Correspondent Banking 2

Risk of Correspondent Banking

Geographic Risk

 

Correspondent banking activity deals with transactions all around the globe. Transactions may originate from, terminate in or pass through High Risk jurisdictions. In some cases multiple High Risk jurisdictions may be involved. Some jurisdictions have inadequate anti-money laundering standards, insufficient regulatory supervision, greater risk for crime, corruption, drug trafficking or terrorist financing. Lack of Information on Parties Involved Correspondent banking transactions are vulnerable to money laundering and terrorism financing because the transactions are executed on behalf of another bank’s customers. The bank is unlikely to have either verified the identities or obtained first-hand KYC information on the correspondent’s customers. Party information available from the transaction is usually limited to Name, Address, and account number which are not always available or of proper quality.

Shell Banks

 

A Shell bank is a credit institution incorporated in a jurisdiction where it has no physical presence and is not affiliated with a regulated financial group. Transactions with Shell banks are prohibited by the Bank Secrecy Act. Ability to identify Shell banks within a correspondent bank’s customer base can help minimize risks.

payable-through account 

The term payable-through account means a correspondent account maintained by a U.S. financial institution for a foreign financial institution by means of which the foreign financial institution permits its customers to engage, either directly or through a subaccount, in banking activities usual in connection with the business of banking in the United States. e.g., the customers of the correspondent may have cheque writing privileges or otherwise be able to provide transaction instructions directly to the institution.  The arrangements pose greater risk to an institution if it does not have access to information about the third parties accessing the account. Regulatory standards for managing the risks of payable-though arrangements may vary significantly by jurisdiction, but at a minimum, the institution providing such services should take additional steps to ensure that their Correspondent Banking Client has conducted sufficient client due diligence on its customers which have direct access to accounts of the Correspondent Bank, and that such information can be provided upon request. It may also be appropriate for the institution to conduct its own due diligence on the third parties.

 

Terrorist Financing, Drug Trafficking and other Underlying Offences

 

Foreign correspondent banking transactions can potentially facilitate and be conduits for financing or laundering the proceeds of several international crimes including Terrorist financing, Drug Trafficking and other underlying offences.

OFAC Risks

 

Correspondent banking activity exposes banks to risk of potential OFAC and other sanctions violations due to transactions originating from jurisdictions that may not honor the sanctions. Additionally, use of codes (such as Chinese Telegraphic Codes) or even deliberate obfuscation or stripping of information can result in the bank inadvertently participating in an OFAC or other Sanctions violation.

Sanctions Violation

 

Entities located in sanctioned countries like Iran, Cuba and North Korea are becoming more proficient in facilitating transactions by obfuscating the true originators and originator locations by setting up shell entities in other jurisdictions (like UAE and Turkey). Correspondent banking relationships with banks located in countries that do not honor U.S. Sanctions and/or UN Sanctions pose a higher risk.

 

 Stripping

 

Some of the major banks including ABN Amro, Lloyds bank etc. have been fined for gross violations for stripping of wire transactions. However it continues to be an issue on a smaller scale. There is a risk of rejected transactions being attempted again after removing or obfuscating the offending information.

Straight Through Processing

 

A large percentage of the wire transfers are processed straight through. Banks pride themselves on the efficiencies achieved in straight through processing. Human intervention is required only if there is a problem in the wire message or a potential OFAC match. While the efficiencies achieved are commendable, it also means that the human factor (as in the case of a bank teller observing suspicious behavior) is completely removed.

Correspondent Bank’s Risk Profile

 

The risk profile of the correspondent banks have to be determined and may be based on the location, ownership, management structure, customer base, AML Policy and strength of the AML Program etc.

 

Identification of Customer’s Customers

 

Obtaining a full understanding of the Correspondent Bank’s customers would be a challenge as all customers may not be involved in transactions through the U.S. banks. Even for customers that do transact, the information on those customers is very limited. It would however be prudent for the U.S. bank to identify customer’s customer that are most active based on transaction history and collect as much information from public sources, external databases and the foreign correspondents.

