A healthy and safe correspondent banking network benefits everyone – and technology has brought it within our reach.
-Ankit Sharma & Saurabh Nagar
Correspondent banking relationships are vital to not only the banking sector, but to economies as a whole. This vast network of bank relationships breeds financial inclusion, providing populations and businesses with access to banking services that they might otherwise struggle to find, and eases trading party relationships between nations.
Correspondent banking is the circulatory system that delivers the nutrients that economies need to thrive, but it is also vulnerable to attack. Banks make an extensive effort to protect themselves and their customers from financial crime – but when they initiate a new relationship with another bank, or do not constantly monitor their existing relationships, institutions do not have a complete and real-time picture into their risk exposures, and the counterparty bank’s risk becomes their own.
De-risking vs Re-risking
Transaction chains can be long and are inevitably complex, involving respondent and correspondent banks and customers across more than one jurisdiction. In the absence of a direct relationship with underlying parties, it is alarmingly easy for banks to be caught out.
In May 2020, the US Department of Justice unsealed an indictment against 28 North Korean and five Chinese bankers who are accused of using more than 250 front companies to obscure $2.5 billion in illicit financial transfers. The transactions were deliberately routed through correspondent banks in order to circumvent sanctions after North Korea’s state-owned Foreign Trade Bank (FTB) was placed on the US Specially Designated Nationals and Blocked Persons list.
This was the latest in a growing list of actions taken by regulators around the world to combat money laundering and terrorism financing in the international banking network. Banks have simultaneously stepped up their compliance measures but the rising cost of compliance and the growing risks associated with correspondent banking relationships has prompted many to “derisk,” and pull out of jurisdictions that are considered to be vulnerable.
Worldwide, the number of correspondent banking relationships fell by a fifth between 2011 and 2018, according to data from BIS. Some regions have been hit harder than others – often those that can afford it the least – as banks have withdrawn predominantly from countries where governance and controls around financial crime were considered to be poor and where economic growth is less robust (the number of correspondent banks in Venezuela, for example, has dropped by more than 60%).
The trend has also been seen clearly across Asia, with Singapore seeing a 10% decrease in correspondent banking relationships between 2011 and 2018, and The Philippines falling more than 20%.
The FATF defines De-Risking as situations where financial institutions terminate or restrict business relationships with entire countries or classes of customers in order to avoid, rather than manage, risks in line with the FATF’s risk-based approach (RBA).
Reversing this trend is in everyone’s interest – with this in mind, institutions should “re-risk” their counterparty relationships, with an RBA framework, rather than blanket re-risking and technology is an enabler providing transparency and a strong and confident correspondent banking network is one where every institution has clear sight of the end customer.
Within this fast-moving regulatory environment, Know Your Customer (KYC) and anti-money laundering (AML) professionals need to be aware of the blind spots that could jeopardise the financial crime screening process, such as:
Reducing AML / CFT risks in counterparty relationships
Some of the basic risk factors include – Nested Accounts, Shell Banks, Customers of Customers, Sanctions, Geographical risks, Limited data sets, among others.
Banks entering into correspondent relationships need to be confident that all correspondent and respondent banks in the chain have the right controls and governance in place, and that their KYC, AML and other due diligence procedures are robust.
Best practice due diligence answers three questions:
Conducting specific enhanced due diligence (EDD) on relationships is the key, but answering these questions is enormously time-consuming if done manually. Automated KYC, AML, payments and sanctions screening provides confidence that enhanced due diligence has been carried out in line with the bank’s risk profile.
The array of counterparty solutions allows banks to rapidly examine the identity of customers, establish Ultimate Beneficial Owners of entities, screen for Politically Exposed Persons (PEPs) and negative news if required, and carry out other enhanced due diligence checks cost effectively, without inconveniencing legitimate customers. This is why 79% of firms see automation of processes such as KYC as their priority.
It is vital to remember that fighting financial crime is an ongoing game of cat and mouse. Criminals are constantly looking for – and finding – new opportunities to exploit international rules and banking systems, while banks work tirelessly to plug any gaps. This is an ongoing fight and today’s anti-financial crime measures will not be sufficient tomorrow.
It is crucial for institutions to constantly review their procedures, provide regular training to their team, and optimize the technology used in their fight against financial crime and counterparty risk management.
By creating a correspondent banking network that instils confidence and reliability in those that use it, we can win the fight against financial crime and create greater financial inclusion across the world. A fight worth winning.