A World Bank report published in November 2015 established that 75 per cent of large international banks acknowledged a decline in correspondent banking relationships.
The same month, the Financial Stability Board (FSB) outlined a four-point plan to curb the decline, which affected mostly lesser developed economies and left some virtually excluded from the global financial system.
Almost three years later, this trend continues, with an estimated 25 per cent cumulative reduction in correspondent relationships from 2009-17.
Despite a seemingly dark picture, I believe there is light emerging, as some banks are starting to build relationships in markets where they previously scaled back. But first, what has been driving de-risking?
Assessing the symptoms
De-risking by correspondent banks has been studied, measured, analysed and reduced to three primary drivers: strategy, cost and risk.
Following the 2007 financial crisis and subsequent capital constraints, businesses needed to make some hard decisions about their future investments in products, markets and client relationships. This was a sign of good discipline and sound business management.
Unfortunately, this had the consequence of some firms deciding to exit certain markets, clients or business lines as they refocused their strategies on areas where they could effectively compete.
The cost of compliance has risen as banks added people, platforms and processes to better manage financial crime risk.
Although fines related to anti-money laundering represent only about 10 per cent of penalties paid by banks over the past 10 years, they have been significant enough to make banks more risk averse.
With compliance costing more, banks need a higher minimum revenue to meet their business objectives, meaning that some relationships will not be large enough to bank. Aggregating smaller relationships is an opportunity for regional banks, but creates a new risk (nested accounts) for upstream correspondents to consider. Reducing the cost of compliance without sacrificing the quality is critical to enabling correspondents to lower the threshold for banking smaller and higher-risk relationships.
Risk as a driver for de-risking has several layers, including country risk, local regulatory supervision and transparency, reliability of laws and actual level of illicit activity. The type of business and respondents’ clientele also affect the risk profile of banks.
Also, correspondents are guided by their own internal ability and tolerance to manage various levels of risk, which is why correspondents have different policies for downstream relationships. Risk in itself is a driver, and it has a high correlation to cost as a driver for de-risking.
Treating the disease
Despite perceptions that nothing has been done to address the underlying issues, there have actually been dozens of initiatives from both the public and private sectors.
The public sector has updated guidance, clarified regulatory expectations, considered revisions to data privacy and information sharing, examined beneficial ownership rules and practices, and provided capacity building to lesser developed markets most affected by de-risking.
More work is needed, but ongoing public-private sector dialogue has changed the tone to create a more collaborative approach to solving financial crime and financial exclusion.
BAFT and other industry associations have also published best practice guidance, and have regularly engaged policymakers to reconcile rules and regulatory intentions with actual practices.
The Wolfsberg Group has expanded the question set in its Correspondent Banking Due Diligence Questionnaire to eliminate the need for multiple questionnaires from different correspondents. And SWIFT has agreed to adopt this as part of its KYC Registry, which helps to streamline the collection of data for over 4,000 participating institutions.
Technology providers have worked closely with banks to deploy artificial intelligence, cognitive computing, biometrics and other emerging technologies to improve efficiency and effectiveness. Using sophisticated algorithms, some firms report having reduced by up to 80 per cent the number of accounts in certain high-risk segments that require enhanced due diligence. This not only reduces cost, but ensures higher quality review on the most risky transaction sets.
BAFT has also expanded its series of financial crime compliance workshops, some of which will take place in the countries where the EBRD invests. These training sessions will be jointly organised by BAFT and the EBRD.
BAFT has also launched a de-risking working group that is preparing a Respondent’s Playbook – a guide for respondent organisations to better understand the expectations of correspondent banks, which can improve their likelihood of securing correspondent relationships.
Some correspondent banks have yet to go through the cycle of business strategy and client/market rationalisation, so there will be more de-risking to come.
However – and here we can begin to be optimistic – some correspondents have begun to “re-risk” and build new relationships in markets where they may have previously scaled back.
The emergence of challenger banks and non-bank payment service providers are creating options to fill the payments and remittances void, leveraging lower cost channels. Non-bank providers are increasing their investments in financing trade. The Financial Action Task Force (FATF) regularly updates its list of high-risk and non-compliant jurisdictions.
Respondents need to ensure their risk management practices and compliance culture meet international expectations. Governments must ensure their regulatory and legal frameworks are robust. The urgency for a solution to derisking is alarming but there is reason to believe there is some light emerging.
Some correspondents have begun to ‘re-risk’ and build new relationships in markets where they may have previously scaled back.