Correspondent banking plays an essential role in the global economy. Over the last few decades, correspondent banking has helped banks enable global payments, enhancing growth in international payments and trade.
This is an excerpt from Future of Payments 2023.
Yet, this stalwart of the banking system is now facing an increasingly complex regulatory shift. The nature of correspondent banking means it must deal with international and domestic regulations for each country a payment is sent to.
Adding this pressure, the traditional system is now being overtaken by technologies which offer the ability to circumvent some of the delays which correspondent banking is plagued with.
Within this context, there have been questions raised over removing correspondent banking from the international payments system entirely, and replacing it with more efficient and innovative systems. However, the reality is that currently these systems are
essential in many parts of the world.
Correspondent banking: increasing compliance cost
Compliance costs pose a major risk to global correspondent banking, as they have an unusually high amount of compliance to deal with through international cross border payments. Adding to this, the global banking landscape is generally much more complicated
than it was 20 or 30 years ago, meaning in some ways, correspondent banking systems are not designed for the current environment.
Bana Akkad-Azhari, head of treasury services Europe, Middle East and Africa (EMEA), BNY Mellon points out that, “concerns over compliance costs – including the potential for penalties for non-compliance – and heightened regulatory requirements has caused
many banks to reassess their strategies to reduce costs and mitigate the risks associated with correspondent banking relationships. In some instances, this has led to the practice of de-risking, whereby banks terminate or limit their relationships with businesses,
sectors or entire regions/countries deemed ‘high-risk’.”
Koldewe has a similar sentiment: “Compliance puts strict requirements on correspondent banking, which demands that banks have their compliance operations well organised.”
However, despite these arguments, Marc Recker, global head of product, institutional cash management, Deutsche Bank, displays a positive outlook towards the regulatory impacts of correspondent banking. “While it is true that correspondent banks face mounting
costs and compliance burdens, international correspondent banks are still well positioned to fulfil a vitally important role in ‘high value cross-border payments’. Banks such as Deutsche Bank are fully aware of their responsibility to remain the lifeblood
of the global economy.”
Indeed, Deutsche Bank currently has a ‘Top 10 list of priorities for correspondent banking,’ which includes a number of points on compliance, including continuing to not only gain a clear understanding of current regulatory requirements, but also look to
the future regulatory trends by maintaining a dialogue with regulators, respondent banks and industry groups.
Akkad-Azhari also offers a solution to this problem in correspondent banking, arguing that: “Enhanced information sharing and capacity building – in jurisdictions with higher risk profiles are both potential means of helping to reduce compliance burdens;
while partnerships, shared utilities and innovative, digital solutions can streamline processes and reduce costs.”
Clear messaging in correspondent banking
Clear messaging and harmonisation are necessary in correspondent banking. This is already on its way with ISO20022, however, even with this progress, there remains problems which may cause issues for the future of correspondent banking.
Akkad-Azhari notes the progress made in messaging: “Clearer guidance and harmonised standards could also help banks to navigate compliance obligations more effectively. A shining example of this is ISO20022 – the new global messaging standard for cross-border
payments – which supports the inclusion of richer and more structured transaction data in payments messages.”
However, she notes that while this has been strong progress, there remains inconsistencies: “While the new standard creates a strong foundation for interoperability, variability remains. Within cross-border payments, ISO20022 is being interpreted and used
differently, which is working to undermine the long-term benefits of having a global standard.”
The G20 cross-border payments programme has identified fragmentation of payments messaging standards in cross-border payments as one of the major frictions contributing to the high cost, slow speed, and lack of transparency.
While ISO20022 has gone a long way to encourage this, the BIS has pointed out in their consultative report that, “how the standard is used in practice can vary quite considerably, meaning that frictions in the processing of cross- border payments could continue
to persist even as ISO20022 is adopted. The limited adoption of ISO 20022 messages by end customers (i.e., corporations) also imposes a further challenge for harmonisation. Jurisdictions, payment system operators and participants should play a key role in
encouraging adoption by end users.”
The BIS report lays out a number of requirements to make sure this messaging works in the way envisioned. Nancy Pierce, managing director, payments, global payments solutions, HSBC, argues that “with the focus on improving the transparency of the messages
that banks use to send payments, it is arguably one of safest ways to move money around the world. As such, there should continue to be a role for the correspondent banking model into the future, alongside the many innovations that are occurring in the overall
payments landscape.”
New technologies threatening correspondent banking
The encroachment of newer technology on correspondent banking is an area which has caused some to be concerned about the future of correspondent banking, and whether it is necessary at all. This is something expressed by Yves Longchamp, head of research
at SEBA Bank, who argues that in, “a blockchain-based financial system, there is no need for dedicated correspondent banks as all actors are connected to a new global system. The blockchain allows users to trade directly with their peers, whilst still being
monitored due to inherent transparency.”
Akkad-Azhari also notes some of the new technologies that are presenting challenges to correspondent banking: “New cross-border payment models – such as payment system interlinking, and peer-to-peer models based on blockchain – have the potential to disrupt
how these transactions are processed going forward.
Using innovative technologies might prove to be the saving grace of correspondent banking. As Akkad-Azhari adds, “it is important that correspondent banks stay abreast of these developments – and, importantly, pivot as necessary – to ensure relevance for
the future.”
Koldewe says: “On top of these relationships Swift related initiatives like Transaction Manager and Swift Go will enable banks to optimise the international payments proposition, whilst not reinventing the wheel and
based on a reach of 200+ countries.”
For correspondent banking to move forward, it will need to embrace newer technologies. Akkad-Azhari points to “leveraging advanced technologies like artificial intelligence (AI) and machine learning (ML), banks can look to better enhance certain compliance
processes and due diligence procedures.” Indeed, within the Deutsche Bank’s top 10 list, one of the priorities is the “further automation of controls and increasing application of AI.”
Moving forward with correspondent banking
Ultimately, there is still room for correspondent banking in the future, indeed, it may be necessary in many countries to maintain their cross-border payments systems. Alexandre Maymat, head of GTPS at Société Générale tells Finextra: “Correspondent banking
is showing its ability to transform and adapt to an ever faster world without renouncing its clients’ security. Banks are indeed trustworthy actors that are heavily regulated and supervised. We should also bear in mind that banks have decided not to sell their
clients data and are currently unique payment actors providing universal payment solutions to their clients, on the contrary of the so-called closed-loop services.”
Many of the restrictions and slower capabilities of correspondent banking services are in place to protect the users and remain compliant. Perhaps as these services begin to embrace more clear messaging and some innovative technologies, these delays could
be improved on. Going forward it is essential to reduce this existing friction, as Pierce notes: “The key for correspondent banking is to focus on ways to reduce the remaining frictions in cross border payments, i.e., those things that prevent safe and secure
end to end straight through processing. It is critical that the industry completes this journey to unleash the many benefits this will provide to customers and market participants.”
Recker concludes: “Fundamentally, correspondent Banking is and remains vital to the global economy. Despite the global Covid-pandemic crisis as well as ongoing geopolitical events, the world continues to be, to source, to produce, to trade, to live global.
Globalisation has been one of the overarching key trends of the last and current decade.”