Trends in de-risking and its impact on International Correspondent Banking - Wolfsberg New AML Questionnaire
Correspondent banking represents the cornerstone of the global payment system designed to serve the settlement of financial transactions across country borders.
International banks in the U.S., Europe and other major money centres around the globe are purging their correspondent banking relationships (CBRs) as part of a phenomenon known as de-risking. The unintended consequence of de-risking is that banks and other financial institutions are being shut out of the global financial system and more profoundly, that certain countries and regions become unbanked or at least, less-banked.
In 2014, AML penalties peaked at $10 billion compounding the challenges banks face in high-risk geographies (Figure1).In this climate, the threat to banks of doing business in these geographies potentially outweighs the benefits of services to their clients, even if there may be good business opportunities to pursue.
The challenges of increased operational costs, competitive and regulatory pressures have driven banks to withdraw from correspondent banking relationships. Historically, these relationships were provided as services to international customers, but this is no longer viable, as banks cannot justify the increased compliance cost associated with offering correspondent banking services to their local customers. As a result, businesses in the regions most affected are struggling to access the global financial systems to finance their operations. Without this access, local banks are forced to use non-regulated, higher cost sources of finance and expose themselves to nefarious actors and shadow banking.
A number of factors have contributed to de-risking, the most important being that the risk / reward balance has become unfavourable for large clearing banks and in response they have taken a country / region risk view in deciding who they can do business with. If we want to reverse this trend and begin to ‘re-risk’, then the ‘antidote’ will require more granular level due diligence and proper risk assessments to provide large clearers with the confidence that they can deal with low risk businesses in high risk jurisdictions.”
The Bahamas, Belize, Kuwait, Lebanon, Liberia, Morocco, Panama, and Samoa, and West Bank and Gaza are examples of jurisdictions that had either experienced CBR withdrawal and were taking action to mitigate the impact, or where the authorities had taken preemptive action to address the risks of CBR withdrawal.
In The Bahamas, 6 institutions, mainly and standalone international banks and a few domestic commercial banks, together representing a small share of total banking system assets, had recently lost CBRs. All of them had additional CBRs, found replacements, or were able to negotiate a continuation in service (including against an additional annual fee). Canadian banks and other international banks maintained direct or indirect access to USD CBRs as they are able to rely on the sound AML/CFT frameworks in place across the group as a whole. MTOs had also been affected. One domestic bank had closed its Western Union money transfer franchise in summer 2015, while another MTO provider had been notified about a possible termination of its banking relationship. Adverse impacts on bank operations had been reflected mainly in prolonged clearance procedures and higher investment and staffing costs stemming from additional reporting requirements and scrutiny. Business segments that had been affected include credit card payments, cash management services, investment services, clearing and settlement, international wire transfers, and remittance services. In addition to engaging with regional stakeholders, authorities had been strengthening their overall risk-based framework for regulation and supervision, and the Central Bank of The Bahamas had finalized amendments to its AML/CFT Guidelines and introduced new wire transfer regulations.
In Belize, the loss of CBRs experienced by the largest banks had been posing significant challenges for the economy. At some point, only 2 of the 10 domestic and international banks had CBRs with full banking services. A systemic bank and its international subsidiary could process only non-USD wire transfers. Other banks had also managed to maintain wire transfer arrangements, including with non-bank providers of payment services. Four banks, including the systemic bank, had also lost their credit card settlement accounts with a small bank in New York, and proceeds from their credit card transactions could only be used through their accounts with a major credit card company or through restricted accounts such as brokerage accounts. The Central Bank of Belize had lost three of its five CBRs in the last two years. On aggregate, the impact of the loss of CBRs on volumes of international transactions was not yet noticeable based on available data as most CBRs were actually lost in late 2015 or early 2016, but there were indications that transaction costs were increasing. For example, one of the larger banks increased wire transfer fees from about US$100 to US$300. The processing time of wire transfers had increased from “within 24 hours” to “several days.” The growth rate of deposits in the banking system had fallen, driven by a significant decrease in deposits in international banks, partially offset by an increase of deposits in domestic banks. However, domestic banks had put in place alternative arrangements, including replacing CBRs.
The authorities had been engaging with regional stakeholders and analyzing the pros and cons of potential solutions.
1) collective action to increase the business volume brought to a smaller number of correspondent banks;
2) introduction of a scheme to purchase CBR insurance policies;
3) creation of a U.S.-licensed special purpose vehicle to process international transactions; and
4) payment of higher CBR service fees.
