Correspondent banking: risks and risk management

Publication date 31-01-2025

Correspondent banking plays a crucial role in the global financial system. It enables international payments, supports trade transactions and facilitates cross-border financial activities. However, due to its complexity and borderless nature, correspondent banking also entails significant risks, particularly in the areas of money laundering and terrorist financing.

This article is written in response to the recommendations from the FATF evaluation of the Netherlands in the summer of 2022. This evaluation highlighted several focus points that are relevant to the effectiveness of measures against money laundering and terrorist financing within correspondent banking relationships. The article brings together existing literature in a readable format and combines this with an analysis of transactions declared suspicious. It thus offers a comprehensive analysis of correspondent banking, how it works, the risks involved, and the measures that financial institutions can take to mitigate these risks.

The information presented is based on a wide range of sources and helps to understand the complexity and requirements for effective risk management in correspondent banking.

Definition of correspondent banking

In non-legal terms, correspondent banking is a service provided by one bank (the correspondent bank) to another bank (the respondent bank) to facilitate cross-border payments and provide other financial services, such as cash management, cheque clearing, accounts payable and foreign currency provision. This often occurs in situations where the respondent bank does not have direct access to a particular market or currency. Correspondent banking relationships utilise a network of banking relationships around the world to execute payments and other transactions on behalf of their clients.

The definition as stated in the Dutch Money Laundering and Terrorist Financing (Prevention) Act (Wwft), Section 1, par. 1 under a and b:

“correspondent relationship:

a. the provision of banking services by a bank as correspondent to another bank as respondent, including the provision of a current or other deposit account and related services, such as cash management, international money transfers, cheque processing, transit accounts and currency exchange services; or

b. the relations between banks, between other financial enterprises, or between banks and other financial enterprises, where similar services as referred to under a are provided by a correspondent institution to a respondent institution, including relations entered into for securities transactions or money transfers;”

Normal functioning of correspondent banking

In practice, correspondent banking encompasses a wide range of services, including facilitating international payments, providing currency exchange services, trade finance, and providing credit lines. A typical example is when a bank in one country wants to make a payment in another currency to a beneficiary in another country. The bank can then use a correspondent bank in that country to facilitate the transaction. This can be done either through a bilateral relationship or via a chain of banks. Another example is a bank in country A entering into a relationship with a correspondent bank in country B in order to gain access to the financial system of country B. This correspondent bank can then process payments, transfer funds and provide liquidity to the bank in country A.

Added value of correspondent banking

The added value of correspondent banking lies in facilitating international trade and payments. It provides banks with access to markets where they would otherwise be unable to operate, supports currency transactions and reduces the need for banks to have offices or subsidiaries in every country. By reducing dependence on multiple banks and currencies, correspondent banking improves the efficiency and effectiveness of the global financial system.

Correspondent banking in the Netherlands

Looking at the situation in the Netherlands, we note the following:

• The Netherlands has traditionally been an international trade hub;
• The Netherlands has three major banks with an extensive network of correspondent banks, which are also major players in international trade and finance [footnote1];
• There are large transaction volumes flowing through the Netherlands [footnote2] and
• The Netherlands has a large trust sector with many foreign clients and use of Special Purpose Vehicles (SPVs) to optimise tax liabilities [footnote3].

This implies that correspondent banking is expected to play a significant role in the Netherlands and that knowledge of the integrity risks associated with correspondent banking is relevant for the Netherlands.

Various forms of correspondent banking

Difference between correspondent banking and intermediary banks

Correspondent banking should not be confused with intermediary banks, although the terms are sometimes used interchangeably. In correspondent banking, there is a direct relationship between the respondent bank and the correspondent bank. Intermediary banks, on the other hand, act as intermediaries in a chain of banks involved in a specific transaction. Intermediary banks are usually used when there is no direct correspondent banking relationship between the banks involved, and their role is often limited to processing payments.

Nostro and vostro accounts

Nostro and vostro accounts form the core of correspondent banking. A nostro account (“our account with you”) is an account that a bank holds with a foreign bank in the local currency of that country. A vostro account (“your account with us”) is the opposite: an account held by a foreign bank with a local bank in the currency of the country where the bank is located. These accounts enable banks to manage liquidity, carry out currency transactions and facilitate cross-border payments.

