Financial-Crime Worries Rise

In a region bedeviled by war, corruption, money laundering and terrorism, banks are finally investing in financial-crime compliance.

Exclusion from international financial markets is the greatest fear for any bank. In the Middle East it is a daily concern, as instances of compliance failures continue to make headlines.

Last year, a group of US citizens sued 11 Lebanese banks for aiding Hezbollah, despite its terrorist classification by the US government. One of these banks was forced to close a few months later.

In 2018, the United Arab Emirates’ largest private bank, Mashreq Bank, had to pay a $40 million fine for violating the US Bank Secrecy Act and anti-money-laundering laws. According to a survey of 488 Middle Eastern lenders by the Union of Arab Banks (UAB), uncertainty around US sanctions is the biggest short-term compliance concern.

These actions are the latest wrinkle in a years-old crisis that never really went away. Four years ago, the Middle East was on the verge of de-risking. A study by the International Monetary Fund, World Bank and Arab Monetary Fund found that 40% of Arab banks were experiencing “a significant decline” in the scale of their correspondent banking relationships.

Over 160 accounts had been terminated in just a year, mostly with European partners and US. Although no data has been published since, the region remains in distress.

“Things are getting even more complicated,” says Ali Awdeh, head of research at the UAB. “Correspondent banks in the US, in particular, have increased their requirements. And although huge efforts have been done by MENA banks—including investment in AML/CFT [countering financing of terrorism], new technology and staff training—the relationship is not improving.”

Compliance is at the heart of the matter. While Arab banks try to follow international standards, global policymakers continue to raise the bar, making it difficult for MENA institutions to catch up. In 2019 alone, Thomson Reuters reports that over 220 international regulatory changes occurred every day, amounting to 80,000 updates that year.

“The past decade witnessed increased regulatory expectations for banks to monitor against a wider set of financial crimes, coupled with intensified enforcement and reputation loss for violations,” says Michael Matossian, executive vice president and chief compliance officer at Jordan’s Arab Bank.

Reputational damage is the biggest fear associated with compliance failure. To make sure they keep their hands clean, Middle East banks often prefer to cut ties with certain clients. In Lebanon, for example, most lenders refuse to open accounts for Syrian nationals, for fear they might be associated with sanctioned individuals or entities. In a survey last year on financial-crime compliance in MENA conducted by Refinitiv, 72% of respondents said they would rather avoid risk than manage it. In the long run, however, such precautionary strategies amount to financial exclusion and could have a negative impact on MENA economies.

Banking on Technology

As it is elsewhere, digital disruption is driving change in how MENA financial institutions comply with regulations. Banks are increasingly investing in new technologies and expect to continue doing so in coming years. The Refinitiv survey found that 25% of banks have more than doubled their investment in technology against financial crime in just the past two years.

“Part of it is chasing fashion,” says Rupert Brown, former chief architect in the CTO group at UBS and founder of Evidology Systems, a London-based regtech that matches regulatory law with IT and processes. “I don’t think blockchain or artificial intelligence, for example, will make compliance any better, because they do not offer enough context to make a judgement. But as oil revenues decline, some banks won’t be able to afford the next new toy, and thus they will have the same lack-of-investment problem we are facing in the West.”

The cost of compliance is a growing concern, making financial institutions cautious to invest in the right tech, for fear it could become obsolete or add an unnecessary layer of complexity. Lenders will either seek guidance from the regulator or go to clearly identified market leaders to minimize risk.

“Technological advancements can also present new challenges and risks that need to be effectively mitigated,” says Matossian. “For example, the convergence of cyber and financial crimes worldwide has become a major challenge. Banks need to maintain the appropriate balance between embracing innovation and effectively protecting against financial crime.”

One area where technology can help improve compliance and oversight is in the automation of time-consuming tasks, such as false-positives reviews and trade finance, which can allow employees to refocus on more analytical and investigative missions. However, innovation and technology require new skill sets not only in the IT department but among employees at all levels. While most banks have training programs in place, a third of MENA’s financial institutions say that driving internal behavioral change is their biggest compliance management challenge.

Data management is a related concern, and one of the main drivers of tech investment in the region. Banks are aware they sit on great resources but don’t know fully how to manage or analyze them. While there is space for innovation and improvement, cultural adjustments are necessary.

“Culturally, the region is a little bit more secretive about sharing data and personal information,” says Nina Kerkez, director of Financial Crime Compliance at LexisNexis Risk Solutions. “That’s a challenge locally and on the international scene, given that the West specially asks for this data to be looked into when onboarding financial institutions or customers from the region.”

Language adds a further layer of difficulty when adapting regulation mechanisms crafted in the West to local realities. “Naming conventions are more challenging in the Middle East,” says Kerkez. “You have over 10 ways to spell Mohammed, but it’s also the way names are put together. In the West, most common naming conventions contain first name, middle name, last name, whereas in the MENA region naming conventions are more complex. That’s where the industry should be a bit more responsible and help the MENA partners overcome these challenges.”

Protecting the Whistleblowers

While banks have made progress in some areas, close observers wonder if they are neglecting others. According to the UAB survey, over 60% of respondents are “very concerned” about money laundering and terrorism financing. These topics outranked other financial crimes such as bribery, corruption, cybercrime and drive resource allocation. While 63% of banks have a dedicated anti-money-laundering team, more than half the respondents said they have no anti-bribery and corruption unit.

A key element to look at here is internal checks and balances. Most recent global financial scandals worldwide, including those revealed by the Panama Papers, came to light thanks to individuals who reported wrongdoing at their institutions. Whistleblowing is among the most effective ways to track and identify compliance failures. It is also very cost-effective. But for it to work, clear mechanisms must be in place that encourages whistleblowers to speak up.

The MENA region still largely lacks a legal framework for whistleblowing. Dubai passed a protection law in 2016, and Tunisia did so the following year, but in most countries it remains a blind spot. In Egypt, for example, if accusations turn out to be false, the whistleblower can be jailed.

“While gaining increased regulatory attention, the complex legal systems and varying cultures that define each Arab country, our region—like many others—have yet to show promising actions that encourage employees to come forward and raise a red flag,” stated the MENA Financial Crime Compliance Group (MENA FCCG), a regional body formed in 2016 by 13 banks from nine countries as a collaborative approach to combat financial crime.

To some close observers, this suggests the need for a more collaborative approach across borders. “It is important to speak as a region, to show that it is not an accumulation of individual concerns but that all the banks are aware of the importance of pushing for better practices and better compliance,” says the UAB’s Awdeh, who is also a founding member of MENA FCCT.

Most MENA bankers believe the benefits outweigh the risks when sharing information and collaborating against financial crime, according to recent data from Refinitiv. As an example, a collaborative approach would be critical to tackling crime in newly regulated industries such as fine art and real estate.

“We know real estate in the Middle East in booming,” says LexisNexis’s Kerkez. “And unfortunately, there is some history of real estate being sold to sanctioned individuals. It will be interesting to see how the MENA region deals with these industries. There will have to be increased collaboration between regulatory bodies to adhere to the requirements.”