AUSTRAC Regulatory Guide

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Chapter 6 - Correspondent banking

 

 



Chapter outline

This chapter discusses requirements and resources for correspondent banking and contains the following sections

 

Key points

Chapter applies to

Financial institutions with correspondent banking relationships

Relevant part of the AML/CTF Act 8
Commencement date 12 June 2007
Relevant AML/CTF Rules Chapter 3 of Anti-Money Laundering and Counter-Terrorism Financing Rules Instrument 2007 (No. 1) & chapter 35 of the AML/CTF Rules in Anti-Money Laundering and Counter-Terrorism Financing Rules Instrument 2009 (No.3)
Relevant guidance note(s)
Correspondent banking
Relevant FATF Recommendation(s) 7 & 18
Relevant section(s) of the AUSTRAC SAQ J & I(4)
What does this chapter mean for me? You must not enter a relationship with a shell bank or another financial institution that deals with shell banks. You must conduct initial and ongoing due diligence assessments on the correspondent banking relationships you have.
What do I need to do? If you maintain correspondent banking relationships you should prepare and document your processes for conducting due diligence assessments

Additional external resources

The Wolfsberg Group's 'Wolfsberg Anti-Money Laundering Principles for Correspondent Banking' website www.wolfsberg-principles.com/corresp-banking.html
The Basel Committee on Banking Supervision's 'Customer due diligence for banks' website www.bis.org/publ/bcbs85.pdf
U.K. - Joint Money Laundering Steering Committee "Prevention of money laundering/combating the financing of terrorism", Parts I and II.

 

 

 

Introduction

This chapter covers the provisions related to correspondent banking in Part 8 of the AML/CTF Act. Correspondent banking was not addressed under the FTR Act.

Correspondent accounts are commonly used by banks internationally to undertake financial transactions for themselves and their customers in jurisdictions where they generally have no physical presence. A wide range of services can be settled through a correspondent banking relationship, including:

  • payments, including telegraphic or electronic transfers and drafts
  • foreign exchange, including wholesale note clearances
  • payable through and nested accounts
  • cash letters and collections
  • managed investments and mortgage schemes
  • custodian account arrangements
  • trade finance transactions
  • syndicated loans.

 

Correspondent banking relationships are vulnerable to money laundering and terrorism financing because they involve a bank carrying out financial transactions on behalf of another bank's customers. This indirect relationship means that the correspondent bank provides services in a situation where it is unlikely to have either verified the identities or obtained first-hand knowledge of the respondent's customers. (27)

If they do not undertake an appropriate level of initial and ongoing due diligence on such accounts, banks expose themselves to a range of risks associated with money laundering or terrorism financing and may find themselves transacting funds that originated from illegal activity.

Correspondent accounts with shell banks are also associated with a very high risk of money laundering or terrorism financing. The AML/CTF Act defines a 'shell bank' generally as a corporation that is incorporated in a foreign country and authorised to carry on banking business in that country, but does not have a physical presence in its country of incorporation. (28)

When do the provisions commence?

The correspondent banking provisions of the AML/CTF Act commenced on 12 June 2007.

What are the relevant FATF recommendations?

Part 8 of the AML/CTF Act contains the correspondent banking provisions, which implement FATF Recommendations 7 and 18.

Appendix H contains the relevant FATF recommendations and associated interpretative notes.

What are the requirements for correspondent banking?

Definition of correspondent banking

'Correspondent banking relationship' is defined in section 5 of the AML/CTF Act and involves the provision of banking services by one financial institution (first institution) to another (second institution), where the financial institutions carry on activities or business at or through permanent establishments in different countries and the banking services are of a kind described in the AML/CTF Rules.

The second institution may be a subsidiary or related company of the first institution. A company is taken to be related to another company as described in section 50 of the Corporations Act 2001 (Corporations Act) where a company is a holding company, subsidiary, or holding company subsidiary, of another company. The term 'subsidiary' is defined in section 46 of the Corporations Act.

Chapter 2 of Anti-Money Laundering and Counter-Terrorism Financing Rules Instrument 2007 (No. 1) provides that the correspondent banking relationship definition relates only to banking services involving nostro or vostro accounts. The terms 'nostro' and 'vostro' are not defined in the AML/CTF Act or AML/CTF Rules, but it is commonly held that:

  • a nostro (Latin for 'ours') account is an account a financial institution holds with a foreign financial institution, usually in the currency of the foreign country
  • a vostro (Latin for 'yours') account is the account a financial institution holds on behalf of a foreign financial institution.

