Correspondent banking relationships have shrunk by 20 per cent in the past seven years1. The number of active correspondent banks dropped 3.4 per cent in 2018 alone2. International banks have de-risked their portfolios, scaling back or terminating their activities in higher-risk jurisdictions in response to prudential regulations, costs of due diligence, and concerns around profitability.
Over one quarter of banks responding to a 2017 International Finance Corporation (IFC) survey reported a reduction in their activities in Eastern Europe, Central Asia, Latin America and the Caribbean, and over one third in sub-Saharan Africa in 20163.
Balancing risk and reward
It is not that the need has disappeared. Correspondent banking is essential to provide access to global trade and investment, but many banks now find it commercially unviable to deliver these services. The cost, and risks associated with anti-money laundering (AML) have increased whilst the need for sanctions screening and transaction monitoring are growing, particularly in economically vulnerable markets.
The unintended consequences of financial crime controls
Financial crime control (FCC) regulations improve the quality and transparency of international finance systems, but they increase the costs of doing business in high-risk economies which could result in a slowdown in financial inclusion4. The IFC notes that the reduction in correspondent banking relationships “threatens to undermine economic stability and growth, financial inclusion and development goals.”5 It also highlights the potential loss of access to trade, “putting at risk the import of critical goods and ultimately economic growth”6.
Local banks have been instructed by their correspondent banks not to service money transfer operators (MTOs)7 (i.e. non-bank remittance companies), as these are cash-intensive and have fewer due diligence and AML obligations. They therefore represent a higher risk to the banks. MTO services are particularly important in less financially developed countries where remittances drive economic sustainability. According to a recent FT study, this year, remittances will overtake foreign direct investment as the biggest inflow of foreign capital to developing countries8. Reduced availability therefore has a major impact on small businesses, individuals and communities.
According to a 2018 World Bank report9, the financial system in Angola, for example, has been significantly weakened by the loss of access to international trade and remittance markets due to the decline in correspondent banking relationships. Almost every sector of the economy has been affected. Small businesses have been impacted by the problem of dollar supply and inflation has risen as a result.
Non-government organisations (NGOs) and development organisations operating in economically vulnerable countries may also find that the cost and risk of distributing aid is higher. As a result, fewer aid and development dollars end up reaching the communities that need them the most, with longer delays.
Rallying the financial community
Banks and industry bodies recognise the risks in vulnerable markets. Led by the Financial Stability Board (FSB), the international community established a four-point action plan in November 2015 to: further explore implications; clarify regulatory expectations; build domestic capacity in key markets and strengthen tools for due diligence by correspondent banks10. It also provides recommendations to MTOs to improve access to banking services.
A key recommendation was to implement the Wolfsberg Group Correspondent Banking Due Diligence Questionnaire (DDQ)11 as a standardised global tool to bring consistency and transparency to the level of financial crime compliance (FCC) that a bank needs to demonstrate in order to gain access to a correspondent banking account. The Wolfsberg Group, comprising 13 leading banks including Standard Chartered, provides such a cohesive framework of principles, guidance and statements for managing FCC risks, including in key areas such as know your customer (KYC), anti-money laundering (AML) and counter-terrorist financing policies. This implementation has been completed.
Stemming the tide through standardisation and innovation
The lack of standardisation in regulatory practices and data sets has been a hurdle to reversing the decline of correspondent banking relationships. There is, however, major progress underway. SWIFT’s move to ISO 20022 formats for cross-border payments in November 202112 will dramatically improve consistency and transparency of payments.
SWIFT has mandated the use of a universal end-to-end transaction reference (UETR) since November 201813, which could go a long way to improving AML risk management. All banks will need to confirm payments to beneficiary accounts via the gpi tracker by end 202014. In addition, we are seeing parallel networks developing for real-time, traceable payments, using emergent technologies such as distributed ledger technology (DLT), including trade consortium-driven networks.
A key outstanding requirement is a universally accessible know-your-customer (KYC) registry. Today, every bank needs to complete KYC and customer due diligence individually, compounding costs and risks. A globally reputable, centralised service would lighten that load considerably by improving the efficiency of each bank’s KYC processes. A significant step towards achieving this is the SWIFT KYC register, which includes Wolfsberg DDQ and other materials and which is accessible by other banks with the requisite consents.