Kuwaiti banks had not faced CBR withdrawal. However, to avoid the perception of risk that could prompt global banks to cut relations, several domestic banks had preemptively severed links with some domestic charities and foreign exchange houses. The Central Bank of Kuwait had been actively participating in international forums aimed at clarifying supervisor requirements in home jurisdictions of correspondent banks, maintaining open channels of communication between domestic and foreign banks and regulators.
CBR withdrawal could hurt cross-border payments, trade finance, and remittances. A few foreign banks had severed business relationships with a few smaller Lebanese banks owing to measures introduced by foreign governments with regard to ML/TF concers. The authorities have continued to strengthen the AML/CTF regulatory environment and risk assessment framework, and to address identified gaps with regards to international tax compliance and exchange of information.
Liberia had experienced a broad-based withdrawal of CBRs. All commercial banks had lost at least one CBR since 2013. Ten global banks had terminated about 48 percent of CBRs (36 out of 75), with the banks experiencing the highest impact having lost 78 percent of CBRs, compared to the banking system average of 46 percent. The advance notice provided for severing the relationship had narrowed from six months to overnight. The loss of CBRs was not unique to commercial banks as the Central Bank of Liberia also had some of its CBRs terminated in March 2014. Addressing deficiencies in the AML/CFT framework would have strengthened the case for containing the loss of CBRs and even reinstating some CBRs. To address gaps within the current AML/CFT framework, a dedicated unit had been set up at the central bank.
The risk of a loss of CBRs was highlighted in the Risk Assessment Matrix in Morocco’s 2016 Article IV Staff Report. While the likelihood of the risk was assessed to be high (for USD flows), the anticipated impact was assessed to be low (as most cross-border payments are in euro rather than USD).
In Panama, changes in capital regulations in source countries, concerns over compliance with tax rules and international standards on financial sector integrity, and increased due diligence by foreign banks, particularly with links to the U.S., had curtailed some smaller Panamanian banks’ access to correspondent banks. The total number of CBRs had remained stable at 463–464 between March 2015 and end-February 2016, as 62 relationships had been lost, while Panamanian banks had managed to establish 63 new relationships. Notwithstanding that, stress testing the impact of a large-scale loss of CBRs on the availability of funding from foreign banks and depositors showed some liquidity problems in the aftermath of a severe loss of CBRs and, hence, foreign-sourced funding might have spilled over to solvency in the medium run, as funding costs might have risen and fee income could have fallen. The authorities were taking action to mitigate the impact. In particular, they were strengthening banking regulatory and supervisory framework and expanding their supervisory coverage to include other financial entities, such as leasing and factoring companies, financial cooperatives, fund-remittance companies and debit and credit card companies, as required by the new AML/CFT legislation. Moreover, cooperation with other supervisors in the region had been considerably strengthened to enhance the enforcement of AML/CFT standards.
To maintain their CBRs, respondent banks had been withdrawing from providing banking services to MTOs, increasing the fragility of the remittances sector, which is also likely to increase the cost of remittances. Remittances amounted to approximately 18 percent of GDP of which about 80 percent were channeled through MTOs. The Samoan authorities have taken important steps to address the phenomenon, including active engagement with global stakeholders. Recent publication of the national AML/CFT strategy was an important step. The authorities were committed to establish a database, which can help facilitate remittances by enhancing compliance.
West Bank and Gaza (WBG)
At the time of the report, a global bank had begun limiting its correspondent banking services to Palestinian banks as part of its regional “derisking” strategy, although given its small presence this does not appear to have had a significant impact. Citing AML/CFT concerns, Israeli banks continue to warn of, but have yet to act on, plans to terminate correspondent services with Palestinian banks. To prevent that, the Israeli authorities have put in place temporary financial and judicial assurance to help preserve Israeli-Palestinian CBRs. Ongoing threats to Israeli-Palestinian correspondent banking relations, if realized, could undermine the payment system, increase cash-based transactions, weaken trade, and erode the tax base. Terminating CBRs could have severe consequences given the central role of the shekel in WBG and the economic ties with Israel via trade, employment, and remittances. The Palestinian authorities are working vigorously to prevent that, with efforts centered on bringing WBG’s AML/CFT regime in line with international standards. Source: Article IV staff reports, West Bank and Gaza, Report to the Ad Hoc Liaison Committee, bilateral discussions with respondent banks.
The US Decline of CBRs vs. China RMB
USD decline: a concentration in relationships or a reduction in USD dominance:
- The number of USD correspondent relationships declined by 15% with euro relationships showing a steeper decline of 23%
- The number of Chinese renminbi (RMB) correspondent relationships increased by 8%
- Global bank locations in developing economies increased by 31% since 2014.
