November 2024 | Issue 58

What to Know: Correspondent Banking, Offshore Banking and Shell Companies

Correspondent Banking

Correspondent Banking is an agreement, or a relationship developed between banks to provide payment services for each other. It is key in the international financial system as its used to facilitate cross-border payments. A correspondent banking agreement occurs between two respondent banks, and a correspondent or service providing bank who is hired as a third party.

• Correspondent Bank – A correspondent bank is a third-party financial institution that is authorized to provide services on behalf of another financial institution.
• Respondent Bank – A respondent bank is the financial institution that is receiving services from the correspondent Bank. Typically, a respondent bank engages in services related to cross-border payments.

The types of services correspondent banking provide include:

• Wire transfers,
• Check clearing and payment,
• Trade finance,
• Cash and treasury management, and
• Securities, derivatives, or foreign exchange settlement, among other service.

According to the Federal Reserve, cross-border payments have grown across all use cases due to globalization, growth in global e-commerce, migration and record levels of worker remittance payments. Estimates suggest cross-border transactions totaled approximately $29 trillion in 2019.

Please see The Correspondent Banking Model below for your reference:

Source: Aite Group, image from the FederalReserve.com

Policy Issues involved with Correspondent Banking:

Bank Secrecy Act (BSA) – The Office of the Comptroller of the Currency (OCC) conducts supervisory activity when it comes to foreign banking. One of the biggest regulations is the BSA establishes program, recordkeeping and reporting requirements for national banks, federal savings associations, federal branches and agencies of foreign banks. Banking institutions are required to be part of a customer identification process known as Know Your Customer (KYC) as part of their BSA compliance.

Correspondent Banking offers opportunities to provide payment services for companies, but BSA policies, as mentioned above, are strict and can inhibit the service involved with this process. These risks include:

Anti-Money Laundering – Defined by Investopedia, Anti-money laundering refers to legally recognized rules, national and international, that are designed to thwart hiding criminal profits inside the financial system.

• Types of Anti-Money Laundering Measures:

1. Identify and verify customer identities.
2. Identify and verify beneficial owners’ identities.
3. Understand customer relationships to develop customer risk profiles.
4. Monitor transactions, update customer identification, and report suspicious activities.

Terrorism Financing – involves the raising and processing of funds to provide terrorists with resources as defined by the International Monetary Fund.

• Countering Measures:

1. Screening for potential Office of Foreign Assets Control (OFAC) violations
2. Conduct risk assessments
3. Establish transaction monitoring programs for BSA compliance

The Financial Action Task Force (FATF) recommendations require financial institutions to identify and manage the risks associated with these business relationships and to apply specific due diligence measures when they are conducted on a cross-border basis.

Companies have been increasingly avoiding corresponding banking due to the risks associated. In doing so, businesses have been terminating relationships with entire regions or classes of customers, this practice is known as “de-risking.” De-risking can cause many problems like financial exclusion, money laundering and terrorist financing risks.

Corporate Transparency Act – The Corporate Transparency Act was enacted in 2021 to help minimize many of the risks associated with Correspondent Banking. Under the act, businesses must submit a Beneficial Ownership Information (BOI) Report to the U.S. Department of Treasury’s Financial Crimes Enforcement Network (FinCEN). The report submitted identifies customer and beneficial owners’ identities that are involved in the financial transactions. The goal is to help minimize the fraud associated with customers profiles and identify scams before businesses enter the partnership.

Offshore Banking

Correspondent banking is key for the international financial system because it’s the model used to facilitate cross-border payments. Let’s take a deeper look into those banks that are utilizing correspondent banking in their day-to-day financial activities. One of these institutions is Offshore Banks.

According to Forbes Advisor, Offshore Banking is any banking that happens outside of your home country. An offshore bank account can make it easier for businesses to operate in foreign currencies. It also allows you to take advantage of any financial security or tax benefits another country offers. The International Revenue Service (IRS) requires all earnings made through Offshore Banking to be reported.

Why Offshore Banking?

If an individual or company is involved in financial activities outside of their home country, they will use offshore banking. There are many benefits when it comes to Offshore Banking such as direct participation in the foreign country’s economy, or the security that comes from having a stable foreign bank account. This can be extremely beneficial for those whose home country is economically unstable. Countries will also provide financial incentives to foreigners and their companies to participate in offshore banking.

