Organized criminal networks, operating across national borders, offer of the clearest and most immediate example of how a financial institution can be exposed to financial crime risk through Correspondent Banking relationships. Despite the growth of alternative remittance channels and the increasingly tight controls applied by financial institutions, the use of mainstream banking networks remains the primary mechanism of choice for criminal groups to transfer funds internationally.
Technology-driven, well conducted, Client Due Diligence and rule-based transaction monitoring remain the best controls which can be applied by institution in order to combat use of their payment channels by criminal actors. Properly captured and monitored KYC data is fundamental to both of these controls, providing sufficient detail for CDD to be conducted and providing context to validate or discount transaction monitoring alerts as they are generated. Identifying beneficial ownership as accurately and efficiently as possible and mapping out high risk network, even across emerging markets, is essential to this work.
Correspondent Banking removes financial institutions from their customers by at least one step and makes the process of collecting KYC more challenging. In the example below we can see how a Tier 1 financial institution has become exposed to money laundering activity. A trans-national criminal group is using money mules to place funds into the legitimate banking system to transfer them to other members of the same group.
Accurate KYC could be used to identify potential mules, and other criminal actors, at the client on-boarding stage and, if this was ineffective, would give AML investigators a greater opportunity to identify this activity after it had taken place. Correspondent Banking shifts the responsibility to collect this data onto smaller banks and limits the Correspondent bank in their transaction monitoring efforts. These smaller banks are also less well placed in terms of their the experience and technology to meet the challenge of confronting sophisticated criminal groups.
In this example a criminal group takes advantage of limited controls and disburses it’s illicit funds across three smaller, in-country, banks. Two of these banks then send the funds onto an overseas respondent bank, which holds an account for another element of the criminal group. As neither of the two respondent banks have relationships with the receiving bank, and are too small to have direct access to the SWIFT network, the funds are sent via a correspondent bank. Therefore exposing that bank to consolidated AML risk.
Furthermore, if Downstream Correspondent Banking relationships are involved then this financial crime risk can increase significantly. Also known as ‘Nesting’, Downstream Correspondent Banking occurs when a respondent bank begins to offer Correspondent Banking services to further financial institutions with or without the knowledge of it’s respective correspondent bank. In this instance the ultimate originator or beneficiary of a transaction may be completely omitted from a SWIFT message and replaced with the downstream respondent bank.
In the expanded example below the illicit funds are still placed into three smaller respondent banks by money mules. However in this scenario the correspondent bank (likely to be a Tier 1 financial institution) indirectly provides services to two of those respondents via a network of nested relationships. In this example it is unlikely that the correspondent bank would even have the name of the original customer who had acted as a money mule and would be unable to properly investigate the transaction.
Correspondent Banking relationships are essential to the proper running of a globalised financial system and the proper collection and distribution of KYC data is a fundamental requirement of proper financial crime compliance. In order to meet these two challenges, major Financial Institutions need to ensure that they correctly managing their correspondent relationships, controlling nesting activity in their customer base and investing in the technology required to maintain and monitor KYC requirements across complex relationships.
- 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.