Correspondent banking relationships have long been used to facilitate cross-border transactions. They have been particularly important for international payments, as well as a bank’s own access to offshore financial systems as a means to source products and services that are unavailable in its home jurisdiction. While banks have traditionally maintained very broad networks of correspondent banking relationships, there are growing indications that this is changing. In fact, from mid-2011 until the end of 2015, the number of correspondent banking relationships worldwide fell despite global payment volumes rising over the same period. Much of this has been driven by banks cutting relationships in jurisdictions where returns do not justify the costs (and risks) of investment. While some of this ‘trimming’ reflects a broader deleveraging by many banks following the global financial crisis, the most common driver of reduced profitability has been the increased cost of regulatory compliance, particularly with respect to Anti-Money Laundering (AML)/Counter Terrorism Financing (CTF) (together, AML) regulations. The quantum of AML compliance costs for the banking industry is far from trivial. Banks globally are forecast to spend an estimated USD 12 billion on their AML compliance programs in 2016. A further USD 16 billion in fines were handed out by U.S. regulators alone since the end of 2009 for AML compliance failings. Many institutions have responded by offboarding more risky customers as part of a general ‘de-risking’ strategy, which is posing a very real risk to the workings of the global financial system. We believe this is a trend that must be reversed. The core problem with existing AML compliance processes at most banks is that they are extremely labour-intensive, with over three-quarters of bank compliance budgets dedicated to personnel responsible for manually onboarding new clients (i.e. KYC or Know Your Customer processes), investigating suspicious payment activities (i.e. surveillance) and producing internal and external reports (i.e. reporting). Moreover, current payment messaging systems such as Society for Worldwide Interbank Financial Telecommunication (SWIFT) are in need of an overhaul, given limited information capture, a lack of straight-through-processing, and the capacity for information to be altered, incorrect or even missing. We believe blockchain technology will have an increasingly important role to play in enhancing the global payments system, both in terms of reducing the amount of manual labour involved with existing AML compliance processes, as well as optimising legacy technology systems that are in operation today. In particular, we see huge potential in the immediate-term for it to run alongside legacy payment and messaging infrastructure, overlaying existing systems with a rich information layer. We estimate blockchain technology has the potential to deliver the industry USD 4.6 billion in annual AML cost savings (i.e. 32% of current annual costs) in the form of (1) reduced compliance headcount and associated costs (2) lower technology spend and (3) fewer regulatory penalties. However, in order for any of these blockchain solutions to truly work, industry-wide adoption is needed. Only then will banks be in a position to move from KYC to KYT i.e. a ‘know your customer’ approach to AML to a ‘know your transaction’ solution.
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