## wp1790

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### Introduction and key messages
- A large-scale withdrawal of correspondent banking relationships (CBRs) is occurring in many regions, including the small states of the Pacific.
- Drivers of banks’ decisions include: cost-benefit analysis; re-evaluation of business models amid evolving regulatory and enforcement landscapes; economic and trade sanctions; AML/CFT policies; and tax transparency regimes (including FATCA).
- Small-state features heightening vulnerability:
  - Weaknesses in AML/CFT regimes and poor compliance by some MTOs.
  - Direct linkages with global banks or indirect linkages via regional correspondents.
  - Presence of offshore financial centers in some jurisdictions.
  - Non-compliance with the U.S. Foreign Account Tax Compliance Act (FATCA) has led in some instances to CBR withdrawal.
- Consequences of CBR withdrawal:
  - Closure of MTO bank accounts both in sender and receiver countries.
  - MTOs operating with a single bank account or with no bank accounts; risk of MTOs ceasing operations or shifting to informal channels (hand-carry cash) or costlier banking channels.
  - Increased concentration in provision of services, raising systemic risk and potential disruption to remittance flows and trade-related financial services.
  - Reduced competition likely to raise cost of financial services, including remittances.
  - Potential to undermine financial system functioning, weaken growth prospects, and reduce resilience to shocks if withdrawals continue without corrective policy action.

### Remittances: magnitude, sources, and vulnerabilities
- In 2015, remittances averaged about 10 percent of GDP in the Pacific islands relative to 5 percent on average for low-income countries.
- Dependency highlights:
  - Tonga peaked at 27 percent of GDP.
  - Countries with high dependency include Kiribati, Marshall Islands, Samoa, Tonga, and Tuvalu.
- Aggregate and country remittance amounts (US$ millions, 2015):
  - Total remittances to the small states are about US$600 million annually.
  - Fiji 222
  - Samoa 154
  - Tonga 118
  - Vanuatu 28
  - Marshall Islands 27
  - Micronesia 24
  - Solomon Islands 19
  - Kiribati 16
  - PNG 10
  - Tuvalu 4
  - Palau 2
- Source countries (regional remittance origins as reported):
  - Australia: 26%
  - New Zealand: 26%
  - U.S.: 26%
  - Rest of the World: 22%
- Main sources overall: Australia, New Zealand, and the United States, with about 25 percent for each country on average (country-level differences noted).

### Survey evidence and country snapshots (IMF June–October 2016)
- Many countries experiencing greater difficulty maintaining CBRs or facing rising costs/complexities in money transfers and repatriation of remittances.
- MTO account closures increasing in Fiji, Samoa, and Tonga (domestically and in Australia/New Zealand).
- CBRs withdrawn or increasingly strained in Kiribati, the Marshall Islands, Samoa, Tonga, and Tuvalu.
- Selected authorities’ verbatim views:
  - Fiji: "CBRs have remained broadly intact." "The cost of remittances to Fiji, especially from New Zealand, has increased since mid-2015."
  - Kiribati: "No, but anecdotal evidence points to increased compliance costs." "No"
  - Marshall Islands: "The country’s sole domestic commercial bank is at risk of losing its US correspondent banking relationship."
  - Palau: "The loss of CBRs has not been an issue in Palau ... No. The remittance sector is very small in Palau."
  - Papua New Guinea: "The level of compliance to maintain CBRs is increasing ... Certain institutions lost CBRs, others have had difficulties securing them ... Money transfers ... are becoming costly."
  - Samoa: "Although CBRs have largely been maintained, they are increasingly at risk." "Yes, the cost of remittance has increased recently."
  - Solomon Islands: "The number of CBRs has declined." "The closure of some MTOs is beginning to affect the cost of sending remittances."
  - Tonga: "Establishing CBRs with U.S. banks has become more difficult." "The cost of remittances from New Zealand to Tonga has risen."
  - Tuvalu: "Tuvalu’s largest bank, the NBT, has maintained the key working international CBRs ... Yes No"
  - Vanuatu: "Though the loss of CBRs is not a serious issue, inclusion in the FATF list may pose some difficulties ... The repatriation of remittances to Vanuatu has been costly for seasonal workers ..."

### Drivers of strain on correspondent banking relationships
- Banks’ heightened scrutiny of respondent banks’ interaction with the remittance sector, leading to MTO account closures.
- AML/CFT weaknesses and compliance failures by some MTOs raising monitoring costs.
- Offshore financial sectors increasing perceived AML/CFT risk.
- Non-compliance with FATCA prompting CBR termination in some instances.
- Regional correspondents’ closer connections with global banks amplifying respondent banks’ CBR challenges.
- Re-evaluation of banks’ business models and changes in regulatory/enforcement landscape (prudential requirements, sanctions, AML/CFT, tax transparency) shape risk and reputational cost perceptions.

