How banks can negotiate the US and European sanctions

To say we live in an interconnected world may be a cliche but, in reality, the extent of interlinkages often run deeper than what can be perceived to a casual observer. Take the case of a small Indian proprietary firm exporting tea to the UAE. Most likely, the firm communicates with its buyers through Gmail and Microsoft Teams, uses FedEx or UPS to courier documents, and Maersk or the Mediterranean Shipping Company (MSC) to ship goods, and invoices those sales in dollars or euros. The company’s local bank, in turn, receives payments for those invoices through its US or European correspondent banks with whom they interact through SWIFT (Society for Worldwide Interbank Financial Telecommunication).

So, what looks like a bilateral deal between residents of India and the UAE leaves footprints in many other shores by virtue of currency, logistics and settlement systems used for the fulfilment of the deal. This explains why US and European sanctions – essentially laws passed by their respective governments in their jurisdictions – have become quasi-universal laws, whose non-compliance can have legal consequences even for entities falling outside those jurisdictions.

In other words, for those involved in international trade, it is no longer adequate to stay within the laws and regulations of the countries of the primary contracting parties. They should also ensure compliance with the laws of any third country that play a role in fulfilment of the contract, no matter how tenuous or peripheral the connection might seem.

Bankers are especially vulnerable here. Their profits, reputation and even the ability to stay in business can get impacted by lapses or indiscretions in complying with all applicable regulations. No wonder more and more banks are choosing to stay out of trouble by simply walking away from such troublesome territories, rather than trying to steer through the labyrinth of rules and regulations that comprise today’s sanctions regime.

This mindset can’t be faulted per se, considering that risk aversion is one of the timeless fundamentals of sound banking. But it comes with some unintended and unwelcome side effects. For one, a blanket refusal to touch anything connected with a sanctioned geography has the practical effect of reinforcing – and even exacerbating – the rigour of the sanctions, thus hampering the efforts of one’s own government to pursue an independent foreign policy and take stances based on one’s own assessment and perception.

It may not be an exaggeration to say that by following such a shutters-down approach, one may be actually deferring to the geopolitical posturing and world-view of a third country. Besides, such denial of service by banks may force their customers to move to other less desirable – or even outright illegal – alternative channels for settlement, adding new hazards to the system.

So, how do we balance the legitimate desire of banks to avoid unnecessary risks, and the equally legitimate service expectations of the customers from their banks? The answer is not easy, but not impossible either. First, banks have to internalise the fact that sanctions do not mean a blanket ban on dealing with the target country. As every Harry Potter fan knows, not all spells are the same. So also with sanctions.

The severity and applicability of sanctions vary widely, according to the composition of the parties involved, nature of goods traded, choice of currency, etc. Banks have to acquire knowledge and build competencies in understanding and interpreting sanction regulations so that they can determine what can pass through and what cannot.

This is not an altogether new requirement. Any bank maintaining correspondent bank accounts with international banks is contractually obliged to have these competencies in place. However, while the emphasis of the current sanctions screening systems is to identify what to block, we have to build a new paradigm in which there will be equal emphasis on identifying transactions that are outside the purview of sanctions, and then helping those through.

Of course, no system is foolproof, and banks may still make mistakes. Luckily, most sanctions regimes show considerable tolerance towards genuine mistakes as long as there is good faith and no attempt to truncate or alter facts. Banks, obviously, should draw their own boundaries as to the type of taxations and parties they will support and those they won’t touch, sanctions or no sanctions.

No bank may want to put their reputation on the line by getting linked with suspected terrorism or war financiers. Luckily again, sanctions programmes provide enough background information about why a sanctioned entity or person is there on the list, so that banks can take fully informed calls on eschewing such entities.