Banking on the unbanked – how technology can revive correspondent finance

Abhijit Deb, Head of Banking & Financial Services, UK & Ireland, Cognizant 

Despite the size of the market increasing, correspondent banking remains under pressure due to the cost of compliance, reputational risk and shrinking margins.

Can technology strike the balance between de-risking and financial inclusion?

A broader distribution of global wealth created new opportunities as well as obstacles for the financial sector. Over time, this has led to increased access to banking facilities in regions where consumers earlier may not have had access to a variety of financial services in the past. In the business world, the introduction of more local banks has allowed for an expansion of the correspondent banking industry, with large international banks competing to provide the infrastructure for smaller or regional outfits to carry out transaction services such as cross-border payments.

It is an industry built on the premise of trust and a network that supports this. For example, local banks must trust that international banking facilitators have a resilient transaction network that is secure and can take the strain of high demand. On the other hand, larger international banks need to trust that the local banks they partner with, which may be under less scrutiny from local regulators, remain compliant. This equilibrium is essential for banks to effectively provide services to those in emerging economies.

However, recent changes to the regulatory landscape such as the Bank Secrecy Act along with material breaches or incidents where banks have been caught off guard and found themselves unknowingly abetting fraud or drug cartels have caused a deterioration of this trust. In fact, between 2014 and 2015, 75 percent of international banks admitted that they were scaling back their correspondent banking operations, according to The World Bank. The reputational risks associated with being linked to money laundering, fraud, sanctions or securities violations – not to mention the high regulatory fines – and subsequent compliance costs, are causing banks to be overly circumspect in where and how they offer their services, in the process sometimes depriving whole communities and business segments – previously served by local banks – from accessing a broader range of services. For example, a typical large global FI[1] could incur costs of up to $25,000 per year just in compliance to keep a bank account open in another country, so if the business or political climate is not there for that country, correspondent relations are often terminated.

Ironically, this trend is counterintuitive given the increase in volume of transactions. For instance, take the case of international payments – over 80 percent of cross-border payments on SWIFT[2] are carried out by banks, including 49 of the top 50 globally. Yet parts of the payments value-chain are still slow, often taking an average of five days. In addition, a lack of information around the payment results in 25% of all international payments requiring manual repairs.

With continued globalisation causing an increase in international trade and investments and fuelling demand for these connected services globally, can technology help revive sector that is struggling to reinvent the fabric of trust and ease that underpins most of it?

Trusting in tech 

Technology can play an important role in making the sector more efficient and profitable. For instance, as many of the processes carried out by large international banks are still manual, the introduction of technology has huge potential to boost efficiencies and streamline processes. Some are introducing Artificial Intelligence (AI) in the form of smart contracts to overcome the pitfalls of subjectivity and flag fraudulent transactions without the need for human insight. Elsewhere, others are using AI and hyper-contextualised analytics to reduce the risk of financial crime, replacing manual transaction monitoring techniques.  Ovum reports that 41% of corporate customers are expecting greater use of AI, while only 9% of banks plan to do so in the next 18 months.

The ‘rails’ of the ecosystem are also evolving: SWIFT’s global payments innovation (GPI) has been rolled out aimed at bringing real time international payments to the global banking population, with GPI set to be the standard for all cross-border payments on SWIFT by 2020. GPI, launched just over 15 months ago, and now represents 25% of all SWIFT cross border payment traffic[3].

Blockchain could also significantly ease the correspondent banking process, allowing instant and more secure cross-border payments. One global bank recently announced the world’s first commercially viable trade finance transaction using blockchain, potentially paving the way for much wider adoption.

Innovations such as the above will see much-needed improvements in speed, integrity and transparency and thereby improve the overall customer experience.

A key factor here is accessibility; while local banks may not necessarily have the appetite or resources to invest in cutting edge technologies, they do not have to if international banks do so instead. These smaller organisations would have access to the platforms of the larger business that they subscribe to as part of a correspondent banking relationship. International banks have the resources to push features such as smart contracts out to local partners and given the right assistance, provide them as a value-added service. Charging more for this type of service could also help solve the problem of profitability for international banks.

