Post-crisis slump in global correspondent banking “disastrous for everyone”

A detailed study of global correspondent banking provides fresh insights into just how much it has deteriorated since the crisis due to de-risking by institutions in response to tougher regulations

The parlous state of global correspondent banking has been revealed by research which shows it has slumped by 25% since the financial crisis as a result of strategic de-risking by banks. The study, the most comprehensive of its kind in recent years, warns that allowing correspondent banking to continue deteriorating “will have disastrous consequences for everyone”.

The report by risk and compliance solutions provider Accuity says the steep fall in global banking relationships between 2009 and 2016 occurred despite growth in global GDP per capita during the same period. The decline is a direct result of tougher regulations since the global financial crisis of 2008, notably demands from financial watchdogs for greater transparency, higher liquidity thresholds for banks and enforcement actions on institutions that violate anti-money laundering (AML) regulations.

Tougher money laundering rules have been an especially major drag on institutions, with Accuity noting that AML penalties peaked in 2014 at an eye-watering $10bn, compounding the challenges banks face in high-risk geographies. (See Fig 1 below) To date the biggest AML penalties levied have been BNP Paribas, fined US$8.9bn in 2014, and HSBC US$1.9bn charge in 2013. Only in January Deutsche Bank was fined a total of £500m by the financial authorities in the UK and US for breaching AML rules. Other banks that have been handed heavy fines over the years include Credit Suisse, Standard Chartered, Santander, BNP Paribas and HSBC.

The report says in such a climate, the threat to banks of doing business in these [non-core] geographies potentially outweighs the benefits of services to their clients, even if there may be good business opportunities to pursue. The challenges of increased operational costs, competitive and regulatory pressures have driven banks to withdraw from correspondent banking relationships.

Fig 1 AML Penalties

With banks unable to justify the increased compliance cost associated with offering correspondent banking services to their local customers, the fall guys have been businesses in the regions most affected as they struggle to access financial services through the global system. The lack of this access has forced local banks “to use non-regulated, higher cost sources of finance and so exposing themselves to nefarious actors and shadow banking”.

Henry Balani, Global Head of Strategic Affairs at Accuity, says: “A number of factors have contributed to derisking, the most important being that the risk / reward balance has become unfavourable for large clearing banks and in response they have taken a country / region risk view in deciding who they can do business with. If we want to reverse this trend and begin to ‘re-risk’, then the ‘antidote’ will require more granular level due diligence and proper risk assessments to provide large clearers with the confidence that they can deal with low risk businesses in high risk jurisdictions.”

Much of the decline in correspondent banking relationships post-crisis can, of course, be attributed to established Western financial institutions pulling out in response to regulatory pressures from their respective watchdogs. Accuity analysed the US, the UK and the European Union’s performance and found that between 2009 and 2016 the number of bank head offices across these territories declined from 23,240 to 17,631 - a decline of 24%. More significantly, the number of times banks were used as correspondents declined 30% in the same period.

The downward trend in correspondent banking is illustrated especially well by the decline in the number of USD relationships since 2014. The US dollar was the currency of choice as the global economy recovered from the global financial crisis in 2008. Still, the number of USD correspondent relationships declined by 15% over 200-2016 (with Euro relationships showing an even steeper decline of 23%). Over the same period the number of US bank head offices declined 25% from 16,257 in 2009 to 12,220 in 2016. (See Fig 2)

While greenback remains the currency of choice, Accuity notes there was a steep drop of 13% in USD relationships between 2015 and 2016 following a decline of 2% between 2014 and 2015.

Figure 2 : Trends in US banking and correspondent relationships 
Fig 2 USA Banks

While actions by US and European regulators have resulted in banks in these territories shunning higher risk economies, so missing out on the potentially profitable use of their currencies for correspondent banking, Chinese banks have been making hay, exploiting opportunities for new business in Asia, Latin America and Africa.  In 2009, Chinese banks had just 65 correspondent banking relationships but by 2016 these links totalled 2,246 – an astonishing increase of 3,355% - even as the global trend between those years was a 25% decline. Over the same period the number of banks in China rocketed 133% from 421 to 983. (See Fig 3)

Accuity says there are two explanations for the decline in USD relationships when compared to the RMB: either there is a concentration in USD relationships, with more transactions settled through fewer relationships, or there is a decline in the dominance of USD. Balani says the shift can also be attributed to the potential AML penalties associated with using these currencies: “Since the financial crash of 2008, we have seen significant commitment from financial institutions in emerging economies to demonstrate they are not high risk. We see this playing out in the East and the increased number of relationships reflects their commitment.”

Figure 3: Trends in Chinese banking and correspondent relationships
  
Fig 3 China Banks


Balani is clear about the dangers associated with the sharp deterioration in correspondent banking links: “Correspondent banking represents the cornerstone of a global payment system designed to serve the settlement of financial transactions across country borders. The irony is that regulation designed to protect the global financial system is, in a sense, having an opposite effect and forcing whole regions outside the regulated financial system. This matters because allowing de-risking to continue unfettered is like living in a world where some airports don’t have the same levels of security screening - before long, the consequences will be disastrous for everyone.”

Miguel Sanchez, head of UK treasury at Zurich-based Habib Bank, is among those in the banking industry who have long expressed concern over the impact of tougher regulations on correspondent banking. Commenting on the Accuity study, he says: “The research shows there is a clear correlation between AML penalties per year and the decline in correspondent banking services throughout different global regions. Although much can be attributed to de-risking by various "traditional" correspondent banking providers, it is clear that regulation has played a very big part in this and the risk-reward has been severely dented. I would not say this is an indication of declining dominance of the US Dollar or EURO for international trade in these high risk regions. Moreover, there is a recalibration occurring of these services across different regions which has led to the rise of more localised providers."

Greg Vincent, head of FX at INTL FCStone’s payments division, says that the Accuity research is “very valuable” and helps bring into sharp focus the dilemma faced by many US and European banks: “On one hand, the regulators have made it so expensive when errors are made - an amount of $10bn is referenced in the research - that the risk/reward balance of running correspondent accounts for banks in non-equivalent jurisdictions simply no longer pays off in many cases."

“On the other hand, demand to support cross border payments, particularly to new and non-traditional markets has never been greater. Globalisation of the economy is ever-increasing, with technology having fundamentally changed how much business is conducted and where talent and workforces are sourced from.”

“We [at INTL FCStone] do not see this trend changing in the near future and believe that the opportunity for organisations who can help the banks bridge this gap will continue to be significant. We see a constantly evolving and growing demand from the global banks to access the services of a specialist like us that has the scale to manage the risks and can balance this risk / reward equation favourably.”

For its report, Accuity compiled data from an average of 29,000 banks in 238 countries or regions across the world. The research is based on standard settlement instruction (SSI) data that Accuity collects for its Bankers Almanac for Payments solutions.