There is a contradiction at the heart of the payments industry. While the government and regulators have been driving hard to open up competition and access into banking and payments, beneath the surface there are very few banks that actually provide transactional banking services for the likes of fintechs and other non-bank payment service companies.
Such banks are reducing the number of companies that can use their current account banking services for managing their basic trading operations. They are either not allowing new companies to open accounts or are telling current customers to move their accounts elsewhere. This is referred to as derisking.
There are a number of factors driving de-risking policies at big banks. For example, there have been many regulatory changes in the US, which is affecting correspondent banking relationships for UK and European banks handling companies doing business that involves US Dollars. "Contrary to what you might think given the advent of much-vaunted challenger bank culture, the general trend is of banking closing down rather than opening up. Combined with Brexit, this constitutes a real threat to the UK's thriving fintech ecosystem," says Tony Craddock, Director General of the payments industry's leading trade association, the Emerging Payments Association (EPA).
Craddock pointed out that simple trading bank accounts are proving very hard to open for many companies in payments and finntech. "We have also met successful payments companies that have been issued with a 'cease and desist notice' from the bank, telling them their accounts are about to be closed. When you have received a cease and desist from one of the big banks, your options for opening a similar account elsewhere are very limited. The outcome is that such organisations are having to shut up shop altogether; 'Without a bank account, you can't run a business," said Craddock.
Derisking started in 2013 and is an increasingly common practice, according to a study by John Howells for The Financial Conduct Authority in February 2016. The EPA asked one of the large banks in Europe why it was declining transactions without giving a relevant reason. The bank said it was struggling to keep up with regulatory changes in the US and simply could not justify the effort and the costs associated with continuing to provide current accounts for the sector. "They just take a black and white approach," said Craddock.
The Advisory Board of the Emerging Payments Association held a round table for CEOs to look into this problem. Those attending were shocked how many companies were actually already affected by derisking. "We expected this to be happening occasionally, but it is clear from the discussion that this was a very common occurrence. The correspondent bank we spoke with was honest and decent enough to tell the EPA that the situation wasn't going to get better; it was going to get worse. The bank was widening the criteria as to which payments and fintech companies it was going to decline ."
Craddock added that this is not an easy subject to tackle because there is no individual payment company that would want to come out and admit they were in that situation. If they do, the one bank that may still be processing them is likely to shut them down.
"It's an industry problem. Everyone is incredibly nervous and no one wants to alienate the banks because we are already struggling with them. We are trying to raise it at regulator level. The regulator is aware of it and reminds us that according to the regulations, banks can't just issue a cease and desist order. They need to give good reasons. But the reason they actually give for withdrawing banking services will be for 'the avoidance of money laundering risks', and that will get them out of everything."
Having explored the world of banking in some detail, Craddock saw patterns emerge which were indicative of the fact that often it's just a small number of big banks providing this service. He said: "I now understand that when you are getting a bank account, it's not enough to get the bank account with a secondary bank, you need to investigate who their primary correspondent bank is. In fact you want them to have a network of correspondent banks."
Blockchain to the rescue
Payments innovation company Ripple has been looking at reducing some of the pain points within correspondent banking and cross-border payments. This week it conducted a test of its digital token for cross-border payments with 12 member banks in the R3 consortium of 60 financial institutions looking to improve efficiency with blockchain.
Marcus Hughes, director of business development, Bottomline Technologies, has been looking at how blockchain can assist the payments arena and address problems like de-risking.
Hughes, who is part of the Whitechapel Think Tank and has just published a paper on how blockchain can handle sanctions filtering and KYC, said: "I like what Ripple are doing but they don't do sanctions filtering. They don't do KYC. I love their liquidity providers; I like their duel currency settlement which is obviously instant settlement between those liquidity providers. They have a lot of good things, but not the full story."
Tony Craddock was not overly enthusiastic about blockchain saving the day in the short or medium term. He said: "Distributed ledgers and the associated blockchain technology has an exciting future, but it very unlikely to reduce the impact of derisking for several years. Blockchain won't help to keep businesses afloat that are threatened by derisking."
*Changes were made to the original version of this article which did not accurately reflect the views of the EPA or its members.