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4.2 Correspondent Banking: Managing Financial Crime risk through data analytics
Correspondent banking is a cornerstone of international finance, offering a critical conduit for transnational transactions and financial services. But as with any large, intricate and partially opaque financial system that relies on mutual trust, it is also a prime target for illicit exploitation, particularly money laundering. Amid an increasingly complex and fluid global financial landscape, financial institutions are grappling with how to manage these inherent risks more effectively.
The complexity and vulnerability of Correspondent Banking
In recent years, high-profile cases have cast a harsh spotlight on how correspondent banking can be hijacked for money laundering purposes. Stiff financial penalties are only one of the repercussions for the institutions involved, with long-lasting reputational damage and a deep-seated loss of trust often causing more enduring harm. Major banking institutions, like Danske Bank and HSBC, have found themselves in the crosshairs of regulatory scrutiny following damaging scandals linked to correspondent relationships.
Current risk management protocols in Correspondent Banking
Risk management strategies in banking for the most part continue to depend on standard Know Your Customer (KYC) and Anti-Money Laundering (AML) processes. These mechanisms demand meticulous checks during client onboarding and regular monitoring of transactions, thereby forming the first line of defence against illicit financial activities.
However, these protocols are not without their challenges. The sheer volume of manual checks required can be daunting, leading to extended delay times and the occasional lapse in accuracy. Further complicating matters is the problem of ‘false positives’, where legitimate transactions are erroneously flagged as suspicious, creating an excessive backlog of investigations and draining resources.
In the context of correspondent banking, there is a specific challenge where the banks involved in the transaction chain, apart from the initial financial institution, typically lack a direct relationship with the individuals or companies initiating the payment.This challenge, sometimes referred to as “Know Your Customer’s Customer (KYCC)”, leads to banks having to put faith in the anti-money laundering and risk management systems of other banks.
Unsurprisingly, faced with these risks, a growing number of banks have decided to reduce their exposure to correspondent banking, choosing to exit commercial relationships with particular banks and sometimes with entire countries.
As data from the Bank of International Settlements shows, in the last decade the number of correspondents has consistently been trending downwards in every region in the world. The resulting impacts include greater market concentration and reduced financial inclusion for vulnerable populations, among others.
The evolution of risk management: Embracing the future with data-driven models
Traditional risk management methods, often manual and dependent on human interpretation, are increasingly giving way to more progressive, data-driven models. Leveraging advanced technologies applied to large volumes of data, these modern methodologies allow for more targeted and scalable approaches.
Among the advantages of a technology and data-driven approach are:
Moving towards the analysis of risk patterns rather than primarily seeking to focus on individual transactions or clients that may be suspicious. By combining transactional data with data from credible open sources as well as proprietary datasets, the tools are now available to analyse large volumes of data and understand overall trends and carry out essential contextual analysis.
The ability to assess the overall risk profile of counterparty banks. For large banks that facilitate millions of cross-border payments a day on behalf of banks in their network, a core driver of risk is their reliance on the risk management systems of their counterparties. A data-driven approach allows them to understand the risk exposure, as well as the strengths and weaknesses of the controls put in place by counterparties.
Conversely, a technologydriven approach can help smaller banks to stand out from the crowd, proving to international counterparts that they have sufficiently strong risk management systems in place to manage their inherent risks.
Last but not least, lower costs: A more granular approach to risk management allows the focus of scarce human resources on the most highrisk cases that merit further investigation, reducing overall compliance and risk management costs.
Introducing Elucidate Ratings: Transforming risk rating in Correspondent Banking
Berlin-based company Elucidate is at the forefront of this shift towards a more modern risk management strategy. With the power of data analysis, Elucidate Ratings provides an easy-to-understand, solid, and measurable risk score. To properly understand your risk appetite and that of counterparties, it is critical to have an overview of each institution’s inherent risk and control effectiveness.
Elucidate Ratings provides a wide range of benefits to managing risks in correspondent banking. In addition to running analyses to identify patterns of behaviour associated with money laundering, Elucidate Ratings works together with traditional KYC and AML processes, filling in gaps and delivering a more thorough risk assessment.
The complicated world of correspondent banking, with its many relationships and transactions, needs smarter tools that can find and manage the risks of money laundering.
Using a data-driven risk rating approach, like Elucidate Ratings, is not just a bonus, but a crucial need in today’s unpredictable financial world.
By integrating state-of-the-art technologies, financial institutions can enhance their correspondent banking risk management, safeguarding against money laundering, terrorism financing and sanctions evasion. In a world where financial crimes and AML structures are becoming increasingly sophisticated, the integration of tools like Elucidate Ratings brings clarity to your external network and internal structures.
Guarding the gate: Compliance amid fraud and money-laundering
To further explore how Elucidate Ratings can revolutionise your correspondent banking risk management, we invite you to reach out to our team for a personalised demo. The future of correspondent banking is here, and it’s data-driven.
RALPH DE HAAS Director of Research European Bank for Reconstruction and Development (EBRD)
