Mitigating AML Risk in Correspondent Banking

Financial criminals depend on advanced technology to complete many of their illegal activities, so financial institutions must use sophisticated methods to identify and stop suspicious activity. Government agencies require these anti-money laundering (AML) efforts, which include identity verification, deep background checks, and transaction monitoring.

AML regulations hold financial institutions responsible for practicing due diligence. You are expected to Know Your Customer (KYC) during and after the onboarding process so you can prevent bad actors from hiding illegal money in your organization’s accounts.

You should be especially vigilant when it comes to correspondent financial institutions — organizations that act on behalf of other financial institutions — usually in foreign nations.

Correspondent banks act as intermediaries to accept deposits, perform fund transfers, complete wire transfers, etc. While many of these institutions are entirely legitimate, they are often used as part of money-laundering activities.

What’s the Purpose of AML?

AML and KYC efforts are essential to curtailing illegal financial activities such as money laundering, terrorism financing, identity fraud and drug trafficking. In the United States, AML efforts originated with the Bank Secrecy Act (BSA) enacted in 1970. The Financial Crimes Enforcement Network (FinCEN), is tasked with enforcing BSA and other financial laws.

Since the enactment of BSA, the U.S. has bolstered its AML efforts through other legislation, such as the Money Laundering Control Act of 1986 and the USA Patriot Act of 2001.

In the UK, the emphasis on AML has come more recently through the Money Laundering, Terrorist Financing and Transfer of Funds (Information on the Payer) Regulations of 2017 and 2019 and the National Risk Assessment of Money Laundering and Terrorist Financing 2020. The NCA, HM Revenue & Customs, and local law enforcement are responsible for investigating most UK financial crimes.

Both nations belong to the Financial Action Task Force (FATF), an intergovernmental agency established in 1989 to develop policies to combat national and international financial crimes.

Money Laundering Risk: Why Are Correspondent Banks at Such High Risk for Money Laundering?

Correspondent banking is at the center of many financial crimes. Transferring the proceeds of criminal activity to another country is an effective way to “clean” its origins. Correspondent banking risks are higher due to the following factors.

Unfamiliarity With Respondent Bank’s Customers

KYC is a central tenet of AML regulations, but correspondent banking services are at a clear disadvantage here. They do not know the respondent bank’s customers and, since they are often in another country, have more difficulty verifying customer information.

Decentralized Structures

In the past, most financial institutions were part of a centralized system that was much easier to regulate. Now, decentralized finance, or DeFi, has become increasingly popular. Numerous non-traditional financial entities offer checking, savings and investment accounts. Many run on hard-to-track cyber currencies. While these organizations provide convenience and profits to consumers, they are also harder to monitor.

Shell Corporations

Shell corporations are considered corporations even though they have no active business operations or significant assets. Legitimate organizations use them for tax benefits, start-up efforts and hostile takeovers. However, they are also often used to hide ownership and disguise shady banking activities. Foreign correspondent accounts and even shell banks are favorites of financial criminals.

Correspondent Banks and the Challenge of AML Regulatory Compliance

Legitimate correspondent banks want to fulfill their AML compliance responsibilities, but they face several significant challenges.

• High costs — KYC and customer due diligence (CDD) efforts can be costly, especially in foreign correspondent banking. Verifying customer identities becomes much more difficult when borders are crossed and government data, including ID numbers, cannot be easily accessed.
• Insufficient systems — Some correspondent banks may be small, decentralized entities without the advanced systems needed to check and monitor customer identities and financial origins.
• Varying regulations across jurisdictions — The laws vary from nation to nation, and financial criminals are well aware of these differences. They often seek out foreign financial institutions and open correspondent banking accounts in nations with relaxed financial laws.

AML Regulatory Requirements: Guidelines for AML De-Risking at Correspondent Banks

Correspondent banks can lower the risk of financial crime by creating and enforcing a comprehensive AML program. These programs must contain key elements, including KYC compliance and CDD.

• Customer due diligence — CDD requires banks to collect all of a customer’s credentials and verify them. Then the correspondent bank needs to evaluate the customer’s risk profile for illegal activity.
• Risk-based management techniques — Risk-based techniques include assigning risk levels to customers based on their business type, transaction patterns and personal history. Risk assessment is key to enforcement efforts, and high-risk clients are monitored more closely.
• Continuous transaction monitoring systems — Monitoring financial transactions requires considerable employee hours if the bank does not have advanced monitoring systems. The right software will automatically and continuously monitor a client’s transactions, making suspicious activity easier to spot.
• Independent testing systems — Objective testing from a trusted but outside system identifies weaknesses in a bank’s efforts to meet regulatory requirements. The system should evaluate the AML compliance program and create a financial systems report of its findings for senior management.
• Ongoing training of AML compliance professionals — AML regulations continually change and are different for the respondent bank’s customers than for correspondent banking relationships. Ongoing training is necessary for employees to understand risk management measures such as checking sanctions lists.

Correspondent banking will always be at higher risk, but these financial organizations can reduce financial crime by creating and implementing detailed AML programs.

Final Thoughts on Correspondent Banking AML

Financial criminals are well-informed about the weaknesses in international AML efforts. They frequently seek out correspondent banks for their ill-gotten gains. These banks are often in foreign nations with less stringent regulatory efforts. Even banks in countries with strong AML regulations may find it difficult to adequately comply with KYC rules and perform CDD.

Jumio offers comprehensive AML software that helps financial services enhance risk mitigation and monitor customers and accounts for suspicious activity. Jumio can help your financial institution stay compliant through automated sanctions screening, identity verification and AML transaction monitoring that ensure compliance while streamlining time investment and reducing costs.