Emerging Correspondent Banking Risks: The Need to Adhere to International Standards

Over the last 15years of managing and dealing with Financial Institutions client relationships, I have observed that Correspondent Banking activities remain a grey area for many banking and other financial sector professionals. There is a knowledge and skill set gap in dealing with Correspondent Banks and why they are very important for the very existence of conducting financial services and integrating banking into the global financial system. Recently, I engaged a colleague friend of mine in a different Financial Institution, discussing the Wolfsburg questionnaire and the conversations pointed to the fact that, there is a lot of misunderstanding to the whole framework. I believe a lot must be done to build capacity and benchmark strength for front office, middle office, and back-office staff. In this piece of article, I seek to discuss into detail the emerging risk in correspondent banking and measures to address the inherent risk to meet international banking standards.

To begin with, it would be good to demystify some concepts and definitions. Correspondent Banking is generally defined as the provision of banking related services by say a Bank A to another company or a financial institution. There are several reasons why a Bank would want to provide such services. So basically, Correspondent Bank enables their respondent clients to provide their own clients with cross border products and services that they cannot provide themselves. These include completing wire transfers, accepting deposits, serving as transfer agents, and coordinating documents for another bank. These clients may be individuals, legal entities, and other financial institutions. The reason why Bank A will support Bank B is typically due to a lack of an international network and largely the scale of banking.

To the extent that a correspondent bank undertakes banking service initiative to a respondent Bank, it becomes obvious that relationship risk arises. This is because the Correspondent Bank has limited information about the entire transaction. It is often dependent on the due diligence processes conducted by its respondent bank on the respondent’s clients. It is important to highlight that the Correspondent Bank does not have a direct relationship with the underlying clients for the transaction and therefore cannot assess if the underlying transaction is consistent with the business profile of the client. As a Correspondent Bank, it facilitates the processing of transactions from entities all over the world to support all forms of activity, such as trade, remittances, payment for services. Therefore, by virtue of facilitating these payments, the Bank is exposed to money laundering and terrorist financing risk through bad actors that may use the financial sector to launder illicit proceeds.

As such, it is very important for a correspondent bank to assess the Financial Crime Compliance controls of their clients (respondent banks). Additionally, these flows must be monitored to identify any flows that present higher financial crime risk or are beyond a bank`s risk appetite.

It got to a point in time where a lot of correspondent banks were de-risking, i.e. cutting down on the number of respondent banks. Among other things, this was underpinned by assessment made on the country to confirm if it is considered Equivalent Low Risk Jurisdiction (ELRJ) or Non-ELRJ. The regulatory framework within a jurisdiction is a key determinant of risk appetite. Therefore, for a respondent bank to meet international banking standards, it`s important to address two critical requirements below.

Adherence to Financial Action Task Force (FATF) Recommendations.

It is important to note that, the FATF is an inter-governmental body established in 1989 by the Ministers of its Member jurisdictions. The mandate of the FATF is to set standards and to promote effective implementation of legal, regulatory, and operational measures for combating money laundering, terrorist financing and the financing of proliferation, and other related threats to the integrity of the international financial system. In collaboration with other international stakeholders, the FATF also works to identify national-level vulnerabilities with the aim of protecting the international financial system from misuse. The FATF Recommendations set out a comprehensive and consistent framework of measures which countries should implement to combat money laundering and terrorist financing, as well as the financing of proliferation of weapons of mass destruction. Countries have diverse legal, administrative, and operational frameworks and different financial systems, and so cannot all take identical measures to counter these threats. The FATF Recommendations, therefore, set an international standard, which countries should implement through measures adapted to their particular circumstances.

