Correspondent banking: The challenges and opportunities

Payment settlement is the end result of any transaction. It is simple when the transaction is dealt with within the same jurisdiction. But if it happens beyond the jurisdiction, the necessity of correspondent banking comes to the fore.
Correspondent banking is defined as the banking-related service provided by one bank (correspondent) to an overseas bank (respondent) to enable the respondent to provide its own customers with its products and services impossible for it in the absence of any international linkage. Payments through correspondents are often executed through reciprocal accounts (so-called "nostro" and "vostro" accounts), to which standing credit lines may be attached. The primary focus of correspondent banking services is the international boundaries. It is also known as agency relationship in some domestic contexts.
The major activities of correspondent banking include opening and maintaining accounts, exchanging authenticated SWIFT message, payment services and collections, granting credit lines for money market, foreign exchange market and derivatives trading. Trade-related business and treasury/money market activities can be settled through the correspondent relationship. To what extent relationship will be established as well as maintained and what types of products and services will be provided depend on the needs of the ability and willingness of the respondent and the correspondent to supply them.
The correspondent is an effective agent/intermediary for the respondent and it executes payment or other transactions for customers of the respondent. The customers may be individuals or corporate or other financial services firms. Beneficiaries of the transactions can be customers of the correspondent, the respondent itself or in some cases customers of other banks.
Very often the correspondent has no direct relationship with the parties to a transaction and hence the correspondent is not in a position to verify their identities. Due to limited information about the transaction, a correspondent bank must consider risk factors from the perspective of money laundering and terror financing. If the correspondent banking relationship is poorly controlled, it can allow an international banking process by other financial institutions which have poor 'anti-money laundering (AML)/combating the financing of terrorism (CFT)' system and controls. If a correspondent handles any transaction involving criminal activity or terror financing, it will result in regulatory fines as well as damage to its reputation.
A correspondent must be careful about the respondent which is a shell bank or provides banking services to shell banks. Therefore, a correspondent bank should apply the customer due diligence upon a respondent.
In order to evaluate the degree of risk of the respondent, the correspondent should review pronouncements of regulatory agencies as well as pronouncement of international bodies such as Financial Action Task Force (FATF).
An owner's location and their corporate legal form are the risk indicators of the respondent. If the respondent is privately owned, identities of beneficiary owners and controllers are considered to address the risk indicators. Knowledge and experience of management, unduly frequent management turnover, PEPS involvement in the management or ownership, business and market types are also considerable factors for the risk indication of the respondent. The correspondent should take reasonable care in case of downstream correspondent clearing.
In order to conduct business comfortably with or for a particular respondent the correspondent must maintain the appropriate level of due diligence. The major due diligence is to scrutinise the respondent's money laundering policy the regulatory environment of its domicile, identities of significant owners and/ or controllers (beneficiary owners) in case of privately-owned respondent, collection of information either from the respondent itself or another reputed existing respondent and / or from other credible sources ( e.g. regulators, stock exchange etc) or from reputed information providing firms. If the respondent is located in a high-risk jurisdiction, the correspondent must consider additional due diligence of the respondent.
After establishing correspondent relationship, monitoring activity is a continuous process. Some techniques can be applied such as detecting the respondent's behaviour (that is monitoring for sudden and / or significant changes in transaction activity by value or volume or both), assessing link analysis (to identify common beneficiaries and remitters or both amongst unconnected accounts).
Commission and fee-based income is generated from correspondent banking services. The major criteria of commission and fees are LC (letter of credit) advising charge, LC confirmation charge, document discount charge, irrevocable reimbursement undertaking charge, payment settlement charge etc. These non-funded incomes under correspondent banking relationship are profitable but profit is under pressure as banks need to comply with more regulation in addition to the increasing competition across the globe.
In Bangladesh the anti-money laundering department of Bangladesh Bank (BB) has been transformed into Bangladesh Financial Intelligence Unit ( BFIU) on January 25 in 2012 under the Money-laundering Prevention Act-2012 and has been bestowed with operational independence. It works under the ML Prevention Act 2012 and the Anti-terrorism Act 2009 (including amendments in 2013). The BFIU also achieved the membership of Egmont Group in July, 2013. On March 3 in 2014 the Bangladesh Bank launched software named "goAML" to strengthen its fight against money laundering and terror financing. It enabled the BB to collect suspicious transaction reports and suspicious activities reports from scheduled banks including all reporting agencies.
All of the above initiatives are important for establishment and maintenance of correspondent banking relationship by Bangladeshi banks in near future.
The writer is Assistant Vice President, International Division, South Bangla Agriculture and Commerce Bank Ltd.  [email protected]