Word of the Week: Correspondent Banking
Updated: Apr 22
Correspondent banking is important for cross-border transactions. It is essential for customer payments and for the access of banks themselves to foreign financial systems for services and products that may not be available in the banks’ own jurisdictions. In February 2022, via SWIFT more than 45 million financial messages per day were facilitated, according to latest traffic data.
For compliance professionals, correspondent banking may be a crucial step in the identification of illicit flows as it may be part of the layering and integration stages of money laundering.
Nowadays, with sanctions on Russia and various export controls, correspondent banking remains a topic which is worth exploring deeper. So, let’s begin with definitions and key characteristics.
According to the FATF, correspondent banking is the provision of banking services by one bank (the “correspondent bank”) to another bank (the “respondent bank”). Large international banks typically act as correspondents for thousands of other banks around the world. Respondent banks may be provided with a wide range of services, including cash management (e.g. interest-bearing accounts in a variety of currencies), international wire transfers, cheque clearing, payable-through accounts and foreign exchange services.
Typically a correspondent relationship is characterized by its on-going, repetitive nature and does not generally exist in the context of one-off transactions.
What makes correspondent banking riskier and complex is that the correspondent rarely has a direct relationship with the underlying parties in a transaction.
Correspondent Banking Risks and Due Diligence
No matter if your financial institution provides or receives correspondent banking services, as compliance professionals we need to understand better what level of due diligence is required.
For banks offering correspondent banking services, the major risk stems from the fact that they don’t have KYC details available for the clients of the respondent bank. And from here we have the term KYCC - Know Your Customer's Customers.
If your financial institution is offering foreign correspondent banking, part of its due diligence program should include policies, procedures, and processes for risk assessment and well-documented risk rating methodologies. As part of their normal CDD processes, financial institutions are required to understand the purpose and nature of the intended business relationship in line with the risks identified. The correspondent institutions are required to understand the target markets and customer segments that are served by their respondent as part of their assessment of risks. Understanding the business profile of the respondent institution requires the correspondent to consider all relevant risk factors (e.g. developing a general overview of the respondent institution’s products and services and customer base, including nested relationships; countries and markets in which it operates; transactions in which it engages on behalf of its customer base and delivery channels it uses).
A common component used for the establishment of a correspondent relationship and used for ongoing monitoring is the Wolfsberg Group Questionnaire - Correspondent Banking Due Diligence Questionnaire. This questionnaire is recommended to be used first with new customers and later expand to existing customers as part of those customers’ periodic reviews. These questionnaires should be at a minimum reviewed once every year (depending on the customer risk).
According to the Wolfsberg Group, when conducting due diligence on any Correspondent Banking Client, the elements set out below to address specific risk indicators shall be considered, as appropriate:
The Correspondent Banking Client’s Geographic Risk
Certain jurisdictions are internationally recognised as having inadequate anti-money laundering standards, insufficient regulatory supervision, presenting greater risk for crime, corruption, terrorist financing or pose elevated risk of evading sanctions. On the other hand, other jurisdictions with more robust regulatory environments represent lower risks. The effectiveness of the particular supervisory regime must be considered, particularly where the regime has been found to be deficient in its application of global AML/CFT standards. Institutions shall review pronouncements from regulatory agencies and applicable international bodies, such as the Financial Action Task Force (FATF), to evaluate the degree of risk presented by the jurisdiction in which the Correspondent Banking Client is based, the jurisdiction in which its ultimate parent is headquartered, and jurisdictions of those with whom they conduct business.
Branches, Subsidiaries and Affiliates of Correspondent Banking Clients
The determination of the level and scope of due diligence that is required on a Correspondent Banking Client shall be made after considering the relationship between the Correspondent Banking Client and its ultimate parent (if any). In general, in situations involving branches, subsidiaries or affiliates, the AML control programme of the Correspondent Banking Client parent shall be considered in determining the extent of required due diligence. In instances when the Correspondent Banking Client is an affiliate, which is not substantively and effectively controlled by the parent, then both the parent and Correspondent Banking Client shall be reviewed. However, certain facts unique to the branch, subsidiary or affiliate may dictate that enhanced due diligence be performed, particularly with respect to local, product or regulatory standards within the specific jurisdiction.