As at November 2023, close to 40 FATF recommendations were set out, highlighting essential measures that countries should have in place to: 1) identify the risks, and develop policies and domestic coordination;2) pursue money laundering, terrorist financing and the financing of proliferation; 3) apply preventive measures for the financial sector and other designated sectors; 4) establish powers and responsibilities for the competent authorities (e.g., investigative, law enforcement and supervisory authorities) and other institutional measures; 5) enhance the transparency and availability of beneficial ownership information of legal persons and arrangements; and 6) facilitate international cooperation.

Respondent banks must know that a USD/EUR/GBP Correspondent Banking clearer like JP Morgan, Citibank etc will not lower international standards by virtue of a respondent banks jurisdictions or low quality of Compliance standards. The same recommendations shall be applied. For example, Banks should apply a risk-based approach (RBA) to ensure that measures to prevent or mitigate money laundering and terrorist financing are commensurate with the risks identified. This approach should be an essential foundation to efficient allocation of resources across the anti-money laundering and countering the financing of terrorism (AML/CFT) regime and the implementation of risk-based measures throughout the FATF Recommendations.

Wolfsberg Group Standard
In fact, the Wolfsberg Group has made life easier for a lot of respondent Banks across the globe. The group is an association of 12 global banks which aims to develop frameworks and guidance for the management of financial crime risks. They developed and published by the Wolfsberg Group, the Correspondent Banking Due Diligence Questionnaire (CBDDQ) that seeks to help Financial Institutions conducting due diligence on Correspondent Banking relationships, as per regulatory requirements and their own internal policies and procedures.

The CBDDQ basically covers a wide range of financial crime risks and is the successor to the Wolfsberg AML Questionnaire which was first issued in 2004. The CBDDQ is revised and updated periodically on an as needed basis. A shorter version, the Wolfsberg Group Financial Crime Compliance Questionnaire (FCCQ), was also developed to designed to address relationships other than those deemed higher risk.

The financial crime compliance sphere continues to evolve rapidly. Professionals in this industry can use their various user-friendly guidance documents and other resources to deepen their understanding of the issues and to meet both internal objectives and regulatory requirements.

Image: Founding members of Wolfsberg Group

Having used their materials; it provides you with an industry perspective on effective financial crime risk management. Respondent banks will need to adapt them to their needs, considering the risks described, the applicable regulatory standards, business profile and the institution’s defined risk management strategy.

Governance and Risk Framework
A bank’s internal structures plays a critical role in evaluating a correspondent banking services. This includes the ownership structure of the bank and whether any of the shareholders has 25% or 10% ownership based on risk rating. An assessment on Key management team with their profiles provided, including their experience and reputation are assessed. How these factors affect the risk profile of the must be known.

An assessment on a banks Anti Money Laundering/Counter Terrorist Financing (AML/CTF) Program and Sanctions Controls to understand if the bank has enough controls in place to manage financial crime risks. The assessment should, at a minimum, include commentary around documented AML/CTF/Sanctions policies and procedures, independent compliance functions, training, client due diligence, independent testing, transaction monitoring, transaction and name screening and sanctions screening etc. Again, an assessment is done ongoing and/or new relevant material non-regulatory financial crime related adverse news involving the bank including adverse news relating to Client’s shareholder(s) and key executives must be detailed, detailed and how the adverse news affects the overall risk of the relationship with must be highlighted.

Adhering to and meeting Compliance standards cannot be over emphasised. Financial Institutions must make efforts to invest in Transaction Monitory, Name and Sanction Screening systems to help fight financial crime. They must take key interest in training their staff and beefing up Compliance teams to meet international reporting standards. Failure to comply with these standards may lead to fines, and revocation of license etc.

Disclaimer: The views expressed are personal views and doesn’t represent that of the media house or institution the writer works.

Credit and Reference: Miriam Amoako, wolfsberg Group, Financial Action Task Force (FATF)

About the writer : Carl Odame-Gyenti, (Dr) is the author of Dare to Dream book, a Financial Institutions Coverage and Fintech expect working with an International Bank in Kenya, East Africa. Contact: [email protected] , Cell: +254 70 5459061