Scalable data processing capacity, sophisticated data analytics and consistent reporting are key to reversing the decline in correspondent banking relationships, as it would enable banks to size and manage their risks. As such, solutions leveraging artificial intelligence (AI) and sophisticated data analytics will become increasingly important. Business Insider Intelligence calculates potential middle office savings from AI in banking of USD217 billion by 2023, which includes savings from key AI use cases in anti-fraud and risk, KYC and AML solutions15. Smart contracts are helping to identify fraudulent transactions more systematically, while hyper-contextualised analytics are likely to replace manual transaction monitoring and reporting techniques.
Sharing expertise and promoting best practices
Some individual institutions also have programmes underway to address the challenge. Standard Chartered is actively cooperating with banks and industry bodies, participating in various industry fora, and also taking proactive steps to de-risk through education. We run Correspondent Banking Academies (CBAs) for our banking partners across our franchise, as well as similar ones for public sector and development organisations.
Our CBAs leverage the Bank’s internal experience and expertise to run workshops for clients on developing robust FCC control frameworks and standards. Standard Chartered’s CBA program was recognised as a mitigant to de-risking in the May 2019 FSB report. We were one of the first in the industry to create an FCC e-earning and Assessment portal which covers the fundamental building blocks of an effective FCC programme. To promote the safety of the financial system and raise awareness of financial crime risks, we also make this e-learning available to our clients and their staff, not just those attending the CBAs and is available to our correspondent banking clients.
Focus, cooperation and innovation
Correspondent banking relationships provide vital connections between local economies and the international financial system, giving access to trade, services and remittances. Reversing the decline is therefore essential to promote financial inclusion. Continued focus and industry cooperation, payment transparency and standardisation, technology innovation and education in FCC best practices will all help to do this.
As new participants and business models emerge, such as virtual banks, consortia and platform companies, these may drive better use of data for risk analysis and value capture. Key to success in maintaining trust and confidence in the correspondent banking system, however, will be full understanding and equitable management of the risks by all industry participants.
This article was also published in Bankable Insights Issue 11
1 CPMI publishes new data on correspondent banking networks showing 20% reduction in relationships over seven years. Bank for International Settlements (BIS). May 2019. Press Release. https://www.bis.org/press/p190527.htm
2 Action Plan to Assess and Address the Decline in Correspondent Banking, 2019. Financial Stability Board (FSB). May 2019. Executive Summary, p.1 and Chapter 1, p.4.
3 IFC Insights: De-risking and other challenges in the emerging market finance sector. International Finance Corporation. World Bank Group. September 2017. Executive Summary, p.(i). opens in a new windowhttp://documents.worldbank.org/curated/en/895821510730571841/pdf/121275-WP-IFC-2017-Survey-on-Correspondent-Banking-in-EMs-PUBLIC.pdf
4 Globally, 69 per cent of adults – 3.8 billion people – now have an account at a bank or mobile money provider, up from 62 per cent in 2014 and 51 per cent in 2011. From 2014 to 2017, 515 million adults obtained an account, and 1.2 billion have done so since 2011. Global Findex Database, 2017. World Bank. Press release. https://www.worldbank.org/en/news/press-release/2018/04/19/financial-inclusion-on-the-rise-but-gaps-remain-global-findex-database-shows
5 IFC, ibid, p.(ii).
6 IFC, ibid
7 The Decline in Access to Correspondent Banking Services in Emerging Markets: Trends, Impacts, and Solutions. World Bank. 2018. Executive Summary, p.viii. opens in a new windowhttp://pubdocs.worldbank.org/en/786671524166274491/TheDeclineReportlow.pdf
8 Remittances: the hidden engine of globalisation, Financial Times, 27 Aug 2019, https://ig.ft.com/remittances-capital-flow-emerging-markets/
9 World Bank, ibid
10 FSB, ibid
11 Wolfsberg Group Correspondent Banking Due Diligence Questionnaire. Updated June 2019. https://www.wolfsberg-principles.com/wolfsbergcb
12 SWIFT. https://www.swift.com/standards/iso-20022-migration-study/timeline
13 SWIFT. https://www.swift.com/news-events/news/swift-introduces-universal-real-time-payment-tracking
14 SWIFT. https://www.swift.com/our-solutions/global-financial-messaging/payments-cash-management/unlocking-payment-confirmations/why-confirmations_
15 Business Insider Intelligence. https://www.businessinsider.com/the-ai-in-banking-report-2019-6?r=US&IR=T