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Correspondent accounts are commonly used by banks internationally to undertake financial transactions for themselves and their customers

in jurisdictions where they generally have no physical presence. A wide range of services can be settled through a correspondent banking relationship, including:

payments, including telegraphic or electronic transfers and drafts foreign exchange, including wholesale note clearances payable through and nested accounts cash letters and collections managed investments and mortgage schemes custodian account arrangements trade finance transactions syndicated loans.

Correspondent banking relationships are vulnerable to money laundering and terrorism financing because they involve a bank carrying out financial transactions on behalf of another bank's customers. This indirect relationship means that the correspondent bank provides services in a situation where it is unlikely to have either verified the identities or obtained firsthand knowledge of the respondent's customers. (27) If they do not undertake an appropriate level of initial and ongoing due diligence on such accounts, banks expose themselves to a range of risks associated with money laundering or terrorism financing and may find themselves transacting funds that originated from illegal activity. Correspondent accounts with shell banks are also associated with a very high risk of money laundering or terrorism financing. The AML/CTF Act defines a 'shell bank' generally as a corporation that is incorporated in a foreign country and authorised to carry on banking business in that country, but does not have a physical presence in its country of incorporation. (28)

What are the requirements for correspondent banking?


Definition of correspondent banking
'Correspondent banking relationship' is defined in section 5 of the AML/CTF Act and involves the provision of banking services by one financial institution (first institution) to another (second institution), where the financial institutions carry on activities or business at or through permanent establishments in different countries and the banking services are of a kind described in the AML/CTF Rules. The second institution may be a subsidiary or related company of the first institution. A company is taken to be related to another company as described in section 50 of the Corporations Act 2001 (Corporations Act) where a company is a holding company, subsidiary,

or holding company subsidiary, of another company. The term 'subsidiary' is defined in section 46 of the Corporations Act. Chapter 2 of Anti-Money Laundering and Counter-Terrorism Financing Rules Instrument 2007 (No. 1) provides that the correspondent banking relationship definition relates only to banking services involving nostro or vostro accounts. The terms 'nostro' and 'vostro' are not defined in the AML/CTF Act or AML/CTF Rules, but it is commonly held that:

a nostro (Latin for 'ours') account is an account a financial institution holds with a foreign financial institution, usually in the currency of the foreign country a vostro (Latin for 'yours') account is the account a financial institution holds on behalf of a foreign financial institution.

Requirements under the AML/CTF Act


The correspondent banking provisions of the AML/CTF Act can be divided into two broad themes:

the prohibition on entering into a correspondent banking relationship with a shell bank the requirements to conduct risk and due diligence assessments in relation to correspondent banking relationships.

The AML/CTF Act provides that:

a financial institution must not enter into a correspondent banking relationship with a shell bank and must terminate any such existing relationship within 20 days, if they become aware that the other party is a shell bank or another financial institution that has a correspondent banking relationship with a shell bank (sections 95 and 96) before a financial institution enters into a correspondent banking relationship with another financial institution, the first financial institution must carry out a preliminary risk assessment and, where warranted, a more extensive due diligence assessment (section 97) the financial institution entering into the correspondent banking relationship is required to have senior officer approval (subsection 99(1)), with the senior officer having regard to the due diligence assessment carried out under section 97 and paragraph 3.1.2 of Anti-Money Laundering and Counter-Terrorism Financing Rules Instrument 2007 (No. 1) where a financial institution has entered into a correspondent banking relationship with another financial institution, the (first) financial institution must carry out regular risk assessments and where the risk warrants them, due diligence assessments (section 98) financial institutions must document each party's AML/CTF responsibilities under their correspondent banking relationships (section 99).

What are the risk indicators for correspondent banking?


Money launderers exploit vulnerabilities to successfully legitimise illicit funds. Vulnerabilities in correspondent banking come in many forms. Identifying these vulnerabilities or risks is critical if a financial institution is to mitigate and manage them. Banks have many considerations when deciding to establish correspondent banking relationships, including credit and operational risk. The risks associated with money laundering or terrorism financing (ML/TF risk) should be an integral part of this process and the main risks are outlined here.

Inadequate due diligence risk


The degree of due diligence exercised by some banks appears to be determined by whether credit is being granted in the correspondent relationship, with more due diligence carried out where credit is being granted. The failure of banks to include measures to detect money laundering or terrorism financing when undertaking due diligence on correspondent accounts exposes them to ML/TF risk. Banks are exposed to greater risk on correspondent accounts if:

the correspondent bank provides services to banks that are not physically present in any country (see 'Shell bank risk') a correspondent bank establishes a relationship with a respondent bank that permits the opening of accounts for carrying out transactions with shell banks the respondent bank has a relationship with a third-party bank (nested accounts) the country of the respondent bank has not implemented AML/CTF regulations (see 'Jurisdiction risk') the correspondent bank has not reviewed the respondent bank's existing AML/CTF practices before establishing the relationship the respondent bank does not apply KYC controls to identify existing and nonestablished customers the respondent bank has a reputation of a poor financial position the respondent bank has been subject to regulatory action the respondent bank does not conduct regular audits the respondent bank does not employ a monitoring system designed to identify and report suspicious activity/transactions the respondent bank does not screen new account activity against lists of known or suspected terrorists. (29)

