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.[[[PAGE]]]

The Middle East is one of the areas affected by international banking exits, but the UAE itself has been less affected than countries such as Saudi Arabia, and exits by some international banks have not had a significant impact. Given the Emirates’ huge current and future potential for global trade, it is essential that both institutional and corporate clients have confidence and certainty in the correspondent banking arrangements that are required to facilitate this trade.

The value of partnership

To provide this confidence, we continue to be proactive in protecting the interests of our clients, and creating a relationship model that forms a blueprint for correspondent banking arrangements across the globe. Firstly, we have at least two correspondent banking partners for each of the major currencies. Secondly, we have successfully built key strategic alliances with major international banks that provide our customers with coverage across their major trading regions. For example, in 2011, we signed a key strategic partnership with Bank of America Merrill Lynch which allows both banks to offer integrated solutions and services that leverage each other’s strengths and capabilities in our respective areas of expertise. In 2012, galvanised by the success of the relationship with Bank of America Merrill Lynch, we signed a second strategic alliance with Santander. Together, these partnerships provide us with deep, stable and reliable coverage across the US, Europe and parts of Asia with Bank of America Merrill Lynch, and the Iberian countries, Latin America and the UK through Santander. We are also working towards a third alliance to provide coverage in sub-Saharan Africa.

The concept of alliances between banks is, in theory, quite common, but many of these can be rather generic in nature and lack the focus, common culture and commitment to joint goals that characterise our partnerships. We recognise the importance of reciprocity, bearing in mind that both banks and their clients have a limited wallet, so there is greater value to each party by consolidating volumes through fewer parties. Furthermore, strategic alliances need to deliver value to alliance partners relatively quickly, rather than focusing only on longer-term benefits. Consequently, we work with our alliance partners to pitch jointly on new customer business, and hold bi-monthly steering committee meetings to discuss each pipeline opportunity, review and refine our value proposition, performance and the value to both parties. We have supported recent trade missions for some of Santander’s UK SME customers and prospects to visit the UAE by making introductions to our clients, and have provided legal and economic insights to help them plan their business strategy. Such initiatives have proved very successful, with a very high conversion of prospects to clients, benefiting all parties. This transparent and pragmatic approach ensures that both parties continue to derive value, ensuring a strong mutual interest in optimising the success of the partnership by deepening client relationships and expanding our offering into new target client segments.

A relationship blueprint

As the regulatory environment evolves, with increasing scrutiny and complexity, the cost of compliance for financial institutions continues to spiral, which is likely to result in further bank exits, creating difficulties in markets that already had only a few banking participants. However, despite the difficulty of achieving compliance and managing risk whilst maintaining profitability, banks and key international bodies alike are committed to making sure that institutional and retail customers globally continue to have access to the international financial system. International bodies such as the Financial Stability Board (FSB) are exploring potential responses, but alongside regulatory initiatives, the alliance model forged between ADCB and our partners is becoming more widely recognised as a blueprint for the wider banking industry.

There are established precedents of successful alliances, such as OneWorld and Star Alliance in the airline industry, and there is considerable incentive for both local and international banks to achieve a similarly integrated network to offer global coverage to clients without adding substantial risk or cost. Local and regional banks gain access to resources and client opportunities, and are in a better position to support their clients’ international growth strategies. International banks gain a cost-effective foothold in a market, whilst also gaining access to new client opportunities, and enhancing their ability to support the needs of their international clients.

Most of all, the benefits to clients are substantial, with reliable market access, and expertise and solutions across the regions in which they operate, without fragmenting banking relationships. Increasingly, institutions and corporations that have experienced the value of a successful banking partnership are approaching their banks in other regions to achieve the same level of assurance and depth of capability. Given the ongoing challenges in correspondent banking that lie ahead, the future of the global trade is likely to be highly reliant on these high quality, trusted relationships that deliver reciprocal value and stability.