Correspondent Banking

A correspondent bank is a financial institution that provides services to another (respondent), usually in another country. It is used to execute transactions (deposit, wire, etc.) in another country where the domestic bank is nonexistent. Domestic banks use correspondent banks to gain access to foreign markets and serve international clients without opening branches abroad.

Correspondent banks act as middlemen between different banks. As such, they provide treasury services (and many more services) between sending and receiving banks. A respondent bank can, in turn, be a respondent bank for another bank (this is called downstream CB). One complex transaction might involve several banks in several jurisdictions, a chain of sub-transactions. This augments the complexity and the fees the initiator customer often pays. Indeed, correspondent banks charge the respondent banks a fee for each transaction.

This complexity creates a vulnerability to money laundering. Indeed, a bank acting as a middleman for another bank carries out transactions on behalf of customers of another bank. This means the bank provides services to persons or entities for which it has no KYC knowledge.

Another risk is the large volume of transactions, which makes it very hard to detect suspicious transactions, especially given that the CB does not have enough information on the parties involved. Each bank sees only the immediate predecessor or successor in the transaction chain.

This makes conducting due diligence on the respondent bank vital. A correspondent bank must ensure that the respondent bank is reliable and reputable and has the correct AML, KYC, and transaction monitoring.

Correspondent banking is crucial in facilitating cross-border payments, but its impact is positive and negative. On the positive side, it enables global transactions by providing a network of relationships between banks, allowing them to offer services in countries where they don't have a direct presence. This network supports international trade, remittances, and financial inclusion for regions that might otherwise be underserved.

However, the negative aspects are significant. Over the past decade, the decline in correspondent banking relationships has led to increased costs, reduced efficiency, and limited access to cross-border payment services for some countries and smaller firms.

This retreat has been particularly pronounced in jurisdictions with weaker governance and deficient controls to prevent illicit financing, which could potentially hinder economic development and drive some transactions underground.

To summarize, CB is very convenient for carrying out international transactions but comes with some risks that must be mitigated.

Contact us if you need expertise to eradicate AML risks, especially with CB.