What Does the Future Hold for Correspondent Banking?

The practice of correspondent banking faces pressure from mounting costs associated with due diligence in trade finance, yet banks are well placed to see off these challenges through a number of collaborative solutions, says Alex Ladaa, managing director and head of trade finance services, Germany, at UniCredit

Alexander Ladaa

Recent difficulties with due diligence requirements belie a promising future for correspondent banking. Indeed, banks are already working on a number of solutions for dealing with the due diligence demands of trade finance, and these promise to pave the way for more efficient and more profitable trade finance operations in the years to come.

Collective action is at the heart of these initiatives – with communal data repositories, standardized documentation and new technology all playing key roles in reducing the operational demands of due diligence on the trade finance industry.

Yet these solutions will take time to bear fruit. In the meantime, banks must be more selective in their choice of correspondent relationships to ensure that their operations remain profitable. And by combining this short-term strategy with longer-term collaborative initiatives, they can forge a path through rough terrain – continuing to provide corporates with invaluable trade finance services, despite the challenges.

Due diligence driving costs

Certainly, there can be no doubt that progress is necessary – not least because correspondent banking plays such a pivotal role in the execution of trade finance. Indeed, the provision of risk mitigation through correspondent banking relationships is vital to the workings of global trade – with instruments such as the letter of credit and the Bank Payment Obligation (BPO) routinely turning unworkable trades into valuable business.

On top of this, there is a host of other benefits associated with correspondent banking, including access to local expertise in foreign markets, as well as to extensive contacts that can help firms find new business and suitable banking partners in unfamiliar regions.

Yet these benefits are becoming increasingly  costly to realize, as banks labour under the growing complexity and expense associated with maintaining their correspondent networks in the face of due diligence requirements. In order to finance trade responsibly, banks must collect huge quantities of data on their counterparties and correspondent partners, as well as on each individual transaction – from financial details to the specifics of goods’ shipping timelines.

This generates a great deal of extra work for correspondent banks – diverting time and resources to seeking out, verifying and recalibrating data from disparate sources.

Drawing together to craft a solution

With the workload so high, collaboration will be central to any solution, and, with this in mind, banks are looking to work together to create communal data repositories that enable participants to add and extract information on counterparties – thereby avoiding duplication of research.

This solution can go some way towards minimizing the work involved in gathering the financial details of parties involved in trade finance, but it cannot help with transaction-specific data, such as the physical flow of traded goods. This must be collected independently for each individual trade. This task, too, however, can be made easier through collaborative means – by promoting and adopting common standards for categorizing, formatting and generating data.

Important steps have already been made in this regard – with the Bankers Association for Finance and Trade (BAFT) bringing out its Master Loan Agreement (MLA) in 2014. This year, we have seen a further step forward, with the International Chamber of Commerce (ICC) launching its Supply Chain Finance Terminology. Both initiatives – aimed at harmonizing practices surrounding trade finance – are highly valuable, but more such work is required to eliminate the difficulties for banks.

Some of the slack can perhaps be taken up by new technologies. Certainly, with technology companies looking to bring innovative solutions to the financial services industry, banks should look to collaborate with these newcomers to reduce the strain of data-gathering on correspondent banks.

Existing technology also has a part to play. The BPO, for instance, can generate standardized data according to ICC’s Universal Rules for Bank Payment Obligations (URBPO), injecting greater speed and efficiency into the trade process.

Dealing with the pressure

While these solutions will require time to take effect, there are ways for banks to deal with the pressure in the meantime. Critically, they must take a highly selective approach to their correspondent banking partners – ensuring that each of their relationships adds value to their clients and to their own business.

Certainly, this is what UniCredit has been doing for some time – pruning marginal activities and relationships in order to build out those which are most promising. This not only improves the overall profitability of a correspondent network, but also simplifies the implementation and monitoring of due diligence processes.

Such an approach should stand as a blueprint for the world’s correspondent banks – showing that even in the face of adversity, there is still scope for running profitable correspondent banking operations. And, through investment in collaborative solutions, this scope can be improved further – helping banks continue to provide the vital trade finance services that sustain the world economy.