Correspondent Banking and AML Risk

A correspondent banking arrangement links banks across borders to settle international payments and provide services in foreign markets. From an AML perspective, correspondent relationships are high-risk because they create layering—multiple intermediaries obscuring transaction origins—and reduce visibility into end clients. A payment might pass through a foreign bank that has limited due diligence standards, making it difficult for the originating institution to know who ultimately benefits.

Why banks use correspondents

International commerce requires cross-border money movement. A U.S. exporter selling goods to a Japanese importer needs both banks to exchange currencies and settle payments. Neither bank can operate in every country and currency. So they maintain correspondent accounts—accounts held by Bank A at Bank B—to facilitate these flows.

The correspondent relationship is foundational to global finance. Bank A pays for imported goods, and that instruction travels through Bank B to Bank C in a third country, eventually reaching the beneficiary. Without correspondent networks, trade and investment would grind to a halt. But this same layering—instructions crossing multiple banks and jurisdictions—creates the perfect vehicle for money laundering. Each intermediary obscures the previous link. Shell companies and false business invoices fit seamlessly into the flow.

Correspondent banking was already risky from an AML standpoint. The post-9/11 push to choke terrorist financing made it riskier. The 2008 financial crisis, and subsequent enforcement actions against major banks for inadequate correspondent screening, made institutions hyper-cautious. Today, correspondent relationships are among the most heavily scrutinised in banking.

How money laundering exploits correspondent chains

The classic trade-based money laundering scheme uses correspondents to move value. A criminal network invoices goods between subsidiaries at inflated or deflated prices. The payment instruction leaves the originating bank, which may verify basic details but cannot easily trace the final beneficiary. It flows through one, two, or three correspondent banks, each with its own AML procedures and data systems. By the time the payment reaches its destination, the origin is diffuse.

More directly: a shell company opens an account at a foreign bank (often in a weak-regulation jurisdiction) and makes deposits of illicit funds. That foreign bank transfers the money onward through a correspondent account. The correspondent bank may not know the foreign bank’s customer base or due diligence standards. The funds arrive at a U.S. or European bank where they are now mixed with legitimate transfers, and the originating criminality is lost in the noise.

Correspondents also enable politically exposed persons to hide assets. A corrupt official’s ill-gotten wealth enters a correspondent network in one jurisdiction, travels through neutral intermediaries, and emerges in a bank account that bears no obvious link to the official. Multiple jurisdictions, multiple banks, multiple languages—each hop is an opportunity to erase footprints.

The shell bank problem

A shell bank is a bank without a physical presence in its home country and unaffiliated with a regulated financial group. It exists mainly on paper to receive and route funds. Shell banks are favorites for money launderers because they often have minimal due diligence standards and no real oversight. A correspondent bank that services a shell bank is, by extension, servicing the financial black market.

U.S. regulators banned banks from maintaining correspondent relationships with shell banks in 1999. However, the definition is narrow: a shell bank must lack presence in its home country and be unaffiliated with a regulated group. A bank that is nominally licensed in an offshore jurisdiction but has minimal oversight and no real operations remains legal to correspond with, and it remains dangerous.

Identifying true shell banks requires due diligence that many correspondent banks have historically not performed. An institution looking to open a correspondent account asks: Does the bank have a real office? Who are its owners? What is its actual AML program? Does it conduct its own customer due diligence, or is it a pass-through? These questions sound straightforward but are hard to verify, especially in poorly regulated jurisdictions where public records are opaque or corrupt officials sit on banking boards.

Enhanced due diligence for correspondent banking

Recognising the risk, regulators now require enhanced due diligence on correspondent relationships. An institution that wishes to accept a correspondent account from a foreign bank must:

• Conduct detailed research into the correspondent bank’s ownership, governance, and AML procedures
• Verify that the correspondent bank is regulated by a credible authority in its home country
• Assess whether the correspondent bank’s AML program meets international standards
• Document the correspondent bank’s customer base and identify any shell-bank associations
• Establish what classes of customers and transactions the correspondent will service
• Monitor the correspondent account for unusual flows and periodic compliance

If a correspondent bank’s AML program is weak, the relationship must be escalated or terminated. A U.S. bank cannot knowingly service a foreign bank whose due diligence is lax. To do so is to knowingly facilitate the movement of illicit funds.

The Federal Reserve and the Office of the Comptroller of the Currency issued detailed guidance on correspondent banking compliance in 2014. Both agencies have brought enforcement actions against major banks for inadequate due diligence on correspondent relationships, resulting in hundreds of millions in penalties. The message is clear: correspondent relationships are not routine; they are high-risk arrangements that demand active management.

Beneficial ownership and the tracing problem

A correspondent payment might list an intermediate entity as the sender. That entity is itself a corporate shell with no obvious beneficial owner. A correspondent bank that cannot identify the ultimate beneficial owner of a transaction cannot assess its legitimacy.

This is where correspondent banking collides most directly with money-laundering schemes. A shell company sends money through Correspondent A, which transfers to Correspondent B, which transfers to the beneficiary bank. At each step, the intermediary is asked: Who owns this shell? What is its business? The answers are often “unknown” or “not our problem.” The correspondent is content to facilitate the transfer and collect the fee.

Modern AML standards require “know-your-customer’s-customer” (KYCC) verification for correspondent transactions above certain thresholds. But KYCC is expensive and technically difficult across jurisdictions. Many banks have responded by simply withdrawing from correspondent relationships in high-risk regions—a form of de-risking that has cut off entire markets from the global financial system.

De-risking and its consequences

De-risking—the withdrawal of correspondent banking services from entire countries or regions—has become endemic in the post-2008 era. Major Western banks have terminated correspondent relationships with banks in Africa, the Middle East, and Pacific island nations. The rationale is defensible: the cost of due diligence and compliance risk is too high to justify the fee revenue.

But de-risking has an unintended consequence: it cuts off legitimate institutions and businesses in those regions from global commerce. A small bank in a developing country may be well-run and compliant, but if it cannot find a correspondent in a major financial centre, it cannot process international payments. Trade halts. The cost falls on exporters and importers who are doing nothing wrong.

Regulators have begun criticising de-risking, arguing that banks should apply risk-based decisions rather than blanket withdrawals. But the incentives are misaligned: banks face enforcement action for a single undetected illicit flow through a correspondent, but they face no sanction for de-risking that impairs an entire economy. Until that calculus changes, correspondent banking will continue to shrink in high-risk jurisdictions.

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