Money laundering risks in correspondent banking

Correspondent banking plays a key role in the global financial system. It facilitates cross-border transactions and supports international trade. Correspondent banking involves financial institutions providing services on behalf of other banks, usually in different countries. These services include conducting transactions, processing wire transfers, and document collection. The relationships within correspondent banking are crucial for international trade, particularly for emerging and developing economies. 

However, correspondent banking can expose financial institutions to significant risks, specifically those of money laundering and terrorist financing. Criminals are able to exploit the complexity and reach of correspondent banking relationships to obscure the origins of illicit funds, making it challenging for authorities to trace and prevent financial crime.

Many banks have been fined for processing prohibited payments. Back in 2019, UniCredit Group paid a hefty $1.3 billion fine for processing prohibited transactions and in 2023, Swedbank Latvia was fined $3.4m for processing transactions related to Crimea through US correspondent banks.

The complex transaction chains involved in correspondent banking business make it harder to trace illicit funds and a lack of transparency in relationships can hinder attempts to detect unlawful activities. Moreover, jurisdictional variations in AML compliance standards, customer due diligence, and anti-financial crime regulations creates gaps that can be exploited to access the global financial system illegally.

High transaction volumes can make it easier for money launderers to blend illicit funds with legitimate ones. Correspondent banking also provides criminals with access to a vast network of financial institutions worldwide.

Criminals use a range of techniques to obscure fund trails using correspondent banks, including:

• Layering: This is where criminals conduct multiple transactions across different correspondent banks, making it difficult to trace the original source of funds.
• Smurfing: Illicit funds are broken down into smaller, legitimate-looking transactions to evade suspicion and reporting requirements.
• Shell companies: Criminals establish or use existing shell companies to hide the true beneficiaries and source of funds.
• Lack of due diligence: Fraudsters are able to capitalize on inadequate KYC and customer identification, weak transaction monitoring, and insufficient risk assessments by correspondent banks to allow illicit funds to flow undetected.
• Jurisdictional differences: Criminals exploit varying regulatory frameworks across different jurisdictions to access the international financial system.

In response to money laundering risks, some financial institutions have adopted a practice known as de-risking, where they avoid conducting business with an entire region or customer class deemed high risk. However, the FATF (Financial Action Task Force) does not recommend this as good practice as it can lead to unintentional financial exclusion; further reductions in transparency; and – ironically – heightened exposure to money laundering and terrorist financing risks as it may drive financial transactions underground instead of allowing the risk to be detected and tackled. 

Mitigating money laundering risks in correspondent banking can be a challenge. Domestic banks processing transactions on behalf of foreign banks often depend on the foreign banks’ AML capabilities. In some cases, a foreign bank's AML compliance program may not meet the requirements of domestic banks, exposing them to potential risks.

To better combat money laundering risks in correspondent banking, regulatory authorities and financial institutions need to implement robust anti-money laundering (AML) measures and know your customer (KYC) due diligence. These processes include enhanced due diligence, transaction monitoring, information sharing, and compliance with international standards.

• Enhanced due diligence – Correspondent banks can conduct thorough due diligence on their customers, including foreign respondent banks, to understand risk profiles adequately before doing business, as well as monitoring changing risk factors on an ongoing basis.
• Transaction monitoring – Correspondent banks can employ advanced transaction monitoring systems to detect suspicious activities and transactions indicative of money laundering.
• Information sharing – Correspondent banks can foster collaboration among financial institutions and regulatory authorities to share information on potential risks and emerging money laundering trends.
• Compliance with international standards – Correspondent banks need to adhere to FATF recommendations and international AML standards to ensure a unified global effort against money laundering.

Correspondent banking remains essential for global trade and economic growth, but it comes with money laundering and terrorist financing risks. To better safeguard the financial system, regulatory authorities and financial institutions need to work together to implement robust AML and KYC measures.

Moody’s KYC solutions automate customer onboarding and perpetual risk monitoring across a range of compliance processes. Integrated with leading data sets, financial institutions can conduct due diligence and enhanced due diligence with a unified risk platform that delivers an always-on profile of risk for individuals or entities.

We help customers automate KYC processes to help mitigate AML risks in 197 countries, across 211 jurisdictions, including screening against our database of +24 million risk profiles, +550 million entities, and tens of thousands of sanctioned entities.

Please get in touch to discuss your KYC and AML processes, we would love to hear from you.