ACAMS AML in Correspondent Banking 2 — Questions and Answers
Question 1: What is a 'respondent bank' in a correspondent banking relationship?
- The larger bank providing services and access to payment systems
- The foreign or smaller bank that receives correspondent banking services from the correspondent bank (Correct answer)
- The central bank overseeing the correspondent relationship
- The regulatory body approving the correspondent agreement
Correct answer: The foreign or smaller bank that receives correspondent banking services from the correspondent bank
In a correspondent banking relationship, the respondent bank is the foreign or smaller institution that gains access to financial services — such as U.S. dollar clearing or trade finance — through the correspondent bank.
Correspondent banking involves two parties: the correspondent bank (typically a large, well-established bank in a major financial center) that provides services; and the respondent bank (typically a smaller, often foreign bank) that accesses those services. The correspondent bank provides services such as: U.S. dollar or euro clearing; wire transfer access; trade finance; foreign exchange; and custody services. The AML risk lies primarily with the respondent bank's customers — the correspondent bank is effectively providing services to the respondent's customers (its customers' customers, or 'nested' customers) without direct knowledge of their identities.
Question 2: What is 'nested correspondent banking' and why does it increase AML risk?
- When a correspondent bank invests in the respondent bank's equity; creates conflicts of interest
- When a respondent bank provides its own correspondent services to other banks using the first correspondent bank's infrastructure, creating additional layers of unknown customers (Correct answer)
- When multiple correspondent banks agree to share AML compliance costs
- When a central bank authorizes a commercial bank to conduct correspondent operations
Correct answer: When a respondent bank provides its own correspondent services to other banks using the first correspondent bank's infrastructure, creating additional layers of unknown customers
Nested correspondent banking occurs when a respondent bank offers correspondent services to other financial institutions (sub-respondents), causing the original correspondent bank to unwittingly provide services to banks it has never vetted, dramatically increasing exposure to unknown ML/TF risks.
In nested correspondent banking, Bank A (correspondent) provides services to Bank B (respondent), which in turn provides correspondent services to Banks C and D using Bank A's infrastructure. Bank A has no direct relationship with Banks C and D and may have no knowledge of their customers. This creates: unknown customer risk (Bank A processes transactions for customers several layers removed); difficulty in applying CDD; potential access to U.S. financial systems by sanctioned or high-risk institutions; and obscured transaction origins. Regulators require correspondent banks to assess respondents for whether they conduct nested services and to implement controls to identify and manage this risk.
Question 3: Under FATF Recommendation 13, what specific AML measures must correspondent banks apply?
- File a SAR for every wire transfer involving respondent banks
- Gather sufficient information about respondent banks, assess their AML controls, obtain senior management approval, and document respective AML/CFT responsibilities (Correct answer)
- Require respondent banks to post collateral equal to 10% of annual transaction volume
- Limit correspondent relationships to banks in FATF member countries only
Correct answer: Gather sufficient information about respondent banks, assess their AML controls, obtain senior management approval, and document respective AML/CFT responsibilities
FATF Recommendation 13 requires correspondent banks to: assess the respondent's AML/CFT controls; document respective responsibilities; obtain senior management approval for new relationships; and be satisfied the respondent is not a shell bank.
FATF Recommendation 13 requires that when establishing correspondent banking relationships, the correspondent institution must: gather sufficient information to understand fully the nature of the respondent's business; determine the reputation of the institution and the quality of supervision; assess the respondent's AML/CFT controls and satisfy itself they are adequate and effective; obtain approval from senior management before establishing new correspondent relationships; and document the respective AML/CFT responsibilities of each institution. Correspondent banks are prohibited from entering into or continuing relationships with shell banks and must ensure respondent banks do not permit their accounts to be used by shell banks.
Question 4: What is a 'payable through account' (PTA) and what AML risk does it present?
