Retraction of global correspondent banking networks challenges financial-crime risk management

By Guest Contributor
July 2, 2013

By Kim R. Manchester, Contributing author for Compliance Complete

NEW YORK, July 2 (Thomson Reuters Accelus) - Global correspondent banks have faced numerous challenges since the onset of the financial crisis in 2008, including heavy scrutiny by regulators on money-laundering and terrorism-financing defenses, shrinking transaction volumes, slashed profit margins and risk parameters that defy rational measurement. A Financial Times report on how global correspondent banks are clawing back the reach of their correspondent banking network operations and trimming respondent banks from their client lists comes as no surprise to the casual observer of international banking.

For the financial intelligence community, this retraction by global correspondent banks will blur their insight into international money laundering and terrorism financing networks and hamper efforts to disrupt organised crime and terrorist groups. For financial institutions, the retraction of networks will create new challenges in financial crime risk management, with painful and expensive consequences if compliance programs are not tailored to meet money laundering and terrorist financing threats within correspondent banking.

In the past, the global correspondent banking business was often a matter of trust and reputation. During the introduction of the euro currency in 1999, it was not well publicized that some regional and national banks had problems with foreign exchange, account management or trade finance systems in processing euro-denominated transactions. Chairman-to-chairman telephone calls delivered reassurance that one bank would extend the necessary institutional credit lines to give another bank enough time to iron out the currency transaction processing bugs. Billions were pledged over the phone based on relationships forged over years of correspondent banking transactions and inter-bank dealing.

Less dramatic examples abound when correspondent bankers reminisce in the hotel lobby bar during SIBOS conventions — the annual gatherings of correspondent bankers hosted by the Society for Worldwide Interbank Financial Telecommunication (SWIFT), which provides secure financial messaging between financial institutions and is the trusted standard of communication between respondent bank and correspondent bank. The business of correspondent banking was how a bank managed its delicate institutional relationships with competitors, clients and its colleagues, often one and the same.

During times of crisis, the rulebook went out the window and regional correspondent banking networks would address blockages in the financial system of one or more countries through communication and mutual self-interest in maintaining banking stability. War, revolution, economic upheaval and natural disaster would force correspondent banking networks to turn on a dime and improvise, often under the guidance of leaders seen as grey-haired banking wizards and financial fairy godmothers. Such “old-school” banking is often mocked by high-tech bankers up until the point they lose their Internet connection or cell-phone signal.

The valuable information contained within international correspondent banking networks is of tremendous use to a financial intelligence unit. Suspicious transaction reports from major correspondent banks can contain a wealth of data that incorporates the bank’s reach into a variety of countries, a tremendous asset for intelligence analysts. No amount of technology can replace boots on the ground and a direct interface with local businesses and institutions.

Information flows to shrink

Now that some international banks are shrinking their correspondent banking networks, the reach of sophisticated financial institutions into emerging markets will be diminished. Less information will flow into an international bank’s own anti-money laundering compliance team for analysis and possible suspicious transaction reporting into a financial intelligence unit.

Financial intelligence units in global financial centers will receive less information on suspicious activity and trends in emerging markets. Given the cross-border nature of most sophisticated money laundering schemes, this drop in financial intelligence quantity and quality will dull the senses of a financial intelligence unit and reduce its ability to piece together patterns of illicit activity.

Perhaps worse is the fact that respondent banks in some of the more volatile economies and regions in the Middle East, Africa, Asia and Latin America will high hurdles in acquiring a major international bank as correspondent in global financial centers such as New York, London, Toronto, Sydney, Paris, and Frankfurt. As a result, the respondent bank will need to acquire a correspondent banking relationship with a large bank that operates in nations where anti-money laundering and counter-terrorist financing compliance are not one of the local banking regulator’s top priorities, to say the least.

Although not offshore financial havens, these “cloudy” financial centers share similar traits, namely a strong distaste for the rule of law, unreliable co-operation with foreign law enforcement officials, fuzzy distinctions between private financial institutions and government officials and a blasé tolerance of money laundering.

In return for higher costs, possibly archaic technology solutions and near-bureaucratic service levels, the respondent bank will acquire transaction relay services in a cloudy financial center, either overt or under a “nesting” arrangement, that will permit the respondent bank’s customers to access international payments, trade finance and currency markets without hindrance.

Offshore financial havens sell banking secrecy to individuals and corporate entities. Cloudy financial centers sell murky regulation and supervision to local or regional financial institutions seeking to avoid the now stringent anti-money laundering and counter-terrorist financing compliance expectations of many, but not all, G20 countries. In fact, some G20 countries will benefit tremendously from a shift to cloudy centers and yet not suffer any sanctions, as realpolitik often dictates the anti-money laundering and counter-terrorist financing policies of nations at the global level.

Some major international correspondent banks have recently paid multi-million dollar settlements to resolve overt or accidental nesting and payment message stripping by banks in sanctioned countries seeking international markets. It is these same banks, and their large international banking peers, that may hand over chunks of their correspondent banking business to banks operating in cloudy financial centers. As many police officers and economists will attest, the harder you come down on a black market, the more expensive the prices, the fatter the margins for the players and the more elusive that market becomes to those seeking to investigate illicit activity.

Due to the new reality within global correspondent banking, respondent banks, correspondent banks and their supervisory agencies will need to re-adjust their risk metrics for 2013 and beyond.

Higher hurdles

Responsible respondent banks will need to accept the higher hurdles for access to a major international correspondent bank and play within the rules. They will need to resist the temptation of handing their business off to a cloudy correspondent bank, as the attraction of lower prices and lesser hoops in due diligence will be counter-balanced by the impact of targeted sanctions by a G7 nation.

Respondent banks will need to absorb the risk-based approach and other anti-money laundering and counter-terrorist financing standards generated by the Financial Action Task Force (FATF). Financial crime typology reports and analyses from G7 countries and FATF-styled regional bodies (FSRBs) should be incorporated into the respondent bank’s compliance program regardless of jurisdiction. The compliance game is becoming increasingly sophisticated, and unless the financial institution is operating at the entrance to the Khyber Pass or in the grasslands of the Kalahari, international standards will be expected by most of their peers.

Major correspondent banks will need to bolster their anti-money laundering and counter-terrorist financing defenses to compensate for degraded capabilities in emerging markets. If expatriate staff and competent local hires are no longer feeding the bank’s head office with timely and accurate news and information, then the bank must raise its remaining risk management defenses.

Sanctions-screening technology within the payments center is now hypersensitive to blacklisted names, yet it is irrelevant for new players, straw men renting or stealing the identities of others and corporations enveloped in bank secrecy. Training frontline and back office staff on the risks of money laundering and terrorist financing has been and will be the primary method by which major correspondent banks can defend themselves against criminal elements shielded by respondent banks.

Training is perhaps even more important for financial intelligence units and banking supervisory agencies, as defending society against those who manipulate and cajole respondent banks requires they understand the intricacies of global correspondent banking in the first place. A reliable network of experts from within the ranks of correspondent bankers is crucial to understanding the business. These individuals should be given whistleblower protections and legal anonymity.

(Kim R. Manchester is the founder and Managing Director of ManchesterCF, a Toronto-based firm that provides financial crime risk management training programs and advisory services to financial institutions and public-sector agencies around the globe.)

(This article was produced by the Compliance Complete service of Thomson Reuters Accelus. Compliance Complete provides a single source for regulatory news, analysis, rules and developments, with global coverage of more than 230 regulators and exchanges. Follow Accelus compliance news on Twitter: @GRC_Accelus)

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