The Trends and Considerations in Correspondent Banking Relationships
28th May 2017, Bachir El Nakib (CAMS), Senior Consultant Compliance Alert LLC
Correspondent banking represents the cornerstone of the global payment system designed to serve the settlement of financial transactions across country borders.
Correspondent Banking due diligence or KYC (CBR-KYC) is a vital and particularly challenging business process. CBR-KYC is a time-consuming and largely manual process that requires the attention of experienced analysts in the desk-based research, sifting, review and recording of Correspondent Bank questionnaires and policies and the performance of other Anti-Money Laundering (AML) checks and verifications leading to the eventual AML risk determination.
IMF Releases Policy Paper Addressing Recent Trends and Considerations in Correspondent Banking Relationships
On April 21, 2017 the International Monetary Fund (the Fund) announced the release of its policy paper addressing recent trends in correspondent banking relationships (CBRs). According to the Fund, CBRs are facing pressure in some countries as cross-border flows are “concentrated through fewer CBRs or maintained through alternative arrangements.” Decisions made by global banks to terminate CBRs often result from a lack of confidence in the respondent bank’s ability to manage risk. Notably, recent changes in regulatory and enforcement requirements—addressing economic and trade sanctions, Anti-Money Laundering/Combating the Financing of Terrorism (AML/CFT) guidelines, and tax transparency standards—have contributed to this problem. The Fund notes that these “financial fragilities” resulting from the terminations have the potential to increase financial services costs and negatively affect bank ratings—thus creating long-term effects on growth. The paper highlights the Fund’s plan to address withdrawal concerns and the resulting implications, including:
· establishing measures to enhance respondent banks’ capacity for risk management;
· strengthening and effectively implementing regulatory and supervisory frameworks, particularly with respect to AML/CFT;
· improving communication between correspondent and respondent banks;
· removing impediments to information sharing between correspondent and respondent banks; and
· understanding the “feasibility of temporary mechanisms, including public-backed vehicles, to provide payment clearing services” in the event all CBRs are withdrawn from a country.
The Fund also notes collaboration efforts with the Financial Stability Board, World Bank, G20, Financial Action Task Force, Arab Monetary Fund, and the Committee on Payments and Market Infrastructures, among others, to “ensure financial stability and promote financial inclusion.”
Earlier, last year, from February through June 2016, the Arab Monetary Fund (AMF), in partnership with the International Monetary Fund (IMF) and the World Bank, undertook a survey on the causes and impact of the withdrawal of correspondent banking1 relationships (CBRs) from banks operating in the Arab region. The survey aimed at assessing to what extent Arab banks have seen terminations/restrictions of their CBRs over the past 4 years (2012-2015), identifying the underlying causes, and collecting evidence on how this withdrawal has impacted banks’ products & services and client segments. The focus of the survey was limited to client banks (Nostro accounts 2 ) with the aim of understanding how they were directly affected by the withdrawal of CBRs. 2. A total of 216 banks operating in seventeen Arab countries provided answers to the survey (participant banks). Despite considering the data gathered as representative, this report does not intend to provide detailed quantitative data that presents an exhaustive overview of the whole correspondent banking practices in the Arab region. In particular, a quantitative discussion of the potential economic effects of a withdrawal of CBRs was outside the scope of this report. Nevertheless, the results of this survey make an important contribution to the ongoing policy debate regarding the need for and design of solutions to the challenge created by the withdrawal of CBRs. 3. Roughly 39 percent of the participant banks in the Arab region indicated that they have experienced a significant decline in the scale and breadth of CBRs, while 55 percent of them have reported no significant change, 5 percent indicated an increase and the residual of almost 1 percent stated as unknown response. In addition, the number of accounts being closed appears to be increasing, with 63 percent of participant banks reporting the closure of CBR accounts in 2015 versus 33 percent in 2012. 4. About 40 percent of the participant banks in the Arab region indicated the United States (USA) as being the home jurisdiction of the largest share of banks that are withdrawing CBRs, followed by United Kingdom (UK), Germany, Kingdom of Saudi
Arabia (KSA), United Arab Emirates (UAE), France, Canada, Italy, Lebanon, Switzerland, and Australia. Where banks have experienced a withdrawal of CBRs, almost 63 percent of them indicated they were able to find replacement CBRs. For the rest, 17 percent of participant banks that had their CBRs terminated and/or restricted managed to establish alternative arrangements to meet their needs, while a significant portion, 20 percent of respondents are still unable to find replacement CBRs or alternative options. 5.
