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Already grappling with a long-term decline in correspondent banking relationships, banks in Eastern Europe and Central Asia are concerned de-risking is accelerating in the wake of sanctions imposed on Russia. However, participants at a recent industry event believe there could be signs of positive change ahead. 

Correspondent banking provides a vital lifeline for regional lenders and their customers, facilitating cross-border payments, foreign currency transactions and other services that are not otherwise possible without overseas branches. 

However, there has been a years-long decline in the number of correspondent banking relationships kept open by international lenders, with the perceived risks and costs often deemed to outweigh the commercial benefit. 

Data from the Bank for International Settlements shows the number of active correspondents has declined by nearly 30% over the past decade. In Eastern Europe and Asia, the number of active counterparties has dropped by 35% and 30% respectively. 

The trend featured prominently at October’s Trade Finance Forum in Vienna, hosted by the European Bank for Reconstruction and Development (EBRD). 

“This is a big issue, particularly for countries in Central Asia and the Caucasus region, and the figures around the reduction of correspondent bank relationships show a significant level of closures,” says Marco Nindl, associate director and senior banker for the EBRD’s Trade Facilitation Programme, speaking to GTR on the sidelines of the event. 

Though this decline is a long-term trend, Nindl says sanctions imposed on Russia since its invasion of Ukraine have worsened the issue. 

“We are trying to raise this concern with a wider audience,” he says. “It’s not just banks that are impacted, but countries as a whole. Some of the smaller countries in Central Asia have become almost unbankable in US dollars. 

“And it is not just trade finance. If all the relevant correspondent bank relationships in a country have gone, there is no way for us as EBRD to transfer US dollar loans to the banks, institutions and companies that need them.” 

Speaking at the event, Istvan Lengyel, secretary general of the Banking Association for Central and Eastern Europe (BACEE), said there are multiple drivers of bank de-risking. 

“Compliance is of course number one – and if you think compliance is expensive, try non-compliance,” he said. 

“Then, if you have correspondent banking relationships you will have credit risk in your bank-to-bank business. Liquidity risk is less well-known, but banks are required to keep 100% coverage for funds from correspondent banks, and this can prove quite expensive.” 

One event attendee, representing a major international lender, said their bank has cut the number of correspondent banking relationships it holds from around 6,000 to 1,600 since 2015. 

Another bank representative said many lenders “just withdraw from this region, because they are not 100% sure they are able to comply” with the ongoing ramping up of sanctions against Russian entities. 

“For banks, the problem is they are fighting on two fronts,” Nindl says. “Not only do they want to avoid getting into trouble over sanctions, but there is a cost issue. Compliance costs are so high that small banking relationships just aren’t worthwhile keeping up anymore.” 

However, speakers also revealed optimism that changing market conditions – particularly as US and European central banks raise interest rates in a bid to tackle inflation – could provide stronger incentives for banks to keep correspondent banking alive. 

“One positive sentiment I heard for the first time was that because of rising interest rates, banks are now earning more money from these transactions,” Nindl says. “That potentially means they can justify having correspondent banking relationships internally.” 

As BACEE’s Lengyel explained, interest income from bank-to-bank transactions “is sometimes overlooked”. 

“The interest rate environment is changing, the period when we have had zero, close to zero or even negative interest rates is over, and this will be a major element of reviving correspondent banking,” he said. 

One speaker described the changing interest rate environment as a “very important point”. 

“There are some positive signs,” they said. “I’m happy to say we have actually been able to grow [corresponding banking] in this respect.” 

At the same time, US authorities are increasingly seeking to discourage de-risking by banks. 

A first-of-its-kind strategy paper published by the US Treasury Department in May admits the government “has limited authority to effectively address some drivers of de-risking, especially those related to business decisions of financial institutions”. 

However, it makes several recommendations to the US federal government, urging it to promote consistent supervisory expectations to lenders and to consider clarifying anti-money laundering regulations set out in the Bank Secrecy Act. 

It says lawmakers should consider requiring banks to incorporate financial inclusion into risk-based anti-money laundering programmes, and calls for an expansion of cross-border co-operation on “creative solutions… such as regional consolidation projects”. 

The Bankers Association for Finance and Trade (Baft) is also targeting de-risking, this week issuing updated guidelines for respondent banks to help them maintain their correspondent banking relationships. 

Meanwhile, the EBRD used the October event to reassure trade finance providers that Ukraine remains a viable market despite the war and challenging sanctions environment. 

“On Ukraine, the message is that we are open for business, and the local banks are open for business,” Nindl says.  

“They have limited risk-taking capacity, given the circumstances, but are doing whatever they can, and they have the support of the EBRD. Banks are still able to conduct trade finance business in Ukraine, imports are still happening, as are exports to a certain extent.”