Correspondent banks: The go-between of banking

Correspondent banks often help expand the services of community banks

Trent Jordan is CFO at First Southern Bank in Florence. Photo by Joe de Sciose.

First Southern Bank, headquartered in Florence, boasts five offices in the Shoals area and assets of $480 million. The bank’s customer base includes many local businesses in the community, First Southern Chief Financial Officer Trent Jordan says. 

 “A small percentage of our customers do business overseas or have overseas suppliers. So, if we have a local customer that needs to send money to China to buy a product for their business, ServisFirst Bank is who we would go through to initiate that international wire,” Jordan says.

ServisFirst, headquartered in Birmingham, is what is known as a correspondent bank. Correspondent banks are third-
party intermediaries that facilitate transactions between banks across borders, both foreign and domestic, and they play an important role in the global payment system. 

Without correspondent banks, says Rodney Rushing, ServisFirst Bank’s executive vice president and CEO: “The services that [small banks] provided to their retail and business accounts wouldn’t be as broad and they couldn’t serve that customer base nearly as well.” 

The services correspondent banks provide can range from overseas wire transfers, check clearing, deposits and currency exchanges to treasury management and various credit products. 

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Let’s say a company in Alabama wants to pay a supplier operating out of Japan. The company’s bank, however, has no direct relationship with the supplier’s bank in Japan, and that is a problem, because many countries require overseas banks to have a physical branch in their country to do business. 

Building and maintaining bank relationships overseas is out of the question for small community banks like First Southern. Furthermore, banks typically avoid doing business with financial institutions with whom they have no relationship. 

That is where a correspondent bank can help. 

In this case, the company’s Alabama bank would turn to a correspondent bank that has a relationship with the Japanese bank. Subsequently, the Alabama bank — the respondent bank — would transfer the funds to the correspondent bank. The correspondent bank would then take a fee before transferring the funds on to the bank in Japan where the supplier can access the payment. 

In the real world, however, the funds would likely move through more than one correspondent bank until reaching one that has a direct relationship with the bank in Japan.

ServisFirst, for example, offers international services such as foreign item clearing and collection and foreign currency exchange, but does not have direct relationships with overseas banks that want to do business in Alabama, Rushing says. 

“We provide foreign international services to many U.S. banks,” says Rushing. “It can be an international wire or they might have a customer in need of some currency for travel, whether its euros or British pounds or whatever the currency is, as long as it’s a country where it’s not a restricted country. But we don’t have any accounts with foreign banks.”

When transferring funds internationally, a messaging system called the Society for Worldwide Financial Telecommunications or SWIFT contains the instructions needed for making the fund transfer. 

But banks must take care to avoid transferring money on behalf of money launderers, drug dealers and other bad actors. Otherwise they can face stiff fines from regulators for failing to adhere to sanctions or anti-money laundering compliance rules. 

“We have anti-money laundering software and systems in place to check those types of transactions and to flag them. ServisFirst is just the processor,” says Jordan. “It’s our responsibility to make sure these things aren’t happening.”

Earlier this year, SWIFT announced plans to remove seven Russian banks from its system upon request by the European Union, “in consultation with the United States, the United Kingdom and Canada,” to punish Russia for its invasion of Ukraine. 

Removal from the SWIFT system puts the brakes on Russian banks’ abilities to carry out transactions around the world and could have a negative impact on that nation’s economy.

Another tool is the OFAC system. 

OFAC, which stands for the Office of Foreign Asset Control by the U.S. Department of the Treasury, is designed to help enforce trade and economic sanctions by flagging the names of international criminals, terrorists or sanctioned countries or regimes that are threats to U.S. security. 

U.S. banks are prohibited from carrying out transactions on behalf of those listed in the OFAC system. Banks that violate sanctions can incur stiff penalties. 

But many correspondent banks limit their risk by working mainly with domicile banks. 

ServisFirst’s correspondent banking clientele, for example, are primarily banks in the United States. Their correspondent banking customer base, in fact, is 340 banks in more than 20 states, Rushing says. Most are small, rural community banks across the Southeast with assets averaging around $500 million. 

For these customers, ServisFirst offers services that include domestic funds transfers and various credit solutions such as holding company loans, loan participation and executive and board accommodation loans. 

A correspondent bank participation loan transaction might involve a community bank with a commercial customer needing to borrow more than the bank’s local, legal lending limit allows. So, the bank would connect with a correspondent bank for the loan. 

“They borrow for various reasons,” says Rushing. “For capital. Sometimes they do it for a branch expansion. Sometimes for acquisitions, but we’ll loan the bank the money directly,” Rushing says. 

But in some instances, a correspondent bank might choose to act as an intermediary instead and introduce a community bank seeking the loan to another bank that is willing to lend the money.

“They [ServisFirst] have a broader footprint through their correspondent division to help us if we want to talk to another community bank,” says Jordan. “If it’s one of their correspondent customers, they’ll help us get in touch and make that connection.”

Rushing says ServisFirst also assists banks that want to issue their own privately labeled credit card.

“So, if a bank wants to have a credit card with their name and logo on it, we can issue that for them and then we share the revenue and the fee earnings from that,” he says. 

But the number of correspondent banks in the world is falling, according to a study published in BIS Quarterly Review in 2020. 

In fact, the study found that between 2011 and 2018, the number of correspondent banks fell 20% “even as the value of payments increased.” 

Consequently, “some jurisdictions could face inadequate access to the global financial system,” the study says.

Competition from digital innovators offering new solutions and the rising cost of cross-border payments due to costs associated with regulatory compliance are among the reasons given for the decline, says a July 2016 report by McKinsey & Company.

Rushing says he has witnessed a number of regional banks getting out of the correspondent banking business. 

“There aren’t as many correspondent competitors taking care of these community banks, and so we’re filling that gap,” he says. 

In the end, working with the community banks as a correspondent banker is like doing business with any commercial client, Rushing says. 

“You develop a relationship, and as long as you provide good service to that customer, they know that if they call you, they can get help.”

Gail Short and Joe De Sciose are freelance contributors to Business Alabama. Both are based in Birmingham.

This story originally appeared in the October 2022 issue of Business Alabama magazine.

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