By Sean Parker and Abdelaziz Abouelhoda
As banks try to stay as the leaders in the payment sector, questions around whether correspondent banking relationships can continue and be competitive remain wide open questions.
· What is Correspondent banking?
· What does the decline look like?
· Why is it happening? And does that decline mean less money laundering and terrorist financing risks overall?
What is Correspondent Banking?
Correspondent banking is where a respondent bank opens a bank account with a correspondent for the purposes of facilitating payments on behalf of the respondent’s underlying customers. These relationships are typically required to facilitate cross border transactions in jurisdictions where the respondent has no presence.
What does the decline look like: A service out of fashion?
Despite being vital for international trade and movement of money (e.g. remittances), fewer banks are deciding to offer correspondent banking services owing to the significant financial crime risks that come with it. This trend is highlighted by the Bank for International Settlements (BIS) which published the following graph documenting the decline in the number of correspondents and active corridors over a period ranging from 2011 to 2019.
https://www.bis.org/cpmi/paysysinfo/corr_bank_data/corr_bank_data_commentary_1905.htm
The decline trend is also documented by the Committee on Payments and Market Infrastructure which analysed SWIFT data between 2011 and 2022 to highlight fewer active correspondents by currency and region – the steepest being for the correspondent banking services being offered out of the Americas (excluding North America) and the decline in the number of USD correspondent banking accounts.
Why is it happening?
There is a variety of reasons:
· Offering correspondent banking services exposes the correspondent to increased financial crime risk. This is because correspondents essentially act as the respondent’s agent in executing and or processing transactions for the respondent’s underlying customers. The correspondent often has no direct relationship with underlying parties and have limited information on the identities of the counterparties and the transaction.
· This risk is amplified when respondents offer downstream services (otherwise known as nesting) – which, in simple terms, is when the respondent in turn provides correspondent banking services to other banks in the same currency offered by the correspondent.
· Financial institutions may not adhere to the same AML/CTF standards. This is compounded by divergences in regulatory oversight/requirements, as well as how banks and jurisdictions deal with certain businesses, products and geopolitical exposures.
· An inadequate financial crime risk management framework can allow other non-bank financial services firms with inadequate compliance systems and controls direct access to the international banking system which exposes the correspondent to reputational and regulatory risk.
· High costs in addressing the above risk, that maybe manual or automated specific to effective transaction monitory system, sanctions screening, KYC/CDD and EDD procedures.
What is the impact?
The Financial Action Task Force (FATF) guidance on correspondent banking clearly calls out that ‘de-risking’ conducted by correspondents has an overall negative impact and that it can quite inversely lead to increased financial crime risk overall all. De-risking can lead to:
· Financial exclusion of certain countries, regions and industries which in turn leads many to turn to alternative less transparent methods such as hawalas and other similar actors to transfer their funds, thereby leading to greater exposure to financial crime risk.
· Further nested activity which could increase the financial crime risk and decrease the ability to get information related to the payment.
· Difficulty for businesses to clear payments, especially where multi currency clearing is required-where less popular currency is offered. This in turn means added costs.
FATF guidance calls for correspondents to avoid terminating their services and rather focus where possible on managing the risks they face. Far from being the sole responsibility of correspondents, FATF also acknowledges that a part of the responsibility lays with clearer expectations and guidance from regulatory bodies which would allow for better risk management.
Next Steps
There are some key things that a financial institution can undertake to address the risk but also allow your institution to take advantage of offering this service:
· Effective transaction monitoring and sanctions screening are vital, but the power lays in an effective correspondent banking programme and having the right personnel that understand what it’s all about. That skill set is unique, retain talented personnel.
· Be at the table when the regulator is looking at developing or changing legislation. Again, the right people being present to provide input and feedback is vital.
· Seek out advisors/technology/service providers who have experience in the field. If they aren’t able to talk about the risk in detail, they shouldn’t be advising your financial institution. The solutions should be fit for purpose.
· Where possible, Banks should be encouraged to collaborate with each other to learn valuable lessons. Many jurisdictions have associations that allow banks to connect. What one banks see as a problem, often is something that is seen at another financial institution.
