Challenges are mounting for the traditional correspondent banking model, but innovative technology can reduce the risks and increase speed and global reach
Correspondent banking facilitates cross-border payments that support global trade, finance and remittances. To borrow the phrase used by the Bank for International Settlements (BIS), it’s an “arrangement under which one bank (correspondent) holds deposits owned by other banks (respondents) and provides payment and other services to those respondent banks”.
This simple definition belies the vast and complex network of relationships, critical linkages, rules and regulations that underpin global payment flows. Although the correspondent model has existed in various forms for centuries, today it faces many challenges that mean it must evolve to remain relevant. The urgent need for change was underlined by the G20 in April 2020, when the Financial Stability Board (FSB) called for the public and private sectors to cooperate on innovation projects. As a result, in October 2021, the FSB issued the G20 Roadmap for Enhancing Cross-border Payments.
Facing the future
So, why the need for change? There are four main problems that payment innovators must solve: high cost, low speed, limited access, and limited transparency. Together they present serious obstacles to growth and financial inclusion. Although the volume and value of transactions are growing, correspondent banking relationships are declining while operational costs are rising and margins are shrinking. According to a recent press release from the BIS, correspondent banking contracted by 25% between 2011 and 2020.
Over the past decade, banks have withdrawn relationships in many countries and regions, a practice known as ‘de-risking’. This is in response to the growth of illicit financing and the introduction of more onerous governance and controls. Anti-money laundering (AML) and countering the financing of terrorism (CFT) regulations have made it more demanding to maintain some relationships – hence the desire to exit certain geographies – while the hardening economic climate after the global financial crisis has dented profitability.
In addition to meeting compliance requirements, banks have experienced operational challenges because of legacy technology platforms, interoperability issues, and the complexity of different data standards. All have been barriers to progress and financial inclusion, with the result that correspondent banking has increasingly become the preserve of privileged regions and customer types. Smaller local banks, money transfer operators (MTOs), start-up businesses and questionable individuals may be excluded because of a binary risk-based approach. Instead of managing risks, banks frequently make simple yes/no decisions, pushing the underserved to use unregulated shadow banking for payments.
The key issue is that banks are assessing opportunities on a subjective basis. Rather than focus on the merits of individual transactions, one transaction at a time, they are entering (or exiting) correspondent relationships based solely on the perceived risks in a particular geography or with a particular customer. This is neither good for business growth nor for financial inclusion. If transactions are processed through complex chains, such as downstream relationships, or nesting, transparency becomes the issue. When multiple underlying relationships are involved, the end customer is obscured and it is far harder to identify bad transactions, so banks don’t want to accept the risk. However, correspondent risks can be managed if banks know the transaction.
Payments in the digital era
Digital technology is modernising parts of the payments chain and can revive correspondent banking, and there is no shortage of fintechs to establish new models – some as challengers, others as collaborators. Think of Ripple, the cryptocurrency and digital payment network for financial transactions, or Facebook’s Diem currency (formerly called Libra). Similarly, money transfer organisations (MTOs) such as Transferwise (now rebranded as Wise) and Payoneer are among a growing breed of alternative payment providers. Then, of course, there is the SWIFT network, which has been the foundation of correspondent banking since the early 1970s.
SWIFT enables banks to connect with each other worldwide, but it doesn’t create new relationships or promote financial inclusion. Although SWIFT’s new ‘global payments innovation’ platform (SWIFTgpi) will improve pricing, speed and transparency, and non-banks are also developing a range of innovative solutions, these payment services still rely on the same underlying correspondent banking system.
Digitalisation has yet to modernise cross-border payments in the same way that it has changed other financial services. According to the World Fintech Report 2020, banks must focus on middle- and back-office technology, which has taken second place to front-end developments, and seek partnerships with fintechs who can improve customer experience and increase straight-through processing and global connectivity. With Covid-19 accelerating digital change, and the growth of open banking encouraging innovation, now is the time to focus on cross-border payments and reimagine correspondent banking.
Correspondent banking as a service
Digital transformation can take place within the existing correspondent banking framework, enhancing SWIFT’s next-generation infrastructure rather than competing with it. This is where correspondent banking as a service comes in as a subset of banking as a service. Proposed by TenureX, the new correspondent model provides the first multilateral matching facility for cross-border payments and follows the example of multilateral trading facilities. The aim is to replace the relationship model with a transactional one that offers richer data for more informed and objective business decisions between counterparties. Instead of de-risking relationships by simply cutting them, banks can de-risk transactions.
Until now, when onboarding customers and managing exposure, banks have lacked a digital, business-oriented approach and a granular level of detail to assess risks. TenureX brings this precision, accuracy and control to every transaction, enabling banks to move away from rigid, binary relationships. Manual processing is replaced by digital analysis, ensuring transparency and clarity on a transaction-by-transaction basis. This will have a significant impact on correspondent banking through increased volumes, greater diversity, more actionable data, lower cost for payments and compliance operations, and higher margins.
TenureX creates a digital layer that enables new payment corridors and new customers to join the banking ecosystem through a pay-per-transaction model instead of the relationship model, which is effectively a membership club. TenureX doesn’t bypass or disrupt correspondent banking; it adds value and control to the existing structure and uses transaction data to strengthen the interface between banks and increase trust.
When counterparties communicate multilaterally and objectively in real time, using objective rules on top of their legacy systems, they will reduce operating costs, gain new revenue streams, diversify income, and boost financial inclusion. This is TenureX’s mission, and it will make a major contribution to the G20 Roadmap for Enhancing Cross-border Payments.