Written by Jon Prentice on Tuesday May 28, 2019
Money laundering scandals have been all over the news recently, with banks such as Danske and Swedbank, amongst many others, being named as facilitating a multitude of transactions involving laundered funds.
The latest reported money laundering schemes, known as ‘laundromats’, have overwhelmingly involved the use of correspondent banks in order to transfer illicit funds, from countries such as Russia, across the world to enter the legitimate financial market.
Correspondent banking is a key facilitator of the global financial framework which promotes inclusion and allows individuals, corporates and other financial institutions and banking services to conduct millions of transactions around the world on a daily basis.
However, correspondent banks are also a risky mechanism that can be vulnerable to exploitation by money launderers, terrorist financers, fraudsters, the corrupt, tax evaders and sanctions breachers.
So, what is correspondent banking and why do we need to understand the risks associated with the service?
What is correspondent banking?
In simple terms, correspondent banking is the service whereby account holders from one bank in a certain jurisdiction (respondent) can benefit from the banking services of another bank in a different jurisdiction (correspondent).
This enables the respondent bank to provide cross-border products and services to its customers in countries in which it does not have a physical presence.
For example, let’s say Company A holds an account with Bank B based in the UK. Company A decides to open a buying office in India and needs to pay suppliers and staff working in that office.
As Bank B is in the UK and has no presence in India, it cannot provide the payment services required. However, it can open a correspondent account with Bank C based in Mumbai which will conduct the transactions required by Company A. In this example, Company A would be the respondent and Bank C the correspondent.
Why do we need to understand the risks associated with correspondent banking?
Correspondent banking, if not governed sufficiently, presents a number of risks which can be exploited. It is essential to be aware of the risks associated with correspondent banking before entering into a correspondent relationship – just ask any of the banks that have been linked to the aforementioned laundromats.
One of the main risks associated with correspondent banking is the fact that the correspondent often has no direct relationships with the underlying parties to a transaction and is therefore not in a position to verify their identities or conduct the necessary due diligence.
This can lead to multiple issues, from inadequate governance of beneficial owners to not establishing the source of funds involved in the transaction.
If the correspondent bank decides to proceed with the relationship relying on the risk framework put in place by the respondent bank, then it leaves itself vulnerable to becoming implicated by association if anything goes awry.
A good example is the Danske Bank money laundering scandal. The Estonia branch of the bank were responsible for facilitating transactions totalling over $200 billion between 2007 and 2015, with the funds coming from the proceeds of criminal activity.
In order to move the funds around the world to enter the legitimate financial system, Danske enlisted the services of correspondent banks such as Deutsche Bank, JPMorgan and Bank of America to conduct their US dollar transactions.
The transactions were processed as requested, allowing billions of dollars’ worth of transactions, involving illicitly obtained funds, to complete.
It wasn’t until 2013 that JPMorgan severed its correspondent banking relationship with Danske over concerns regarding the legitimacy of the funds it was handling.
Despite having its own concerns, Deutsche Bank didn’t terminate its correspondent relationship with Danske until 2015, when it eventually made the decision that it was too risky to further continue to offer its services.
The seriousness of the issue resulted in Deutsche Bank massively scaling back its correspondent banking services by 60% as it was deemed too risky to be continued.
The potential repercussions
By not governing correspondent banking relationships effectively, firms leave themselves open to a range of negative factors, such as:
The reputational and financial costs of entering into a ‘bad’ correspondent relationship has lead to banks withdrawing their correspondent banking services, given the risks outweigh the rewards. This process is known as de-risking.
The danger of de-risking
Although correspondent banking relationships have reduced over recent years – in particular the access to correspondent banking services in emerging markets as a result of de-risking – they are still an everyday essential to global banking.
Without the service, banks in developing countries would struggle to gain access to tier 1 banks, and firms across the world would struggle to conduct international transactions. This could actually result in an increased risk associated to correspondent banking.
If major banks are removing their correspondent banking services, the need for those services will remain, forcing correspondent banking relationships to be set up with smaller banks which perhaps don’t have the capacity and resources to implement the necessary risk framework.
In addition, rather than utilising the services of smaller banks, the correspondent services may be pushed underground to illegal or unregulated services, where there is a fertile environment for illicit finance to take place.
To learn more about the risks associated with correspondent banking and the ways in which to combat the threats associated with the service, why not look at enrolling onto the ICA Specialist Certificate in Money Laundering Risk in Correspondent Banking.
Stay current on your favourite topics. Explore more recommended reading:
This article forms part of the #BigCompConvo - Join us as we explore and debate the latest challenges and issues facing you and regulatory and financial crime compliance professionals all over the world. If you’d like to contribute an article as part of the Big Compliance Conversation get in touch with us at email@example.com
Thank you. Your comment is awaiting moderation and should appear on the site shortly.
Required fields are not completed, please ensure all required fields (*) have been filled in properly.
You can leave the name empty should you wish to remain Anonymous.