Risk Aversion Keeps Banks on the Innovation Sidelines

Risk aversion is a silent killer -literally-so last week's statement from the U.S. Treasury's Financial Crimes Enforcement Network reminding banks to work with money services businesses deserves passionate support.

But the conversation about bank derisking prompted by the U.S. financial surveillance regime needs to go deeper. It's possible that regulators' efforts to root out terrorists, money launderers and other criminals cost more in dollars and lost opportunities than they provide in security. The government should reevaluate its financial surveillance priorities using cost-benefit analysis and the best risk management tools. Meanwhile, regulators should use the work they have done to capture the risk profile of the digital currency arena to persuade banks to come off the financial innovation sidelines.

In case it needs repeating: when banks refuse to serve entire business lines, the result is stunted job creation and innovation, not to mention customers who are denied services they often rely upon. Banks that have cut ties with money service businesses in response to the regulatory crackdown on anti-money laundering rule violations, for example, have inadvertently prevented many Somalis from receiving badly-needed remittances. Risk aversion means fewer jobs, less to eat for many people, less access to medical care, less time available to raise the children right, and countless other lost opportunities. It all adds up to diminished and shortened human lives. This is why I say risk aversion is a silent killer.

The problem dates back to the passage of the U.S. Bank Secrecy Act in 1970, which obligated U.S. financial services providers to help prevent tax-cheats, criminals and terrorists from using their systems. Many people have now come to assume that this is a natural obligation of providing financial services. But there's nothing natural about it. It's a policy choice that should be made based on careful analysis.

Financial surveillance has such broad purposes that it may be hard to analyze, but the stakes are high enough that failing to examine its utility cannot be excused. Regulators should quantify the risk reduction that financial surveillance produces and examine the losses to society that occur with and without various financial surveillance measures. They also should gauge the cost of security measures in order to select the most effective ones.

Government agencies experienced with risk reduction have found that costs of less than $10 million per life saved are generally worthwhile, while costs above that threshold are not. Programs that expend a great deal of resources without saving a commensurate number of lives needlessly sap nations' strength, working at cross-purposes with the goal of having a wealthy, safe, and free society.

Unless financial surveillance is grounded in risk management and real-world cost-benefit calculations, we can expect to see risk management addressing the wrong risks. Right now, financial services providers are managing the risk of regulatory enforcements, not working toward protecting the public. In order to avoid regulators' wrath, they cut off entire business lines rather than assessing which businesses are legitimate and which may be part of a harmful criminal enterprise.

Risk aversion in financial services is of particular concern to the nascent digital currency industry. The Bitcoin community, which is increasingly populated by mature, sophisticated, and law-abiding business people, is fervent about bringing unbanked and underbanked communities in the U.S. and around the world into a secure financial services system. But many Bitcoin businesses struggle to find and maintain banking relationships. This drag on Bitcoin business development is stymying an industry that has the potential to create more jobs, produce technological advancements and help more people engage in affordable, secure, and convenient financial transactions.

FinCEN is one of many regulators worldwide that have worked hard to understand Bitcoin, determine what risks it may hold for consumers, and examine the challenges it may raise for law enforcement. The consensus U.S. policy is to maximize the benefits of Bitcoin while mitigating the risks. But the benefits of Bitcoin and other digital currency innovations will be slow to materialize while the mainstream financial services industry sits on the sidelines.

The financial services industry must learn to intelligently embrace risk. This will be encouraged by regulators who are good risk managers themselves.

Jim Harper is global policy counsel for the Bitcoin Foundation.