Kathleen A. Scott ()
Last year, in September, I discussed the increasing trend for some banks to terminate their banking account relationships with banks in certain areas of the world. Kathleen A. Scott, “Work Continues on Addressing Correspondent Banking Decline,” New York Law Journal, Sept. 16, 2016. In this month’s column, I highlight some of the recent efforts by international organizations to attempt to address this trend, which unfortunately continues today.
A Little Background
As explained in my September 2016 column, funds transfer around the globe by use of accounts banks maintain with each other—most of them maintained by banks (respondents) at large international banks (correspondents), primarily in the United States, Canada, Europe and the United Kingdom. If the correspondent banks see a higher risk in maintaining those accounts and decide to close them, respondent banks have increasing difficulty accessing the international financial system, which can to consequences such as curtailing international business transactions and impeding the ability for residents of these countries to receive remittances from relatives working abroad.
The Financial Stability Board (FSB) a group of international banking regulators, has been working on this issue and established the Correspondent Banking Coordination Group (CBCG). This organization has been submitting periodic reports to the G-20, the group of international finance ministers and central bank governors. Its latest report was submitted to the G-20 at its July meeting in Germany. Financial Stability Board, “FSB action plan to assess and address the decline in correspondent banking,” July 4, 2017.
In addition, the Financial Action Task Force (FATF), the international organization developing anti-money laundering standards, issued guidance on Correspondent Banking Services issued shortly after last year’s column appeared, and the Basel Committee of the Bank for International Settlements issued revisions in June to its correspondent banking guidance contained in its anti-money laundering guidelines. Financial Action Task Force, “Correspondent Banking Services,” Oct. 21, 2016; Basel Committee on Banking Supervision, “Sound management of risks related to money laundering and financing of terrorism,” June 2017.
All of these organizations work together and cite each other’s work in their issuances and emphasize the utility of these correspondent banking relationships.
Two of the FATF Recommendations on combatting money laundering and terrorist financing focus on the need for financial institutions to conduct adequate due diligence on their customers (Recommendation 10) and the obligation to perform additional due diligence when establishing a correspondent banking relationship (Recommendation 13). Financial Action Task Force, “International Standards on Combating Money Laundering and the Financing of Terrorism & Proliferation.” The point of the Guidance was to address the de-risking in correspondent bank accounts and highlight the FATF’s concern that it could “drive financial transactions into less/non-regulated channels, reducing transparency of financial flows and creating financial exclusion, thereby increasing exposure to money laundering and terrorist financing (ML/TF) risks.”
The purpose of the Guidance was to clarify the application of the FATF standards with respect to correspondent banking such as the following:
• Identifying the risks by conducting due diligence on the respondent and developing an understanding of the respondent’s business
• Verifying the respondent’s information and assessing and documenting any higher risks identified in the verification process
• Managing the risks through ongoing due diligence, transaction monitoring, ongoing communication and dialogue between the parties, and adjusting pertinent risk mitigation measures where necessary
• Having an agreement between the correspondent and the respondent that clearly sets out the terms of the account relationship, such as specifying the products and services to be provided, and the use by, and restrictions on, third parties accessing the respondent’s account
The FATF emphasizes that customer due diligence, i.e., “know your customer” or KYC as it is commonly called, does not require “knowing your customer’s customer,” or KYCC, with respect to correspondent banking relationships, and thus no requirement for the correspondent to conduct due diligence on the respondent’s customers. What is required is a monitoring of the respondent’s transactions to detect any changes in the respondent’s risk profile or implementation of risk mitigation measures, any unusual transactions or activity by the respondent, or deviations in any of the terms of the correspondent relationship.
If any such occur, the next step should be a request for more information from the respondent, not closure of the account. While the FATF requires termination of accounts when the correspondent cannot adequately manage the identified risks of a particular respondent’s account, it sees that as the last measure after other less final steps are taken, such as refusing to conduct certain transactions, filing suspicious activity reports and restricting the services and products offered to the respondent through the account.
The revised Basel Committee guidelines on correspondent banking relationships divided its recommendations into eight segments:
• The guidelines focus on the higher risk that cross-border (rather than domestic) correspondent banking services pose to the correspondent, and in a reference to the FATF Guidelines, note that it is the respondent which is responsible for the due diligence on its customers, not the correspondent.