Downstreaming, nesting and transit accounts

Downstreaming means that a respondent bank receiving services from a correspondent bank passes these services on to other banks that have no direct relationship with the original correspondent bank. This increases the integrity risk (such as money laundering and terrorist financing) because the underlying banks and their clients may not be sufficiently vetted.

Transit accounts exist when the correspondent bank account of the respondent bank is directly accessible to clients of the respondent bank and these clients can carry out their transactions directly through this account by making deposits and writing out cheques on the account.

Recommendation 13 of the FATF

The Netherlands previously complied with most of the requirements for correspondent banking, but there were shortcomings with regard to enhanced customer due diligence for financial institutions (FIs) in EU Member States and enforcement in the case of pay-through accounts.

Customer due diligence in correspondent banking

• Financial institutions (FIs) in the Netherlands must conduct customer due diligence (CDD) on every client, including correspondent banking relationships.
• For cross-border correspondent banking relationships, FIs must gather information about the respondent bank, evaluate that bank's anti-money laundering and counter-terrorist financing (ML/FT) procedures, obtain senior management approval, and define responsibilities. However, this only applies to correspondent banking relationships outside the EEA (European Economic Area).
• FIs must ensure that the respondent bank identifies and verifies the identity of clients with direct access to transit accounts, and that client information is available upon request. These requirements only apply to correspondent banks outside the EEA.
• Prohibition on Shell Banks [footnote4]: FIs may not enter into or continue correspondent banking relationships with shell banks [footnote5] or with FIs that are known to allow shell banks to use their accounts.

Money laundering risks of correspondent banking

Correspondent banking is inherently risky due to the involvement of multiple parties and the often cross-border nature of the transactions. Because the services often involve multiple banks, respondent banks may be exposed to the weaknesses of other banks in the chain. The weakest bank in the transaction flow makes every bank vulnerable.

This complexity can be exploited by money launderers and terrorist financiers to conceal cash flows. The ability to transfer large sums of money quickly between banks and jurisdictions without direct control over the final beneficiary increases the risk of money laundering. A well-known example of this is the Danske Bank Laundromat. Between 2007 and 2015, approximately €200 billion in suspicious transactions were processed through the bank's Estonian branch, mainly originating from Russian and other Eastern European clients.

An example of a money laundering risk is the use of shell banks via correspondent banking relationships. Shell banks can be used to carry out anonymous transactions, which poses a significant money laundering risk. This risk can now be considered very low for Dutch financial institutions due to the ban on relationships with shell banks.

Correspondent banks often have no direct relationship with the ultimate parties to a transaction, which means that they have no way of verifying the identity of these parties. This lack of transparency increases the risk that correspondent banks' clients will gain access to international banking systems without sufficient controls.

The involvement of payment institutions in the payment chain is seen as a new emerging risk.

The degree of risk depends on many factors. These include geographical factors and supervision in the jurisdictions concerned, the products and services used, the risk measures taken by the banks involved, the transparency of the parties concerned about their own ownership structures, and the extent to which banks have agreements among themselves about responsibilities for mitigating risks.

Red flags for detecting abuse of correspondent banking vulnerabilities

Some important red flags mentioned in the literature that may indicate abuse of correspondent banking relationships include:

• Unusual or complex payment chains involving multiple intermediary banks.
• Irregular or unexpected transactions in terms of volume, frequency or geographical region.
• The use of shell banks or unknown banks in high-risk jurisdictions.
• Correspondent banking relationships with banks without adequate anti-money laundering procedures.
• Requests for payments to or from jurisdictions with weak supervisory and anti-money laundering regimes.

Key risk mitigation measures

Financial institutions can take various measures to mitigate the integrity risks of correspondent banking:

1. Risk Assessment: where risk mitigation measures always start; conducting a detailed correspondent banking risk assessment. Especially if you act as a correspondent bank. This can be part of the Systematic Integrity Risk Analysis (SIRA) for the corporate banking department, with questions such as: How many respondents do we have? Where are they active? What kind of client base do they have? How many requests for information do we send? What fluctuations do the respondents/ correspondents have in their payment transactions?
2. Due diligence: performing strict due diligence before entering into a correspondent banking relationship, including assessing the counterparty's anti-money laundering measures, their compliance history, and their presence in risk areas.
3. Transaction monitoring: implementation of advanced transaction monitoring systems to detect suspicious transactions. This includes the use of data analysis and artificial intelligence to detect patterns that indicate possible money laundering activities.
4. Periodic reassessment: regular reassessment of existing correspondent banking relationships to ensure that they continue to meet the internal risk criteria and comply with laws and regulations.
5. Training and awareness: regular training of employees on money laundering risks and the specific risks associated with correspondent banking to improve the effectiveness of monitoring and risk management.

