The complexity of correspondent banking

I love the idea of money without government but, having sat through a regulatory discussion of correspondent banking, I think this hope is possibly false placed.  However, for my banking fraternity, I think they’ll be very interested in two reports recently produced on correspondent banking by the Committee on Payments and Market Infrastructures (CPMI) for the Bank of International Settlements (BIS), and the Financial Stability Board (FSB) for the G20.

The CPMI report may be summarised as follows:

Correspondent banking - consultative report, October 2015

Through correspondent banking relationships, banks can access financial services in different jurisdictions and provide cross-border payment services to their customers, supporting international trade and financial inclusion.

In view of the importance of correspondent banking, the keen interest of central banks in this activity and the trends that point to risks to its safe and efficient functioning, the BIS Economic Consultative Committee (ECC) Governors have mandated the CPMI to produce a report on this issue. In response, the CPMI Working Group on Correspondent Banking has prepared this technical report describing current trends and analysing technical measures that might alleviate some of the concerns and cost issues related to correspondent banking.

Banks have traditionally maintained broad networks of correspondent banking relationships, but there are growing indications that this situation might be changing. In particular, some banks providing these services are reducing the number of relationships they maintain and are establishing few new ones. The impact of this trend is uneven across jurisdictions and banks. As a result, some respondent banks are likely to maintain relationships, whereas others might risk being cut off from international payment networks. This implies a threat that cross-border payment networks might fragment and that the range of available options for these transactions could narrow.

Rising costs and uncertainty about how far customer due diligence should go in order to ensure regulatory compliance (ie to what extent banks need to know their customers’ customers - the so-called “KYCC”-) are cited by banks as among the main reasons for cutting back their correspondent relationships. To avoid penalties and the related reputational damage correspondent banks have developed an increased sensitivity to the risks associated with correspondent banking. As a consequence, they have cut back services for respondent banks that (i) do not generate sufficient volumes to overcome compliance costs; (ii) are located in jurisdictions perceived as very risky; or (iii) provide payment services to customers about which the necessary information for an adequate risk assessment is not available.

The regulatory framework, and in particular the AML/CFT (Anti-Money Laundering/Counter Financing of Terrorism) requirements and the related implementing legislation and regulations in different jurisdictions, are taken as given in this report. It is acknowledged that these requirements, as agreed by the competent authorities, along with strict implementation, are necessary to prevent and detect criminal activities and ensure a healthy financial system.

The working group limited its analysis to technical measures that could help improve the efficiency of procedures, reduce compliance costs and help address perceived uncertainty, without altering the applicable rules and the basic channels for correspondent banking services between correspondent and respondent banks. The group analysed in detail some potential measures and translated them into four technical recommendations.

The working group believes that its recommendations might alleviate some of the costs and concerns connected with correspondent banking activities. However, the members are aware and would like to stress that, in isolation, these technical measures will not resolve all such issues. The working group acknowledges that the issues surrounding the withdrawal from correspondent banking are very complex and that costs related to AML/CFT compliance are only one of the elements that have to be considered in order to understand recent trends. Those include business considerations as well as economies of scope and scale issues. Limiting information challenges through the use of enhanced technical tools will only address part of AML/CFT compliance costs but does not resolve issues such as uncertainty about how far customer due diligence should go. In particular, the proposed technical measures will not immediately help the banks without access to correspondent banking services to gain such access.

In any case, all relevant stakeholders would need to be consulted before an implementation process for the recommended technical measures could start. This report is being published to seek public comment on these technical measures, by 7 December 2015, to be sent to the CPMI Secretariat (cpmi@bis.org). The comments will be published on the website of the BIS unless respondents have requested otherwise.

Recommendations:

• Recommendation on the use of KYC utilities: The use of KYC utilities in general - provided that they store at least a minimum set of up-to-date and accurate information - can be supported as an effective means to reduce the burden of compliance with some KYC procedures for banks active in correspondent banking business. Relevant stakeholders (eg the Wolfsberg Group) may review the templates and procedures used by the different utilities and identify the most appropriate data fields to compile a data set that all utilities should collect as best practice and that all banks have to be ready to provide to banks which require the information.

• Recommendation on the use of the LEI in correspondent banking: In addition to the general promotion of LEIs for legal entities, relevant stakeholders may consider specifically promoting the use of the LEI for all banks involved in correspondent banking as a means of identification which should be provided in KYC utilities and information-sharing arrangements. In a cross-border context, this measure is ideally to be coordinated and applied simultaneously in a high number of jurisdictions. In addition, authorities and relevant stakeholders (eg the Wolfsberg Group) may consider promoting BIC to LEI mapping facilities which allow for an easy mapping of routing information available in the payment message to the relevant LEI.

