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Emerging market trade and the continued rise of correspondent banking

As the emerging markets become ever more important to the global economy, correspondent banking networks are proving increasingly valuable in enabling global trade. Ramona Homfeld, Trade Product Manager at Commerzbank, answers Global Banking & Finance Review’s questions on why correspondent banking continues to defy expectations.

Global Banking and Finance Review: Could you outline the current state of correspondent banking?Emerging market trade and the continued rise of correspondent banking 2
Ramona Homfeld:  Rather than becoming marginalised, as some commentators had predicted, the figures demonstrate that over the past ten years the correspondent banking model has thrived. A World Bank study on Brazil, published in 2006, revealed that the number of correspondent banking outlets increased from 6,000 at the turn of the millennium, to over 38,000 in 2004. Similarly, Commerzbank’s own correspondent banking network has grown to include relationships with over 7,000 banks globally.

GB&FR: In your opinion what factors are behind this growth?
RH: Very simply, the essential principles and processes underlying a correspondent banking continue to retain clear-cut advantages over alternative models. . Some commentators, thought the continued expansion of branch networks would lead to the eventual demise of correspondent banking. However, in many cases branch networks are neither viable nor preferable. Expanding branch networks is heavily resource-intensive, and inevitably limited by the capacity of the individual bank. Correspondent banking networks, on the other hand, can extend coverage beyond the range of even the largest commercial banks, creating efficiencies right along the value chain.

GB&FR: What impact did the financial crisis have on correspondent banking?
RH: Prior to 2008-2009 I think that trading entities had a tendency to consider many of the emerging markets as interesting but not essential markets for growth.. However, in the wake of the crash, we have seen a significant shift in trading power from the OECD region to the emerging markets, as companies pursue the huge opportunities for import and export. Correspondent banking networks enable extensive coverage to be matched up with the local expertise vital for operating successfully in these markets. As such, the financial crash has strengthened the importance of correspondent banking networks.

GB&FR:  Talking of the shift in trading power away from the OECD, could you comment on the impact of China’s launching its RMB trade settlement scheme?

RH:  Just two years after the launch of the RMB Trade Settlement Pilot Scheme in 2009, over 70,000 Chinese businesses are now able to make trade settlements in RMB. This represents an enormous expansion in the scale and scope of opportunity for trade with previously remote parts of China.

In addition, China’s growing role in the global economy means that banks increasingly need to be able to settle payments in RMB outside of Asia. These Chinese businesses and institutions often want to conduct trade in RMB. As a result, exporters in developed countries need banks capable of conducting trade finance operations in RMB to markets extending well beyond China’s main cities. Correspondent banking has flourished in this environment because it provides the ideal means of enabling heavily localised markets with the ability to engage in global trade.

GB&FR: Why is local expertise  so important ?
RH: It is frequently the case that branch networks of global banks simply don’t possess the required knowledge of local languages, regulations and habits to operate effectively in emerging markets.  

A good example is in relation to the negotiation and settlement of Letters of Credit (LCs). Even a minor error in these complex processcess can result in payment delays, or worse. As a result it is generally preferable that these transactions are overseen, or undertaken, by a local bank with an innate understanding of the local regulatory environment.  Such experience can take many years to acquire.

Country and credit risk are also high up on the list of concerns when trading in emerging markets. Local knowledge on the state of the economy, regional politics, and the credit-worthiness of local businesses, are vital in ensuring that risks are minimised. As a result of the level of trust we place in our global financial institutions partners, Commerzbank has a unique risk appetite to conduct business in markets where other international banks have withdrawn, or never maintained, a presence.

Correspondent banking, therefore, has the potential to provide the best of both worlds. It combines the local trade finance infrastructure of a leading international bank with the local knowledge of a community bank..

GB&FR: What are the benefits for banks that engage in correspondent relationships?
RH:  Both sides can benefit from a correspondent banking partnership. Global banks are able to take advantage of shared risks, lower coasts, and the expansion of coverage into new markets.
Local banks are also able to expand their service offering, and can benefit from the assistance of their partner in managing loan books, and, when necessary, with problems of liquidity and capital.

GB&FR:  What are the weaknesses of the correspondent banking model?
RH:  The key word here is ‘trust’. Banks must be able to ensure the quality and reliability of all their correspondent partners, in order for the network to function. Commerzbank has a network of 40 representative offices across the globe, tasked exclusively with ensuring the soundness of its financial partners.

GB&FR: What do you envision as the future direction of correspondent banking?
RH: Traditionally tThe success of correspondent banking has been a result of its its ability to link corporates in the developed world with the financial institutions used by their trading partners, and the rapidly growing consumer base in emerging markets..  Given the rise growth of trading links between emerging markets and the rest of the world, the future of the correspondent banking model looks to be very strong. . This is not because an out of date system has become ingrained, but because it remains beneficial to both banks and clients.