The Casualties of Correspondent Banking
Banks use a system of correspondent banking to gain access to markets in which they don’t have branches. Under this system, credit institutions in foreign countries act as agents for banks, accepting deposits and conducting transactions, such as loans or remittances from expatriate workers, on their behalf. This system facilitates the cross-border transactions necessary for international trade and inclusion in the global financial system. Correspondent banking, however, has come under closer scrutiny as countering terrorism has become a focal point of U.S. policy.
While regulations have existed for decades to counter money laundering and other financial crimes, U.S. government agencies were granted greater authority following the 9/11 attacks. In recent years, there has been an increase in the number of fines and criminal prosecutions for money laundering and terrorist financing. Many large banks, including HSBC, Standard Chartered, and Barclays have been handed significant fines. Last year, BNP Paribas was fined a record $9 billion for violating U.S. sanctions against Sudan, Cuba, and Iran.
Taken together, this regulatory tightening places greater scrutiny on correspondent banks as the potential facilitators of illegal transactions. Given that most international transactions are in dollars, are regulated by the U.S. Office of Foreign Assets Control, and eventually find a way back to U.S. clearing banks, it is United States policy that essentially determines the fate of correspondent banking.
With stricter regulations and higher fines, many banks have been forced to re-examine their cost-benefit calculation of maintaining correspondent banking relationships. Ultimately, many have abandoned the practice entirely, cutting correspondent ties in some countries due to low profit and increased perceived risk through a process known as “de-risking.” Rather than mitigate risk, this decision eliminates it entirely. At the same time, de-risking can also leave populations, sectors, or countries, like Somalia and Pakistan, with little to no access to international financial services.
Although de-risking has a number of effects on access for individuals and companies, remittances have become one focal point. Restrictive policies are especially detrimental for countries that are highly dependent on remittances and are also perceived as high risk. According to the World Bank, remittances to the developing world are expected to reach $440 billion this year, which is around three times the expected amount of Official Development Assistance going to these countries[i],[ii]. China and India lead the way in total remittance inflows (see the accompanying chart). If money sent from the U.S. were to end up in the hands of bad actors, intermediary banks could be held responsible, despite their best efforts to conform to regulations. Further, charities, peacekeepers, and even U.S. embassies are feeling the consequences as it becomes more difficult to complete international financial transactions in certain countries.
Notably, the growing lack of access to international finance in some countries could be instrumental in creating the poverty, exclusion and, possibly, crime that the initial regulations were meant to prevent. This unintended outcome is more likely in poor countries and those in conflict — countries that rely most heavily on correspondent banks because of their weak domestic financial systems.
For a more in-depth report on the issue see this article from the Milken Institute Review: Casualties of War