Banks face a hidden risk of sanctions under a complex correspondent banking system

Financial institutions without exposure to Russia still face significant indirect sanctions risk through the correspondent banking services they provide to other banks.

Correspondent banks act as intermediaries in cross-border transactions between banks that do not have formal ties, and they rely on “responding” banks to perform due diligence on customers. They risk facilitating illicit payments if the responding banks knowingly or unknowingly breach the sanctions.

“You trust that your correspondent banking customers’ anti-money laundering systems will detect the risk – but what if they don’t and you unknowingly process those funds?” said Eric Li, director of research at Coalition Greenwich, a research firm owned by S&P Global.

That means banks without direct exposure to Russia could end up unwittingly facilitating money transfers for sanctioned entities, Li said. The US, EU and other governments have imposed sanctions on Russian banks following the Russian invasion of Ukraine.

“The risk is real, and it will probably, at some point, affect every bank on this planet,” Li said. said.

Most banks around the world engage in correspondent banking, with more than 11,000 financial institutions using Swift, the messaging system that underpins the business. In February, Swift facilitated more than 45 million financial messages per day, according to its latest traffic data.

Correspondent banks generally do not have direct relationships with the underlying parties in a transaction. Their clients, the responding banks, conduct customer screening, including determining beneficial owners or sources of funds.

Some U.S. banks have already cut U.S. dollar clearing services to Western lenders who have remained in the Russian market, even though they are there legally, according to Daniel Tannebaum, global head of sanctions at consultancy Oliver Wyman.

“The appetite for absorbing any sort of indirect risk is just zero among some vendors,” said Tannebaum, who worked for the US Treasury’s Office of Foreign Assets Control. “If you are involved in the underlying financing of an unauthorized transaction and you are within a few layers of where this potential breach occurs, you may still be held liable.”

Banks remaining in Russia

Banks will be particularly exposed to the risks of indirect sanctions through correspondent links with ffinancial institutions in countries that have close ties to Russia or no sanctions program in place, such as China or India, or Russian lenders that are not sanctioned, Li said.

But Western counterparties can also pose a risk, given that many have maintained some presence in Russia, Tannebaum said.

“Correspondent banking due diligence has always been quite difficult. This situation makes it impossible,” he said.

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Banks risk facilitating illicit payments due to deliberate attempts by responding banks to evade sanctions or accidental or administrative errors because relevant information was not accurate or available, said Rachel Woolley, global chief crime officer. finance at Fenergo, a regulatory technology company.

Typically, payment messages sent through Swift will provide some, but not all, details related to a transaction, Woolley said. For example, they may not include information about the beneficial owners of a company.

The lack of transaction information makes it harder for bank screening software to detect sanctioned activity that passes through correspondent banking links, said Braddock Stevenson, a lawyer in investigations and white-collar defense practices at the Paul Hastings law firm.

“The problem with indirect exposure is that compliance verification procedures may not see it,” Stevenson said.

A network of intermediaries

A complex web of global correspondent banking relationships means that a single cross-border payment may pass through several intermediary banks in different jurisdictions before arriving at its final destination.

The more intermediaries there are, the harder it is for a financial institution to validate the legitimacy of a cross-border payment, according to a 2020 report from the Financial Stability Board. Data provided to respond to initial checks may lack elements needed for checks under other national regimes, he said.

According to the US National Counter-Terrorist Financing Strategy 2020, weak or inconsistent sanctions oversight across jurisdictions increases the likelihood that correspondent accounts can be exploited to facilitate the flow of illicit proceeds.

Correspondent banking has been at the heart of major financial crime schemes, where illicit actors have exploited weak links in the chain to launder money in the European and American financial system.

The Estonian branch of Danske Bank A/S, for example, was discovered in 2018 by an internal investigation to have handled up to €200 billion in suspicious money from non-residents between 2007 and 2015. Meanwhile, international lenders including JPMorgan Chase & Co., Bank of America Corp. and Deutsche Bank AG would have acted as correspondent banks for the branch and helped it to clower dollar transactions.

JPMorgan reportedly ended its relationship with Danske Bank Estonia in 2013, while Bank of America and Deutsche Bank followed in 2015. Deutsche received an administrative fine in Germany for reporting misconduct related to the case, although cleared of allegations of aiding and abetting money laundering. US investigations into the case are ongoing.

S&P Global Market Intelligence contacted JPMorgan, Bank of America, Deutsche Bank and Swift to ask if the correspondent bank poses an increased risk of sanctions in the current environment. All declined to comment.

Fines can happen

Banks now face a “significant operational burden” to ensure transactions through their correspondent banking relationships are compliant, and they will likely re-examine relationships in light of the dispute, Woolley said.

Correspondent banks could face administrative or financial penalties if they fail to put in place appropriate controls and policies to mitigate risk, Woolley said, adding that the reputational damage of being embroiled in a scandal could be detrimental.

Failure to comply with sanctions is a serious offence. French bank BNP Paribas SA paid a record fine of around $9 billion in 2015 after violating US sanctions against Sudan, Iran and Cuba.

Given the complexity of sanctions against Russia, it’s “highly likely” that authorities, including the United States, will begin to investigate breaches over time, said Vitaline Yeterian, the group’s senior vice president. Financial Institutions Index from DBRS Morningstar. It’s the “frontline” banks that face the highest enforcement risk, she said.

As is often the case, it could well take years for such scandals to emerge, Li said.

About Ruben V. Albin

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