- A nostro account used for foreign currency settlement; creates currency mismatch risk
- An account a foreign bank maintains at a U.S. bank that allows the foreign bank's customers to conduct transactions directly, potentially giving unknown third parties access to U.S. financial systems (Correct answer)
- An escrow account held for a specific business purpose; creates misappropriation risk
- A savings account with automatic bill payment; creates overdraft risk
Correct answer: An account a foreign bank maintains at a U.S. bank that allows the foreign bank's customers to conduct transactions directly, potentially giving unknown third parties access to U.S. financial systems
Payable-through accounts allow customers of a foreign respondent bank to directly access the U.S. correspondent bank's services, potentially giving unknown foreign individuals direct access to the U.S. financial system without adequate AML screening.
Payable-through accounts (PTAs) are correspondent accounts through which the respondent bank's customers can conduct transactions directly (writing checks, making wire transfers) using the correspondent bank's U.S. account. The AML risk is that the correspondent bank may not know the identities of the foreign bank's customers who are directly accessing U.S. financial services. Under 31 USC 5318(i), U.S. banks maintaining PTAs must identify and verify the identity of each foreign bank's customers who are authorized to use or direct transactions through the PTA, unless the foreign bank provides certification that it has applied appropriate customer identification procedures.
Question 5: Which regulatory action best illustrates the consequences of inadequate correspondent banking AML controls?
- The imposition of Volcker Rule restrictions on proprietary trading
- The $1.9 billion FinCEN/DOJ settlement with HSBC in 2012 for AML failures including correspondent banking violations (Correct answer)
- The Glass-Steagall separation of commercial and investment banking
- The Basel III capital adequacy requirements for systemically important banks
Correct answer: The $1.9 billion FinCEN/DOJ settlement with HSBC in 2012 for AML failures including correspondent banking violations
The 2012 HSBC settlement — then the largest AML penalty in U.S. history — resulted from HSBC's failure to maintain adequate AML programs, including processing transactions for drug cartels through its U.S. operations and providing correspondent banking services to banks with ties to sanctioned countries.
The 2012 HSBC settlement ($1.9 billion) was groundbreaking and involved: HSBC Mexico serving as a conduit for drug cartel money (Sinaloa, Norte del Valle cartels); HSBC's U.S. affiliate clearing transactions for HSBC affiliates in high-risk countries; inadequate transaction monitoring; and correspondent relationships with banks that had ties to countries under U.S. sanctions. HSBC entered into a deferred prosecution agreement (DPA) and was required to install an independent compliance monitor. The case demonstrated that even the largest global banks face criminal liability for AML failures and established precedents for individual accountability, enhanced monitoring requirements, and clawback of compensation.
Question 6: What does it mean for a correspondent bank to conduct 'due diligence on the due diligence' of a respondent bank?
- Auditing the respondent bank's financial statements for accuracy
- Assessing the quality and robustness of the respondent bank's own AML/KYC program, rather than simply accepting certifications at face value (Correct answer)
- Requiring the respondent bank to submit to joint regulatory examination
- Verifying that the respondent bank has filed the required number of SARs annually
Correct answer: Assessing the quality and robustness of the respondent bank's own AML/KYC program, rather than simply accepting certifications at face value
Due diligence on due diligence means the correspondent bank evaluates how well the respondent bank actually knows its own customers — assessing the quality of the respondent's AML program, not just confirming it exists.
When a correspondent bank conducts due diligence on a respondent, it should go beyond confirming that policies exist. It should assess: whether the respondent's AML policies align with international standards; whether the respondent is subject to effective regulatory supervision; quality of the respondent's CDD and EDD procedures; whether beneficial ownership is properly identified; how effectively the respondent monitors transactions; the respondent's SAR filing history and quality of STR reporting; any past regulatory actions or enforcement; and whether the respondent's controls are consistent with the risk of its customer base and geographic footprint. This assessment helps the correspondent bank understand whether relying on the respondent's KYC creates unacceptable risk.
ACAMS AML in Correspondent Banking 2
What is a 'respondent bank' in a correspondent banking relationship?