 

Requirements under the AML/CTF Act

The correspondent banking provisions of the AML/CTF Act can be divided into two
broad themes:

  • the prohibition on entering into a correspondent banking relationship with a shell bank
  • the requirements to conduct risk and due diligence assessments in relation to correspondent banking relationships.

 

The AML/CTF Act provides that:

  • a financial institution must not enter into a correspondent banking relationship with a shell bank and must terminate any such existing relationship within 20 days, if they become aware that the other party is a shell bank or another financial institution that has a correspondent banking relationship with a shell bank (sections 95 and 96)
  • before a financial institution enters into a correspondent banking relationship with another financial institution, the first financial institution must carry out a preliminary risk assessment and, where warranted, a more extensive due diligence assessment (section 97)
  • the financial institution entering into the correspondent banking relationship is required to have senior officer approval (subsection 99(1)), with the senior officer having regard to the due diligence assessment carried out under section 97 and paragraph 3.1.2 of Anti-Money Laundering and Counter-Terrorism Financing Rules Instrument 2007 (No. 1)
  • where a financial institution has entered into a correspondent banking relationship with another financial institution, the (first) financial institution must carry out regular risk assessments and where the risk warrants them, due diligence assessments (section 98)
  • financial institutions must document each party's AML/CTF responsibilities under their correspondent banking relationships (section 99).

 

Requirements under the AML/CTF Rules

Chapter 3 of Anti-Money Laundering and Counter-Terrorism Financing Rules Instrument 2007 (No. 1) addresses correspondent banking. These Rules have been made to clarify:

  • what matters must be addressed when conducting a due diligence assessment before entering into a correspondent relationship
  • what matters must be addressed when conducting regular due diligence assessments on existing relationships
  • other issues about correspondent banking relationships.

A financial institution must assess the following matters when conducting initial or regular correspondent banking due diligence:

 

Assessable matters for correspondent banking due diligence:

  1. the nature of the other financial institution's business, including its product and customer base
  2. the domicile of the other financial institution
  3. the domicile of any parent company of the other financial institution
  4. the existence and quality of any AML/CTF regulation in the other financial institution's country of domicile
  5. the existence and quality of any AML/CTF regulation in the country of domicile of any parent company of the other financial institution - where the parent company has group-wide controls and where the other financial institution operates within the requirements of those controls
  6. the adequacy of the other financial institution's controls and internal compliance practices in relation to AML/CTF
  7. the ownership, control and management structures of the other financial institution and any parent company, including whether a politically exposed person has ownership or control of the other financial institution or any parent company
  8. the other financial institution's financial position
  9. the reputation and history of the other financial institution
  10. the reputation and history of any parent company of the other financial institution
  11. whether the other financial institution has been the subject of an investigation, or any criminal or civil proceedings relating to money laundering or terrorism financing.

Exemptions

The Anti-Money Laundering and Counter-Terrorism Financing Rules Amendment Instrument 2009 (No. 3) has added Chapter 35 into the AML/CTF Rules, providing an exemption for reporting entities from carrying out customer identification procedures in relation to signatories of vostro accounts.

What are the risk indicators for correspondent banking?

Money launderers exploit vulnerabilities to successfully legitimise illicit funds. Vulnerabilities in correspondent banking come in many forms. Identifying these vulnerabilities or risks is critical if a financial institution is to mitigate and manage them. Banks have many considerations when deciding to establish correspondent banking relationships, including credit and operational risk. The risks associated with money laundering or terrorism financing (ML/TF risk) should be an integral part of this process and the main risks are outlined here.

Inadequate due diligence risk

The degree of due diligence exercised by some banks appears to be determined by whether credit is being granted in the correspondent relationship, with more due diligence carried out where credit is being granted. The failure of banks to include measures to detect money laundering or terrorism financing when undertaking due diligence on correspondent accounts exposes them to ML/TF risk. Banks are exposed to greater risk on correspondent accounts if:

  • the correspondent bank provides services to banks that are not physically present in any country (see 'Shell bank risk')
  • a correspondent bank establishes a relationship with a respondent bank that permits the opening of accounts for carrying out transactions with shell banks
  • the respondent bank has a relationship with a third-party bank (nested accounts)
  • the country of the respondent bank has not implemented AML/CTF regulations (see 'Jurisdiction risk')
  • the correspondent bank has not reviewed the respondent bank's existing AML/CTF practices before establishing the relationship
  • the respondent bank does not apply KYC controls to identify existing and non-established customers
  • the respondent bank has a reputation of a poor financial position
  • the respondent bank has been subject to regulatory action
  • the respondent bank does not conduct regular audits
  • the respondent bank does not employ a monitoring system designed to identify and report suspicious activity/transactions
  • the respondent bank does not screen new account activity against lists of known or suspected terrorists. (29)

 

Adding to the risk for banks is the possibility that, when they attempt to undertake due diligence, the respondent bank may not want to cooperate. Third-party relationships are then unlikely to be disclosed and there is the risk of banks being misled or given unreliable information, either intentionally or unintentionally.

