AUSTRAC Regulatory Guide
Chapter 6 - Correspondent banking
This chapter discusses requirements and resources for correspondent banking and contains the following sections
Additional external resources
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:
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)
The correspondent banking provisions of the AML/CTF Act commenced on 12 June 2007.
Part 8 of the AML/CTF Act contains the correspondent banking provisions, which implement FATF Recommendations 7 and 18.contains the relevant FATF recommendations and associated interpretative notes.
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:
Requirements under the AML/CTF Act
The correspondent banking provisions of the AML/CTF Act can be divided into two
The AML/CTF Act provides that:
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:
A financial institution must assess the following matters when conducting initial or regular correspondent banking due diligence:
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.
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:
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.
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:
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
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.
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 or funds transfer systems such as SWIFT may represent a heightened degree of risk, depending on factors such as:
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
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:
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:
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.
(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.