A Collaborative Approach to Correspondent Banking
by Padmanabha Mishra, Head of Institutional Clients Group, Abu Dhabi Commercial Bank
One of the key customer segments at Abu Dhabi Commercial Bank (ADCB) is our Institutional Clients business, which has flourished to become a sophisticated, highly integrated offering across both correspondent banking and solutions for non-bank financial institutions. Over the past year or so, the future of correspondent banking has become a key discussion topic amongst the financial community, including in the UAE. As this article outlines, ADCB is a key participant in this ongoing debate. The approach we are taking to secure our clients’ cross-border business is becoming widely recognised as a valuable means of addressing some of the risk and uncertainty to which banks, and the institutions that they support, are increasingly subject.
Correspondent banking at the crossroads
Correspondent banking is critical to global trade, facilitating the cross-border flow of goods and services, and connecting banks and their customers worldwide. As the range of organisations involved in cross-border trade continues to grow, and supply chains become more widely distributed, the ability to make and receive international payments has never been more important. Banks cannot – nor would they wish to - build and maintain a global network to support every international payment from end to end. Consequently, banks work together to leverage their products and geographic footprint by establishing correspondent banking networks that enable their clients to trade across the world.
Although the correspondent banking model is not perfect in every respect, particularly as banks have their own systems, formats and service models, which can create some inconsistency in cross-border payment processing, the model has proved robust and capable of supporting cross-border trade. Furthermore, there are initiatives underway, such as the global payments innovation initiative co-ordinated by SWIFT, and emerging fintech solutions, including those based on blockchain, that aim to accelerate cross-border payments, and give payment users better visibility over the status and cost of these payments.
While these initiatives will undoubtedly increase the speed, security and convenience of cross-border payments, they do not address the biggest challenge facing correspondent banking, namely banks’ increasing cost and risk associated with regulatory compliance, specifically those that aim to combat financial crime and boost resilience in the financial sector. Some of this additional regulatory burden is the result of central banks in many countries becoming more proactive in reducing financial crime, but many of these regulatory developments have global applicability, such as KYC (know your customer) rules, FATCA (Foreign Account Tax Compliance Act) and Basel III. The effect of this growing regulatory burden, and the risk of penalties and reputational damage in the case of non-compliance, is that some banks are choosing to scale back their correspondent banking networks, a trend that is likely to continue over the foreseeable future. The regions hardest hit by these exits are those where banks perceive the potential risks and costs of associated controls to outweigh the value, most notably the Middle East, Caribbean, East Asia Pacific, Eastern Europe and Central Asia.
The changing state of correspondent banking relationships
So what does this mean in practice? Firstly, every bank, including ADCB, needs to make choices about which clients and which transactions they are able to support in order to comply with both local and international regulations, irrespective of the potential value to the bank. Given how difficult it can be to navigate the various regulations, and the complexities in interpretation in some cases, banks will inevitably err on the side of caution, so it is important to work closely with partner banks to discuss potentially complex transactions. Secondly, we are seeing high profile bank exits continue, both US and European banks exiting more than 500 correspondent banking relationships in emerging markets, with other international banks making similar strategic decisions. This could lead to some organisations facing the prospect that their banking partner in a particular country has no correspondent banking partner at all. This would cripple cross-border payments and collections and render the business in that country potentially worthless to the wider organisation.