The correspondent banking industry faces an unprecedented combination of challenges, tasked to take effective measures to reduce financial crime on the one hand, and to comply with liquidity and capital requirements of Basel III on the other. While banks are giving these issues the high priority they deserve as they fulfil the role expected of them by regulators, the costs in terms of time, effort and resource is likely to make many correspondent banking players revisit their business model.</p> Financial crime compliance</strong></p> Regulations around anti-money laundering, sanctions screening and client due diligence are vital to maintaining the integrity of the financial system. While major correspondent banks are making significant efforts and investments to comply, many challenges remain.</p> Ambiguous regulations can result in inconsistent interpretation and application, and consequently potential breaches and ensuing penalties. Today, banks are tasked not only to be responsive to potentially suspicious transactions, but also to take preventive action which is far more difficult to achieve in practice and where failures can attract significant penalties.</p> The high costs and resource requirements that financial crime compliance entail could result in the channelling of valuable resources from customer solutions, business development and innovation. This poses challenges for many international banks, and is likely to have an even greater impact for smaller banks.</p> De-risking</strong></p> With compliance costs skyrocketing and the risks of non-compliance even higher, many banks are de-risking their business by exiting certain markets, product lines, specific customers or customer segments.</p> Even in core markets and with key customers, banks are increasingly cautious in deciding what business to accept or transactions to process. This could inconvenience and adversely impact relationships with bona fide customers who do not understand why legitimate routine business transactions attract additional scrutiny or investigation.</p> In addition, correspondent banks’ decision to de-risk their business has significant implications for international trade. Every trade transaction has a linked settlement: if a counterparty is unable to settle as no bank is able or willing to process the transaction, their business will inevitably be impacted.</p> Banks in emerging markets are not always fully aware of the regulatory expectations in developed markets, which could result in banks exiting certain emerging markets. This is likely to lead to unintended consequences, specifically that these countries’ economic growth and participation in the international trade community would be inhibited.</p> Liquidity and capital</strong></p> Previously, banks often left a credit balance in accounts opened with their correspondent banking partner instead of paying fees, as income from those balances was adequate compensation for the correspondent bank. Under Basel III, such balances are considered “flighty”, and therefore cannot be used for lending and have to be invested entirely in high-quality liquid assets.</p> This results in low, zero or even negative returns for the correspondent bank, thereby impacting the economics of correspondent banking services. Additionally, the central banks of different countries may have different policies on reserves, adding further complexity.</p> Mitigating the impact</strong></p> These complex challenges place correspondent banking at a crossroads.</p> While correspondent banking is critical to global trade and investment, several players are rethinking their business models and de-risking strategies.</p> For example, a couple of European banks have exited USD clearing, whilst others are de-risking by exiting markets and/or clients. As an alternative, some correspondent banks have chosen to de-risk by providing training to user banks on regulatory expectations rather than exiting markets, services or relationships. With the increasing costs of doing business, industry consolidation is also likely amongst both providers and buyers.</p> Numerous discussions are underway with the World Bank, FSB, International Chamber of Commerce (ICC) and other global organisations to demonstrate these challenges to political leaders, and explain the potential impact of banks’ de-risking on international trade and competition. Ideally, a middle ground will emerge that allows correspondent banks to facilitate normal global trade and investments through international payments and trade services while effectively meeting financial crime compliance and other regulatory requirements. </p> As more and more banks comply with emerging regulations, and local regulators adopt international standards, the boundaries between managing risk and facilitating trade will hopefully be reviewed and potentially revised with a positive outcome for the future of global trade and investment.</p>