Although there are many benefits when it comes to Offshore Banking, its important to understand the associated risks.

Some of the risks when it comes to Offshore Banking include:

• High scrutiny,
• Increased transparency from offshore jurisdictions, and
• Risk of working with the wrong individuals or institutions.

Shell Companies

Shell Companies are corporations that have no assets or business operations in place. Although these entities are often affiliated with illegal activity, there are several legitimate reasons behind the use of shell companies, as outlined below.

Purposes of Legitimate vs. Illegal Shell Companies

There are many reasons why Shell Companies are so attractive, some of those reasons include:

• Strict banking secrecy laws
• Easy and fast incorporation
• Minimal reporting requirements 
• Lack of transparency and accountability
• Weak regulatory oversight
• Low or no corporate tax rates

How are Shell Companies possible?

Shell Companies must have a registered agent where the companies’ headquarters are located. If someone from the United States were looking to set up a shell company abroad, they must register it through the Securities and Exchange Commission. Once the shell company has been established, they have free range to participate in activities such as transferring funds in and out of their home country, open bank accounts, or purchase real estate. All of this is legal in the United States. It is when the companies participate in deceptive activities that the shell companies become seen as illegal.

It is important to be able to indicate whether a shell company is being used for legitimate business purposes. If a company is giving signs of an illegal shell company, there are some measures you should take to identify the company’s true purpose. Make sure you can pinpoint the owner of the shell company who is “in-charge” of the companies’ earnings. When dealing with a shell company, one should record all the transactions that are completed for reference. This will help minimize grey-area or lack of clarity if issues were to occur down the road.

When doing business with a shell company, make sure to take preventative measures and look out for indicators of illegal activity that might be occurring.

Red Flag Indicators

While correspondent banking, offshore banking, and shell companies are not illegal, they are practices that could indicate criminal activity or other risky business practices. The key red flags to watch out for regarding shell companies include their secrecy and the deliberate withholding of information. The following list of red flag indicators should be considered when considering business partnerships.

• If transactions are occurring between two or more parties that are connected without an apparent business or trade rationale.
• If there are an extremely large number and variety of beneficiaries receiving wire transfers from one company.
• If payments do not specify a purpose nor a reference of goods or services, and solely identify a contract or invoice number.
• If address-related inconsistencies have emerged. For example, transacting companies may use the same address or disclose merely the address of the registered agent.
• If multiple high-value payments or transfers among shell companies appear to have no legitimate business purpose
• If business transactions involve family members of one or more of the parties without a legitimate business rationale

Tools Utilized in the Fight Against Money Laundering

Section 314(a) of the USA PATRIOT Act of 2001 is a tool that investigators can use to locate accounts and transactions for individuals and entities believed to be involved in terrorism or money laundering.  FinCEN compiles a list of identifiers based on law enforcement requests and shares it with financial institutions nationwide on a rolling basis.  These institutions must check these identifiers against their customer records and notify FinCEN of any positive matches. 314(a) Fact Sheet - https://www.fincen.gov/sites/default/files/shared/314afactsheet.pdf

Section 314(b) of the USA PATRIOT Act of 2001 is a protection offered to financial institutions to share information voluntarily among themselves to detect and report activities potentially related to terrorism or money laundering.  Through this program, institutions can collaborate with one another to share intelligence on suspicious entities and transactions without violating privacy laws, helping to build more comprehensive risk profiles on customers who may be using the institution’s resources to conduct criminal activity or to defraud the institution itself. 314(b) Fact Sheet - https://www.fincen.gov/sites/default/files/shared/314bfactsheet.pdf

An Egmont request is a tool that investigators can use to obtain foreign financial institution account and transaction information from Financial Intelligence Units (FIUs) across the world.  These requests are accepted and routed by FinCEN directly to the FIU of the country in question.  An informal collaboration framework, the Egmont Group is a global network of FIUs from over 150 countries that participate in information sharing relating to money laundering and terrorist financing investigations. Egmont Group - https://egmontgroup.org/about/

HSI encourages the public to report suspected suspicious activity through its toll-free Tip Line at 877-4-HSI-TIP. Callers may remain anonymous.

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