Correspondent Banking Money Laundering Risks

Correspondent Banking refers to the bank that is providing services to the bank of one country from another to provide the financial resources. This post, however, discusses the Correspondent Banking Money Laundering Risks.

What is meant by Correspondent Banking?

Let us assume that a bank in India wants to expand its operations in the United Arab Emirates. Then, the banking regulator of the UAE needs to grant a license to Indian Bank. But Indian bank needs to do business in all the major countries where the Indian diaspora is present then it will take a lot of time to open branches across the world. In such a situation, Correspondent Banking comes into the picture.

Indian Bank engages with a local bank in every country as they have better access to local markets, loans, and other financial instruments. Local Banks also have a better understanding of local laws and maintain relationships with regulators.

In such a case, the Indian Bank signs a correspondent banking agreement with the local banks. A correspondent bank is regarded as a financial institution and organization which is authorized to provide the services on behalf of the financial institution. Correspondent banking is an arrangement where the correspondent bank holds the balance on behalf of the respondent bank and offers payment and other services to the clients of the respondent banks.

Correspondent Banking Services

The correspondent bank offers the services like Trade Finance, Nostro and Vostro Accounts, Relationship Management, Payment Solutions, Treasury Management, and Foreign Exchange services to its respondent bank and the customers of the respondent bank.

Correspondent Banking Money Laundering Risks

The facilities offered by correspondent banks can be exploited by money launderers if not monitored properly. One of the major challenges for the correspondent banks is the inherent challenges in performing KYC.

Risk of KYC

The correspondent bank will often have no direct relationship with the beneficiaries and parties to a transaction and, therefore, can not verify their identities or conduct the necessary due diligence.

Correspondent Banking is an essential part of the global payment system and international trade depends largely on it.

This is mainly due to the fact that correspondent banks carrying out transactions on behalf of foreign banks have to rely on the AML framework of the respondent banks.

Often, these are insufficient and do not allow to correctly:

• Identify customers
• Determine the beneficial owners
• Monitor transactions

Examples of Correspondent Banking Laundering

In the year 2017, the world witnessed the massive scandal of Danske Bank. This scandal exposed the weaknesses in the European Anti-Money Laundering Directives. Estonian Branch of Danske Bank used correspondent banking relations with JP Morgan, and Deutsche Bank to remit the criminal proceeds. Post this episode, even Swedbank reported a similar problem.

Correspondent Banking Money Laundering Risk in Vostro

A correspondent bank will hold “Nostro” accounts where they accept foreign currency from a respondent bank and a “Vostro” account in which they will hold funds for the respondent banks. Correspondent banks carry out payments and wire transfers on behalf of the customers of the respondent banks.

Correspondent banking money laundering risk will emerge from the relationships that involve the Vostro account facilities for the respondent banks which are Offshore Banks. These banks are limited to conducting business with non-residents.

The risk is even higher when the respondent financial institution is located in a foreign country having weak AML/CTF laws, or poor or limited supervision of those laws. The banks from the sanctioned countries would always be phishing for the correspondent banking relationships using different structures and hence due diligence on the respondent banks is also essential before signing any agreement for correspondent banking.

Conclusion

The due diligence assessment is focused on ensuring that you understand the ownership and control of the respondent institution, the AML/CTF context in which it operates, and the effectiveness of its AML/CTF systems and controls. Maintaining good communication channels and Clear terms governing the correspondent banking relationship & open dialogue between the institutions is the most critical aspect of mitigation of the correspondent banking money laundering risks.