3/9/18 - Adapting to Changes in Correspondent Banking
Home > News & Insights > Insights & Publications

3/9/18 - Adapting to Changes in Correspondent Banking

The correspondent-banking industry has undergone a significant shift in recent years. Motivated by profitability and concerned about exposure to money-laundering and terrorist-financing risks, correspondent banks have developed stricter criteria for doing business with respondents, which have been forced to adapt despite a lack of detailed information about the issues correspondents face. Many respondents have lost correspondent-banking relationships (CBRs), making access to international markets more difficult. Addressing the challenges of this new environment will require respondents to develop a long-term strategy for maintaining their existing relationships and building new ones. Before they can do so, however, respondents need to gain a better sense of correspondents’ risks and concerns. Only then will they be able to determine where they stand as prospective clients relative to other respondent banks.

Correspondent Banking: a Market in Decline

In July 2017, the Financial Stability Board released a report1 that showed a continued decline in the number of CBRs. The predominant currencies for international payments are the U.S. dollar and the euro, which account for approximately 53% and 29%, respectively, of the value of all international payments made through the Society for Worldwide Interbank Financial Telecommunication’s network.2 Between 2011 and 2016, the number of active correspondents for both the euro and the U.S. dollar decreased by approximately 15%. Meanwhile, the number of U.S.-dollar correspondent accounts decreased by 19.6%, and the number of euro correspondent accounts decreased by 28.3%.3

At first glance, the reduction in active correspondents does not seem to have resulted in fewer transactions. In fact, between 2011 and 2016, the global volume of SWIFT payments (measured by payment messages) increased by 36%.4 However, payments did not increase every year in every country, and the increase in payment messages could be the result of longer payment chains. According to the FSB, “As large clearing banks have reduced their correspondent banking network, the number of intermediaries needed to connect two banks may have increased, which would require a larger number of messages.”5

Drivers of the Decline

While respondent banks can address a range of factors to increase their chances of keeping or gaining a relationship with a correspondent, some factors — such as a respondent’s country of origin — remain outside their control. Respondents in Latin America and the Caribbean, for example, seem to be particularly vulnerable to certain perceptions of risk.

As expected, the FSB reported a strong correlation between compliance with the standards of the Financial Action Task Force (or the availability of information on compliance with FATF standards) and correspondent-banking activity. Countries that the FATF had not assessed for compliance, that the FATF identified (in 2014) as not having taken sufficient measures to address issues with their anti-money-laundering/counter-terrorist-financing frameworks, and that faced calls to action from the FATF, experienced sharp reductions in the number of correspondents between 2011 and 2016. Countries that the FATF was simply monitoring to address deficiencies, meanwhile, were less affected.6 The number of active correspondents also decreased more sharply in countries with relatively small economies,presumably because those countries are perceived to have weaker AML/CTF frameworks.

According to an FSB survey of 128 respondent banks, drivers related to risk appetite, profitability, and AML/CTF sanctions, compliance, and reputation-related issues accounted for more than half (around 56%) of the reasons respondents lost relationships.8 However, the actual percentage could be higher. Business-strategy reasons accounted for 36.4% of the total reasons respondents said they lost relationships, but as an example given by the FSB of potentially overlapping responses, “a change in the business model [a business-strategy driver] may be due to a change in risk appetite.”9  

Not surprisingly, profitability drivers affected small and midsize respondents more than large respondents. Profitability reasons accounted for 20% of the reasons small respondents lost CBRs and 17.2% of the reasons midsize respondents lost CBRs, compared to just 13.6% of the reasons large respondents lost CBRs.10 Also, terminations of CBRs over due-diligence concerns affected small and midsize banks more than large banks and occurred most frequently in Latin America and the Caribbean,11 where respondent banks tend to be smaller, on average, than those domiciled in other jurisdictions.

In addition to terminating relationships, correspondents also imposed more restrictions on respondent banks between 2011 and 2016. Smaller respondents with fewer correspondent-banking providers faced the most restrictions, on average; in 2016, respondents depending on one or two correspondents faced restrictions on 29% of their relationships, while respondents depending on more than two correspondents faced restrictions on 15% of their relationships.12 Respondents in Latin America and the Caribbean, where 56% of banks depend on just one or two correspondents,13 appear to have been especially affected by the increase in restrictions.

Implications and the Responses of Regulators and Respondents

Fewer CBRs and more regulatory restrictions have made respondents more dependent on the banks they continue to conduct business with, leading to a higher degree of interconnectedness and an increase in systemic risk. In addition, since 2011, 25% of banks have changed their correspondent-banking arrangements to allow payments to move through different countries, potentially leading to longer payment chains, rendering payment services less efficient, and indicating a shift toward downstream correspondent banking, or nesting,14 which could further increase risk and financial instability.15 Non-U.S. banks offering U.S. clearing services are becoming especially prevalent in places like Latin America and the Caribbean, where de-risking has forced respondent banks to find creative ways to access international markets.

