Can Compliance Help Defend the Model?

Thesecond in a series ofExpert ViewsfromSociete Generale Global Transaction Servicesin the run up toSibos 2016,Emmanuel de Bouard,Global Head of Cash Clearing Servicesat SG GTB,discusses:

“Evolution of correspondent banking:

Can compliance help defend the model?”

Correspondent banking faces pressure from regulation, geopolitics, and new payment providers,as well as rising costs, shrinking margins, and evolving customer expectations.Banks are expected to transact payments more quickly and cost-effectively, with greater transparency toward customers and regulators, while mitigating compliance and reputational risk.How will the changing model and emerging payments methods affect compliance practitioners and processes?Can compliance add valueto the evolving correspondent banking model, thus helpingto ensure its long-term sustainability?

Regulationhas an impact onmany different areas of correspondent banking. In regards to liquidity, for example,regulators do not consider balances on correspondent banking accounts as stableand therefore they cannot be used for liquidity ratio purposes. At the same time, they charge for funds deposited at the Central Bank. This makes therefore things difficult as we have to tell customers that we now require their accounts to be at zero balance at the end of the day, but funded first time next day for us processing their payments. At the same time, there areanti-money laundering (AML) lawswhichare not harmonisedacross countries. Large banking groups have to deal with AML regulations in North America, Europe and Asia. Banks have to respect the regulations of the countries in which they operate and make no transgressions. Any bank witha large correspondent banking network will have to alignevery subsidiary and customerwith these regulations despite facing discrepancies.

Another regulatory challengethat has to be met is thestrengthening of know your customer (KYC) rules. In many cases nowbanks need to knownot only everythingabout their customers, but also about their customers’ customers. This could become infinite and there is a moment when the KYC controls have to stop.Correspondent banking relies on trust, but in this environmenttrust is being overruled by evidence. Compliance teams will insist on evidence that a particular customer should be trusted before they are onboarded or business is done with them. This can be the case even with long-standing customers.

Regulation is of course necessary, but in general itimposes many constraintson correspondent banks that are difficult to tackle. New customers cannot be brought into the network without the involvement of the compliance department. Theregulators have only one approach: there must be no default, no errorswhen it comes to adhering to regulation.

In a perfect world, compliance would bring more transparency and knowledge about customers, which should prove to bea competitive advantageover other players that don’t have the same level of controls.An inability to complywith the many regulations affecting correspondent banking or to control compliance effectivelycould result in some competitorsin the correspondent banking marketwithdrawing.

Becauselarge banks operate widespread networks,they must consider their subsidiaries as they would their customers. Compliance should apply to these subsidiaries in the same way. This approach has been particularly appropriate following the large fines dealt out to banks whose subsidiaries were engaged in illegal activities such as money laundering.Subsidiaries must be subject to the same controls as external customersso that the bank has better knowledge of what is going on and the overall compliance picture of the group, despite the rules they must follow are the same within the Group, and therefore better known than those of an external customer.

The definition ofa ‘high risk’ bankin the correspondent banking networkis open to interpretation.Some banks that are very engaged with Africa, for example, may be considered high risk by other banks.Banks that have faced very large finesfor transgressions might also be defined as high risk.The definition differs from one bank to anotherbut there is a danger thatif everything is defined as high risk the term will mean nothing.There isa high level of de-risking taking place at presentbecause banks feel they cannot get the information they would like in order to make a decision about doing business with a particular counterparty.Compliance departments err on the side of cautionand recommend exiting from a relationship in such cases.

Another reason to exit from doing businesswith a particular correspondent banking partner could bethe cost of compliance. If a counterparty doesnot yield sufficient returnin orderto cover the costs of controlsetc, a bank may decide to close that account. However, a customer that may not bring a great deal of revenue but is not costly in terms of compliance may be kept on as a client.

Regulations run counter to the acceleration of paymentsthat regulators are requesting. In a world where payments are meant to be transacted more quickly,there will be little time to conduct the controls necessaryfor AML and sanctions adherence for example. Banks will consider if they cannot conduct controls because they are too onerous for a particular bank, they will refuse to work with that bank. Therefore,many of the smaller or ‘riskier’ banks will not have access to an instant payments system. Againthere will be two systems: instant payments for banks that are deemed safe, and slower payments for those that require more controls. It is likely thatFintechs will step into the gap and service the latter banks.

There aremany controls on correspondent bankingthat havemade it a safer environment and have added value. But at the same time the results from these controls and regulations are not at the level of the investment banks have had to make. There is little evidence that these controls have stopped any acts of terror, for example.

“Derisking opens the door to a parallel system in correspondent banking. Smaller banks, or those operating in higher risk countries may not be able to find clearers, which could have an impact on trade. These actors will appear further down the line and may be served by other banks that are willing to work with them or Fintechs that may go less deeply into transactions. In extreme cases transactions may be conducted in cash.”