Correspondent banking has been in a state of deep decline. As Reuters reported last year, the decline shows no sign in slowing. The Financial Stability Board (which co-ordinates G20 regulations) conducted a global survey suggesting that emerging markets, particularly small economies, are suffering as a result.
Most worrying of all, whilst the number of active correspondent relationships globally fell by 6%, according to the FSB’s survey, the decline in US dollar and euro relationships fell by 15%.
The reasons for the withdrawal appear to be profitability concerns, but a deep motivation is the fear of regulatory breaches by correspondents, particularly regulations designed to combat AML-CFT.
A decline in the number of CB relationships is a deeper problem for safety of the global financial system. An absence of correspondent banking activity drives money flows underground (often illegitimately), and impairs a customer’s ability to perform international payments.
Correspondent banking is a high risk area for a variety of reasons: chiefly the liability associated with a correspondent account and the risks associated with acting as a correspondent’s agentor conduit, executing and/or processing payments or other transactions for the correspondent’s customers.
The World Bank, responding to the survey, recommended that more work needs be done to ensure that both the public and private sector can deal with the risk and reverse the decline. These recommendations, whilst useful, have not sufficiently addressed the advance of technology in correspondent banking to mitigate regulatory risk.
Over the course of this series, we’ll be weighing up the risks and opportunities in correspondent banking relationships and consider the commercial opportunity available to financial institutions. We’ll also consider the global ramifications of an international reduction in correspondent banking activity, alongside a look at the application of technology to safeguard this opportunity.
Correspondent banking is still a market opportunity
To get an idea of the scale of this market for banks, if the downward pressure of regulation were to drive cross-border revenue margins down to domestic levels - according to McKinsey, the industry loss in revenue would be $230 billion at a 70% drop of 2014 transactional revenues.
Moreover, correspondent banking isn’t going to cease to be a service offered by the banking industry. Correspondent banking has been around since the Medici. Cross-border payments are improving via technology companies such as TransferWise, but the correspondent banking network is the only entirely ubiquitous solution, offering access to any jurisdiction in any currency to anyone with a bank account. It is also safer, as banks operate within a regulatory framework far more stringent than money-transfer operators such as MoneyGram and Western Union. Banks still maintain a 95% share of the sector, and offer access to desirable services such as alternative financing or foreign exchange.
As Susan Skerritt, CEO of Deutsche Bank Trust Company was quoted recently in the The Banker, the correspondent banking industry is a proven success story:
The correspondent banking industry has a proven record of continuous improvement - automation/STP processing, reachability and scalability. We process thousands of payments every second.
Correspondent banks already have the infrastructure in place to deliver a comparable customer experience to an international payment systems such as Paypal. Straight-through-processing [STP] payments are already possible in less than a day at highly competitive rates.
It is the exceptions which increase the cost of the system. Clarity on enforcement of obligations on correspondent banks in collecting payments would require strong commitment among participating banks and improvements in Know Your Customer [KYC], and, by extension, KYCC - Know Your Customer’s Customer.
Why not blockchain?
Whilst distributed ledger technologies [DLT] are theoretically helpful in delivering traceability and control to any cross-border payment system, it will take many more years before they can be universally adopted in every jurisdiction and currency, and crucially, to match disparate international regulations: a vast undertaking. Simplifying the process of conducting KYC and tightening existing correspondent banking relationships represents a bigger, achievable step forward.
The ability to reduce the need for ‘manual intervention’ in investigations will allow the correspondent banking market to be restored to its previous health whilst working within its existing infrastructure.
Conquering correspondent banking risks with technology
The FSB’s recent progress report on their implementation of a four point action plan to address the decline in correspondent banking, amounts to:
1) examining the dimensions and implications of the problem; (2) clarifying regulatory expectations such as the FATF; (3) Domestic capacity-building in countries home to respondent banks; (4) strengthening due diligence tools by correspondent banks.
By working with these smaller banks to improve their compliance, as part of a broader correspondent relationship, global financial institutions can also improve the stability of the whole market in which they are operating and therefore reduce the total financial crime and compliance risk which they currently face.
The advances in technology via cloud-platforms for monitoring customers of risky respondent bank make each of these challenges managable. Correspondent banking can create a proliferation of unknown entities that need to be verified, but technology conquers each of these areas.
- Network diagrams of risky entities and records can ensure that high risk groups are understood, and frequency of monitoring can be tailored according to the risks by the correspondent bank.
- Automated processes for identifying ultimate beneficial owners take the legwork out of identifying unknown risks, and captured data from emerging markets can increase the visibility.
- The automated triggering of investigations, operations and due diligence for associated entities in a single source, alongside the autopopulation of entity data from third party sources, with the ability to differentiate between high-risk and low-risk jurisdictions, removes the manual work associated with data scarcity in emerging markets.
Suitably equipped with these powers, correspondent banks can once again upscale their business without fear of regulatory repercussion and reputational damage.