Lack of Full Picture of Transactions

 

The U.S. bank would not be in a position to see all the transactions performed by the foreign correspondent’s customers. This limits the ability to perform any meaningful behavioral profiling on those customers. The pattern analysis will be limited to the transactions that pass through the U.S. bank.

Cross Border Privacy Issues

 

Ability to obtain further information on the customer’s customer even in cases of suspicious activity may be a challenge due to privacy issues or reluctance of the correspondent to divulge full KYC information available to them.

Request for Information (RFI) Response Duration

 

Even when the foreign banks provide information in response to RFIs, there may be large or unacceptable delays due to protocol, communication issues and other challenges of cross border information sharing.

Limited Access to Documentation on Specific Transactions

 

During investigation of suspicious activity related to correspondent banking activity, there is usually not much documentation to go by except the wire instruction that came through the payment system. For example a copy of check related to a domestic transaction is easily available but the original wire form is rarely available.

Structuring

 

Structuring refers to the breaking down of a larger transaction into multiple smaller transactions that are under a threshold amount (typically $10,000) to avoid reporting requirements. Though the reporting limit of $10,000 is for cash or cash equivalents, people try to structure transactions below that amount even for wires and other types of transactions. Micro-structuring is a similar concept with much smaller amounts. Typically, the number of transactions tend to be larger.

Nesting

 

Downstream (or nested)  refers to the practice among foreign financial institutions conducting international transactions of allowing one foreign bank to process the cross-border bank transactions of another foreign bank through its U.S. correspondent account. Essentially, one foreign bank serves as the service provider and acts on behalf of its customer, another foreign bank, to wire or transfer funds from or to the U.S. via its account in the U.S. For example, The Foreign Country Bank provides wire transfer and payment transaction services to the many smaller banks in its country that it calls its customers. Foreign Country Bank has a relationship with and corresponding account at Large U.S. Bank. Foreign Country Bank transfers $100,000 for a customer, Small Country Bank, on behalf of Small Country Bank’s client, ABC Agricultural Products Ltd., to a regional bank in the U.S. The fund transfer shows Foreign Country Bank as the named account, Small Country Bank as the nested account and $100,000 as the amount.

 

Layering

 

Layering of transactions (mainly across borders) can be detected by identifying transactions where the originator name and beneficiary name are the same but with different addresses. Such a detection mechanism is more useful for transactions by individuals but can result in a large number of false positives on businesses due to inter-company transfers.

 

 

U Turn

 

Transactions originating and terminating in the same country after passing through multiple jurisdictions would be of interest due to lack of business reason for doing so in many cases. Note: Iranian U Turn transactions are no longer permitted.

Limited Data: US banks have to ensure that they secure adequate documentation on specific customers and transactions. If a foreign financial institution does not collect data needed for the US bank’s compliance staff, the relationship cannot go forward.

 

Typologies/ Remedy

Certain rules may be applied by financial institutions to specifically target the risks associated with correspondent banking activity. These need to be applied in conjunction with policies, procedures and a robust due diligence program for correspondent banking that manage the risk by incorporating appropriate account-opening procedures, risk assessment and its use in monitoring, understanding of the foreign correspondent’s customer base, usage of the correspondent account, their AML controls and customer due diligence processes.

Following are some of the useful typologies applicable to correspondent banking.

High Risk Jurisdictions and High Risk Corridors

 

Transactions involving one or more High Risk jurisdictions should be analyzed for suspicious activity. Transactions related to high risk corridors (a set of one or more countries to another set of one or more high risk countries) are of more interest. For example transactions originating from countries with high corruption indices to tax havens or transactions from a Drug Consumption jurisdiction to Drug production jurisdiction can be monitored.

Multiple Jurisdictions

 

Transactions involving multiple jurisdictions can be detected by counting the number of countries of each party including the intermediary banks involved in the transaction. Most transactions involve 2 or 3 jurisdictions and is not a cause for concern. When the number of jurisdictions get to 4 or higher they would need to be reviewed.