All join hands for the ‘Dance of Collaboration’

The traditional model of correspondent banking is changing as the relationship between global and local banks evolves. But how and what is driving this? PETER JAMESON from Bank of America Merrill Lynch analyses the landscape and considers what the future might hold

For many years, industry specialists have suggested that correspondent banking is dead and that now is the time for partnership and collaboration. While this has been a recurring theme for at least the last 10 years, truly sustainable partnerships have rarely come to pass.

Today, while there are many forces at work that are resulting in new bank relationships being forged, only half of the old mantra is true: correspondent banking certainly isn’t dead; there is plenty of life in it yet. But banks are now looking for a lot more return from these relationships.

There are three key factors behind this change. Firstly, the economic environment remains challenging and earnings on deposits have declined significantly, eroding what has been a valuable revenue stream that underpinned the transactional business historically. As a result, both international and local banks are seeking greater returns from the correspondent relationships into which they have entered.

At the same time, the post-crisis landscape continues to deliver a barrage of regulation at the national, regional and global level, imposing considerable cost on the industry and diverting resources from discretionary investment.As we’ll discuss, regulations such as Basel III and ever-increasing risk and compliance requirements facing banks could have a particular impact on how correspondent banking develops.

Also, corporates’ needs are evolving and becoming more sophisticated. This means that banks have to respond more quickly and creatively than in the past. Clients are becoming no less demanding, and, at the same time, they are increasingly agnostic about how exactly their banks deliver the services that they require. They are much more open to banks operating through a variety of network models. What matters is that their bank takes responsibility for meeting their needs, whether or not they deliver them through their own branch network.

The airline alliance model

The result is that different types of bank partnerships can be a much more effective way of delivering the deeper, local capabilities that clients expect. Some US and European banks, for example, build a network that in many ways is like an airline alliance. They invest in building a broad base of relationships with other banks that operate in complementary geographies, allowing them to extend their own network into these locations. In response, these in-region partner banks can provide the ability for their clients to tap back into the US or Europe.

Such mutually beneficial relationships can deliver real value to each bank’s own clients as they expand their activities into new markets, but it’s much broader than simple reciprocity. Fundamental to this relationship is an accountability to ensure that each other’s clients are serviced to the same high standard they would expect from their own bank. Each provider should be proud of the partnership and open with their clients about how it operates, as ,ultimately, it provides corporates with the services they require in the markets where they want to do business.

The right partners

So how can banks select the right partner? The crucial factor is their ability to deliver the suite of local or regional capabilities that clients require. Every bit as important though, is the need to have a similar outlook in terms of engagement with clients and the same philosophy around high service standards. A partner is not just a service provider or a vendor: it is an organisation that one can completely trust and feel totally comfortable with when side-by-side in front of a mutual client.

This is a challenging industry. There’s no room for excuses, saying, “We deal with a partner in that market: you’re going to have to wait until tomorrow.” Clients have a reasonable expectation that bank partners will operate with the same sense of urgency and integrity as they would expect from their primary local bank. It is also important that they show commitment for the long-term – both to the client and the markets in which they do business – and that they seek to form a broad relationship based on a number of products and capabilities, not just a single service.

So what about correspondent banking? Even as these new types of banking partnerships develop in more markets, it is clear that traditional correspondent banking is still alive and well – but it is evolving. In Europe, for example, consolidation is the watchword. Many banks continue to maintain relationships that pre-date the birth of the euro. As it is no longer necessary to have a euro account in Spain, Austria, Slovenia, Germany and so on, banks are consolidating their complex network of correspondents down to a more manageable number of strategic providers.

In the US, many are reconsidering the strategic value of maintaining an expensive branch infrastructure. This includes the costs of running and upgrading bank systems: complying with continually changing clearing requirements and regulatory rules can be crippling. In the new environment these pressures are forcing many banks to reconsider whether to “go it alone” is still a viable option, or whether they should seek to partner in the market with a scale provider, one that has the long-term commitment and business appetite to continue investing in a sustainable cash management infrastructure.

Regulation is also a factor behind the evolution of correspondent banking, and in particular Basel III. There has been considerable debate around the impact of this wide-reaching regulation on trade finance, but there has been less discussion concerning the potential outcome on the cross-border payments business.

The fundamental impact of Basel III as it comes to fruition is that FI deposits will attract increased capital requirements, ultimately making them less attractive compared with corporate or retail deposits – in an environment where deposit returns are already at an all-time low. Should the expected consequences of Basel III transpire, for some institutions, continuing to provide correspondent banking in certain markets could become a real commercial issue.

In addition to these future balance sheet pressures, the burden of complying with “know your customer” and anti-money laundering requirements continues to increase. New customer data has had to be collected, technology updated and in many instances, compliance teams have had to grow. For international banks, operating outside their home markets can create additional complexities in the compliance process. When combining the pressures of increased capital requirements and increasingly stringent compliance requirements, ultimately there is a risk that local banks and their clients will lose access to international markets if their global banking providers and partners can no longer support a sustainable correspondent banking model.

This in turn could have unintended consequences for local economies if there are fewer banks that can provide comprehensive financing and transactional services in the major world currencies.

The four Cs

Leaving aside regulation and compliance, there are two key trends – the more integrated, relationship-based partnership, and driving efficiencies and improvements in the traditional correspondent banking model – which are still evolving and are far from mature.

But they are very “grown up”: they recognise that, in different places or at different points in time, banks may be each other’s clients, collaborators, competitors or counterparties – the “four Cs”.

There’s a healthy recognition that there are spaces where banks will clearly compete, yet there are others where each bank needs the other in order to deliver complementary capabilities for mutual clients. In the bank-to-bank ecosystem, they may be collaborating at the same clearing house committee, as counterparties with the same vested interest in stability and risk management yet are competing in other contexts.

In the future, banks will need to be more pragmatic about where they compete and where they collaborate – client expectations will demand it and the new market paradigm will require it. The deeper relationships being formed between banks are value-enhancing and more sustainable for all parties, ensuring the maintenance and enrichment of services to local economies and corporates operating both locally and internationally. Greater collaboration is one of the ways that banks will need to operate in the future as part of adapting to the challenges ahead.