Adding to the risk for banks is the possibility that, when they attempt to undertake due diligence, the respondent bank may not want to cooperate. Third-party relationships are then unlikely to be disclosed and there is the risk of banks being misled or given unreliable information, either intentionally or unintentionally. .12 Correspondent Banking a) Correspondent banking is the provision of banking services by one bank (the correspondent bank) to another bank (the respondent bank). These services may include cash/funds management, international wire transfers, drawing arrangements for demand drafts and mail transfers, payable-through-accounts, cheques clearing etc. Banks should gather sufficient

information to understand fully the nature of the business of the correspondent/respondent bank. Information on the other banks management, major business activities, level of AML/CFT compliance, purpose of opening the account, identity of any third party entities that will use the correspondent banking services, and regulatory/supervisory framework in the correspondent's/respondents country may be of special relevance. Similarly, banks should try to ascertain from publicly available information whether the other bank has been subject to any money laundering or terrorist financing investigation or regulatory action. While it is desirable that such relationships should be established only with the approval of the Board, in case the Boards of some banks wish to delegate the power to an administrative authority, they may delegate the power to a committee headed by the Chairman/CEO of the bank while laying down clear parameters for approving such relationships. Proposals approved by the Committee should invariably be put up to the Board at its next meeting for post facto approval. The responsibilities of each bank with whom correspondent banking relationship is established should be clearly documented. In the case of payable-through-accounts, the correspondent bank should be satisfied that the respondent bank has verified the identity of the customers having direct access to the accounts and is undertaking ongoing 'due diligence' on them. The correspondent bank should also ensure that the respondent bank is able to provide the relevant customer identification data immediately on request. b) Correspondent relationship with a Shell Bank Banks should refuse to enter into a correspondent relationship with a shell bank (i.e. a bank which is incorporated in a country where it has no physical presence and is unaffiliated to any regulated financial group). Shell banks are not permitted to operate in India. Banks should also guard against establishing relationships with respondent foreign financial institutions that permit their accounts to be used by shell banks. Banks should be extremely cautious while continuing relationships with respondent banks located in countries with poor KYC standards and countries identified as 'non-cooperative' in the fight against money laundering and terrorist financing. Banks should ensure that their respondent banks have anti money laundering policies and procedures in place and apply enhanced 'due diligence' procedures for transactions carried out through the correspondent accounts. 2.13 Applicability to branches and subsidiaries outside India The guidelines contained in this master circular shall apply to the branches and majority owned subsidiaries located abroad, especially, in countries which do not or insufficiently apply the FATF Recommendations, to the extent local laws permit. When local applicable laws and regulations prohibit implementation of these guidelines, the same should be brought to the notice of Reserve Bank. In case there is a variance in KYC/AML standards prescribed by the Reserve Bank and the host country regulators, branches/overseas subsidiaries of banks are required to adopt the more stringent regulation of the two. 2.14 Wire Transfer Banks use wire transfers as an expeditious method for transferring funds between bank accounts. Wire transfers include transactions occurring within the national boundaries of a country or from one country to another. As wire transfers do not involve actual movement of currency, they are considered as a rapid and secure method for transferring value from one location to another.

i) The salient features of a wire transfer transaction are as under: a) Wire transfer is a transaction carried out on behalf of an originator person (both natural and legal) through a bank by electronic means with a view to making an amount of money available to a beneficiary person at a bank. The originator and the beneficiary may be the same person. b) Cross-border transfer means any wire transfer where the originator and the beneficiary bank or financial institutions are located in different countries. It may include any chain of wire transfers that has at least one cross-border element. c) Domestic wire transfer means any wire transfer where the originator and receiver are located in the same country. It may also include a chain of wire transfers that takes place entirely within the borders of a single country even though the system used to effect the wire transfer may be located in another country. d) The originator is the account holder, or where there is no account, the person (natural or legal) that places the order with the bank to perform the wire transfer. ii) Wire transfer is an instantaneous and most preferred route for transfer of funds across the globe and hence, there is a need for preventing terrorists and other criminals from having unfettered access to wire transfers for moving their funds and for detecting any misuse when it occurs. This can be achieved if basic information on the originator of wire transfers is immediately available to appropriate law enforcement and/or prosecutorial authorities in order to assist them in detecting, investigating, prosecuting terrorists or other criminals and tracing their assets. The information can be used by Financial Intelligence Unit - India (FIU-IND) for analysing suspicious or unusual activity and disseminating it as necessary. The originator information can also be put to use by the beneficiary bank to facilitate identification and reporting of suspicious transactions to FIU-IND. Owing to the potential terrorist financing threat posed by small wire transfers, the objective is to be in a position to trace all wire transfers with minimum threshold limits. Accordingly, banks must ensure that all wire transfers are accompanied by the following information: ( A ) Cross-border wire transfers i) All cross-border wire transfers must be accompanied by accurate and meaningful originator information. ii) Information accompanying cross-border wire transfers must contain the name and address of the originator and where an account exists, the number of that account. In the absence of an account, a unique reference number, as prevalent in the country concerned, must be included. iii) Where several individual transfers from a single originator are bundled in a batch file for transmission to beneficiaries in another country, they may be exempted from including full originator information, provided they include the originators account number or unique reference number as at (ii) above. ( B ) Domestic wire transfers i) Information accompanying all domestic wire transfers of Rs.50000/- (Rupees Fifty Thousand) and above must include complete originator information i.e. name, address and