Branches, Subsidiaries and Affiliates of the Institution
As noted, when an entity affiliated with the institution is the account holder, it is also a Correspondent Banking Client which is generally subject to the due diligence measures outlined in these Principles. The level and scope of due diligence on such a Client shall be dependent upon the level of control exercised by the parent institution, certain facts unique to that branch, subsidiary or affiliate, as well as regulatory standards and risks that may apply within the jurisdiction of that entity.
The Correspondent Banking Client’s Ownership and Management Structures
The ownership and management structure of the Correspondent Banking Client may present increased risks. Relevant risk considerations include the domicile and reputation of the owners; the corporate legal form of the Correspondent Banking Client; whether it is state-owned, publicly held, or privately owned; the transparency of the ownership structure; whether it is publicly held, its shares traded on an exchange in a jurisdiction with an adequately recognized regulatory scheme and the identity of any significant ownership. The structure and experience of Executive Management, e.g.most senior executives in charge of its day-to-day business, may also be appropriate for consideration. Depending on the circumstances of the Correspondent Banking Client, this may include the members of the Correspondent Banking Client’s Board of Directors, Supervisory Board, Executive Committee or its equivalent. The presence of any politically exposed persons (PEPs) in the Executive Management or ownership structure is also an important consideration. For all significant controlling interests, the ultimate beneficial owners, sources of wealth and background, including their reputation in the marketplace (particularly as may be related to any negative or adverse AML matters) as well as recent material ownership changes shall also be ascertained to the extent available through inquiry or public sources. Similarly, a more detailed understanding of the reputation of the client’s Executive Management, as well as recent material changes in the Executive Management structure and the identity of any significant controlling individual(s), shall be considered where there is evidence of any associated adverse reputational risk.
The Correspondent Banking Client’s Business
The types of financial products and services the Correspondent Banking Client offers to its own clients, as well as the type of markets the Correspondent Banking Client serves, may present greater risks. Involvement in certain business segments and providing certain products or services generally recognized as being vulnerable to money laundering, corruption, terrorist financing or evading sanctions, may present additional risks and shall be considered. Increased risk factors include operating in high risk jurisdictions, MSBs, private banking and cross border wire transactions.
The Correspondent Banking Client’s Customer Base
The types of businesses/clients serviced by the Correspondent Banking Client may be relevant to the risk it poses to the institution providing Correspondent services. A Correspondent Banking Client which derives a substantial part of its business income from Clients posing elevated risk due to activities they engage in, or jurisdictions, in which they operate, may present greater risk themselves. Each institution offering Correspondent Banking services shall assess whether such activities are relevant to its relationship with the Correspondent Banking Client and give the appropriate weight to each risk factor as it deems necessary.
Products or Services Offered to the Correspondent Bank Client
The business purpose(s) for the relationship with the Correspondent Banking Client, including the products and services offered to that Client. Expected business activity to be transacted through the Correspondent account shall be documented to reflect reasonably an understanding of what is normal and expected.
Regulatory Status and History
Reasonable measures shall be taken to verify that the Correspondent Banking Client is subject to regulatory oversight in the jurisdiction where it operates. The institution shall determine if the client has been the subject of any relevant, material regulatory action and assess the extent to which it is relevant to the establishment/continuance of the relationship or whether enhanced risk mitigation measures may be appropriate.
Anti-Money Laundering Controls
Using a risk based approach, the institution shall evaluate the quality of the Correspondent Banking Client’s anti-money laundering programme, including how it meets internationally recognised standards and sufficiency so as to mitigate the risk presented based upon their products, customer base and jurisdiction. The extent to which an institution will enquire about the Correspondent Banking programme will depend upon the risks presented. Additionally, the institution may speak with representatives of the Correspondent Banking Client, review AML controls and corroborate findings.
No Business Arrangements With Shell Banks
The institution shall confirm that the Correspondent Banking Client is not a Shell Bank and does not provide products or services to Shell Banks.
The PATRIOT Act in the US prohibits a ‘‘covered financial institution’’ from providing ‘‘correspondent accounts’’ in the United States to foreign banks that do not have a physical presence in any country (foreign shell banks).
Section 313 of the USA PATRIOT Act prohibits US financial institutions from establishing, maintaining, administrating or managing correspondent accounts for foreign shell banks. US financial institutions are required to take reasonable steps to ensure that they are not providing banking services to foreign shell banks indirectly through correspondent accounts maintained for other foreign banks. A shell bank is a foreign bank with no physical presence in any country.
