Further action is needed to address the global decline in correspondent banking relationships, warns the Financial Stability Board in a July 4 report to G20 leaders. Targeted geographic regions are being “de-risked,” leaving local businesses without access to the international financial community.
Correspondent banking relationships are those where one financial institution provides services on behalf of another in a different location to facilitate cross-border payments. In recent years, these financial relationships have declined most significantly in Eastern Europe, Africa, the Caribbean, Latin America, and the Pacific locales of Melanesia, Micronesia, and Polynesia.
The decline, the FSB says, is a concern because it may affect the ability to send and receive international payments or drive payments underground in certain jurisdictions. This could negatively affect trade, financial stability, and the integrity of the financial system.
The FSB—currently chaired by Mark Carney, governor of the Bank of England—was established to coordinate, on an international level, the work of national financial authorities and international standard setting bodies. This report is part of that effort.
Data in its new report was collected from a survey of more than 300 banks in nearly 50 jurisdictions. Also factored in was data provided by the Society for Worldwide Interbank Telecommunications relating to payment traffic over its SWIFT network.
Its research shows that the decline in the number of correspondent banking relationships is continuing across all continents, although to a varying degree and more pronounced for U.S. dollar and euro transactions.
According to SWIFT’s data, the number of active correspondent banking relationships declined by 6 percent across all currencies between 2011 and 2016.
At the global level, the decline in the number of active correspondents has not resulted in a lower number of payment messages or a lower underlying value of the messages processed through SWIFT, the report adds. To the contrary, the number of payment messages has increased between 2011 and 2016.
“Against this background, the decline in correspondent banking relationships appears to lead to a greater concentration, where countries and banks rely on fewer correspondent banks, and may lead to longer payment chains, which means that a higher number of intermediaries are involved in processing the same payment,” the report says. “The countries where banks are most affected by exits of foreign correspondent banks tend to be small economies or jurisdictions for which the compliance with standards for anti-money laundering and combating the financing of terrorism is insufficient or unknown.”
Intertwined reasons account for the reduction in correspondent banking relationships, the report says. Among them: industry consolidation, reduced profitability from these activities, risk appetites, and various reasons related to AML/CFT or sanctions regimes, the report says.
“Correspondent banking is an essential part of the global financial system,” Alexander Karrer, chairman of the FSB’s Correspondent Banking Coordination Group said in a statement. “The banking industry and the official sector will continue to work together to make improvements to simplify due diligence in correspondent banking.”
Data culled from recent research by Accuity—a provider of financial crime compliance, payments, and know-your-customer solutions—suggests an even steeper decline in correspondent banking relationships. It estimates a 25 percent drop globally, a decline it squarely blames on a retreat by U.S. and European banks.
“Correspondent banking is an essential part of the global financial system,” said in a statement. “The banking industry and the official sector will continue to work together to make improvements to simplify due diligence in correspondent banking.”
Alexander Karrer, Chairman, Correspondent Banking Coordination Group, FSB
“We have seen a significant drop around the world which is compounded by the fact that you actually see an increase in some of the other metrics out there in terms of things like the number of bank branches and locations,” says Henry Balani, global head of strategic affairs at Accuity.
Among Accuity’s data points:
China has experienced a 133 percent increase in the number of banks since 2009 and a 3,355 percent growth in correspondent banking relationships;
The number of U.S. dollar correspondent relationships declined by 15 percent, with Euro relationships showing a steeper decline of 23 percent;
Declines in U.S. dollar banking relationships is either indicative of a concentration in relationships or a reduction in USD dominance; and
The U.S. market has experienced growth rates higher than other advanced economies, yet despite this, there has been a drop in correspondent banking relationships.
A key takeaway: Even though the U.S. banking sector has recovered and prospered since the 2008-2009 financial crisis, it is not growing in “high risk” jurisdictions. As a result, Chinese banks are increasingly stepping in to fill the void.
The term “de-risking” is “headline grabbing and sounds bad, but it implies kind of a single cause in terms of what is happening,” Balani says. “It is really a withdrawal of correspondent banking relationships.”
Increased regulation, compliance mandates, and sanctions demands are all adding to the reluctance of U.S. banks to enter beyond certain borders.
“Ultimately it comes down to a business decision,” he says. “Is it profitable to maintain a relationship? They look at all these penalties and fines and so forth, and it is really a simple risk-reward ratio. Is the cost of doing business worth the fines and penalties I might get?”
Since the financial crisis of 2008, regulators have imposed requirements for greater transparency, established higher liquidity thresholds for banks, as well as stepped up enforcement actions on institutions that violate AML regulations.
In 2014, AML penalties peaked at $10 billion, compounding the challenges banks face in high-risk geographies, Accuity explains in its report. In this climate, the threat to banks from 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 and competitive and regulatory pressures have driven banks to withdraw from correspondent banking relationships,” it says.
Belows is guidance on supervisory expectations from the OCC.
In October 2016, the Office of the Comptroller of the Currency issued risk management guidance that addresses periodic reevaluations of the risks associated with foreign correspondent banking accounts.
The guidance reiterates the agency’s supervisory expectation that the banks it oversees assess these risks as part of their on-going risk management and due diligence practices.