### MTO compliance weaknesses and operational features
- MTOs’ compliance with formal Know-Your-Customer (KYC) requirements is sometimes weak or absent, particularly where customers are known personally to the proprietor in small communities.
- KYC compliance is hampered by the lack of formal means of identification in many small states that do not issue national IDs and where many individuals do not have driver’s licenses or passports.
- Banks report concerns about their ability to respond to requests for information about underlying remittance customers (Know Your Customers’ Customer, KYCC). Although KYCC is not formally required, banks often perceive it as a requirement because of:
  - banks’ understanding of the consequences of U.S. regulatory requirements;
  - reputational risk concerns;
  - increased oversight by correspondent banks; and
  - the need to satisfy domestic legislation.
- To avoid perceived KYCC obligations or the compliance cost, banks may opt to close MTO bank accounts.
- Operational model and monitoring challenges:
  - MTOs often accumulate a large number of two-way transfers that are netted out; low fees charged and profits determined by transaction volume.
  - Example: In Samoa, MTOs handle just over half a million inward money transfers a year, with an average size of just US$270.
  - Typical practice: bundling cross-border transfers into a single transaction complicates banks’ monitoring.

### BIS-CMPI / SWIFT evidence (2012–2015) and interpretation caveats
- Sharpest fall in active correspondents has occurred in Oceania (BIS country grouping classifications).
- Between 2012 through 2015, Melanesia, Micronesia, and Polynesia experienced declines in active CBRs in almost all years, with net losses of more than 10 percent in 2012 in Australia and New Zealand, and in Melanesia, and Micronesia.
- Country-level changes in selected small Pacific states (Table 3: Trends in CBRs and Transactions in Selected Small States of the Pacific (2012–15)):
  - Fiji: Change in number of active correspondents: -1.5; Change in transaction volume: 18.8; Change in transaction value: 114.2
  - Kiribati: Change in number of active correspondents: 10.6; Change in transaction volume: 8.3; Change in transaction value: 8.5
  - Papua New Guinea: Change in number of active correspondents: -11.6; Change in transaction volume: 31.6; Change in transaction value: -13.4
  - Samoa: Change in number of active correspondents: 4.5; Change in transaction volume: 25.5; Change in transaction value: 44.5
  - Solomon Islands: Change in number of active correspondents: -18.3; Change in transaction volume: 8.7; Change in transaction value: -8.7
  - Tonga: Change in number of active correspondents: -8.3; Change in transaction volume: 3.2; Change in transaction value: -15.9
  - Tuvalu: Change in number of active correspondents: -15.5; Change in transaction volume: 47.7; Change in transaction value: 12.0
  - Vanuatu: Change in number of active correspondents: -4.2; Change in transaction volume: -1.7; Change in transaction value: -33.2
- Interpretation caveats:
  - Changes in transaction value and volume are not straightforward and can reflect rerouting, netting changes, or shifts from netted MTO transfers to direct bank transfers.
  - Data comparing 2015 with 2012 may underestimate impacts that escalated in the latter half of the sample and continued into 2016.

### Evidence of MTO account closures and operational impacts
- Closure of MTO bank accounts has added to fragility of the remittance sector.
- AUSTRAC data: at least 719 bank accounts belonging to remittance businesses were closed by banks in Australia between January 2014 and April 2015.
- Australian small-scale survey (October 2015, 63 responses):
  - 60 percent now have just one account
  - 20 percent have no accounts
  - Most respondents had been in operation for more than 5 years (65 percent); money transfers were their core activity (85 percent); had no adverse AUSTRAC opinion/conditions (94 percent); and had conducted an independent review of their business (63 percent).
- World Bank survey: closure of MTO accounts has intensified since 2010; a large share of MTOs responding in the United States and Australia report closure of at least one bank account.
- Reported operational impacts on MTOs:
  - Some MTOs now have at most one bank account compared with several previously.
  - A few MTOs without a business bank account are using personal accounts.
  - New restrictions include caps on amounts and frequency of transfers.

### Remittance costs, price structure, and trends
- The cost of remittances appears to be rising again, reversing an earlier declining trend.
- Average cost of sending remittances to Pacific island countries:
  - From Australia: about 12–13 percent
  - From New Zealand: 10–11 percent
  - G20 target: 5 percent by 2020
- Cost drivers:
  - High fees and high foreign exchange margins.
  - Pricing not transparent and varies by destination, product, and whether the migrant uses a bank or an MTO.
- Provider/product differences:
  - Costs are much lower for remittances by MTOs than by banks (lower fees and smaller FX margins).
  - Account-to-account services (banks) are the most expensive means of transferring money.
  - Online, mobile, and card services charge much less and are largely offered by MTOs.
- Policy suggestion: authorities may wish to consider the feasibility of a payments cost study to understand relative costs and drivers.

