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2016 Expert views

Re-inventing correspondent banking

“The correspondent banking industry can benefit from new technologies as long as it can be proved that we can provide a combination of technology and the normal business of banks, which is risk taking and liquidity provision.”

By Emmanuel de Bouard, Head of Cash Clearing, GTB

Correspondent banking is facing a revolution: new compliance requirements, new entrants, real-time payments and new technologies, are changing the nature of correspondent banking. The nature of risks banks face is also changing.

These changes come with costs; compliance in particular requires significant investments by correspondent banks. For example, Know Your Customer laws mean that extensive customer identification processes have to be carried out by each bank. Correspondent banks have built up their customer bases over many years and would be reluctant to share customer names among themselves in a utility-type arrangement, which would reduce costs. The costs correspondent banks face are likely to increase in the future, but are so far not reflected in the fees charged to customers.

New entrants into the payments market have their own technologies, systems and in some cases currencies. They are taking payments that used to go through banks. While a payment remains within a particular community – such as Bitcoin or Ripple – the payment can be treated as a book entry transfer. However, once a member of one of these communities wants to pay someone in another, a bank or a settlement system must become involved.

The new correspondent banking environment has three elements: traditional correspondent banks, new providers and a combination of the two. I am not certain that any of the players will ‘eat’ the other. New entrants lack the trust the correspondent banking community has built over the years. While all the participants within Bitcoin, for example, trust each other do they trust the participants in Ripple? In these cases people will want to link in with an entity that can provide trust and cover the risk – such an entity is a correspondent bank.

This becomes a wider issue as real-time payments are rolled out internationally. There is a push for real-time payments in many countries and correspondent banking will have to evolve to meet these international, real-time payments requirements.

The new technologies making real-time payments possible will also play an important role in helping banks to meet their compliance requirements. New regulations require banks to put a great deal of information together in a very short time, therefore such technologies will help, particularly when it comes to fighting fraud or money laundering.

The promise of new technologies and real-time payments needs to be balanced with the knowledge, trust and risk mitigation that are the characteristics of traditional correspondent banking. These characteristics have enabled the correspondent banking industry to enable payments to be made in near real-time around the world. If the industry is to move to fully real-time payments, the principles of trust, availability of liquidity and risk mitigation must remain in place.

Central banks will accept new market entrants because to do so is in line with their competition policies. However, if these new entrants start to lend to each other that is another matter because they will be creating money and will have to be regulated in a different way.