Responsibility and supervision

Financial institutions involved in correspondent banking have a responsibility to take adequate measures to prevent money laundering and terrorist financing. This includes performing due diligence when entering into correspondent banking relationships, monitoring transactions, and reporting suspicious activities to the relevant (supervisory) authorities in a timely manner.

Supervisory authorities also play an important role by monitoring compliance with legislation relating to correspondent banking in processes such as risk identification, evaluation and mitigation. Banks are required to ensure transparency and to implement robust anti-money laundering programmes.

Analysis of suspicious transactions reported in relation to correspondent banking

Section 16, par. 1 of the Wwft stipulates:

" an institution shall report unusual transactions that have been carried out or are planned without delay to the Financial Intelligence Unit once the unusual nature of the transaction has become apparent."

The Financial Intelligence Unit (FIU) may declare these transactions suspicious after analysis and thus transfer them to investigative authorities. Based on the transactions declared suspicious, the AMLC conducted an analysis of transactions that appear to be related to correspondent banking. Suspicious transactions are not automatically labelled as related to correspondent banking by reporting institutions or the FIU. We therefore used a search query to filter transactions that contained keywords in the transaction notes that could be related to ‘correspondent banking’.

Number of suspicious transactions in relation to correspondent banking

Suspicious transactions were found based on the following search terms:
"correspondent banking", "MT202", "MT103", "intermediary bank", "loro", "nostro", "vostro", "correspondent fee", "intermediary charges", "intermediary fee", "swift charges", "swift fee". Despite validation of these search terms by experts, these search terms will not be exhaustive.

The explanatory notes accompanying these transactions declared suspicious were read and classified in the context of the preparation of this article. The search resulted in 121 suspicious transactions with transaction dates in the period from May 2012 to mid-2024.

The transaction date may be years in the past, because the unusual nature of transactions sometimes becomes apparent later, or because facts and circumstances arise at a later date that result in a declaration of suspicion. It should be noted that the majority of the suspicious transactions analysed have a transaction date after 2019. The explanatory notes accompanying the 121 suspicious transactions were read and classified in the context of the preparation of this article.

Disclaimer regarding the filtering of transactions declared suspicious

Perhaps needless to say, the filtering method we use does not provide a 100% reliable picture. However, the descriptions accompanying these transactions declared suspicious do provide some insight into the types of risks that need to be considered in correspondent banking. This is all the more so because, in the vast majority of cases, the reporting banks provided very extensive and detailed descriptions of the reasons for reporting.

Most notable findings regarding transactions declared suspicious

Based on the analysis of transaction descriptions, we have arrived at the following findings:

