Correspondent Banking: The Hidden Risk to Global Financial Stability
December 8, 2023 - A shrinking correspondent banking network poses significant risks to global financial stability, including limiting access to international finance and exacerbating money laundering and terrorist financing concerns.
The Decline of Correspondent Banks
The number of active correspondent banks worldwide has declined by about 4% in 2020 and a staggering 25% between 2011 and 2020. This contraction is partly due to increased compliance costs associated with enhanced regulatory scrutiny. The dominance of the US dollar in global trade creates challenges for emerging market banks, as moving money requires a USD correspondent bank, which can be difficult to find.
Consequences of De-Risking
- Disproportionate impact on emerging markets: De-risking - the practice of terminating respondent relationships based on geographic factors rather than true risk posed by the respondent - disproportionately impacts banks in emerging markets.
- Exacerbated access issues: This process exacerbates issues associated with access to global financial systems and undermines broader global efforts to ensure a secure and inclusive financial system.
The Human Cost
Limited access to financial services may impact individuals and businesses in certain regions, leading to delays and higher costs for international transactions. Financial exclusion could worsen for underserved areas, hindering their participation in the global economy and access to vital financial services.
Regulatory Action Needed
To effectively de-risk, regulators must align local regulations with international standards, such as those set by the Financial Action Task Force (FATF). Commercial banks must establish transparent, trusting partnerships with counterparts and enhance Anti-Money Laundering/Combating the Financing of Terrorism (AML/CFT) measures.
Collaboration Key to Addressing Correspondent Banking Risks
A multi-faceted approach that involves collaboration between regulators, commercial banks, multilaterals, and governments is crucial to address correspondent banking risks. Identifying and engaging a broader network of specialist banks capable of working in partnership with larger correspondents is essential to reduce overreliance on a limited number of large correspondents.
Promoting Financial Inclusion
Granting licenses to specialist banks with expertise in emerging markets to operate as correspondents in these regions can help address the significant challenges posed by correspondent banking de-risking. This innovative measure can also reduce the burden on the small number of large correspondents who today manage the vast majority of the world’s payments.
By fostering strategic partnerships and addressing the unique needs of vulnerable countries, the global financial community can enhance the resilience and effectiveness of correspondent banking relationships, ensuring a more robust and inclusive international financial system for all.