While the 25% drop in global correspondent relationships is greater than the USD correspondents decline, the trend for USD is particularly significant when compared to the contrarian increase in the number of Chinese RMB correspondent banking relationships. Since 2014, research shows an 8% increase and since 2012, the number of the RMB relationships showed a dramatic increase from 3,600 to 8,800 relationships in 2016.
There are two explanations for this decline in USD relationships when compared to the RMB. Either there is a concentration in USD relationships, with more transactions settled through fewer relationships, or there is a decline in the dominance of USD.
Global bank locations in developing economies have also increased by 31% since 2014, largely due to growth in China and APAC. This is significant as the number of banks in established global financial centers are in decline.
Actions from US and European regulators have resulted in banks shunning higher risk economies while missing out on the potentially profitable use of their currencies for correspondent banking, in the process. Research reveals that the areas benefiting from the changes are largely in the East. For instance, China has experienced a 133% increase in the number of banks since 2009 and an astounding 3,355% growth in correspondent banking relationships during the same period.
The decline in USD relationships has several explanations:
1) either we are seeing a concentration in USD relationships among fewer correspondent banks, or
2) we are seeing a decline in USD dominance.
The shift can also be attributed to the potential AML penalties associated with using these currencies. Since the financial crash of 2008, we have also seen significant commitment from financial institutions in emerging economies to demonstrate they are not high risk. We see this playing out in the East and the increased number of relationships reflects their commitment.” As we see more regulation come into place, global banks can support growth in local businesses by investing in technology that can securely and quickly determine the risk of a transaction in a high risk geography.”
The importance of CBRs and some of the AML/CFT requirements for CBRs.
define correspondent banking as the banking services – mainly payments, cash management and trade services - provided by banks to customers via other banks. Giving the arguments that heightened AML/CFT rules and the associated costs of compliance are the main drivers for banks de-risking, the provides a more useful definition. It states:
Some of the major characteristics of for identifying correspondent banks relates to size, location, funding capability as well as range and sophistication of services or diversification of interests. Most are located in major money centres in the U.S., Europe and other parts of the globe.
Correspondent banking relationships play a vital role in economic development and trade. According SWIFT, correspondent banking is still the primary channel to deliver cross-border banking services. Looking at cross-border customer payments on SWIFT in August 2011, those settled bank-to-bank were 67% of total volume.
A strong correspondent banking network can help local banks in the Caribbean and Africa bridge the knowledge, technology, product and risk management gaps. International banks can use their extensive payments infrastructure, as well as provide risk mitigation structures using trade finance techniques to enable their corporate clients to navigate the risks inherent in trading relationships.
CBRs allow smaller banks to offer payment and documentation infrastructures as well as the opening and settlement of payment risk instruments such as letters of credit. This trade finance instrument is particularly useful when companies are entering a new trade relationship or are unsure of their counterparty’s creditworthiness, as they can pass the "unknown" risk on to their own advising or confirming bank.
One of the big issues with CBRs is that a smaller bank is likely to transfer some portion or all of the risk inherent in its assets to the international bank. De-risking may be a signal of the poor distribution of risk and inadequate compensation for risks incurred in the process. The issues surrounding the fact that risk and compensation for risk may not be evenly or fairly distributed is compounded by the fact that the banks in the Caribbean and Africa face different funding and administrative costs than banks in major money centres. The difference in costs means that net returns for a given transaction or services may be more adequate for one bank and less adequate for another bank in the CBR.
Correspondent banking is vulnerable to money laundering risk for a host of different reasons, including:
Ø Foreign jurisdictions with weak/inadequate AML/CFT Rules, banking or accounting standards
Ø Nested Accounts
Ø A culture of lax due diligence
Ø Lack of information exchange or cooperation
Ø Bank secrecy and barriers to seizing illicit funds
has agreed on a number of important Principles that constitute global guidance on the establishment and maintenance of Foreign Correspondent Banking relationships. The Wolfsberg Group believes that adherence to these Principles will further effective risk management and enable institutions to exercise sound business judgement with respect to their clients. The Principles are summarized below:
Banks are required to define policies and procedures which require specified personnel to be responsible for ensuring compliance. A formal governance body with specific oversight of Foreign Correspondent Banking, inclusive of on-boarding and escalations, may be considered for this purpose.