Catering to a new generation

In order to incentivise local counterparts to use their services again large, international banks could also focus on implementing different processes and pricing models. As B2B customer demands evolve, the interactions offered by larger banks to local partners have increasingly fallen short. Although there is a need to re-look at legacy business processes tied to existing products such as cheques, which are due an update for a present-day customer base, customer service failings often occur because some of the modules they offer are scrapped due to large compliance costs. Could international banks consider a different pricing structure for their services, adopting a model more akin to retail banks?

For example, some larger banks are now offering specific services around transaction screening, document and contract management, or financial analytics. This ultimately benefits the experience provided to local banks, by offering them more affordable bite-size products that meet their needs more accurately. It also has the potential to reduce service and compliance costs, while enabling participants in the ecosystem to vary how they charge for their services. In other words, it gives local partners an almost iPhone-like experience, in that they are not so much paying for a product, which is largely similar but for the way it is presented to them. In the banking world, this could mean that any fee is based on the value that the larger global banks are providing, as opposed to a flat cut of each transaction.

It is a team effort 

On the surface, the market opportunity seems huge, but underneath there are concerns within each stakeholder preventing correspondent banking from reaching its potential. For example, international banks might be conscious of risks such as money laundering, but regulators equally need auditability. The additional challenge of broaching technological innovation with banks’ legal, HR and risk teams means that reviving the industry will be no easy task. Although these obstacles are having an impact on potential revenues for international banks, there are starker implications for financial provision, meaning the masses in unbanked regions could lose the opportunity to access banking services if their local banks do not have the infrastructure to support them.

Key to solving the insecurities plaguing the industry is bringing banks, fintech companies, consultants and regulators together to establish a balanced approach that addresses the needs of all stakeholders. After all, correspondent banking is fundamentally a people-led business, built on assurance, predictability and quality of service. By improving efficiency through use of technologies such as AI and analytics, banks and regulators can be more flexible and ultimately collaborate to realise the potential of the correspondent banking market to enable local banks to provide financial services to their customers.

Abhijit Deb, Head of Banking & Financial Services, UK & Ireland, Cognizant 

Despite the size of the market increasing, correspondent banking remains under pressure due to the cost of compliance, reputational risk and shrinking margins.

Can technology strike the balance between de-risking and financial inclusion?

A broader distribution of global wealth created new opportunities as well as obstacles for the financial sector. Over time, this has led to increased access to banking facilities in regions where consumers earlier may not have had access to a variety of financial services in the past. In the business world, the introduction of more local banks has allowed for an expansion of the correspondent banking industry, with large international banks competing to provide the infrastructure for smaller or regional outfits to carry out transaction services such as cross-border payments.

It is an industry built on the premise of trust and a network that supports this. For example, local banks must trust that international banking facilitators have a resilient transaction network that is secure and can take the strain of high demand. On the other hand, larger international banks need to trust that the local banks they partner with, which may be under less scrutiny from local regulators, remain compliant. This equilibrium is essential for banks to effectively provide services to those in emerging economies.

However, recent changes to the regulatory landscape such as the Bank Secrecy Act along with material breaches or incidents where banks have been caught off guard and found themselves unknowingly abetting fraud or drug cartels have caused a deterioration of this trust. In fact, between 2014 and 2015, 75 percent of international banks admitted that they were scaling back their correspondent banking operations, according to The World Bank. The reputational risks associated with being linked to money laundering, fraud, sanctions or securities violations – not to mention the high regulatory fines – and subsequent compliance costs, are causing banks to be overly circumspect in where and how they offer their services, in the process sometimes depriving whole communities and business segments – previously served by local banks – from accessing a broader range of services. For example, a typical large global FI[1] could incur costs of up to $25,000 per year just in compliance to keep a bank account open in another country, so if the business or political climate is not there for that country, correspondent relations are often terminated.