The guidance describes a range of best practices for banks to consider when conducting periodic reevaluations and making account retention or termination decisions. They include:
Establishing and maintaining an effective governance function to review the method for periodic risk reevaluation and to monitor the appropriateness of recommendations regarding foreign correspondent account retention or termination.
Communicating foreign correspondent account termination decisions regularly to senior management, with consideration given to the extent to which account closures may have an adverse impact on access to financial services for an entire group of customers or potential customers, or an entire geographic location.
Communication with foreign financial institutions that includes consideration of specific mitigating information these institutions may provide, and providing them sufficient time to establish alternative banking relationships before terminating accounts, unless doing so would be contrary to law, or pose an additional risk to the bank or national security, or reveal law enforcement activity.
Ensuring a clear audit trail of the reasons and method used for account closure.
Having an ongoing due diligence processes for foreign correspondent account relationships that may include periodic site visits based on risk.
Specifying the length of time that foreign correspondent accounts can remain dormant before being subject to closure.
Avoiding the termination of entire categories of foreign correspondent account relationships without regard to the risks presented by individual foreign financial institutions, unless specifically required by law.
The guidance is applicable to all OCC-supervised banks that maintain foreign correspondent banking relationships.
Banks must choose whether to enter into or maintain business relationships based on their business objectives, an evaluation of the risks associated with particular products or services, and an evaluation of customers’ expected and actual activity, the OCC says.
“As usual when managing risks, banks apply the mandatory requirements of the Bank Secrecy Act and anti-money Laundering laws and regulations,” the guidance reiterates. “Banks should ensure that decisions to terminate foreign correspondent account relationships resulting from risk reevaluation are based on analysis of the risks presented by individual foreign correspondent account relationships and the banks’ ability to manage those risks.”
As a general matter, however, the OCC “does not direct banks to open, close, or maintain individual accounts,” nor does it encourage banks “to engage in the termination of entire categories of customer accounts without regard to the risks presented by an individual customer or the bank’s ability to manage the risk.”
“Decisions to retain or terminate banking relationships reside with the bank,” the guidance says.
“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,” it adds. “As a result, businesses in the regions most affected are struggling to access the global financial systems to finance their operations,” it adds. “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.”
The irony, according to Balini, is that regulation designed to protect the global financial system is 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,” he says. “If we want to reverse this trend and begin to ‘re-risk,’ then the ‘antidote’ will require more granular 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,” he added.
Concerns over the state of correspondent banking relationships are hardly a new phenomenon. Banks have been caught between a rock and a hard place when it comes to balancing regulatory expectations with enforcement realities and what may seem to be conflicting messages from the government. Regulators are instructing them to be alert for customers who could be engaged in illegal activities, but at the same time urging them to continue providing banking services to legal, but potentially high-risk businesses.
In August 2016, the U.S. Treasury Department issued a four-page fact sheet—developed with the Federal Reserve Board, the Federal Deposit Insurance Corporation, the National Credit Union Administration, and the Office of the Comptroller of the Currency—to outline and clarify supervisory and enforcement activities regarding anti-money laundering and sanctions in the area of correspondent banking.
Treasury Department officials said the document was intended to dispel “certain myths about U.S. supervisory expectations” and it “confirms that there is no general expectation for banks to conduct due diligence on the individual customers of foreign financial institutions.”
The document stresses that the United States “maintains an effective anti-money laundering AML and countering the financing of terrorism CFT regime, which rests on clear requirements, strong and effective supervision, and meaningful and proportionate enforcement.”
“Correspondent banking relationships help improve livelihoods and foster global economic growth by enabling banks to facilitate international trade, conduct cross-border business and charitable activities, and provide U.S. dollar financing,” a statement from the participating agencies says. “The U.S. financial system is a critical part of the global economy, and the government believes that expanding access to that system and protecting it from illicit activity are mutually reinforcing goals that can and must be addressed simultaneously.”
The clear message: They want to see case-by-case customer due diligence, not wholesale de-risking. International agencies, including the International Monetary Fund, have similarly warned that arbitrary de-risking could be devastating to emerging markets.
The conundrum for banks: slice away potentially risky correspondent banking relationships through de-risking efforts and face criticism, or maintain these relationships only to be scrutinized and fined if taking on that risk comes back to bite them.
Under existing U.S. regulations, there is no general requirement for U.S. depository institutions to conduct due diligence on a foreign financial institution’s customers, it says. In determining the appropriate level of due diligence necessary for an FFI relationship, banks “should consider the extent to which information related to the FFI’s markets and types of customers is necessary to assess the risks posed by the relationship, satisfy the institution’s obligations to detect and report suspicious activity, and comply with U.S. economic sanctions.”
This may require a request for additional information concerning the activity underlying the FFI’s transactions in accordance with suspicious activity reporting rules and sanctions compliance obligations, institutions were told.
A blog post, posted on the Treasury Department’s Website, addressed enforcement concerns.
“The rare but highly visible cases of large monetary penalties or settlements for AML/CFT and sanctions violations have generally involved a sustained pattern of reckless or willful violations over a period of multiple years and a failure by the institutions’ senior management to respond to warning signs that their actions were illegal,” it said. “These large cases did not represent small or unintentional mistakes.”