But, in recent years, correspondent banks have also been thrust into the spotlight due to their role in something called
Trade-Based Money Laundering (TBML).
So, what is a correspondent bank? And how does it fit into the broader effort to prevent financial crime in global trade?
A correspondent bank is a financial institution that provides services to another bank, usually in a foreign country, to facilitate international transactions. Think of it as a "middleman" bank that helps make global payments and currency exchanges possible.
Correspondent banks act as intermediaries, enabling banks from different countries to communicate and conduct transactions efficiently without needing a direct relationship.
Here's an example:
Imagine, a bank in Japan wants to send money to a bank in Brazil, but they don’t have a direct partnership. Instead, they use a third-party correspondent bank—possibly based in the U.S.—to help process the transaction. Correspondent banks hold "Nostro" and "Vostro" accounts (Latin terms meaning "our" and "your," respectively), which keep track of transactions between the two banks in different currencies.
In short: Correspondent banks are essential for processing cross-border transactions and are especially important in regions where direct bank relationships are limited or costly.
Why Correspondent Banking Matters in International Trade
Correspondent banking is crucial for international trade. Without it, businesses worldwide would struggle to pay suppliers, receive payments from customers, or even convert their currency to one that’s globally recognised.
But there's more to it:
The role of correspondent banks extends beyond convenience—they’re also gatekeepers of international financial security, and this is where things get interesting.
In the wrong hands, the very same financial channels that allow smooth trade transactions can be misused for financial crime. One of the growing concerns in recent years has been
Trade-Based Money Laundering (TBML).
So what is a correspondent bank and the link to TBML? Here's what you need to know:
The Role of Correspondent Banks in Trade-Based Money Laundering (TBML)
Trade-Based Money Laundering is a method used by criminals to disguise illegal funds by manipulating trade transactions. TBML schemes might involve over-invoicing, under-invoicing, or falsely describing goods to make dirty money appear legitimate. Since correspondent banks often handle these transactions, they can unintentionally become part of the money laundering chain.
Here’s why TBML is such a big problem: according to the
Financial Action Task Force (FATF), global TBML operations are estimated to involve trillions of dollars annually, impacting economies around the world.
Correspondent banks, with their role in processing international transactions, are in a position to spot anomalies that might indicate TBML. However, identifying these red flags is challenging due to the sheer volume and complexity of trade transactions.
Example of TBML Using Correspondent Banking
Let’s say a criminal organisation wants to move large sums of money from a country with strict financial regulations to a country with looser regulations. They might:
- Over-invoice a shipment of inexpensive goods (e.g., light bulbs) from Company A in Country X to Company B in Country Y, inflating the price on paper to launder money.
- Use a correspondent bank to process the payment from Company B to Company A, making the transaction look like a legitimate business deal.
In this scenario, the correspondent bank plays a vital role in the transaction, even though it may not be aware that money laundering is taking place.
The Risks of Correspondent Banking in Financial Crime
Correspondent banks face a range of risks due to their involvement in TBML. These risks can lead to massive fines, reputational damage, and even severed banking relationships. One challenge is the risk of "de-risking."
De-risking occurs when banks, due to concerns over regulatory compliance or perceived financial risks, decide to close or limit correspondent relationships in high-risk regions. While de-risking aims to reduce exposure to illicit activity, it can also reduce access to financial services for legitimate businesses in affected regions.
According to a study by the Centre for Economic Policy Research (CEPR),
de-risking is a global issue that affects international trade. The study found that "de-risking of correspondent banking relationships can result in increased barriers for cross-border trade," impacting small businesses and emerging markets most severely, ironically driving more transactions into less regulated channels, further complicating the fight against TBML.
Money Laundering Risks & Correspondent Banking: A Moody’s Insight
Moody’s, a leading credit rating and financial analysis firm, emphasises the
risks correspondent banks face in money laundering scenarios. Because correspondent banks often have indirect relationships with customers (they’re dealing with another bank’s clients, not their own), they rely heavily on the information provided by the bank they’re representing. This makes it difficult to perform due diligence on each transaction and increases the chances of TBML slipping through the cracks.
Action to Take Against TBML
Although correspondent banks face unique challenges in preventing TBML, there are steps they can take to reduce these risks:
- Enhanced Due Diligence (EDD): Correspondent banks can implement stricter customer checks, especially for high-risk regions or industries. EDD involves a thorough review of a customer's financial history, business practices, and the purpose of the transaction.
- Transaction Monitoring: Advanced transaction monitoring systems help identify unusual patterns. For instance, if a trade transaction consistently involves goods being under or overvalued compared to market rates, this can trigger a red flag.
- Continuous Training: Staff training on financial crime compliance and identifying TBML schemes, especially in trade finance transactions, is crucial. Correspondent banks should keep employees updated on new laundering tactics and red flags to look for.
- Collaborative Efforts and Regulatory Compliance: Collaborating with other financial institutions and regulatory bodies enhances information-sharing and compliance with anti-money laundering (AML) regulations.
These actions are essential in preventing TBML and minimising the risks associated with correspondent banking. As financial crime becomes more complex, correspondent banks must stay vigilant and proactive in addressing the evolving challenges posed by TBML.
Real-World Consequences of Correspondent Banking Failures
In recent years, several high-profile cases have highlighted the risks and consequences of correspondent banking failures. When correspondent banks don’t catch suspicious transactions, the results can be devastating:
- Case Study 1 (Danske Bank Scandal): Danske Bank’s Estonian branch was involved in one of Europe’s largest money laundering scandals. With over $200 billion in suspicious transactions linked to Russia and other former Soviet states, the scandal revealed how correspondent banks were used to launder massive sums of money. Many of these funds flowed through correspondent banking channels, exploiting the complex layers and indirect relationships typical in correspondent banking.
- Case Study 2 (Deutsche Bank’s Correspondent Banking Woes): Deutsche Bank faced significant fines and regulatory scrutiny after failing to detect TBML and other money laundering schemes within its correspondent banking relationships. The case underscored the difficulties banks face in managing the TBML risk posed by indirect relationships.
Both cases underline the importance of rigorous monitoring and
due diligence in correspondent banking. When these measures aren’t in place, correspondent banks risk becoming conduits for illicit activity.
Why Correspondent Banking and TBML Matter to You
Understanding correspondent banking and its connection to TBML isn’t just for industry insiders—it’s a critical part of understanding how international finance works and why financial crime prevention matters in today’s globalised economy. Correspondent banks play a pivotal role in enabling international trade, but with this power comes responsibility. By being vigilant and proactive, these institutions help protect the global financial system from the harms of TBML.
Are you a professional in trade finance, compliance, or risk management?
Learn more about how to protect your institution from the risks of TBML with our
specialised course on Trade-Based Money Laundering. Gain practical insights, expert guidance, and the skills needed to spot TBML risks before they escalate. Don’t miss your chance to stay ahead—register today and become a key player in the fight against financial crime.
FAQ
What is the difference between a beneficiary and a correspondent bank?
A beneficiary bank is the bank where the recipient (beneficiary) holds an account and will receive the funds from a transfer. A correspondent bank, on the other hand, acts as an intermediary between two banks that don't have a direct relationship, facilitating international transactions by holding accounts on behalf of other banks. In cross-border payments, the correspondent bank enables the transfer, while the beneficiary bank ultimately delivers the funds to the recipient.