Shell bank risk

Section 95 of the AML/CTF Act prohibits a financial institution from entering into or maintaining a correspondent banking relationship with a shell bank. This is because providing services to shell banks, or dealing with respondent banks that provide services to shell banks, involves an increased risk of being exposed to activities associated with money laundering or terrorism financing. However, the challenge for reporting entities is being able to correctly identify whether they are dealing with a shell bank or with a respondent that deals with a shell bank.

There is no public or private resource that provides a complete list of shell banks, but several organisations create bank identification lists. However, the authors may not necessarily verify whether the information is accurate or current. Because shell banks can open and close quickly, they may also be considered a 'moving target'. The fact that they have no physical presence also makes it difficult to gain access to records or identify the:

  • ownership structure
  • nature of customer base
  • services they provide
  • purpose of accounts.

To minimise shell bank risk, the USA PATRIOT Act requires US financial institutions to obtain a declaration from foreign financial institutions wishing to establish a correspondent banking relationship, stating that the foreign institution is not a shell bank. Financial institutions with correspondent banking relationships may wish to consider having counterparties sign
a similar declaration.

 

Jurisdiction risk

Jurisdiction poses the following significant risks associated with money laundering or terrorism financing for correspondent banking relationships:

Inadequate AML/CTF standards and supervision. According to the U.K. - Joint Money Laundering Steering Group, 'Certain jurisdictions are recognised internationally as having inadequate AML standards, insufficient regulatory supervision, or present greater risk for crime, corruption or terrorist financing'. (30) Banks with which a correspondent relationship may be considered high risk may be located in tax and/or secrecy havens and jurisdictions that have previously been designated as non-cooperative in the fight against money laundering (see the FATF's list of non-cooperative countries and territories www.fatf-gafi.org).

Increased chance of high-risk clients. High-risk jurisdictions may present an increased chance of high-risk clients. Some correspondent banks assume their correspondent banks have already performed all necessary anti-money laundering controls, including KYC and other customer due diligence. This assumption may not be valid. Money launderers exploit banks in countries with weak AML/CTF laws that do not undertake stringent customer identification and verification procedures.

Different risks in different jurisdictions. In dealing with a bank in one particular jurisdiction, it cannot be assumed that the ML/TF risk associated with that jurisdiction will be the same as that faced by a branch of that bank in another jurisdiction. The fact that a particular bank may have branches located in a high-risk jurisdiction may impact on the overall ML/TF risk presented by the correspondent bank.

Inadequate and/or inappropriate due diligence assessments. Inadequate and/or inappropriate due diligence assessments of jurisdiction risk may arise from following standard risk formulas, or from general risks that have not been tailored to take account of new information known in the industry or the individual circumstances surrounding the correspondent relationship. Inadequate due diligence risk is discussed further below.

Product/service risk

The form and flexibility of different products and services related to correspondent banking mean that some are more vulnerable to money laundering or terrorism financing than others. Many services in correspondent banking are 'pay away' in nature, providing irrevocable release of funds. Loss of control over these products and services due to shared responsibility for creating and delivering them may lead to an increased vulnerability to money laundering or terrorism financing. The following specific products or services may be particularly vulnerable.

Payments

Payments or funds transfer systems such as SWIFT may represent a heightened degree of risk, depending on factors such as:

  • the number and dollar volume of transactions
  • whether cash is involved
  • the geographic location of originators and beneficiaries (see 'Jurisdiction risk')
  • whether the originator or beneficiary is a bank customer
  • whether the customer has been identified
  • whether the source of the funds has been established.

 

Payable through accounts

Banks should be particularly alert to the risk that correspondent accounts might be used directly by third parties to transact business on their own behalf; for example, by using payable through accounts.

Payable through accounts typically involve a foreign bank providing its local customers with a full range of banking services (including deposits, withdrawals and cheque accounts) at the local bank through the foreign bank's correspondent account. Payable through accounts are also known as 'pass through accounts' or 'pass by accounts' and such customers are referred to as 'sub-account holders'.

