The great unbanking

Unchecked financial blacklisting, fueled by regulatory zeal, is neither reasonable nor prudent

COMMENT | ROBERT SKIDELSKY | Nigel Farage, the former leader of the UK Independence Party (UKIP) and the driving force behind the campaign for the United Kingdom’s exit from the European Union, recently caused an uproar when he revealed that his bank accounts were closed two months earlier, allegedly because of his political views.

Farage claimed that he tried to open new accounts with seven other banks, all of which turned him down. His original bank, Coutts a subsidiary of NatWest that caters to an ultra-wealthy clientele later stated that the decision to shut down his account was purely commercial and that Farage simply fell below the bank’s wealth threshold.

But Farage maintained that he had been blacklisted. He suggested that he had been labeled a “politically exposed person” (PEP), a designation he attributed to unfounded accusations that he had received payments from the Russian government, and claimed that members of his family were affected by this designation. Farage’s accusations immediately triggered a political backlash. The UK Treasury announced a review of whether existing regulations strike the “right balance between the rights of a customer to express themselves freely and the right of the bank to manage commercial risk.”

The acronym PEP ought to be more widely recognised. Until a few months ago, I thought it stood for “personal equity plan,” a government-backed investment scheme that was introduced in the UK in the 1980s to encourage savers to invest in British companies and was abolished in 1999. I was unaware that it now refers to a category of individuals who are significantly exposed to corruption or blackmail.

In its current meaning, PEP originates from a 2015 EU directive aimed at combating money laundering and terrorist financing. The directive instructs banks to implement particularly rigorous “due diligence” measures for government officials, legislators, auditors, regulators, and diplomats who are at risk of being exposed to bribery and corruption. And this measure extends to their families and business associates as well.

The Financial Action Task Force, the intergovernmental watchdog charged with combating money laundering and terrorist financing, stipulates that such diligence should be proportionate and must not be “interpreted as stigmatising PEPs as involved in criminal activity.” Banks across the EU, the United States, and other regions now have access to an international list of PEPs and their families, which also includes individuals subject to economic (that is, political) sanctions whose assets have been effectively frozen or seized.

Given that managing the accounts of such individuals could expose them to reputational damage and compliance risks, banks have found that it is more cost-effective to close PEP-related accounts and decline to open new ones than to improve their fraud detection and prevention mechanisms.

Due diligence, at least as it is commonly understood, means taking reasonable precautions against illegal or reckless activity to protect the financial system’s integrity. But this unchecked financial blacklisting, fueled by regulatory zeal, is neither reasonable nor prudent. Overregulation can incapacitate the financial system as much as rampant corruption can.

Banks and other financial institutions carry out due diligence by collecting as much information as possible about every individual to assess the risks and benefits of establishing a relationship with them. Although many people remain under the radar, the increasing availability of personal data via social media suggests that many individuals might soon become subject to something akin to China’s social-credit system, where their “scores” will dictate their access to various services and utilities.

The Farage revelations are merely the tip of the iceberg. They have already spurred a wave of similar claims by prominent people who have had their accounts closed or new account applications denied for unknown reasons. These include the UK’s current Chancellor of the Exchequer, Jeremy Hunt, and former Chancellor Kenneth Clarke. During a recent House of Lords debate on economic crime, hereditary peer Merlin Hay expressed his indignation, stating, “I personally find it offensive that I am deemed to be a risk and a crook. I thought that in this country we were innocent until proven guilty.”

At this point, I must declare a personal interest. As a PEP myself, three of my bank accounts were shut down without any explanation. Moreover, these accounts were blocked for several months before the funds were finally released, greatly enhancing my empathy for Farage’s predicament.

Few people realise that when they deposit money in a bank, it is no longer theirs. In essence, they have given the bank the right to use those funds. In return, the bank accepts the obligation to repay any sum upon request, up to the full amount deposited. Without this bilateral contract, the modern banking system would be unsustainable, leaving people better off keeping their liquid assets in cash.

Recognising the problem, the British government has proposed a bill aimed at ensuring that domestic PEPs, considered to pose a lower risk of involvement in money laundering and terrorism, are subject to “lesser enhanced due diligence measures.” However, it is doubtful that this will significantly alter banking practices. When banks were freed from exchange and capital controls in the 1980s, no one anticipated a politically-driven surge in money laundering, because no one could foresee the resurgence of state and sub-state terrorism. But this unexpected development necessitated a completely new set of banking regulations targeting those who pose the most risk.

Technological advances, particularly the advent of online banking, have led to another significant shift. In the past, bank managers knew their customers as intimately as internists knew their patients. But that era is long gone; account management has become an increasingly automated process, largely devoid of human intervention. While this has made the banking system more efficient, the growing number of people placed on PEP blacklists by unaccountable algorithms underscores the urgent need to reverse this creeping Orwellian trend.

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Robert Skidelsky, a member of the British House of Lords, is Professor Emeritus of Political Economy at Warwick University.

Copyright: Project Syndicate, 2023.