Correspondent banking 4.0?

June 2018

One of the unintended consequences of post-crisis regulatory tightening has been a reduction in correspondent banking relationships. But new technologies and a collaborative willingness to keep funds flowing across borders give cause for optimism, reports flow’s Janet Du Chenne

Thirty minutes or less is the new standard for cross-border payments. It is a far cry from when correspondent banking originated in 15th-century Florence and played a vital role in facilitating global trade and economic activity. Yet correspondent banking remains the dominant model for settling B2B cross-border payments, with the majority of corporates’ international payments settled bank-to-bank. However, over the past decade and following the Global Financial Crisis in 2008, a combination of tightening regulations, increasing customer expectations, and new competition have placed new pressures on this age-old banking model.

Since December 2015, SWIFT global payments innovation (gpi) – which joins together all payment intermediaries via a cloud-based cross-border payments tracker – has focussed on responding to these shifts. In a press release on 28 February 2018, SWIFT announced that, in total, more than US$100bn per day is being sent on SWIFT gpi; nearly 50% of payments sent using SWIFT gpi are credited to the end beneficiary in less than 30 minutes; and overall, 92% of payments are received by the beneficiary within a day. All of this has been achieved since gpi was created. Harry Newman, SWIFT’s Head of Banking, underlines the impact that the service has already had on the industry: “Banks are able to credit payments within minutes and even seconds, while their customers benefit from shorter supply cycles and are able to ship goods faster.”

7 billion
The traffic of messages SWIFT recorded in 2017 as a result of a growth in payments (SWIFT, 2018)

This need for speed is just one of the drivers for the correspondent banking industry to come together to improve experience in cross-border payments, along with transparency and traceability of payments via better remittance data. Efforts have also focussed on both the quality of correspondent relationships, and trust in the system to ensure the network and the reach is preserved. As Christian Westerhaus, Head of Clearing Products, Cash Management at Deutsche Bank, put it during a Sibos Toronto 2017 session on this topic, “It can disrupt the market if a player can’t connect to another player in a destination country.” He explained, “The current model works well through trust, but this is not enough.” While financial institutions have the SWIFT network to reach their FI counterparties, it is not yet clear how alternative payment providers can have the same reachability for corporate clients that happen to send and receive payments from all over the world. “They want us not just to connect with a single bank in country X, Y or Z, but also to ensure overall reachability in that country,” he said.

"Today, corporates are rightfully demanding more from their banking partners"
Christian Westerhaus, Head of Clearing Products, Cash Management, Deutsche Bank

In other words, correspondent banking solves particular problems, such as providing a service for exporters and importers engaged in cross-border trade, but counterparties want to be able to track their payments – in just the same way an international courier delivery can be tracked – and be sure they are operating in a safe and sound system. Thankfully, SWIFT gpi now allows the same-day processing (and availability) of funds – a development that should enable corporates and FIs to grow and become more efficient, and that gives them greater visibility over a transaction’s fees, as well as foreign exchange (FX) rates used.

By joining all payments intermediaries in one place and gaining improved visibility over transaction fees and FX rates used, this cuts down the time of credits reaching the beneficiary from several days to less than half an hour or, in some cases, minutes or even seconds. If received prior to a receiving a bank’s cut-off time, banks will credit funds on the day of receipt.

Cost of compliance

Requirements to know and classify counterparties (Know Your Customer, or KYC), understand other parties in the payment or trade chain, and meet criteria relating to Anti-Money-Laundering (AML) controls have been core elements of the regulatory tightening. But their effective implementation takes time and resources.

This has been felt particularly keenly in the trade finance space which, despite some progress towards digitalisation, is still dominated by paper-based processes. Compliance is labour-intensive, requiring significant data collection, examination and cross-checking of trade documents, all of which adds to the cost of the transaction.

More than 68% of respondents to the ICC Banking Commission’s 2017 Global Survey on Trade Finance (which pulled together 255 responses from banks located in 98 countries) suggested that compliance and regulatory requirements had become their most significant challenge to finance provision.1 This has, naturally, forced banks to review their correspondent relationships from a profitability aspect and, in some geographies, terminate them.

The cash space is no different. Marc Recker, Deutsche Bank’s Head of Market Management, Cash Management, reflects that “maintaining an open global payments network across many different standards and under a strict regulatory framework is prohibitive from a cost perspective – banks can no longer treat correspondent banking as a hobby”.

De-risking in the correspondent banking context is something that the Financial Action Task Force (FATF) has been addressing by highlighting the scale of the problem and providing guidance to clarify supervisor expectations for correspondent banking relationships. “De-risking may drive financial transactions into less/non-regulated channels, reducing transparency of financial flows and creating financial exclusion, thereby increasing exposure to money laundering and terrorist financing risks,” it warns. It counsels financial institutions to identify, assess and understand their money laundering and terrorist financing risks and implement measures commensurate with the risks identified.2

An emphasis on quality, not quantity

In response, banks today are concentrating their efforts on fewer, but more strategic, partnerships with financial institutions across the globe. Ulf-Peter Noetzel, Deutsche Bank’s Global Head of Trade Finance, Financial Institutions, explains that this needn’t be considered a negative exercise and that regulatory requirements “have provided a good opportunity for the bank to go through its existing correspondent network and look at which contracts drive the most value for us and our corporate clients”. Then they can focus efforts on servicing and strengthening these ties.