• The number of transactions declared suspicious in relation to correspondent banking (121) over a period of 10 years is not exceptionally high. There may be various reasons for this, such as:
  • unknown foreign transaction parties, which limits the effectiveness of matching in ongoing investigations;
  • Dutch banks' lack of familiarity with the background of the transactions and the transaction description, which is often based on a request from the correspondent bank to the respondent bank;
  • low priority or not always correct labelling of these types of transactions at banks or FIU;
  • the possibility that correspondent banking remained underexposed for a long time, partly due to the complexity of the transactions, which made it difficult (and still does) to notice and report their unusual nature.
• From 2019 onwards (Danske), we have seen an increase in the attention paid to correspondent banking by several parties in the chain, and banks are also paying more attention to control. The size of these transactions (see next bullet point) and their descriptions (as further explained in the list below) therefore indicate more than a low risk of money laundering in correspondent banking.
• The average transaction amount is over €2.5 million. The total amount of the 121 transactions declared suspicious (both actual and intended) is therefore over €300 million;
• In approximately 40% of cases, the suspicious transactions involve a transaction party (country of origin of funds/country of destination of funds) in a (then qualifying) high-risk jurisdiction, such as the United Arab Emirates, Turkey and Russia;
• Approximately 1/5 of the transactions were shared by a foreign FIU with the Dutch FIU;
• Based on the description of a number of suspicious transactions, it appears that approximately 20% can be linked to investigative information. These transactions may have been reported following media attention;
• From the description of the vast majority of suspicious transactions, it is clear that these transactions can be very complex in nature. This is due to the involvement of multiple parties in the transaction: not only multiple financial institutions, but also parties that initiate and receive transactions. A significant number of reports concern a sending bank, several intermediary banks and a receiving bank, with the initiating and receiving parties to the transaction initially only partially visible to the reporting bank. Nevertheless, in many reports it can be concluded that the compliance department of the reporting party is still able to uncover a great deal of information retrospectively and add this to the report to the FIU;
• In many cases, corresponding (and reporting) banks do not obtain a clear picture of the legitimacy of the transactions because they have no direct relationship with the private or business parties initiating or receiving the transactions. In many cases, the banks do not receive any explanations for the transactions when they make enquiries. The descriptions indicate that reporting banks regularly have to route these requests for information through various parties (because they do not have a direct client relationship themselves, they have to request information from the correspondent bank), which seems to suggest that this makes it more difficult to gain a clear picture of the legitimacy of the transactions. Incidentally, the description does not reveal what actions banks subsequently take (such as blocking such payments or reviewing correspondent banking relationships), apart from reporting the transactions to the FIU;
• Sectors that are regularly mentioned in the descriptions of the transactions include traders in fruit and vegetables, gold, flowers, perfume and cosmetics, cars/trucks, electronic goods, and immovable property.
• In some cases, the reporting institution links the transactions to terrorist financing, VAT carousel fraud, laundering of proceeds from drug trafficking, etc.
• Banks often report a combination of red flags, such as the suspicion that the payer and recipient have the same identity, an unexplained increase in volume (in both number of transactions and volumes) in a very short period of time, rounded amounts, amounts that appear to fall just below reporting thresholds, involvement in laundromats, illogical payment routes (e.g. from country A to B to C and finally to D), involvement of PEPs or UBOs who appear in bad press or are far too young for the activities they perform on paper, involvement of high-risk jurisdictions and industries.

Conclusion

Correspondent banking plays a crucial role in the global financial system, but also carries risks in the areas of money laundering and terrorist financing. These risks require constant attention and action from financial institutions and regulators. Implementing robust risk management practices and technologies can help banks minimise their exposure to these risks and contribute to a safer and more resilient financial system.

In the FATF evaluation of the Netherlands in 2022, the Dutch FIU assessed the money laundering risk associated with correspondent banking as “medium”. This classification is based on the observation that the parties involved appear to be aware of the risks. In the Netherlands, De Nederlandsche Bank (DNB) and the FIU participated in a risk analysis in the field of correspondent banking in 2023 and 2024, known as the EU-COBA PROJECT. This led, among other things, to DNB including correspondent banking in its sector analysis (publication expected at the end of January 2025) and DNB indicated that it would pay extra attention to this, the form of which is still being studied. In 2025, FIU-NL will also enter into discussions with banks that offer COBA services in order to improve the recognisability, quality and uniformity of reports on correspondent banking.

In addition, the Netherlands' National ML/TF Risk Assessment (NRA) states that correspondent banking relationships pose a systemic risk over which money launderers have relatively little direct influence. For these reasons, correspondent banking is not considered one of the highest risks.

At the same time, the suspicious transactions analysis in this article shows that there are serious money laundering indicators, such as large transaction volumes, complex chains and the involvement of high-risk countries.

Footnotes

[Footnote1,back to text] Although specific details about the size of their correspondent banking networks are not publicly available, it is reasonable to assume that ING, Rabobank and ABN AMRO Bank, given their size and international activities, have the largest correspondent banking networks in the Netherlands.

[Footnote2,back to text] An important indicator of this is the balance of payments, which provides an overview of all transactions between the Netherlands and other countries within a certain period.

https://www.dnb.nl/statistieken/dashboards/betalingsbalans

Another relevant aspect is international trade in goods and services. In 2018, the import value of goods amounted to €442 billion, while the export value was €495 billion. This underlines the significant trade flows that pass through the Netherlands.

https://longreads.cbs.nl/trends19/economie/cijfers/internationale-handel

[Footnote3,back to text] SPV: Special-purpose vehicle: a company established and used for only a single transaction.

[Footnote4,back to text] Section 5, par. 5 Wwft

[Footnote5,back to text] Shell banks are banks without a physical presence in any jurisdiction and without affiliation to a regulated financial group.