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Financial Risk in Correspondent Banking: Project Agora and the case for Tokenisation of Correspondent Banking
Date:June 17, 2024
We have seen in the first three parts of this series[1] that the Correspondent Banking business is experiencing challenges due to the complexity of the transactions facilitated, creating additional regulatory risks from an AML/CFT perspective, which impacts the viability of the Correspondent Banking business. We discussed how transitioning to digital technologies such as AI can support the Operational efficiency of the Financial Crime processes, help mitigate risks and how adopting ISO20022 payment standards can support more transparency by providing better quality transaction data.
Introduction to Project Agora
In this part we will discuss project Agora launched in May 2024 by the Bank for International Settlement[2]. This project aims at exploring “how tokenisation can enhance the functioning of the wholesale cross-border payments”, and what it could mean for Correspondent Banking transactions and addressing FinCrime requirements in that space. One of the objectives of Project Agora is to counter the global decrease in Correspondent Banking activities, due mainly to the heavy burden of regulatory requirements and Financial Crime risks that Correspondent Banks are exposed to[3].
Project Agora leverages the unified ledger technology, used as a new Financial Market Infrastructure (FMI), to support the integration of tokenised commercial bank deposits and Central Bank Digital Currency (CBDC) with smart contracts, to enhance complex cross border transactions such as the ones facilitated by Correspondent Banks and make their execution more frictionless by sharing information in a secure and transparent way between all parties involved.
Unified ledgers, tokenised deposits and smart contracts
Creating tokens for both Correspondent Banks and Central Banks deposits, which are backed by real-world assets, means representing them digitally on a programmable platform – the unified ledger – and encompassing in the tokens all the data and information of these assets, along with the rules governing their usage.
The unified ledger is then the common place on which the tokens can be exchanged, where all the information regarding a specific transaction is contained and all rules and requirements are available to all participants in the transaction, in the shape of a smart contract, updated in real time as data becomes available.
Simultaneous Execution and AML/CFT Compliance
The role of the actors involved in the CB transaction (see part 1 of the series) remains the same, but exchanging tokens on the unified ledgers would enable simultaneous execution of all steps of the end-to-end transactions, including AML/CFT and sanctions screenings, and potentially remove risks of re-work in case of errors at any step of the transaction.
This structure allows for seamless integration and automation of complex financial transactions such as Correspondent Banking cross border transfers [see Fig 1].
Benefits to Financial Crime Compliance
From a Financial Crime perspective, the tokenisation could support the integration of AI technology by providing a secure environment to share transaction screening and KYC data between all stakeholders of the transaction, [see Fig2] and allow for quicker, easier execution of transactions and more efficient completion of Financial Crime screenings. The ability to include all relevant rules in the programming of the general ledger can also more efficiently block any suspicious transactions and report it to the Compliance analysts in both Correspondent and Respondent banks and relevant Financial Intelligence Units.
Future Prospects and Challenges
Tokenisation is therefor a promising avenue to support the future of Correspondent Banking business, and the specific regulatory compliance challenges that come with it, to complement the digital transformation we discussed previously in part 2 of this series.
However, as for the adoption of ISO20022, the BIS indicates that adopting unified ledgers for cross-border transaction does require alignment and interoperability across banks, payment service providers and central banks located in different jurisdictions, subject to different regulatory frameworks. The harmonisation effort would be significant and so it remains at this stage a long-term endeavour.
Conclusion and Future Monitoring
As the Agora project is at its early stage and a lot of practical and technical questions remains to be clarified, our ProjectiveGroup experts in Risk & Compliance, Transformation, Payments and Data will continue monitoring these developments to ensure we provide the cutting edge advice and solutions to support the transformation of your Compliance functions and your Correspondent Banking business, to meet the ever demanding requirements to prevent and mitigate Financial Crime risks.
[1] Part 1: Managing Regulatory Expectations, Part 2: Leveraging Digital Transformation for Compliance and Part 3 : Accelerating Compliance with ISO20022
[2] See : https://www.bis.org/about/bisih/topics/fmis/agora.htm
[3]At this stage the following Central Banks are involved in the project : Bank of France (representing the Eurosystem), Bank of Japan, Bank of Korea, Bank of Mexico, Swiss National Bank, Bank of England and the Federal Reserve Bank of New York. Note that a call for action to private sector FIs has completed on 31st May 2024.
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