The main causes/drivers in foreign financial institutions’ decisions to terminate or restrict CBRs with banks operating in Arab region are believed to include the following according to their relative ranking:
(1) overall risk appetite of foreign financial institution,
(2) changes to legal, regulatory or supervisory requirements in foreign financial institutions’ jurisdiction,
(3) lack of profitability of certain CBRs services and products,
(4) sovereign credit risk rating in Arab countries’ jurisdictions, and
(5) concerns about money laundering/terrorism financing risks in Arab countries’ jurisdictions. 6.
Banks in the Arab region that have experienced a significant decline in the scale of CBRs indicated that the impact on their ability to conduct foreign currency denominated capital and current account transactions is significant in the USA (55 percent) followed by Europe and Central Asia (45 percent). Consistent with those findings, the ability to conduct international wire transfers in US dollars (USD) has been most significantly affected followed by Euro, pound sterling (GBP), Saudi Arabia Riyal (SAR), Japanese Yen (JPY), Australian Dollar (AUD), Canadian Dollar (CAD), and United Arab Emirates Dirham (AED). 7. The products and services identified by those banks as being most affected by the withdrawal of correspondent banking are: trade finance, letters of credit, and documentary collections (58 percent), and clearing and settlement (54 percent). A majority of participant banks report that money transfer operators (MTOs) and other remittance services providers are most affected (51 percent) followed by small and medium exporters (46 percent). Moreover, participant banks reported that the Time/Cost involved in finding alternative channels to offset the impact of a withdrawal of CBRs is significant, and the terms and conditions of replacements were not comparable to the previous CBRs, with some noting a substantial increase in pricing. 8. The outcomes of this survey should be considered as food for thought for further analysis, particularly, the perceived drivers of the decision to withdraw CBRs from banks operating in the Arab region. A set of key issues and questions for more consideration are highlighted in section 3 of this report.
Hence, the “de-risking” phenomenon involves financial institutions’ practices of terminating or restricting business relationships with clients or categories of clients to avoid rather than manage risks. It is a misconception to characterize “de-risking” exclusively as an anti-money laundering/ combatting terrorism financing issue. In fact, “de-risking” can be the result of various drivers, such as concerns about profitability, prudential requirements, anxiety after the global financial crisis, and reputational risk.
During the 2009-2016 period, fines for anti-money laundering grew significantly, peaking at $10 billion in 2014, according to statistics by the U.S. Department of the Treasury’s Office of Foreign Assets Control, and compounding the challenges banks face in high-risk geographies.
The irony is that regulation designed to protect the global financial system is, in a sense, having an opposite effect and forcing whole regions outside the regulated financial system. This matters because allowing de-risking to continue unfettered is like living in a world where some airports don’t have the same levels of security screening – before long, the consequences will be disastrous for everyone.
“All banks, including foreign banks operating in the United States, are facing the de-risking trend,” says Daniel Son, head of U.S. Trade at Wells Fargo Bank. “They are all trying to consolidate risk and focus more on their core competencies. In many cases, that means exiting non-strategic banking areas and cutting down on unnecessary accounts and less strategic relationships.” Smaller commercial banks, especially, are no longer offering the full spectrum of services to their customers.
Anti-money laundering regulations and sanctions regimes are the main compliance areas that international banks face, two areas that are particularly sensitive when international trade transactions are involved. “In the current environment, banks must not only know their customers, they must know their customers’ customers, this has led banks to exit portfolios and clients, lower credit limits and, in some cases, getting out of doing business in certain countries.
“Compliance and regulatory responsibilities continue to increase and add to the cost of capital,” explains Jonathan Heuser, head of Global Trade, Commercial Banking, at JPMorgan. “Clients need to be prepared that their bank will ask for in-depth information about their businesses, flows and counterparties.”
Banks will probe new and existing customers for much more information than they have in the past, and the customers had better be open to remarkable levels of transparency with their bankers. “Exporters need to understand the regulatory environment that banks face,” says Huh. “Exporters can educate themselves on what banks will require from them. They need to know which are the sanction countries and they need to be prepared to provide all of the information that the bank asks of them. The de-risking trend shouldn’t scare bank customers if they are doing their homework and being transparent.”
The increased risk of regulatory enforcement has pushed Western banks to cut back on so-called correspondent banking relationships, in which they rely on foreign institutions provides opportunities to establish new correspondent banking relationship with Chinese rivals with the RMB as reserves currency as of October 2016.