account number etc., unless full originator information can be made available to the beneficiary bank by other means. ii) If a bank has reason to believe that a customer is intentionally structuring wire transfer to below Rs. 50000/- (Rupees Fifty Thousand) to several beneficiaries in order to avoid reporting or monitoring, the bank must insist on complete customer identification before effecting the transfer. In case of non-cooperation from the customer, efforts should be made to establish his identity and Suspicious Transaction Report (STR) should be made to FIU-IND. iii) When a credit or debit card is used to effect money transfer, necessary information as (i) above should be included in the message. iii) Exemptions Interbank transfers and settlements where both the originator and beneficiary are banks or financial institutions would be exempted from the above requirements. (iv) Role of Ordering, Intermediary and Beneficiary banks (a) Ordering Bank An ordering bank is the one that originates a wire transfer as per the order placed by its customer. The ordering bank must ensure that qualifying wire transfers contain complete originator information. The bank must also verify and preserve the information at least for a period of ten years. (b) Intermediary bank For both cross-border and domestic wire transfers, a bank processing an intermediary element of a chain of wire transfers must ensure that all originator information accompanying a wire transfer is retained with the transfer. Where technical limitations prevent full originator information accompanying a cross-border wire transfer from remaining with a related domestic wire transfer, a record must be kept at least for ten years (as required under Prevention of Money Laundering Act, 2002) by the receiving intermediary bank of all the information received from the ordering bank. (c) Beneficiary bank A beneficiary bank should have effective risk-based procedures in place to identify wire transfers lacking complete originator information. The lack of complete originator information may be considered as a factor in assessing whether a wire transfer or related transactions are suspicious and whether they should be reported to the Financial Intelligence Unit-India. The beneficiary bank should also take up the matter with the ordering bank if a transaction is not accompanied by detailed information of the fund remitter. If the ordering bank fails to furnish information on the remitter, the beneficiary bank should consider restricting or even terminating its business relationship with the ordering bank. 2.15 Principal Officer (a) Banks should appoint a senior management officer to be designated as Principal Officer.

Principal Officer shall be located at the head/corporate office of the bank and shall be responsible for monitoring and reporting of all transactions and sharing of information as required under the law. He will maintain close liaison with enforcement agencies, banks and any other institution which are involved in the fight against money laundering and combating financing of terrorism. (b) The Principal Officer will be responsible for timely submission of CTR, STR and reporting of counterfeit notes to FIU-IND.

Clearing house (finance)


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A clearing house is a financial institution that provides clearing and settlement services for financial and commodities derivatives and securities transactions. These transactions may be executed on a futures exchange or securities exchange, as well as off-exchange in the over-thecounter (OTC) market. A clearing house stands between two clearing firms (also known as member firms or clearing participants) and its purpose is to reduce the risk of one (or more) clearing firm failing to honor its trade settlement obligations. A clearing house reduces the settlement risks by netting offsetting transactions between multiple counterparties, by requiring collateral deposits (a.k.a. margin deposits), by providing independent valuation of trades and collateral, by monitoring the credit worthiness of the clearing firms, and in many cases, by providing a guarantee fund that can be used to cover losses that exceed a defaulting clearing firm's collateral on deposit. Once a trade has been executed by two counterparties either on an exchange, or in the OTC markets, the trade can be handed over to a clearing house which then steps between the two original traders' clearing firms and assumes the legal counterparty risk for the trade. This process of transferring the trade title to the clearing house is called novation. It can take fractions of seconds in highly liquid futures markets; or days, or even weeks in some OTC markets. As the clearing houses concentrates the risk of settlement failures into itself and is able to isolate the effects of a failure of a market participant, it also needs to be properly managed and well-capitalized[1] in order to ensure its survival in the event of a significant adverse event, such as a large clearing firm defaulting or a market crash. Many clearing house guarantee funds are capitalized with collateral from its clearing firms. In the event of a settlement failure, the clearing firm may be declared to be in default and clearing house default procedures may be utilized, which may include the orderly liquidation of the defaulting firm's positions and collateral. In the event of a significant clearing firm failure, the clearing house may draw on its guarantee fund in order to settle trades on behalf of the failed clearing firm. The term is also used for banks like Suffolk Bank that acted as a restraint on the over-issuance of private bank notes.[2]