned to provide these sorts of ‘at cost’ global banking mechanisms, Lagarde noted it wasn’t a bad idea and that she would certainly consider it. Nevertheless her initial instinct was the IMF would need an enhanced structure from a technology point of view and from a market capacity point of view.
But ultimately the key takeaway point is this. For as long as the private sector remains reluctant to fund the global payments systems, public bodies in developed nations will be required to fill the void in a manner which socialises the costs, impacting their own prosperity. If they are stopped from doing this before the private sector can be wooed back, globalisation could be threatened. Hence, getting the private sector to fund these operations is critical.
This, however, is much more likely if value creating behaviours can be encouraged in areas currently deemed high risk. To ensure that, however, active and responsible supervision by western institutions must also be part of the course. Yet the cost of that currently is too high to make it worthwhile. Thus, the reasoning goes, if the costs can be brought down with the cunning use of technology then we can all have our cake and eat it.
Which is all very nice.
Except, as we’ve recounted before, the view neglects that such costs aren’t necessarily linked to supervision as much as to enforcement. More so, that simply adding everyone’s name to an almighty blockchain in the sky does little to encourage positive-sum behaviours let alone the private sector to underwrite risk in areas where there is a general contempt for the rule of law.
So unless a global blockchain comes complete with a robotic enforcement division or a new way to of encouraging rich countries to transfer capital permanently to poor countries with no strings attached, we suspect we’ll find ourselves back at square one (or living in a global panopticon system). None of which is all that encouraging.
Related links:
Fintech paradoxes, blacklist edition – FT Alphaville
Dollar re-shoring risk and fintech panaceas – FT Alphaville
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