• Not all correspondents pose the same money laundering risk and thus the level of customer due diligence on respondents varies by risk; this section is the most lengthy and provides examples of specific risk indicators and risk assessments, as well as presenting the risks of “nested” or downstream correspondent banking
• The level of due diligence varies with the risk posed by the respondent, but due diligence should not be treated as a “paper-gathering” exercise, merely checking off items on a list; instead, the correspondent should undertake such tasks as assessing the respondent’s internal ML/TF controls and determining how often its internal audit function reviews those controls, and contacting the respondent’s local management and compliance officer or even a in-person visit.
• Senior management should approve any new correspondent banking relationship; if significant ML/TF issues arise during the relationship, it should be reviewed and senior management should approve termination or new restrictions placed on the relationship; in addition, correspondents should refuse to do business with “shell” banks (that is, banks with no physical presence or affiliated with a regulated financial institution) and ensure through their due diligence that a respondent is not a shell bank.
• Correspondents should establish internal controls in order to be able to detect financial activity that is not consistent with the services agreed to be provided pursuant to the agreement between the correspondent and the respondent. If the correspondent allows the account to be used directly by the respondent’s customers, then it should conduct enhanced risk-based monitoring of those activities and satisfy itself that the respondent itself has conducted adequate due diligence on those customers being given direct access to the correspondent account.
• Correspondents should monitor the quality of the payment messages used in cross-border wire transfers and consider sample testing; if the respondent is ordering the transfer, then it is responsible for due diligence on its customer originating the transfer.
• If the correspondent has relationships with respondents that are part of the same group, then the head office of the group should ensure that risk assessments of individual respondents are consistent with the risk assessment of the overall group.
• Written agreements should be in place between the correspondent and their respondents that specify the responsibilities of each party and the services to be provided, including notice periods for terminating or limiting services provided under the agreement.
The FSB provided the latest updates on its 4-point action plan to address the decline in correspondent banking relationships, noting that the implementation of the plan was making “good progress:”
• Further examining the dimensions and implications of the issue: The CBCG has established a workstream to identify the remaining gaps in understanding the decline in correspondent banking and undertook a survey of data from banks and others, which is analyzed in a separate report mentioned below, that shows that the decline in providing correspondent banking services has continued. The CBCG also is working to develop a global framework for more regular data collection and monitoring of global trends. The FSB noted the continued participation of the International Monetary Fund and the World Bank in analyzing the decline in correspondent banking services.
• Clarifying regulatory expectations, as a matter of priority, including guidance from the FATF and the Basel Committee: The CBCG noted the issuance of the FATF guidance and the Basel Committee guidelines discussed above. Among other highlights, they particularly noted FATF’s clarification of there being no requirement for the correspondent to “know the customer’s customer,” and the Basel Committee’s expansion of its guidance on “downstream” clearing (where a respondent uses its account at the correspondent to provide its own correspondent banking services to other banks, usually smaller banks in the respondent’s home jurisdiction).
• Domestic capacity-building in jurisdictions that are home to affected respondent banks: The FSB is working to improve supervision and compliance in those jurisdictions which are perceived to have weaknesses in those areas and thus can suffer from a lack of correspondent banking services. This capacity-building includes assistance at the ground level in drafting enhanced legislation and regulations for these jurisdictions and training of supervisors and law enforcement. The CBCG has compiled a list of international technical assistance resources and other capacity-building activities, continues to encourage participation by the private sector and ongoing continued dialogue between the private and public sectors on these issues.
• Strengthening tools for due diligence by correspondent banks: The FSB continued to work on utilization of customer due diligence tools, including use of central depositories for collection of KYC information (KYC utilities) and regulatory expectations; utilization of legal entity identifiers in correspondent banking because they would provide access to more comprehensive identification of parties to a correspondent banking transaction; improvement in the quality of payment messages used in cross-border funds transfers; and initial discussions on how “fintech” advances could be used with other tools such as the LEI and the KYC utilities to increase the knowledge base of information by correspondents on their respondents.
The CBCG also produced a separate report that provided an enhanced and detailed analysis on the continued decline in correspondent banking relationships. Financial Stability Board, “FSB Correspondent Banking Data Report,” July 4, 2017. The report was compiled from an FSB survey of more than 300 banks representing approximately 50 jurisdictions, and also utilized data from the SWIFT (Society for Worldwide Interbank Telecommunications) international payment network.
Short of enforcing international economic sanctions to isolate certain entities and governments from accessing the financial system, it generally is in no one’s interest to narrow the ability of banks to interact with each other, particularly central banks which need to able to be an active part of the international financial system. Money laundering is a real risk and governments and international organizations are working to attain a viable balance between ensuring a robust international effort against money laundering yet still allowing banks to efficiently process international transactions for each other.