What is an Intermediary Bank in Anti-Money Laundering?

Definition

An Intermediary Bank, also known as a Correspondent Bank, is a financial institution that acts as a middleman or facilitator in international financial transactions. Specifically in the context of Anti-Money Laundering (AML), an intermediary bank helps process, verify, and forward cross-border payments between the originating bank (where the funds are sent from) and the receiving bank (where the funds are to be credited), especially when these two banks do not have a direct relationship. It ensures that such international transfers comply with relevant AML regulations by conducting due diligence and monitoring suspicious transaction activities before funds reach the beneficiary.

Purpose and Regulatory Basis

Role in AML

Intermediary banks are crucial in the AML framework as gatekeepers guarding the integrity of cross-border transactions. Their responsibilities include:

• Verifying the legitimacy of funds moved between countries to prevent illicit money flows such as money laundering and terrorist financing.
• Executing due diligence on both sending and receiving parties to detect and prevent transactions involving illegal funds.
• Ensuring compliance with international AML standards such as those set by the Financial Action Task Force (FATF).
• Facilitating transparency and information sharing among financial institutions and authorities, enabling reporting of suspicious transactions.

Why It Matters

Money launderers often exploit complex international payment chains that involve multiple banks to obscure the origin of illicit funds. Intermediary banks act as control points that can slow or stop these flows by conducting AML checks.

Key Global and National Regulations

• Financial Action Task Force (FATF) Recommendations: Provide global AML standards and guidance requiring banks to conduct customer due diligence, monitor transactions, and file suspicious activity reports.
• USA PATRIOT Act: Imposes AML requirements on U.S. banks and correspondent banking relationships, including enhanced due diligence on foreign banks.
• European Union AML Directives (AMLD): Set AML/CFT (Counter-Terrorism Financing) regulations for financial institutions within the EU.
• Local Regulations (e.g., State Bank of Pakistan AML/CFT Regulations): Require customer identification, transaction monitoring, and correspondent banking risk management activities specific to jurisdictions.

When and How It Applies

Real-World Use Cases

Intermediary banks come into play primarily in international wire transfers, cross-border payments, and currency exchange scenarios where direct relationships between sending and receiving banks do not exist.

• When bank A in country X must send money to bank B in country Y, but no direct banking link exists, bank C (the intermediary) facilitates the transaction.
• International trade payments, remittances, and interbank settlements where the currency conversion may also occur at the intermediary stage.
• Situations where intricate financial networks or sanctions restrictions require enhanced scrutiny on funds routing.

Triggers and Examples

• Cross-border transfers involving high-risk jurisdictions.
• High-value or unusual transactions flagged for AML scrutiny.
• Correspondent banking relationships requiring layered due diligence.
• Wire transfers passing through multiple banks before reaching their final destination.

Types or Variants

While the terms intermediary bank and correspondent bank are often used interchangeably, distinctions exist:

Type	Description	Example
Correspondent Bank	A bank that holds accounts for other banks to provide services like clearing and settlement.	Bank C maintains an account for Bank A in a foreign jurisdiction.
Intermediary Bank	Acts as a middleman in a specific transaction when direct correspondent relationships do not exist.	Bank C facilitates a wire transfer between Bank A and Bank B without direct relationship.

There may also be nostro/vostro accounts involved where funds are held in different currencies to facilitate currency conversion within intermediary operations.

Procedures and Implementation

Steps for Compliance by Financial Institutions

1. Risk Assessment: Evaluate risks associated with correspondent and intermediary banking relationships.
2. Due Diligence: Conduct thorough customer identification and verification (KYC) of the intermediary bank and its clients.
3. Transaction Monitoring: Implement real-time or periodic monitoring to detect unusual or suspicious activity.
4. Screening: Check intermediary banks and transactions against sanctions lists and watchlists.
5. Record-Keeping: Maintain detailed transaction logs and due diligence documentation.
6. Reporting: File Suspicious Activity Reports (SARs) or equivalent to regulatory authorities when suspicious behavior is detected.
7. Ongoing Review: Periodically reassess the relationship and transaction patterns with intermediary banks.

Systems and Controls

• Automated AML transaction screening software.
• Integration with global sanctions and PEP (Politically Exposed Persons) databases.
• Robust internal audit and compliance departments.
• Training for staff on AML policies related to intermediary banks.

These measures ensure that intermediary banks do not become conduits for money laundering and terrorist financing.

Impact on Customers/Clients

Rights and Restrictions

• Customers may experience delays or additional verification in cross-border transactions involving intermediary banks.
• Transparency on fees: Intermediary banks may deduct fees which can reduce the final amount received.
• Customers must provide accurate and complete information to comply with AML requirements.
• Customers have the right to request details about fees and the path of their transfer but typically have limited influence over intermediary selection.

Interactions

• Customers should expect enhanced due diligence, especially for high-value or international transfers.
• Financial institutions may request additional documentation to satisfy intermediary bank compliance checks.

Duration, Review, and Resolution

• Intermediary banking transactions generally occur in real-time or within 1-3 business days depending on complexity.
• Ongoing review of correspondent/intermediary banking relationships is mandated, often annually or bi-annually.
• Institutions must continually update AML risk assessments and adjust controls as necessary.
• Resolution of flagged transactions may require investigation and coordination with law enforcement or regulatory agencies.

Reporting and Compliance Duties

• Intermediary banks must document the entire transactional flow, maintain audit trails, and ensure transparency.
• They have a duty to report suspicious transactions to Financial Intelligence Units (FIUs) or equivalent national authorities.
• Non-compliance can result in severe penalties, including fines, license revocation, and reputational damage.
• Banks must comply with relevant AML laws in all jurisdictions involved in the transaction.

Related AML Terms

• Correspondent Banking: The broader relationship under which intermediary banking services are executed.
• Wire Transfer: Electronic transmission of funds often involving intermediary banks.
• Customer Due Diligence (CDD): Processes used to verify customer identity, applicable to banks and intermediaries.
• Suspicious Activity Report (SAR): Filed to report potentially illicit transactions.
• Beneficiary Bank: The bank receiving the funds.
• Originating Bank: The bank sending the funds.
• Know Your Customer (KYC): Verification practices integral for intermediary banks.

Challenges and Best Practices

Common Issues

• Lack of transparency in correspondent relationships.
• Inadequate due diligence leading to exposure to money laundering risks.
• Complex multi-layered transactions complicating AML monitoring.
• Use of shell companies and opaque ownership structures.
• Increased regulatory scrutiny and penalties.

Best Practices

• Conduct enhanced due diligence and risk-based assessments.
• Employ advanced monitoring technology for transaction screening.
• Maintain open communication with partner banks and regulators.
• Implement regular training and audits for compliance teams.
• Adopt collaborative approaches with other banks and FIUs.

Recent Developments

• Fintech and Blockchain: Emerging technologies offer new ways for intermediary banks to improve transparency and speed of cross-border AML compliance.
• Regulatory Updates: Increased focus on correspondent banking risks post-pandemic with new FATF guidelines encouraging tighter controls.
• AI and Machine Learning: Used for enhanced pattern recognition in detecting suspicious transactions involving intermediary banks.
• Global Cooperation: Greater information sharing between countries and institutions to combat money laundering globally

Intermediary banks are indispensable actors in the international financial system, enabling seamless cross-border transactions while serving as critical checkpoints in AML compliance. By facilitating legitimate payments, performing rigorous due diligence, and monitoring transactions for suspicious activity, intermediary banks help prevent the misuse of the global financial network for illicit purposes. Given their complex role, effective regulatory compliance, technological adoption, and collaborative risk management are essential for upholding the integrity and security of international banking.