• Recommendation on information-sharing initiatives: The work already conducted by the authorities with responsibility for AML/CFT (ie the Financial Action Task Force (FATF) and the Basel Committee on Banking Supervision AML/CFT Expert Group (AMLEG)) is very much appreciated. It is recommended that the FATF and AMLEG be invited to: (i) provide additional clarity on due diligence recommendations for upstream banks, in particular to what extent banks need to know their customers’ customers (“KYCC”); (ii) further clarify data privacy concerns in the area of correspondent banking; and (iii) detail, to the extent possible, the type of data that information-sharing mechanisms could store and distribute in order to be a useful source of information. In order to facilitate compliance with FATF customer due diligence recommendations, (i) the use of information-sharing mechanisms (if they exist in a given jurisdiction and data privacy laws allow this) for knowing your customers’ customers could be promoted as the first source of information by default, which (ii) could be complemented bilaterally with enhanced information should there be a need. In order to support information-sharing in general, the respondent bank may include provisions in its contractual framework with its customers (eg in the terms and conditions or in a supplementary agreement) which allow the bank to provide such information on request to other banks for AML/CFT compliance purposes.

• Recommendation on payment messages: It is recommended that the relevant stakeholders determine whether the MT 202 COV payment message is as efficient and effective as intended or whether relying only on the MT 103 and the serial processing method would better serve the needs of clients, the industry and law enforcement in light of the fee structure, technological changes and payment capabilities for processing correspondent banking payments. The Wolfsberg Group seems to be the most appropriate body to review the issue and to initiate a recommendation in this field and lead any consequential changes if required.

The report can be downloaded here, and seeks comments on the recommended technical measures by 7 December 2015, to be sent to the CPMI secretariat.

The FSB report for the G20 may be summarised as follows:

Report to the G20 on actions taken to assess and address the decline in correspondent banking

Correspondent banking, which can be broadly defined as the provision of banking services by one bank (the “correspondent bank”) to another bank (the “respondent bank”), is essential for customer payments, especially across borders, and for the access of banks themselves to foreign financial systems. The ability to make and receive international payments via correspondent banking is vital for businesses and individuals, and for the G20’s goal of strong, sustainable, balanced growth. At the extreme, if an individual bank loses access to correspondent banking services, this may affect its viability and if a country’s banks more generally face restricted access then it may affect the functioning of the local banking system. In addition, loss of correspondent banking services can create financial exclusion, particularly where it affects flows such as remittances which are a key source of funds for people in many developing countries.

In January this year, the FSB agreed to coordinate work to examine the extent and causes of banks’ withdrawal from correspondent banking and the implications for affected jurisdictions including for financial exclusion, and to identify possible policy responses to address this issue. A World Bank survey of jurisdictions and banks commissioned by the FSB has confirmed that roughly half of the emerging market and developing economy jurisdictions surveyed have experienced a decline in correspondent banking services. The withdrawal is not on a global scale, but in some countries may lead to banks relying on a narrow range of providers. If withdrawals continue, this has the potential to rise to a systemic issue for the regions affected as well as to drive some payment flows underground, which would make it harder for authorities to prevent financial crime and the financing of terrorist activity.

This report describes work to date to assess and address the issue by a number of international organisations, including the Basel Committee for Banking Supervision (BCBS), Committee on Payments and Market Infrastructures (CPMI), Financial Action Task Force (FATF), International Monetary Fund (IMF), Legal Entity Identifier Regulatory Oversight Committee (LEI ROC) and World Bank.

The FSB will continue to work in partnership with these organisations to address this issue through a 4-point action plan:

1)      Further examine the dimensions and implications of the issue: The World Bank is publishing in November the results of its correspondent banking survey, together with a report commissioned by the G20 on remittances. The survey provides information on the scale of reduction in correspondent banking, regions and types of customer most affected, and the causes of the decline. The withdrawal of services is apparently continuing. The FSB will continue to encourage the collection of information by the World Bank and other international organisations on the scale of withdrawal, its causes and effects. National authorities should also improve their own data collection. The work to date and needed next steps are described in Section I below.

2)      Clarifying regulatory expectations, as a matter of priority, including more guidance by the FATF on the application of standards for anti-money laundering and combating the financing of terrorism (AML/CFT) to correspondent banking, especially on the customer due diligence expectations for correspondent banks when faced with respondent banks in “high-risk scenarios”, as well as additional work on remittances, financial inclusion and non-profit organisations. The FATF aims to complete its work on these four projects at its Plenary meetings of June and October 2016.

3)      Domestic capacity-building in jurisdictions that are home to affected respondent banks, building upon assessments and technical assistance from the international financial institutions, the FATF and FATF-style regional bodies and the sharing of best practices within the financial industry, including by global correspondent banks with local banks.

4)      Strengthening tools for due diligence by correspondent banks. This includes correspondent bank information sharing, through Know Your Customer facilities and broader use of the global LEI. The CPMI and the LEI ROC have made proposals in these areas.

The report can be downloaded here.