Decisions loom on correspondent banking

Laurence Neville
Published on:

One impact of the current economic and regulatory environment is that correspondent banking – the provision of services to other banks to enable them to service their own clients – is facing a shake-up.

The demand for such services could fall given the need to control costs, according to Peter Jameson, head of GTS FI product and network strategy, EMEA, at Bank of America Merrill Lynch. "Often banks have built up broad correspondent networks," he notes. "In many cases, the fixed costs of maintaining these networks – in terms of account management and due diligence – are not matched by the volumes of payments their clients make."

When interest rates were high, fixed costs were relatively unimportant. "Now the focus is on reducing fixed costs if they are not delivering profitability and balance-sheet value in terms of the cost of business," says Jameson. "For example, if a bank’s clients only make a handful of payments in a currency, it is increasingly difficult to justify maintaining accounts with correspondent banks in that market. Instead, they might consider whether it makes sense to consolidate correspondent accounts for multiple countries to one global bank. Alternatively, they could simply initiate payments out of a centralized account in one currency, such as euro, and use their transaction bank’s FX capabilities to make overseas payments on behalf of clients."

For end-users, a move away from a network of correspondent banks to provision of services by a global transaction bank should have limited impact. "Cut-off times may be less competitive than if accounts were held locally" says Jameson "but given that by definition the underlying clients in such a situation have limited traffic, that is unlikely to be a problem (especially if the end-client is not in the same time zone). Any increase in transaction costs as a result of the elimination of local correspondent accounts can be easily borne by the FI given they will benefit from the cost and efficiency savings of eliminating one or more correspondent relationships."

Just as demand for correspondent banking services could be reduced to cut costs, the pressures of the low interest rate environment and strong pricing competition on transaction fees is also likely to prompt small and medium-sized banks to reconsider if they want to continue to provide correspondent banking services – potentially reducing supply. "Many of these banks have never consciously decided to become correspondent banks anyway," says Nadine Lagarmitte, global head of financial institutions, payments and cash management at HSBC, "they just built up services as a result of reciprocity."

Another disincentive to act as a correspondent bank is the ever-increasing volume of anti-money-laundering and anti-terrorism compliance requirements such as the EU directive on money laundering and the USA Patriot Act, which add an additional component of risk to the business. Moreover, correspondent banking will no longer be as financially attractive because of Basle III. Historically, banks have been rewarded by the balances that result from flows. However, under Basle III, balances can no longer be treated as part of the correspondent’s balance.