In ‘Correspondent Banking 3.0’3, published in 2012 and superseded by SWIFT gpi, SWIFT argued for a three-tier segmentation of correspondent banking relationships that is now becoming apparent. This comprised:

Partner banks (based on true synergies, with relationships typically based on a partner bank’s strong presence in a particular geography and its ability to transact a high volume of business across a broad range of products);
Specialist banks (where the correspondent bank has capabilities in specific product lines); and
Coverage banks (to fill out the geographic footprint of a bank’s capability in areas where it does not have a presence, but its clients need to do business).
Correspondent banks, such as Deutsche Bank, are investing in a clear policy to manage and mitigate risk. “In this new environment, there is not only a need to comply with the regulation in a safe and secure way, but also to make sure that this compliance is efficient and continues to support the growth of a bank’s business,” says Recker.

What does this mean in practice? For a start, correspondent banks should communicate their risk tolerance policies and expectations to respondent institutions – including issuing policy statements on transactions that are prohibited and that they consider ‘high risk’. In turn, such communication helps the correspondent bank to flag new and emerging risks, and assists the respondent institution in its capacity to comply.

Rising customer expectations in the digital age

However, compliance is not the only new pressure facing correspondent banks. Driven by their experiences within the retail banking sector, corporates have, over the past decade, come to expect higher levels of transparency, convenience, speed and price from their wholesale providers.

Does this make instant digital payment services offered by third-party providers – think PayPal – a genuine threat to correspondent banking? No. Recker points to the fact that treasurers of multinational companies with complex treasury structures – whether payment factories, shared service centres or full-scale regional treasury centres – require sophisticated solutions integrated into their own processes and systems, with the aim of driving better liquidity or working capital management.

Only a large-scale banking network can meet these needs. But, nonetheless, banks must adapt and evolve. “Today, corporates are rightfully demanding more from their banking partners,” says Westerhaus. “It is no longer acceptable for cross-border payments to take a week to be credited to a beneficiary’s account. It is no longer acceptable for payment and FX to be shrouded within long and complicated payment chains.”

Both Westerhaus and Recker cite SWIFT gpi, which has met customers’ expectations for speed, the same-day clearing of funds and full remittance data. It also introduces the SWIFT gpi Tracker, which Westerhaus likens to a “courier’s tracking platform” – enabling full visibility of a transaction’s journey via end-to-end status updates. This visibility of payment status, unaltered remittance information and the transaction costs can be updated by FIN Message or application programming interface (API) and accessed via a graphical user interface (GUI) – making it interoperable with a bank’s other back-office systems. In its latest press release,4 SWIFT also stated three bold ambitions for the service: 48 out of the 50 top banks on the SWIFT network have committed to using SWIFT gpi to send payments. In total, 45 banks are live, with more than 100 banks in the implementation phase; by the end of 2018, every bank that joins gpi will be able to trace every payment it sends using SWIFT gpi across more than 10,000 banks on the SWIFT network, and SWIFT gpi is on track to become the standard for all cross-border payments by the end of 2020.

flow’s online report on the corporate engagement for SWIFT gpi, published in January 2018, goes on to point out that this cannot happen without the corporate determination to make this the default cross-border payment solution. And – although predominantly bank-led – SWIFT gpi is designed with the corporate and FI client firmly in mind. Crucially, it allows the same-day processing (and availability) of funds – a development that should enable corporates and FIs to grow and become more efficient.

Technology transfer?

Technology clearly has a huge part to play in modernising the correspondent banking process. Blockchain in particular has caught the attention of corporates, and flow online reported in December 2017 how this particular use of distributed ledger technology had moved beyond the proof of concept (PoC) stage into actual trade finance deals.5 Another blockchain-based initiative, the we.trade joint venture in the SME and mid-cap space comprising nine partner banks, including Deutsche Bank,6 was featured at Sibos Toronto 2017. In addition, SWIFT’s recently concluded a DLT PoC for nostro reconciliation tested whether nostro Account owners, and their servicers, could potentially share a private confidential ledger recording transactions related to their Nostro accounts. The PoC leveraged ISO 20022 standards and gpi innovations – including the unique end-to-end transaction reference – and integrated intraday liquidity standards.

Noetzel urges an element of realism when it comes to how quickly these initiatives may reshape banking models, given the heightened compliance environment. His view is that modernisation should be tackled in a pragmatic and measured way, with the focus not on the technology, but rather on the needs and challenges of corporate clients.

Westerhaus agrees, pointing out that many new solutions are “still in their infancy” and that it will take time for them to meet the relevant compliance criteria – and even longer to be equipped to handle the high-value, high-volume payments required for international trade. Ultimately, success will be judged by global reach and any technology will need to achieve full connectivity across all countries, currencies and bank accounts worldwide.

Other innovations, such as artificial intelligence (AI) and enhanced data intelligence could have a more powerful impact in the near term – allowing for more efficient and cost-effective risk management processes. For example, an AI-enabled system that had learned money-typologies could, in theory, proactively ascertain when and where risks are likely to emerge based on past trends. It could intelligently analyse high numbers of contextual data points (such as account profile data from CRM, non-transactional behaviour from web login activity, and other unstructured data sources) to create a highly-refined risk score, and help ensure strong risk controls.

The reinvention of correspondent banking has risen to a new normal, with new technology enabling the industry to reach a higher level of efficiency, while maintaining its focus on the safe and secure movement of funds around the world.


1 See https://bit.ly/2uOKVKr at iccwbo.org
2 See https://bit.ly/2eAUhAd and the FATF recommendations at https://bit.ly/2GHXKr9 at fatf-gafi.org
3 See https://bit.ly/2GFluwl at swift.com
4 See https://bit.ly/2q9O80r at swift.com for updates on SWIFT gpi
5 See Trade Finance and the Blockchain at corporates.db.com
6 See https://we-trade.com at we-trade.com

Christian Westerhaus

Head of Clearing Products, Cash Management | Deutsche Bank

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