Payable through account activities should not be confused with traditional correspondent banking relationships, whereby a foreign bank's customers can transact through a domestic bank but they do not have direct access to the correspondent account at the domestic bank. A payable through account arrangement actually provides sub-account holders with direct access to the domestic bank to independently transact.

Payable through accounts may be prone to higher ML/TF risk because banks do not typically implement the same level of customer due diligence, if any, on these accounts as they do
for their own customers.

Nested accounts

Nested accounts allow a foreign financial institution to gain access to the domestic financial system by operating through a domestic correspondent account belonging to another foreign financial institution. The problem occurs where a bank operating in Australia is unaware that its foreign correspondent financial institution is providing such access to third-party foreign financial institutions. As a result these third-party financial institutions can effectively gain anonymous access to the Australian financial system.

Nested accounts add another layer in the flow of funds between sender and beneficiary and mean the Australian bank is further removed from knowing the identities, business activities or types of financial services provided by these sub-respondents. Behaviour that indicates nested accounts includes:

  • transactions with jurisdictions in which the foreign correspondent financial institution has no known business activities or interests
  • transactions involving total volumes that significantly exceed expected activity for the foreign correspondent financial institution, considering its customer base and asset size.

 

Cash letters and wholesale note clearances

Cash letters and wholesale note clearances involve the use of a carrier, courier or a referral agent employed by the courier to transport currency (wholesale note clearances), monetary instruments (cash letters) and other documents from a foreign bank to a local bank (or vice versa, however, the risk may be different). Cash letter and wholesale note clearance services are commonly offered in conjunction with correspondent banking and contain loan payments, transactions for demand deposit accounts and other transactions. (31)

An example of the ML/TF risk associated with cash letters is that criminals can purchase these at a value below the reporting threshold in order to avoid reporting requirements, or from banks in countries with weak AML/CTF regulations, and have them couriered to credit accounts in foreign institutions.

Indicators of money laundering in cash letters include instruments:

  • purchased on the same or consecutive days at different locations
  • numbered consecutively in amounts under the threshold
  • with payee lines left blank or made out to the same person
  • containing little or no purchaser information
  • bearing the same stamp, symbol or initials
  • purchased in round denominations or repetitive amounts
  • where, after being deposited, a funds transfer out soon follows.

What resources are available to assist reporting entities?

The Wolfsberg Group

The Wolfsberg Group is an association of 12 global banks, which aims to develop financial services industry standards for KYC and AML/CTF policies, among other topics.

In November 2002 the group released the Wolfsberg Anti-Money Laundering Principles for Correspondent Banking, which is available at www.wolfsberg-principles.com/corresp-banking.html.

Basel Committee on Banking Supervision

The Bank for International Settlements is an international organisation that fosters international monetary and financial cooperation and serves as a bank for central banks.

The Basel Committee on Banking Supervision was established by the Bank for International Settlements and in October 2001 released the Customer due diligence for banks paper, which includes a section on correspondent banking and is available at www.bis.org/publ/bcbs85.pdf.

 


Additional AUSTRAC resources

 

Frequently asked questions

Q. Can a reporting entity adopt its foreign parent company's correspondent banking due diligence assessments to meet its obligations under Australian law?

A. A correspondent banking due diligence assessment must reflect the specific circumstances and business arrangements of the reporting entity and its correspondent banking relationships. To ensure that the correspondent banking assessment delivers outcomes that ensure compliance with the AML/CTF legislation, a reporting entity may use their foreign parent's correspondent banking assessments but only as a starting point for their own assessment.

 


 

(27) FATF 2002, Report on Money Laundering Typologies 2001-2002, FATF, Paris, France, February, www.fatf-gafi.org/, viewed 24 February 2009.

(28) See section 15 of the AML/CTF Act 2006, available from www.comlaw.gov.au

(29) Bert, S. 2004, Developing Correspondent Account Procedures and Policies: Part II, cited in Compliance Headquarters, http://www.complianceheadquarters.com/AML/AML_Articles/8_25_04b.html, viewed 24 February 2009.

(30) Joint Money Laundering Steering Group, Prevention of Money Laundering/Combating the Financing of Terrorism - Guidance for the UK Financial Sector Part II: Sectoral Guidance, January 2006, Correspondent Banking, p. 109, available at www.jmlsg.org.uk/content/1/c4/68/87/Final_Part_II_030306.pdf.

(31) Federal Financial Institutions Examination Council, BSA/AML Examination Manual 2006, Pouch Activities, p. 182, available at www.occ.treas.gov/handbook/BSA-AMLintro-overview.pdf.


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