Correspondent banking, the chain of relationships that allows financial institutions to co-operate across regional borders, has been with us since the days of Italy's Medici dynasty. Anything that's remained in use that long has to be pretty good, and as a tool to enable domestic banks to access foreign financial markets it has value in promoting financial inclusion for emerging markets. But is a solution conceived during the Renaissance still the best option in decade two of the twenty-first century?
Before we start the case for the prosecution we should consider the positives. Correspondent banking has been a positive force in international finance for a long time. It provides important treasury services:
We live in an age of challenge, in which any list of requirements begs questions on whether those requirements are being met in the best way possible. Applying that principle to the list above, we find a number of shortcomings.
The correspondent chain can become extended when there's a requirement for multiple "jumps". Each participating bank imposes a charge, and this cost is passed on to the customer. Many banks charge a percentage of the transaction value, but there's a baseline cost that impacts heavily on smaller transactions. This causes significant erosion of the amount received by the beneficiary, a factor that mitigates strongly against emerging economies, making them less competitive and less able to grow.
Maintaining a correspondent network requires considerable resource. Nostro and vostro accounts need to be serviced and liquidity managed. Network teams are required to oversee regional macro-economics, country risk, acceptable counterparties, to say nothing of re-onboarding in response to external changes. Whether or not transactions flow, network management costs frequently run into millions. A bank maintaining correspondence for 100 countries could easily exceed $30 million just to keep the rails open.
Each link in the correspondent chain is a potential bottleneck. Time zones mean that instructions frequently land outside business hours. Each bank needs to satisfy compliance rules - a job that's complicated by the fact that little KYC information is usually shared. Processing time is limited by a bank's capacity and priorities. All this leads to an increase in chase queries, all of which add to workload and introduce their own delays.
While SWIFT is undeniably the vastly capable enabler of world banking, it's not - nor would the Society for Worldwide Interbank Financial Telecommunications claim it to be - a panacea for all ills. It excels as a means of conveying instructions and other such pre-defined core operations, but it's unable to accommodate highly variable or detailed information pertaining to a transaction. This requires banks to duplicate effort in establishing the trustworthiness of correspondent operations.
It's an irrefutable fact that no bank can rely on the due diligence of other organisations in order to make its own compliance decisions. Yet an element of this is unavoidable where correspondence - or indeed intermediary - relationships exist. Should a compliance failure occur somewhere in the network, all other parties involved in the operation are likely to come under scrutiny. Even a no-foul result soaks up resource and creates cost. And if a procedural failure is identified in your own compliance - whether or not you were involved in the failure under investigation - the resulting penalties can be disastrous.
The recent failure of Signature and Silicon Valley Banks reminds us that the stability of commercial banks isn't a given. If a link in the correspondent chain fails, then funds in vostro accounts or in transit can be lost. And even if those funds can be recovered, once again, the resource cost of clearing the debris is a significant risk factor.
Derisking is an inevitable result of at least four, if not all, of the five factors above. Faced with rising cost, management complexity and unlimited financial risk, many banks have simply withdrawn operations from more challenging regions. As we observed in our article in 2020, the number of active correspondent banks has fallen considerably, particularly in areas seen as high risk. not only does this isolate large areas of the globe, it means that financial institutions are missing out on valuable revenue through the absence of a commercially viable means of cross-border funds transfer.
It will come as no surprise that we highlighted these problems in order to knock them down, but you can't blame us if we honour the zeitgeist of second-decade challenge and conceive a better way of delivering those five requirements sitting near the top of this page. Let's start with the easy ones:
Our focus on pushing the KYC envelope borders on obsessive, but it's served us well and kept our customers - and their customers - safe from risk since we launched the biz.Clarency platform in 2020. The result of more than fifteen years of refinement and enhancement, it's become the benchmark for transactional diligence. I'll not bang on too much about it here as you can learn more on our compliance page. Suffice it to say that it monitors every party in every transaction, as well as assessing the journey, purpose and value of the goods involved. All of that information is made sharable between all counterparties by an ingenious extension of the SWIFT MT103 message that gives access to every element of each instruction.
The cost, complexity and risk of correspondent banking has forced too many financial institutions to turn away from the opportunities of the world's emerging economies. By reducing or removing all three, we're reopening those opportunities, enriching economies and restoring profitable trade for people, businesses and financial institutions across the globe.
Take the first step to joining the revolution by getting in touch today.