Correspondent banking due diligence (CBDD) is the process of assessing and mitigating the risks associated with providing banking services to other financial institutions (the "correspondent banks"). These correspondent banks, in turn, provide services to their own customers. This creates a layered risk profile, as you're indirectly dealing with the customers of the correspondent bank.

The primary purpose of CBDD is to prevent the correspondent banking relationship from being used for illicit activities such as money laundering, terrorist financing, sanctions evasion, and other financial crimes. It's a crucial part of a financial institution's Anti-Money Laundering (AML) and Know Your Customer (KYC) programs.

Here's a breakdown of key aspects of correspondent banking due diligence:

1. Risk Assessment & Categorization:

• Understanding the Risk: The first step is to assess the overall risk posed by establishing a correspondent banking relationship. This involves considering factors such as:


• Geographic Location: Countries with weak AML/CFT regimes, high levels of corruption, or known terrorist financing activities pose higher risks.


• Customer Base: The types of customers served by the correspondent bank. (e.g., high-risk industries, politically exposed persons (PEPs), cash-intensive businesses).


• Services Offered: The types of services the correspondent bank offers (e.g., wire transfers, trade finance, cash management).


• Regulatory Environment: The regulatory oversight in the correspondent bank's jurisdiction. Is it a member of FATF? How effectively is the local regulation enforced?


• Ownership Structure: Who owns and controls the correspondent bank? Is it transparent?


• Reputation: Any negative news, regulatory actions, or investigations involving the correspondent bank.


• Risk Categorization: Based on the risk assessment, correspondent banks are typically categorized as high, medium, or low risk. This categorization determines the level of due diligence required.

The due diligence process involves gathering and analyzing information about the correspondent bank. The depth of the due diligence should be commensurate with the assessed risk. Common due diligence steps include:

• Information Gathering:


• KYC Information: Collect standard KYC information, including the correspondent bank's name, address, incorporation details, ownership structure, and key personnel.


• AML/CFT Program Information: Review the correspondent bank's AML/CFT policies, procedures, and internal controls. This should include:


• Customer Due Diligence (CDD) processes


• Transaction monitoring systems


• Sanctions screening procedures


• Suspicious Activity Reporting (SAR) procedures


• Independent audit functions


• Training programs for employees


• Regulatory Information: Obtain copies of relevant licenses and regulatory approvals. Verify their good standing with local regulators.


• Financial Information: Review the correspondent bank's financial statements to assess its financial stability.


• Certifications and Questionnaires: Request completion of certifications regarding compliance with AML/CFT regulations and sanctions programs. Standardized questionnaires like the Wolfsberg CBDDQ (Correspondent Banking Due Diligence Questionnaire) are often used.


• On-site Visits (for high-risk correspondent banks): Conducting an on-site visit to the correspondent bank to assess its operations and compliance programs firsthand.


• Verification:


• Independent Verification: Verify the information provided by the correspondent bank through independent sources, such as:


• Regulatory databases


• Credit reporting agencies


• Public records


• Commercial databases


• Internet searches


• Beneficial Ownership Verification: Identify and verify the ultimate beneficial owners of the correspondent bank.


• Analysis and Documentation:


• Document Everything: Maintain a clear and auditable record of all due diligence activities, including the information gathered, the verification methods used, and the conclusions reached.


• Risk Profile Creation: Develop a risk profile for each correspondent bank, summarizing the key risks and mitigating factors.

• Periodic Reviews: Conduct periodic reviews of correspondent banking relationships, based on the risk rating. High-risk relationships should be reviewed more frequently.


• Transaction Monitoring: Monitor transactions flowing through the correspondent account for unusual activity, patterns, or red flags that could indicate money laundering, terrorist financing, or sanctions evasion. This includes:


• Unusually large or frequent transactions


• Transactions to or from high-risk jurisdictions


• Transactions involving shell companies


• Transactions that are inconsistent with the correspondent bank's business profile


• Negative News Screening: Continuously monitor for adverse news or media reports that could impact the correspondent bank's reputation or compliance with AML/CFT regulations.


• Updating Information: Regularly update KYC information and risk assessments to reflect changes in the correspondent bank's business, regulatory environment, or risk profile.

• Triggering Events: Have clear criteria for terminating a correspondent banking relationship, such as:


• Failure to provide required information


• Discovery of significant AML/CFT deficiencies


• Evidence of illicit activity


• Regulatory sanctions or enforcement actions


• Changes in the correspondent bank's risk profile that are unacceptable


• Documentation: Document the reasons for terminating a correspondent banking relationship.


• Reporting (if applicable): Report the termination to the appropriate regulatory authorities if required.

• De-risking: The trend of financial institutions terminating correspondent banking relationships with banks in certain regions or sectors due to perceived risks. While de-risking can reduce risk for the individual institution, it can also have negative consequences for financial inclusion and economic development.


• Shell Banks: Prohibited from establishing correspondent banking relationships with shell banks (banks that have no physical presence in any country).


• Beneficial Ownership Transparency: Obtaining accurate and up-to-date information on the ultimate beneficial owners of correspondent banks can be challenging.


• Cost and Resources: Implementing a robust CBDD program can be resource-intensive, requiring dedicated staff, technology, and training.


• Global Standards and Regulations: Navigating the complex and evolving landscape of AML/CFT regulations and standards across different jurisdictions.


• Technology Solutions: Leveraging technology solutions, such as AML transaction monitoring systems, KYC platforms, and screening tools, to automate and streamline the CBDD process.

Several regulatory bodies provide guidance on correspondent banking due diligence, including:

• Financial Action Task Force (FATF): The FATF Recommendations set the international standard for AML/CFT.


• Basel Committee on Banking Supervision (BCBS): Provides guidance on risk management and supervision of correspondent banking.


• U.S. Department of the Treasury's Office of Foreign Assets Control (OFAC): Enforces sanctions programs and provides guidance on sanctions compliance.


• The Wolfsberg Group: An association of global banks that develops standards and guidelines for financial crime compliance. Their CBDDQ is a widely used tool.


• Local Regulators: Each country's banking regulator will have its own specific requirements for CBDD.