Ironically, this trend is counterintuitive given the increase in volume of transactions. For instance, take the case of international payments – over 80 percent of cross-border payments on SWIFT[2] are carried out by banks, including 49 of the top 50 globally. Yet parts of the payments value-chain are still slow, often taking an average of five days. In addition, a lack of information around the payment results in 25% of all international payments requiring manual repairs.

With continued globalisation causing an increase in international trade and investments and fuelling demand for these connected services globally, can technology help revive sector that is struggling to reinvent the fabric of trust and ease that underpins most of it?

Trusting in tech 

Technology can play an important role in making the sector more efficient and profitable. For instance, as many of the processes carried out by large international banks are still manual, the introduction of technology has huge potential to boost efficiencies and streamline processes. Some are introducing Artificial Intelligence (AI) in the form of smart contracts to overcome the pitfalls of subjectivity and flag fraudulent transactions without the need for human insight. Elsewhere, others are using AI and hyper-contextualised analytics to reduce the risk of financial crime, replacing manual transaction monitoring techniques.  Ovum reports that 41% of corporate customers are expecting greater use of AI, while only 9% of banks plan to do so in the next 18 months.

The ‘rails’ of the ecosystem are also evolving: SWIFT’s global payments innovation (GPI) has been rolled out aimed at bringing real time international payments to the global banking population, with GPI set to be the standard for all cross-border payments on SWIFT by 2020. GPI, launched just over 15 months ago, and now represents 25% of all SWIFT cross border payment traffic[3].

Blockchain could also significantly ease the correspondent banking process, allowing instant and more secure cross-border payments. One global bank recently announced the world’s first commercially viable trade finance transaction using blockchain, potentially paving the way for much wider adoption.

Innovations such as the above will see much-needed improvements in speed, integrity and transparency and thereby improve the overall customer experience.

A key factor here is accessibility; while local banks may not necessarily have the appetite or resources to invest in cutting edge technologies, they do not have to if international banks do so instead. These smaller organisations would have access to the platforms of the larger business that they subscribe to as part of a correspondent banking relationship. International banks have the resources to push features such as smart contracts out to local partners and given the right assistance, provide them as a value-added service. Charging more for this type of service could also help solve the problem of profitability for international banks.

Catering to a new generation

In order to incentivise local counterparts to use their services again large, international banks could also focus on implementing different processes and pricing models. As B2B customer demands evolve, the interactions offered by larger banks to local partners have increasingly fallen short. Although there is a need to re-look at legacy business processes tied to existing products such as cheques, which are due an update for a present-day customer base, customer service failings often occur because some of the modules they offer are scrapped due to large compliance costs. Could international banks consider a different pricing structure for their services, adopting a model more akin to retail banks?

For example, some larger banks are now offering specific services around transaction screening, document and contract management, or financial analytics. This ultimately benefits the experience provided to local banks, by offering them more affordable bite-size products that meet their needs more accurately. It also has the potential to reduce service and compliance costs, while enabling participants in the ecosystem to vary how they charge for their services. In other words, it gives local partners an almost iPhone-like experience, in that they are not so much paying for a product, which is largely similar but for the way it is presented to them. In the banking world, this could mean that any fee is based on the value that the larger global banks are providing, as opposed to a flat cut of each transaction.

It is a team effort 

On the surface, the market opportunity seems huge, but underneath there are concerns within each stakeholder preventing correspondent banking from reaching its potential. For example, international banks might be conscious of risks such as money laundering, but regulators equally need auditability. The additional challenge of broaching technological innovation with banks’ legal, HR and risk teams means that reviving the industry will be no easy task. Although these obstacles are having an impact on potential revenues for international banks, there are starker implications for financial provision, meaning the masses in unbanked regions could lose the opportunity to access banking services if their local banks do not have the infrastructure to support them.

Key to solving the insecurities plaguing the industry is bringing banks, fintech companies, consultants and regulators together to establish a balanced approach that addresses the needs of all stakeholders. After all, correspondent banking is fundamentally a people-led business, built on assurance, predictability and quality of service. By improving efficiency through use of technologies such as AI and analytics, banks and regulators can be more flexible and ultimately collaborate to realise the potential of the correspondent banking market to enable local banks to provide financial services to their customers.