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The unintended consequence of tackling financial crime

Why a decline in correspondent banking is endangering trade and posing a threat to financial inclusion

Correspondent banking has been a cornerstone of transaction banking for many years, facilitating the cross-border flow of goods and services, and connecting banks and their customers from around the world.

However, as banks, regulators, policymakers and law enforcement agencies address the challenge of tackling money laundering and the financing of terrorism, one outcome is that some banks are choosing to de-risk their business by exiting correspondent banking in certain markets, with very real implications for the global economy.

With companies of all sizes now involved in global trade – and given the complex nature of supply chains – the ability to make and receive international payments is essential to doing business. No bank has a global network that can facilitate cross-border payments and collections across all currencies, so correspondent banking fulfils a vital role.

However, there is growing evidence that increasingly stringent regulation, together with the cost and risk of compliance with these regulations, not to mention the potential for reputational risk, is resulting in some banks choosing to reduce their correspondent banking activities from specific client segments or entire markets.

This particularly applies to regions where banks believe that the potential risks and costs of associated controls outweigh the strategic benefits of serving those markets, with the Caribbean, East Asia Pacific, Eastern Europe and Central Asia most affected.


Access problem

Banks are committed to the fight against financial crime and have invested billions of dollars to reduce access to the banking system for its perpetrators. However, the complexity of compliance with diverse regulations across markets, the uncertainty around interpretation and implementation, and the risk of significant penalties in case of non-compliance is having unintended consequences.

Specifically, the impact of banks’ decisions to de-risk their business is that local and regional banks, and remittance providers, are finding it more difficult, if not impossible to access international services. This, in turn, affects cross-border payments and collections and trade finance, endangering already fragile trade and posing a threat to financial inclusion.


IMF concerns

This issue are now being discussed at the top table of international finance. Managing Director of the International Monetary Fund (IMF) Christine Lagarde recently emphasised that regulators in both developed and emerging countries had a role to play in halting the decline and helping banks to maintain their correspondent banking relationships.

Lagarde pointed to the fact that at least 16 banks in five countries in the Caribbean had lost all or some of their correspondent banking relationships by May of this year, and that countries such as Belize have been particularly hard-hit, stressing that ‘even if the global implications of these disruptions are not visible so far, they can become systemic if left unaddressed.’

She added that smaller countries need to upgrade their regulatory and supervisory frameworks to enhance compliance with international standards, particularly in areas such as anti-money laundering and anti-terrorism finance compliance.


Positive steps

Despite the perceived challenges, the good news is that banks and key international bodies such as the Financial Stability Board (FSB) are united in their recognition and desire to maintain access to the international financial system for businesses and individuals in many of the world’s most vulnerable regions.

The FSB is working in partnership with the Basel Committee for Banking Supervision, the Committee on Payments and Market Infrastructures (CPMI), the Financial Action Task Force (FATF), the IMF, the Legal Entity Identifier Regulatory Oversight Committee and the World Bank to address this issue.

In July 2016, for example, a report released by the CPMI emphasised that banks’ network of correspondent relationships appears to be shrinking, with the risk that cross-border payment networks could fragment, resulting in a narrower choice of options for payment users.

The CPMI proposes three next steps:

  • First, a focus on further data collection and examination to understand the current situation more fully and the implications, with a number of bodies having undertaken studies
  • Second, clarify regulatory expectations, including more guidance from FATF, which is working to outline in more detail customer due diligence expectations for correspondent banks when working with respondent banks
  • Third, continued support for domestic capacity building in the most affected locations is important, including assessments and technical assistance to help identify and address deficiencies before they result in a reduced access to the global financial system

Banks also have a role to play by recognising the wider implications of their commercial and regulatory decisions to exit specific markets or activities. There are undoubtedly challenges. However, banks have an important role in collaborating to build consensus over controls such as ‘know your customer’.


How to continue supporting economic development

At Standard Chartered, we take our responsibility for managing financial crime risk very seriously. We have developed a strategy for correspondent banking called ‘de-risking through education’, focusing increasingly on how we partner with those clients who have the right intent but not yet the right tools or experience to build robust controls for financial crime risks. For example, we are actively promoting training and workshops for our clients through our ‘Correspondent Banking Academy’, as well as continuing to invest in due diligence and oversight.

The value of this approach is not simply to strengthen compliance, but also to build strong, open and pragmatic relationships with clients. We are also collaborating through industry bodies such as the Wolfsberg Group to engage in the discussion as to what constitutes an appropriate level of transparency, how the regulators can support correspondent banking, and law enforcement derive benefit from financial intelligence. These measures will help to make the financial system a hostile environment for criminals and terrorists, whilst supporting the economic development that is important for the societies we serve.