IMF: Global Banks’ Retreat From Some Countries Poses Financial Risk

Global banks’ retrenchment from emerging markets and developing economies poses a threat to regional financial stability, the International Monetary Fund said, laying some of blame on tighter postcrisis regulatory standards.

In recent years, several countries have reported a decline in the type of banking relationships that give smaller, less-developed economies access to the global financial system, the IMF said in a paper exploring the phenomenon. In less-developed economies, local banks rely on financial giants with global reach and access to the U.S. Federal Reserve system to facilitate cross-border payments and other financial services. The World Bank has similarly expressed concerns over the fact that more of these correspondent bank relationships are being terminated.

Regulatory costs and complexity have risen since the financial crisis. The IMF said that global overhauls in the aftermath of the crisis, including higher bank capital requirements, have been key to restoring financial stability. At the same time, more rigorous capital and liquidity requirements have increased banks’ cost of holding risk on their balance sheets, making it less attractive for some banks—many of them struggling to boost profit amid still-low interest rates—to operate in smaller markets where local regulations don’t match up to international rules.

In some cases, global banks are choosing to stop doing business in certain countries to avoid hefty fines and public embarrassment, especially when it comes to perceived risks related to potential money laundering, terror financing and drugs, Yan Liu, assistant general counsel at the IMF and an author of the report, said on a related podcast.

The IMF cautioned that “without cross-border banking services, the flow of money, investment, trade, and foreign payments—all of which grease the wheel of a country’s economy—may stop.”

Moreover, people might find themselves iced out of their own financial system, setting in motion a domino effect of lower consumer spending, slower job growth and reduced economic output.

For some affected countries, the ability to receive formal remittances amounts to a significant chunk of gross domestic output—up to 40%, in some cases, according to Ms. Liu. She highlighted the Caribbean, where 16 banks across five countries have lost all or some of their correspondent banking relationships, and Belize, where even the nation’s central bank has lost relationships with global banks. Roughly three-quarters of Caribbean banks depended on one correspondent bank in particular, making them vulnerable if they lost that relationship, the Caribbean Association of Banks, a trade group, said in a report last year.

So far, the impact has been contained, the IMF said. “We have not observed macroeconomic consequences at a global level,” said Ms. Liu, in part because of efforts by the IMF to support affected member nations and because of some local banks’ abilities so far to lean on remaining global banks—though that often comes with a price, such as newly imposed minimum activity thresholds and higher costs arising from increased due diligence.

But while fallout by some of the world’s biggest banks to stop doing business in certain countries has been confined to small countries across Africa, the Caribbean, Europe and the Pacific, the IMF cautioned that terminated correspondent bank relationships could become systemic if unaddressed, potentially undermining financial stability in countries such as Somalia, Samoa and Russia. “The global effect so far has been a gentle ripple, but if unaddressed, it may become more like a tsunami for the countries they leave,” the IMF said on its blog.

The IMF said both the public and private sectors have a role to play in mitigating the risks stemming from financial exclusion. It credited the banking industry for strides it has taken to lower compliance costs by sharing information but said there is more to be done, including developing more innovative approaches to payments. The IMF called on regulators to ramp up outreach and education efforts, particularly by home supervisors of global banks, to help clarify regulatory requirements and strengthen regulatory and supervisory frameworks.

If a complete loss of a correspondent banking relationship is imminent, the IMF said, public support should be considered. The fund suggested the use of publicly backed vehicles or direct central bank involvement, along with political engagement at the highest level.

“Ultimately, it’s the customers of the banks who are affected,” Ms. Liu said. “At the end of the day, it will be the customers who will bear these costs.”

Write to Lisa Beilfuss at lisa.beilfuss[a]wsj.com