Regulators have generally responded to challenges in the correspondent-banking environment by trying to alleviate concerns about the perceived risks of money laundering and terrorist financing in their jurisdictions. Many have implemented or enhanced AML/CTF regulations and adopted international standards and are attempting to facilitate transparency, encourage financial inclusion, and discourage de-risking. However, regulators are limited in the tools they have to solve the problem, and the current state of the correspondent-banking environment suggests that their efforts to date have not been sufficient.

Suggestions for Respondents

Correspondent banking does pose significant risks for international banks. Respondents should consider developing long-term strategies to mitigate these risks and increase their chances of maintaining and developing CBRs. Similar to any business strategy, CBR strategies should be based on a variety of internal factors, such as technology, profitability, size, client demographics, industry concentration, and client types, as well as external factors, such as market risks, country risks, and changing regulations.

However, before a respondent bank can create an effective strategy to develop and maintain its CBRs, it must first understand the issues affecting correspondent-banking providers. It should then assess its own value as a potential correspondent-banking client relative to other respondents, since the risk to a correspondent of working with a respondent (and the perception of that risk) is best understood in context.

To start, respondent banks should consider:

  1. Retaining an independent third party to perform a gap analysis of their AML compliance and financial-crime risk management programs to identify misalignments with international standards and assist in developing a strategic plan to remediate deficiencies.
  2. Discussing the results of the gap analysis and strategic plans with correspondent-banking partners, emphasizing the need to perform independent evaluations on an annual basis and sharing the results of those evaluations with their correspondent partners.
  3. Communicating on an ongoing basis with the compliance and risk management personnel of correspondent banks, for example, by meeting on a periodic basis to discuss the progress of their AML compliance and financial-crime risk management programs and to explain any transaction-monitoring and customer-onboarding trends.
  4. Understanding the governance and approval hierarchies of large-scale correspondent banks and determining which governing bodies are ultimately responsible for deciding whether to keep or exit relationships with respondents.
  5. Discussing market trends with peer institutions, banking associations, and consulting firms, to understand how to position themselves to correspondents as viable business partners.

Respondent banks should also keep in mind that most correspondents view CBRs from a dispassionate business perspective in which cost, benefit, and risk are the key drivers. In some cases, smaller correspondents that are new to the market may accept monthly fees from respondents that want access to their systems, regardless of wire activity. However, most tier-one correspondent banks review accounts on a holistic basis. While they do not often charge additional fees for services, they tend to seek broader relationships to generate revenues through the provision of additional services. Succeeding in today’s correspondent-banking environment requires new ideas, new processes, and a new perspective, but respondents would do well to heed the business goals and objectives of their correspondent-banking providers.

How We Can Help

Promontory Financial Group, an IBM company, has strong AML expertise and relationships with U.S., U.K., and European financial institutions. Our experience and capabilities enable us to provide timely insights and guidance to both correspondent and respondent banks. We have worked with several financial institutions to help them address deficiencies, with the goal of maintaining or re-establishing at-risk U.S. correspondent relationships due to the AML concerns of their correspondent-banking partners. We can also assist institutions in working through regulatory concerns to meet U.S. standards.

To re-engage correspondents or preserve existing relationships, respondent banks will need to demonstrate that they have designed, documented, and implemented effective AML compliance and financial-crime risk management programs that satisfy the requirements of the jurisdictions in which their correspondent partners operate, among other measures. We help institutions perform AML program reviews and implement enhancements to meet the standards of U.S. correspondent banks.

In addition, many of our professionals are former regulators or practitioners with the expertise to assist foreign banks in establishing a presence in the U.S. and, subject to relevant regulation, directly participate in the U.S. banking system through U.S. licensing strategies.

Contact Us

Robert Pargac 
Managing Director
rpargac@promontory.com 
+1 212 542 6705

Kobi Dorenbush
Director
kdorenbush@promontory.com
+1 416 863 8563

Chad Carson
Associate
ccarson@promontory.com
+1 202 370 0526


FOOTNOTES

1. “FSB Correspondent Banking Data Report,” Financial Stability Board (July 4, 2017)

2. Ibid.

3. Ibid.

4. Ibid.

5. Ibid.

6. Ibid.

7. Ibid.

8. Ibid.

9. Ibid.

10. Ibid.

11. Ibid.

12. Ibid.

13. Ibid.

14. An example of downstream correspondent banking, or nesting, would be when a bank in Colombia establishes a correspondent account in U.S. dollars with a bank in Mexico that has an account with a U.S. correspondent.

15. “FSB Correspondent Banking Data Report,” Financial Stability Board (July 4, 2017)