The phenomenon of de-risking: Unintended consequences and possible solutions

Abstract

Global commerce relies on correspondent banking to execute international transactions. Due to the increasing cost of compliance, however, some US-based global financial institutions have been terminating their correspondent banking relationships — a practice known as de-risking. In some cases, correspondent banks have even terminated their relationships with central banks. This kind of situation creates systemic risk at a country level, and central banks are looking at alternatives to better serve the needs of their respective financial systems. This paper analyses prior work and surveys on the magnitude of de-risking, and cross-references the findings with recent surveys conducted in the Dominican Republic and Argentina to determine whether market failures and systemic risk are inevitable. The results indicate that while the situation is not yet catastrophic, it is sufficiently precarious that foreign countries that rely on the US dollar should start looking for alternative solutions for global correspondent banking immediately. The paper also describes some of the alternatives currently available, including intervention from the Federal Reserve Bank of New York, regional payments systems, and smaller US correspondents.