Correspondent banking is a type of banking relationship between two financial institutions, usually in different countries, that enables them to provide services to their customers that they would not be able to offer on their own. This type of banking relationship allows banks to offer their customers a variety of services such as international payments, foreign exchange services, access to foreign markets, and more. It is an important part of the international banking system and is necessary for banks to conduct international transactions.
The risk of correspondent banking is that it can expose banks to financial losses if the counterparty does not fulfill its obligations. This includes the risk of financial losses from the failure of a counterparty to meet its obligations, fraud, money laundering, and other illegal activities. Additionally, correspondent banks may be exposed to operational risk from inadequate internal control systems, inadequate liquidity, and inadequate capital.
Correspondent banking involves financial institutions providing services to each other, such as providing access to foreign markets, and can be a particularly attractive option for money launderers. By using correspondent banks, criminals are able to move money through the global financial system without being detected. Money launderers will often use several correspondent banks in different countries to further obscure the origin of the funds.
The risk of money laundering through correspondent banking is particularly high due to the lack of due diligence and oversight. Financial institutions conducting correspondent banking transactions may not have a full understanding of the customer’s identity or may not take the necessary steps to verify that the customer is not involved in illegal activities. This leaves the door open for criminals to take advantage of the system.
In order to reduce the risk of money laundering through correspondent banking, financial institutions should take a number of steps to ensure that proper due diligence is conducted. This includes implementing effective customer due diligence procedures such as verifying the customer’s identity and understanding the source of their funds. Financial institutions should also ensure that they have adequate monitoring and reporting systems in place to detect and report suspicious activity.
In addition, financial institutions should ensure that they have appropriate policies and procedures in place to manage the risks associated with correspondent banking. This includes having a risk-based approach to selecting customers, conducting regular reviews of the customer base, and having a clear understanding of the customer’s business activities. Financial institutions should also ensure that they have adequate systems in place to detect and report suspicious activity.
By taking the necessary steps to understand the risks associated with correspondent banking and implementing effective controls, financial institutions can reduce the risk of money laundering and ensure that they are not being used as a vehicle to move illicit funds. However, regulators may chase a chain of illicit funds through the correspondent system and take appropriate action. International consortiums such as Deutsche Bank have been penalized and deferred of prosecution for their correspondent activities for mainly clients located in offshore jurisdictions and international financial centers.