READ
Financial Crime Risks in Correspondent Banking: Managing Regulatory Expectations
Date:May 15, 2024
Correspondent Banking (CB) is a key component of large international Financial Institutions’ (FI’s) service offerings. By providing cross-border facilities to a large network of other FI’s of many sizes, they create a system to virtually connect every account in the world. However, by having to execute transactions for beneficiaries they have not fully identified or have knowledge of, Correspondent Banks are exposed to increased financial crime (FinCrime) risks.
We have observed that Banks have backlogs on their Know your Customer (KYC) processes, Transaction Monitoring, Sanctions Screening and Suspicious Activity Reporting (SARs) related to CB activities, thus creating regulatory and operational risks.
In addition to the inherent complexity of the transactions involved, the FinCrime Compliance coverage of CB is made particularly challenging by the uncertain geopolitical and economic environment, adding more layers of due diligence (Politically Exposed Person (PEP) screening), sanctions, with unprecedented programmes in scale and complexity from the US, UK and EU, and fraud monitoring.
In this 3-part series, we will examine the specific regulatory challenges of CB services, and how digital transformation, on one hand, and tapping into structured Payment data, on the other hand, can overcome these challenges.
Introduction
Correspondent Banks are usually global FIs operating in several markets and jurisdictions, and therefore having access to several currencies. By offering cross-border services to smaller FIs of many sizes, they facilitate global transactions for a large variety of agents. The specific products and services offered involve financial risks due to the complexity of the transaction structures and lack of transparency on the end beneficiaries of these transactions.
In this first article of the series, we will illustrate the basic CB relationship to highlight the specific risks involved, and how regulators and governing bodies expect Correspondent Banks to address these risks.
The Scenario
The Financial Action Task Force (FATF) defines CB as the provision of services by one bank (the correspondent) to another (the respondent) and covers cross-border services such as cash management, international wire transfers, cheque clearing, payable through accounts and foreign exchange.
A basic scenario would be, for instance, for a client of a local bank A in the UK, to instruct a payment to a vendor in Japan. Bank A then orders a payment to its Correspondent in Japan, to credit the vendor’s account at his own Bank B (see Fig.1).
From a FinCrime compliance perspective, the main challenge for Bank A’s Correspondent Bank in Japan revolves around the complexity and the transparency of the transactions carried out. And this can increase significantly when the structure of the CB relationship involves Nested Banks[1] or Payable Through Accounts[2] for instance.
As the Correspondent Banks have no direct business relationship with the clients these transactions are conducted on behalf of (in Fig. 1: both Payer and Payee), and often involve high value payments, the CB services therefore face very high risks, and have been historically targets for money laundering activities. Significant efforts are required to mitigate these risks and meet regulatory expectations in a timely and cost-effective manner.
Due Diligence Recommendations
Correspondent Banks are required to perform due diligence on their respondent counterparts, but not on their end clients. The FATF, Wolfsberg Group and Basel Committee on Banking Supervision (BCBS), have published recommendations to conduct Customer Due Diligence, on-going monitoring and, when required, relationship termination and suspicious activity reporting on their respondent clients, on which the FCA and PRA have based their regulations[3], including:
- Customer Due Diligence (CDD):
- To verify the respondent bank’s jurisdiction, geographic risk, the products it offers and its customer base,
- To understand the purpose of the relationship,
- To conduct adverse media screening,
- To assess the bank’s AML/CFT control framework.
- Risk-based approach to perform Enhanced Due Diligence (EDD):
- To understand the respondent bank’s ownership and control structure,
- To identify Ultimate Beneficiary Owner (UBOs), their network and any PEPs,
- To monitor and report suspicious activities and local regulator expectations.
- On-going Due Diligence:
- To apply a risk rating and adequate review period to the relationship,
- To re-assess risk score based on updated data.
- Ongoing Transaction Monitoring:
- To detect transaction patterns not in line with the expected activity of the relationship,
- To assess the quality of a response to a request for information sent to the respondent,
- To monitor the quality of data in SWIFT messages to enable sanction screening and transaction monitoring.
- Policies and Procedures:
- To define a clear risk appetite for CB business approved by senior management. In addition to this, in the context of the new Sanctions regimes (against Russia in particular) it becomes more and more critical to also understand potential correspondent counterparties’ risk appetite, and to be able to rapidly take measure if the correspondents’ activities fall outside of your own risk appetite,
- To define a control and governance framework involving the three lines of defence and ensure staff have the adequate training to conduct compliance controls on CB services.
Due to the nature of the CB activities, FIs providing these services face not only increased regulatory and reputational risks, but also operational risks, due to the complexity of the AML, Sanctions, Fraud control, screenings and reporting requirements, impacting the services provided to their customers. The challenge is to embed these specific, complex requirements in the digital transformation of the Compliance function, to prevent backlogs and ensure regulatory focus on these activities.
In part 2 of this series, we will explore how FIs can leverage technology to streamline their CB-related FinCrime Operations and gain competitive advantages in this space.
Want to know more?
Do you need some clarity about the Correspondent Banking regulatory requirements affecting your organisation? Or could you use some support with your existing FinCrime frameworks?
[1] Nested Banks: several small local banks use the existing CB relationship of a larger bank to provide banking services in foreign jurisdictions to their clients.
[2] Payable Through Accounts: Clients of a local Bank can access an account directly in the Correspondent Bank’s books to perform their transactions in foreign jurisdictions.
[3] See FCA Financial Crime Guide and examples of good and bad practice
Latest insights
READ MORE