Debanking for fraud prevention: could it be a valid measure or more of an overreach?

Money launderers are increasingly using cryptocurrencies to conceal the origins and movement of illegally obtained funds, according to the latest money laundering and cryptocurrency report from Chainalysis, a blockchain analysis firm. 

This pattern of increasing money laundering cases, also those that are driven by the widespread use of cryptocurrencies, highlights the growing challenge of finding a good balance between the need to ensure fair and inclusive access to banking services and the implementation of strong fraud prevention measures.

The debanking trend from major financial institutions can be attributed to various factors, including both regulatory pressures to combat financial crimes and dissatisfaction with traditional banking services by customers. Thus, the intersection of debanking and fraud prevention appears to be a complex and dynamic topic in the financial industry. If we refer to the most common understanding of the term, debanking is a practice where financial institutions deny or withdraw services from certain customers or businesses, often citing compliance with anti-money laundering (AML) and counter-terrorism financing (CTF) regulations. While these actions are intended to safeguard the financial system, they can inadvertently impact legitimate customers leading to a lack of access to essential banking services.  

High-Risk Sectors and Debanking 

This issue is particularly relevant for high-risk sectors such as cryptocurrency, where the risk of fraud and money laundering is perceived to be higher. And as highlighted in the Chainalysis report, blockchain technology presents here both challenges and opportunities. Blockchain technology is the foundation of decentralised finance (DeFi) banking applications, which provide a variety of financial services without the need for traditional intermediaries such as banks, brokers etc. Public blockchains, while transparent and traceable, are also used by illicit actors to launder funds due to their cross-border, instant, and inexpensive nature. Financial institutions use sophisticated blockchain analysis tools that can track transactions and spot suspicious patterns suggestive of money laundering in order to manage these complexities. These instruments are crucial for identifying illicit activities, including the use of so-called cross-chain bridges, privacy coins, and mixers by cybercriminals to conceal the source and flow of money (for details, please refer to the mentioned report). 

However, the reliance on these technologies and stringent compliance measures can result in an overly generalised ‘broad-brush’ approach to risk management, leading to the debanking of entire sectors and groups perceived as high-risk. This can have significant consequences for legitimate businesses and individuals, pushing them towards less regulated and riskier financial alternatives including crypto.   

Blockchain presents a huge potential to foster financial inclusion by providing financial services to unbanked and underbanked groups of population however the concerns about its potential for illicit activities and the need for robust governance frameworks around crypto transactions continue to be significant topics for discussion.  

Therefore, maintaining fair equitable access to necessary banking services while also keeping a balance between the need for strong fraud prevention mechanisms presents a way out and a real challenge.  

Enhanced Know Your Customer (KYC) and transaction monitoring protocols, combined with cross-border collaboration and public-private partnerships, can help achieve this to an extent. By leveraging data-driven insights and maintaining a risk-based approach, financial institutions can better distinguish between legitimate and illicit activities, thereby reducing the likelihood of unnecessary debanking while effectively combating financial crime. 

Debanking: Does It Help or Hinder Fraudsters? 

Given the complex interplay between the need for robust fraud prevention mechanisms and ensuring equitable access to banking services, it becomes imperative to explore diverse perspectives on this issue. Recently, an expert panel discussion titled "Freedom and Debanking: Has It Helped or Hindered Fraudsters?" hosted by CFAAR (The Crypto Fraud and Asset Recovery network) and Pennington Manches Cooper in London, provided valuable insights into these challenges.  

Expert Insights 

Sean Kiernan, the founder and CEO of Greengage emphasised the importance of a nuanced approach to risk management: "It is crucial for financial institutions to develop more sophisticated risk assessment models that accurately differentiate between legitimate and high-risk clients. Overreliance on ‘blanket’ policies can result in the exclusion of many legitimate businesses, particularly in the emerging fintech and crypto sectors." 

Heather Buchanan, Director, Bankers for Net Zero, highlighted the challenges faced by small businesses and startups. "Debanking has had a disproportionate impact on smaller enterprises that lack the resources to deal with complex regulatory environments. These businesses often turn to less regulated financial services, which, ironically, increases their risk of exposure to fraud," she noted.   

Frederic Buret, Digital Assets Investigations Assistant Manager at Grant Thornton UK, provided his thoughts on how advanced blockchain analysis tools are being used to combat financial crime. "Cryptocurrency is way more attractive for customers as they remain in possession of their funds. However, from the standpoint of the fight against financial crime, the transparency of blockchain technology is a double-edged sword. While it allows for effective tracing of illicit activities, it also requires constant adaptation to new techniques employed by criminals. Financial institutions need to stay ahead of these trends to prevent misuse while ensuring they don't stifle innovation." 

The discussion also touched on the broader implications of debanking for financial inclusion. As noted by Charlotte Hill, moderator of the panel and partner at Pennington Manches Cooper, "Financial inclusion is a critical goal that should not be sacrificed in the name of fraud prevention. The key is to strike a balance that protects the financial system without unduly penalising legitimate customers. This requires collaboration between regulators, financial institutions, and technology providers to develop more refined and equitable policies."  

Balancing Security and Access 

The debate around debanking and fraud prevention is complex. While the need for stringent measures to combat financial crime is clear, as it’s becoming increasingly sophisticated and has recently even been called by Francesca Carlesi, Revolut’s UK Chief Executive Officer, “a national emergency that needs to be fought like a normal crime.” 

Financial institutions must adopt a more targeted approach to risk management, applying advanced technologies and data-driven insights to distinguish between suspicious illicit activities and legitimate transactions. 

In this effort, cross-border collaboration and public-private partnerships come as essential. As mentioned by the experts on the Panel, by sharing information and best practices, stakeholders can develop more effective strategies to combat money laundering and fraud without compromising access to financial services. Enhanced KYC and AML protocols coupled with advanced transaction monitoring systems could help achieve this balance ensuring that the financial ecosystem remains both secure and inclusive at the same time. 

The ultimate objective is of course to build a financial system that can withstand fraud and money laundering while giving everyone fair access to banking services. But to achieve this ideal picture, all the parties involved must maintain communication, creativity, cooperation and intelligence sharing on an ongoing and constant basis.