A correspondent bank is a financial institution providing services on behalf of another financial institution. The bank accepts deposits, collects documents, facilitates wire transfers, and conducts business on behalf of a banking counterpart. Correspondent banks are most often used by domestic banks who want to offer services in a foreign country. The correspondent bank acts as the domestic bank’s foreign agent.
A bank can employ a correspondent bank for several reasons, but most banks opt to do so because they have limited access to foreign financial markets. Domestic banks without physical bank branches in foreign countries can forge a correspondent banking relationship to serve their clients abroad. A correspondent bank can process documents, facilitate transfers, and accept deposits on behalf of a domestic bank “back home.”
Both banks hold an account for the other bank, referred to as nostro and vostro accounts. These names refer to the account held for another bank by the holding bank and the account of the counterpart respectively. These accounts allow both parties to track credits and debits and are the core of the correspondent banking relationship.
Correspondent banking brings international financial access to countries who are otherwise cut off from the global banking network. When banks lose their access to a correspondent bank, the poorest countries are the ones who suffer the most.
The correspondent banking industry is facing a crisis. Offshore banks are losing their American correspondent banking relationships at an unprecedented rate. U.S. banks cite increasing compliance costs and lack of profitability as their main reasons for shutting down correspondent banking relationships. Sounds familiar? These are the same reasons given to explain the MSB banking crisis. And the ramifications are just as serious.
The truth is that the termination of correspondent banking relationships comes down to one thing and one thing only: risk-based compliance. For American banks, compliance hangs heavy over every transaction. Banks face penalties and fines if they are found to be in violation of the Bank Secrecy Act. For banks working with partners abroad, the compliance risk is even higher. The sheer physical separation makes it harder for banks to keep a handle on the relationship. Is the foreign partner meeting Know Your Customer (KYC) requirements, keeping proper records, and properly vetting every customer and transaction?
Why is the decline in correspondent banking relationships so bad? This phenomenon reduces the ability to send and receive international payments and threatens to drive payment flows underground to the black market. The Financial Stability Board (FSB), which coordinates financial regulation for G20 countries, notes that this trend has “potential adverse consequences on international trade, growth, financial inclusion, as well as the stability and integrity of the financial system.” The countries hit by derisking experience a loss of financing options and difficulties importing and exporting goods.
American nonprofits working abroad are also hit by the actions of their domestic banking partners. When correspondent banking ties are severed, NGOs can have difficulty accessing cash to carry out their operations. This translates into project delays or even the shutting down of non profit operations.
The domino effect of derisking is such that when one bank is hit with fines, other banks follow suit. Currently, U.S. banks are severing their correspondent banking ties with foreign banks in the the Caribbean, Latin America, and Africa in an attempt to avoid regulatory penalty. How can banks safely serve foreign financial institutions? It boils down to creating effective KYC policies and procedures. A heightened level of transparency and increased communication can also support compliant correspondent banking relationships. Banks abroad that rely on American correspondent banks should take swift action to implement enhanced KYC and compliance programs.
In the same way that the correspondent banking crisis promotes international financial exclusion in the poorest countries, the MSB banking crisis cuts of financial access in the poorest American neighborhoods. As a result of redlining, many low income neighborhoods do not have traditional bank branches. Even if they did, the high costs of traditional banking would exclude low income families. Money service businesses like check cashers offer alternative financial services that fill this void in banking access.
Unlike foreign banks, money service businesses are subject to the same strict risk-based compliance regulation as their American banks. As a result, forging compliance and profitable relationships should not present the same challenge. American banks, however, are still severing ties with domestic money service businesses. Thanks to both the real risk and the heightened perceived risk of alternative financial service providers, banks are terminating MSB bank accounts. Similar to the correspondent banking crisis, MSBs can make themselves more attractive to big banks by implementing a rigorous compliance program.
By adhering to rigid new customer vetting practices, maintaining detailed and adequate records, submitting the appropriate reports, and submitting to external audits, MSBs can signal to banks that they are serious about financial regulation. The first step is to hire an MSB compliance expert to analyze the risks associated with your business. From there, you can craft a compliance program that meets federal regulation and takes your unique traits into account.
For both banks and the MSBs they serve, the main regulation guiding compliance efforts is the Bank Secrecy Act of 1970 (BSA). The BSA was enacted by Congress to encourage inter-agency cooperation by requiring U.S. financial institutions to assist U.S. government agencies in the detection and prevention of money laundering. When we speak about anti-money laundering (AML) efforts, we are most often discussing BSA requirements.
The documents generated by MSBs and banks in compliance with the BSA are used by law enforcement agencies. These agencies rely on the reports and records heavily to identify patterns of suspicious behavior and, in turn, to detect financial crime. On the other side, these meticulous records aid in the prosecution of financial criminals. The inter-agency cooperation required by the BSA is the best line of defense against money laundering and other illegal financial activities.
Since regulations are constantly changing and new threats arise daily, MSBs rely on compliance experts. In order to stay banked, MSBs can’t risk falling behind on regulatory requirements or marring their compliance records. A strong compliance program is the key that opens the door to a reliable banking relationship. MSBs need a real MSB business bank account in order to facilitate transactions, so a smart MSB stays laser-focused on compliance.
NCC was founded to confront the threat of derisking. As an ally for MSBs and check cashers, NCC provides real MSB bank accounts, MSB banking services, and compliance consulting for money service businesses. To do this, NCC uses a network of MSB banks that they have built as a result of their excellent compliance record. NCC’s team of compliance experts tracks federal and state regulations to provide solutions before new requirements are handed down by FinCEN. This means that you are never scrambling last minute to comply, which can leave you vulnerable to a violation.
As you can see, the threat of derisking has serious consequences both at home and abroad. The best way for your MSB to stay ahead of the threat is to stay compliant and find a reliable bank account. NCC’s unique network of banks gives you redundant banking partners. This means that even if one bank decides to shed risk, there are others waiting to accept your account. There is no other way to gain this kind of banking continuity in today’s financial regulation landscape.