Section 319(b) of the Act requires US financial institutions that provide a correspondent account to a foreign bank to maintain records of the owners of the foreign bank and to maintain the name and address of an agent of the foreign bank in the United States authorized to accept service of legal process for records regarding the correspondent account. US financial institutions that are unable to obtain the required information or assure themselves that the correspondent account is not being used to indirectly provide services to a foreign shell bank are required to cease transactions and close the account.
Unless other measures suffice, a representative of the institution should visit the Correspondent Banking Client at their premises, prior to or within a reasonable period of time after establishing a relationship with a Correspondent Banking Client, to support the client due diligence process. Site visits by AML subject matter experts may also be conducted at the time of periodic review if deemed necessary.
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:
If a PEP appears to have involvement in the Correspondent Banking Client, then the
institution shall ensure it has an understanding of the person, their role and the appropriateness of that role, their ability to influence the Client and the risk they may present to the relationship.
A downstream correspondent (also referred to as “nested”) relationship occurs when a
Correspondent Bank client provides Correspondent services to other banks, domiciled inside or outside their country, to facilitate international products and services on behalf of the Downstream Correspondent’s clients, e.g. when a Regional savings bank offers correspondent services to the local savings banks in its area. When these services are offered by a Correspondent Banking Client to a Downstream Correspondent, the institution shall take reasonable steps to understand the types of financial institutions to whom the Correspondent Banking Client offers the Downstream Correspondent services. These may include the types, number, scale of services and geographic distribution of Downstream Correspondents, any identified issues with the Downstream Correspondent either directly or indirectly, and consider the degree to which the Correspondent Banking Client examines the anti-money laundering controls of the financial institutions to which it offers those services and whether the activity poses elevated risk.
Approval of higher risk Correspondent Banking relationships at the time of on-boarding and periodic review shall be subject to a higher level of approvals by business and Compliance, or relevant control function. Periodic reviews shall be conducted of all high risk Correspondent Banking relationships, at minimum on an annual basis.
Correspondent banking is where FIs need to be proactive in AML and sanctions compliance as the traditional screening or monitoring is more likely to fail.
Now that we know the due diligence process of onboarding a correspondent bank and all that needs to be assessed, it is time to see how all these tie in practice with the new sanctions environment.
In a correspondent banking transaction, when the financial institution is acting as a correspondent only, there is rarely KYC information for the transacting parties. The correspondent bank has to rely on the due diligence performed by their client bank.
When assessing the correspondent banking risks following the Russian invasion of Ukraine, Eric Li, research director at Coalition Greenwich said: “Banks will be especially exposed to indirect sanctions risks through correspondent ties to financial institutions in countries that have strong links to Russia or no sanctions program in place, such as China or India, or Russian lenders that are not sanctioned”. Affected by the sweeping global sanctions, Russian banks will be looking for loopholes trying to engage in ‘nested’ activity. Likely they will try to use the correspondent relationships of non-sanctioned or friendly financial institutions.
Additionally, due to the number of Russian entities and individuals coming under scrutiny, the potential for sanctions evasion is high. Russian entities and individuals were subject to sanctions since 2014 and thus they became proficient in their use of shell companies registered in offshore jurisdictions.
“Financial institutions that bank such structures usually obtain full disclosures, but they cannot independently verify their authenticity nor can they always be sure if a declared shareholder/beneficial owner is not just a nominee," George Voloshin said in Aperio’s February FINANCIAL CRIME DIGEST.
Often the ownership structures can be compared to Russian nesting dolls - operating and creating multiple layers of ownership that make it virtually impossible to know the actual involvement of individuals or firms. FinCEN highlights the use of shell companies to obscure ownership and conduct international wire transfers, and the use of third parties to shield the sanctioned person or PEP involved.
In terms of correspondent banking, you will need to know that your client performs indepth review and checks.
KYC in the spotlight: Implementing effective KYC procedures and ongoing monitoring
Beneficial ownership: regular research and updates of beneficial ownership information
Offshore & trusts: Apply extra due diligence and try to get the most details as possible.
In the end, if something does not make sense, it’s best if we do not repeat the mistakes in correspondent transactions that Deutsche Bank made and had to pay a penalty of $150 million penalty in 2020.