Over the last 15 years 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 conducting financial services and integrating banking into the global financial system.
Recently, I engaged a colleague friend of mine at a different financial institution in discussing the Wolfsburg questionnaire – and the conversation pointed to the fact that there is a lot of misunderstanding for 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 article, I seek to discuss into detail the emerging risk in correspondent banking and measures to address inherent risks 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, Bank A to another company or financial institution. There are several reasons why a bank would want to provide such services. So, basically, a correspondent bank enables their respondent clients to provide their own clients with cross-border products and services 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 would 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 initiatives 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 when a lot of correspondent banks were de-risking – i.e. cutting down on their number of respondent banks. Among other things, this was underpinned by assessments made on the country to ascertain if it is considered an 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 the 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 FATF’s mandate is to set standards and promote effective implementation of legal, regulatory and operational measures for combatting money laundering, terrorist financing and financing the proliferation of weapons of mass destruction, and other related threats to the of the international financial system’s integrity. 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 that countries should implement to combat money laundering and terrorist financing, as well as financing the proliferation of weapons of mass destruction. Countries have diverse legal, administrative and operational frameworks as well as different financial systems, and so they cannot all take identical measures to counter these threats. The FATF recommendations therefore set an international standard that 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 financing the proliferation of weapons of mass destruction; 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 for 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 standard: the same recommendations will 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 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 aim to develop frameworks and guidance for the management of financial crime risks. They are 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 a successor to the Wolfsberg AML Questionnaire that 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 and 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 also 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 for their own 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 correspondent banking services. This includes the bank’s ownership structure and whether any of the shareholders has 25% or 10% ownership based on risk rating. An assessment of Key management teams with their profiles provided, including their experience and reputation should be made. How these factors affect the bank’s risk profile must be known.
An assessment of a bank’s Anti-Money Laundering/Counter Terrorist Financing (AML/CTF) Programme 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 done for 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, and how the adverse news affects overall risk of the relationship with the bank must be highlighted.
The need for adhering to and meeting Compliance standards cannot be overemphasised. Financial institutions must make efforts to invest in Transaction Monitory, Name and Sanction Screening systems to help fight financial crime. They must take keen 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/or revocation of licence etc.
Disclaimer: The views expressed are personal views and don’t represent those of the media house or institution the writer works.
Credit and Reference: Miriam Amoako, Wolfsberg Group, Financial Action Task Force (FATF)
The writer is author of Dare to Dream and a Financial Institutions Coverage and Fintech expert working with an International Bank in Kenya, East Africa. Contact: [email protected], Cell: +254 70 5459061