All Correspondent Banking Clients shall be subjected to appropriate due diligence that will seek to satisfy an institution that it is comfortable conducting business with a particular client, given the client’s risk profile and the nature of the business relationship with that client. In conducting due diligence on any Correspondent Banking Client, the elements set out below to address specific risk indicators shall be considered, as appropriate:
Ø The Correspondent Banking Client’s Geographic Risk
Ø Branches, Subsidiaries and Affiliates of Correspondent Banking Clients
Ø Branches, Subsidiaries and Affiliates of the Institution
Ø The Correspondent Banking Client’s Ownership and Management Structures
Ø The ownership and management structure of the Correspondent Banking Client
Ø The Correspondent Banking Client’s Business
Ø The Correspondent Banking Client’s Customer Base
Ø Products or Services Offered to the Correspondent Bank Client
Ø Regulatory Status and History
Ø Anti-Money Laundering Controls
Ø No Business Arrangements With Shell Banks
Ø Client Visit
In addition to due diligence, each institution shall also apply enhanced due diligence to those Correspondent Banking Clients which present greater risks. The enhanced due diligence process shall involve further consideration of the following elements, designed to satisfy the institution that it has secured a greater level of understanding:
Ø PEP Involvement
Ø Downstream Correspondents
Ø Approval and Periodic Review of higher risk Correspondent Banking relationships
The institution shall implement bank-wide policies and procedures to detect and investigate unusual or suspicious activity and report any such activity as required by applicable law.
Correspondent Bank relationship and apply to both the correspondent and any related “suspect” activity. This is commonly referred to as the feedback loop.
The Principles should form an integral component of the institution’s wider anti-money laundering programme, including anti-bribery and corruption, fraud and evasion of sanctions.
22 February 2018:
Wolfsberg Group Correspondent Banking Due Diligence New Questionnaire
The Wolfsberg Group is pleased to announce the publication of the updated Correspondent Banking Due Diligence Questionnaire (CBDDQ) and related guidance material (Completion Guidance, Frequently Asked Questions (FAQs) and Glossary). The CBDDQ aims to set an enhanced and reasonable standard for cross-border and/or other higher risk Correspondent Banking Due Diligence, reducing to a minimum any additional data requirements, as per the Wolfsberg definition and current FATF Guidance. It is also the Group’s expectation that the Group members will begin to use the CBDDQ, in a phased approach, with all of their respondents.
In the long term, it is the Group’s view that the adoption of a standardised, reasonable CBDDQ should engender a less arduous, and thereby inherently less costly, due diligence process for Correspondent Banks, which, as it beds down, should also allow for a standard which all Financial Institutions, and their supervisors, can work towards achieving. This should, in the end, support the objectives of the G20 and other supranational organisations towards a well supervised and more harmonised regulatory standard in the correspondent banking space, with longer term positive effects on de-risking, access to finance, the development of trade and financial inclusion.
The Group is also conscious that its original questionnaire has been used in multiple other customer type due diligence scenarios and, therefore, while not seeking to prescribe how, or for which customer types, the questionnaire should be used, the Group has nonetheless issued the Wolfsberg Group Financial Crime Questionnaire (FCCQ) which is a shorter version of the CBDDQ and contains a basic set of questions to address Industry demand.
The Wolfsberg Group Secretariat has created a dedicated address for any CBDDQ related questions: firstname.lastname@example.org.
Wolfsberg's CBDDQ 220218 V1.2 (Excel version)
Wolfsberg's FCCQ 220218 V1.0 (Excel version)
International banks are de-risking their correspondent banking relations with foreign banks in small low income countries that provide banking services with money services businesses. As note in the Wolfsberg Principles international banks are responsible for due diligence of their clients. This means not just knowing the bank in small low income countries but also knowing how well banks do due diligence of their own clients. This is a costly process. Compliance officers at international banks are required to have an in-depth knowledge of the legal and regulatory framework in their country and that knowledge should extend to jurisdictions in which their banks have CBRs. Do you believe this is a realistic expectation of banks and compliance officers? Please share your thoughts.
The wholesale culling of the network of relationships that tie the global financial system together is driving up the costs of finance for poor countries and people. Banks are not de-risking because they have evidence of malfeasance. In most cases anecdotal evidence suggest they are de-risking because of the costs and hassle of checking on their correspondents outweigh the measly profits they generate. Furthermore, ambiguity and lack of clarity in AML/CFT as well as seemingly shifting goalposts or discernible rule is also reasons for de-risking.
1) IMF Report March 16, 2017 RECENT TRENDS IN CORRESPONDENT BANKING RELATIONSHIPS—FURTHER CONSIDERATIONS - file:///C:/Users/Bashir/Downloads/031617.pdf
2) Wolfsberg Group - CBDDQ 22.02.2018 - http://www.wolfsberg-principles.com/wolfsbergcb
3) FX-MM De-Risking responsible for drop in correspondent banking relationships https://www.fx-mm.com/news/68707/correspondent-banking-relationships-fall/