How RegTech can help correspondent banking make a comeback

The news that Western Union is suspending its services in Afghanistan due to the ongoing instability in the country is just one more blow to those Afghans who rely on remittances to survive. Indeed, the global economic disruptions of the last 18 months have refocused attention on the issues surrounding international remittance flows in a far wider sense.

These vital drivers of humanitarian assistance and global development have increasingly been impeded by a high regulatory burden that has led to a global decline in correspondent banking – a key if often overlooked pillar of the global economy. Fortunately, new technical solutions – Regulatory Technology (RegTech) – to deal with regulatory compliance more effectively already exist, and their large-scale application could incentivize banks to retain their correspondent banking networks – and facilitate remittances again.

A global lifeline

A look at the importance of remittances, especially in the context of the Covid-19 pandemic, gives an idea of the host of problems related to the inability of people to send money to their families abroad – and showcases RegTech’s potential. Economies and individuals all over the globe have been hit hard by the pandemic, but perhaps none more so than low and middle income countries (LMICs) which are highly dependent on the monies earned by their expatriate populations and sent home. In places like Haiti, Honduras, Tajikistan and Tonga, such remittances account for over a fifth of GDP. Although the World Bank’s predicted 20% drop-off in remittances didn’t manifest itself globally, certain regions experienced greater austerity than others.

Bangladesh, for example, is the 11th largest recipient of remittances across the globe, with a 13 million-strong diaspora contributing around $15 billion to the economy. The freeze on some industries and the collapse of others meant that 660,000 Bangladeshis were sent back to their home country in the wake of the Covid-19 outbreak, with an estimated two million more at risk of following in their footsteps. That meant that 2020 was the lowest year for remittance reporting in a decade and a 25% decrease from 2019, resulting in a 50% increase in poverty levels over.

Correspondent banking’s global decline

At the same time, transferring remittances across the globe has become more difficult over the years, due to the fact that the web of global correspondent banking relationships has been shrinking continuously. Correspondent banking – the provision of banking services by one bank to another in a different jurisdiction – allows for effecting global financial transactions in places where they have no physical presence. However, as a report by the Bank for International Settlements (BIS) revealed, “over the past decade, cross-border correspondent bank relationships have declined by about one fifth.”

Between 2011 and 2018, the number of corresponding banks dropped by 20%, primarily due to increased regulatory pressures on banks to adhere to an increasingly complex catalogue of compliance rules. Tellingly, regulatory fines have surpassed $300 billion in the last ten years, while the cost of compliance is only set to rise further. This has led many banks to cut ties to their local correspondent banking partners, opting to “de-risk” rather than deal with now-outdated compliance regulations related to cutting terror-financing and money-laundering imposed by the US Treasury and Federal Reserve on the global banking system.

Feeling the pain in Bangladesh and Mexico

Even so, these developments don’t affect all regions equally. For example, South Asia, Latin America, including Mexico, and the Caribbean have been hit hardest, from Islamic banks to national flagship institutions. Bangladesh especially has been facing de-risking by international banks since 2008. One of the biggest hits to the country occurred in 2016 when HSBC terminated all US-dollar clearing services in the country and, by doing so, exposed Bangladesh’s banking sector to severe vulnerability – and reduced its access to the international banking system.

Mexico has been disproportionally affected as well, reflecting the challenges of Latin America as a whole. Highly dependent on cross-border financial transactions and remittances from the US, Mexico’s remittances payment market in recent years gradually shrank from one characterized by competition between a multitude of service providers to one dominated by banking oligopolies, as a direct consequence of excessive regulatory requirements imposed by US financial institutions. This not only carries greater risk of making the market, ironically, more opaque, but also increases the cost of family remittances in what is a painful blow to Mexico’s economic development.

Can Regtech undo de-risking?

While regulatory pressures are behind the current decline in correspondent banking, the trend could be reversed using state-of-the-art vetting technology. Advanced tools such as biometrics, blockchain and data analytics can already be leveraged to make compliance less time-intensive and, importantly, less costly, doing away with the need to “de-risk” altogether.

Companies like QuantaVerse are seeking to tackle regulation and compliance using AI that detects suspicious activity and reduces false positives. At the same time, Fenergo is working to replace de-risking “by effective Customer Due Diligence (CDD) or Enhanced Due Diligence (EDD) practices” in order to prevent financial institutions from opting to pull its correspondent banking business from a given area of the world and encouraging a transition to more cost- and operationally-efficient systems.

Such benefits derive from RegTech’s capacity to automate most, if not all, processes involved in compliance, which can importantly do away with the time lag usually involved in data collection by the financial institution and assessment and verification by the regulator. Use of AI and complex data analytics means that data collection and assessments happen in real-time.

Large-scale implementation of these and other solutions would help re-integrate economies from Bangladesh, the Middle East and Mexico into the global financial system and would likely lead to reduced remittance fees as competition in the sector rises again. Not only would this potentially help prevent driving payments underground, but instead contribute to tackling inequality in the developing world and medium-income countries.

Image credit: Mike Lawrence/Flickr

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