Correspondent banking involves financial institutions, often larger international banks, providing banking services to smaller banks or credit unions in different jurisdictions. These services can include facilitating cross-border transactions, currency exchange, and access to global financial networks. While correspondent banking is essential for international trade and finance, it can also pose money laundering and terrorism financing risks. Therefore, correspondent banks must conduct due diligence on their correspondent relationships and implement anti-money laundering (AML) controls to prevent illicit activities.
How Correspondent Banking Works
Correspondent banking allows a financial institution (the respondent bank) to access financial services in a foreign market without having a physical presence there. This is achieved by establishing a relationship with a local bank (the correspondent) that provides services such as clearing, payments, wire transfers, and foreign exchange. Through this partnership, the respondent bank can offer its customers cross-border transaction capabilities, often using nostro and vostro accounts to manage balances and settlements.
These relationships are essential for enabling international commerce, remittances, and global financial inclusion. They form the backbone of the global payment system, allowing funds to move quickly and securely between institutions and jurisdictions.
Services Offered in Correspondent Banking
A typical correspondent banking relationship can involve a wide range of services, including:
Execution and settlement of international payments
Foreign exchange and trade finance transactions
Check clearing and liquidity management
Investment and custody services
Support for local regulatory and reporting requirements
Correspondent banks also offer access to SWIFT messaging services, which allow institutions to securely transmit payment instructions and confirmations across borders.
Financial Crime Risks
Despite its critical role in the financial system, correspondent banking presents elevated risks related to money laundering, terrorist financing, tax evasion, and sanctions violations. The key risks stem from the indirect relationship between the correspondent bank and the respondent bank’s customers. This lack of direct visibility into the ultimate originators or beneficiaries of a transaction can create blind spots in due diligence and monitoring.
Common financial crime concerns include:
Use of correspondent accounts to process transactions for shell banks or high-risk clients
Nested accounts, where third-party banks access services indirectly through a respondent institution
Obscured ownership or jurisdictional risks when dealing with complex legal entities or high-risk countries
Inadequate AML controls or compliance practices by the respondent bank
As a result, correspondent banking has been a focus of international regulatory scrutiny and enforcement actions, often leading to de-risking by global institutions.
Regulatory Expectations and Due Diligence
To mitigate these risks, global AML frameworks impose enhanced due diligence (EDD) requirements for correspondent banking relationships. Key regulatory expectations include:
Understanding the nature of the respondent bank’s business, reputation, and regulatory status
Assessing the respondent bank’s AML/CFT controls, including whether they are aligned with FATF standards
Monitoring transactions conducted through the correspondent account, especially for unusual or high-risk activity
Screening against sanctions and PEP lists, including ongoing monitoring
Documenting ownership structures and beneficial owners, particularly in high-risk jurisdictions
Institutions are also expected to prohibit relationships with shell banks, which are entities without a physical presence in any jurisdiction or supervision by a recognized regulator.
Challenges in Practice
While regulatory guidance is clear, executing effective oversight in correspondent banking can be operationally complex. Challenges include:
Gathering sufficient documentation from foreign institutions with varying regulatory standards
Managing language, legal, and cultural differences in due diligence processes
Monitoring high volumes of transactions in real time with limited transparency into end users
Balancing risk management with the need to preserve access to financial services, especially in emerging markets
These difficulties have led many global banks to exit correspondent relationships in high-risk regions, raising concerns about financial exclusion and reduced access to the global financial system for smaller or developing economies.
Innovation and the Future of Correspondent Banking
To address ongoing risks and inefficiencies, the correspondent banking model is evolving. Innovations include:
KYC utilities and registries, such as the SWIFT KYC Registry, that streamline due diligence documentation
Blockchain-based cross-border settlement solutions, offering enhanced transparency and speed
AI-driven transaction monitoring tools, improving the detection of suspicious activity across multiple geographies
Regulatory technology (RegTech) platforms that facilitate compliance with changing regulatory requirements
These developments aim to restore confidence in correspondent banking relationships while reducing compliance costs and expanding access.