### Potential consequences for small Pacific states
- Increase in systemic risk:
  - Small number of banks implies loss of CBRs or closure of MTO accounts can quickly create systemic risk as services concentrate in a single entity.
  - Small banks rely on correspondent banks to offer a broader range of services; loss of a CBR could leave local businesses without access to some services.
- Fragile remittance sector:
  - Closures of MTOs’ bank accounts and MTO exits increase fragility of remittance corridors.
  - Remittances could be deceptively stable as flows are diverted through alternative channels; but number and reliability of MTOs have fallen.
- Increased use of more expensive or non-transparent channels:
  - Shift toward unregulated channels or increased hand-carry of cash has been reported.
  - Reduced transparency limits authorities’ ability to monitor and investigate transactions.
- Increased cost of remittances:
  - Continued strain in CBRs could raise remittance costs further.
  - Weaker competition and closure of MTO bank accounts limit MTOs’ ability to find lowest transfer costs, pushing up average costs.
  - Shift of flows into banks will further boost average costs.
- Negative consequences for financial inclusion:
  - Closure/curtailment of MTOs could significantly impact financial inclusion.
  - Example: Samoa is a cash-based society and about 85 percent of remittances are channeled through money transfer operators (MTOs).
  - Reach comparison: largest MTO has 30 branches outside of Apia, compared with 15 for the four banks combined.
- Decline in growth and reduced resilience to shocks:
  - Remittances support household consumption; Samoa: remittances amount to 20 percent of GDP.
  - Any decline in remittances could have a significant impact on GDP and reduce longer-term growth prospects.
  - Remittances play a key role in immediate assistance after natural disasters.

### Policy recommendations — collective action and regulatory responses
- Collective action needed across authorities in small states, remitter countries, and home countries of global correspondent banks.
- Core collective actions:
  - Affected countries must upgrade regulatory and supervisory frameworks to comply with international standards on AML/CFT and tax transparency; ongoing donor support will be needed in many cases.
  - Regulators should continue outreach and dialogue with global banks and with regulators in countries whose banks serve as intermediaries for affected jurisdictions.
    - Objective: clarify compliance frameworks to ease correspondent bank concerns and ensure home country regulators consistently communicate expectations.
    - Encourage correspondent banks to upgrade information gathering so a well-informed risk-based assessment drives termination decisions.
  - Financial industry engagement:
    - Deploy new tools (for example, KYC utilities) to help lower compliance costs for banks.
    - Support training of bankers in implementing AML/CFT in remote jurisdictions to achieve consistent application of standards.
- Short-term mitigation and medium-term development measures for affected countries:
  - Establish a national database — a KYC utility — to reduce costs and enhance compliance.
  - Develop the digital economy and new financial technologies (Fintech) to create low-cost remittance channels while ensuring payments system integrity.
  - Upgrade payments systems and legally accept electronic signatures to support Fintech.
  - Conduct a payments cost study to identify drivers of high costs and suggest ways to lower costs in the remittance sector.
  - Address shortcomings in domestic AML/CFT frameworks and effectiveness; implement recommendations from Mutual Evaluation Assessments by APG where completed.
  - Increase AML/CFT capacity and awareness across central bank, Ministry of Finance, Customs, judiciary, Attorney General’s Office, police, financial sector, and MTOs.
  - Create a local capacity AML/CFT Specialists Certification Program via a training-for-trainers approach; donor assistance may be needed.
  - Increase dialogue with key stakeholders: communicate progress to foreign regulators, financial intelligence units, and correspondent banks; where appropriate, emphasize limited links between MTO remittance channels to small states and the offshore financial sector.
  - Upgrade the sanctions regime to ensure UN Security Council resolutions and financial sanctions are properly enforced; implement a terrorism financing sanctions framework to support foreign bank confidence.
  - Ensure compliance with FATCA:
    - Central bank could negotiate an intergovernmental agreement (IGA) with the U.S. Treasury on FATCA implementation.
    - FATCA compliance is essential to ensure continued correspondent relationships in U.S. dollars and to avoid a 30 percent automatic withholding by U.S. banks of any non-compliant bank’s U.S. dollar transfers.
    - By signing an IGA, domestic central banks could reduce risks, complexity, and cost for local banks and lower risks of foreign bank exit and correspondence withdrawal.
    - Samoa has begun negotiations on such an IGA.

### Centralized national KYC utility: rationale, scope, and operational design
- Rationale and scope:
  - Collecting KYC Data on individuals receiving or sending remittances through MTOs and possibly including KYC data on bank customers as well as beneficial ownership information for companies is possible given the relatively small population sizes of the islands.
  - Housing the utility within the Financial Intelligence Units (already established in many jurisdictions) would:
    - help satisfactorily address correspondent banks AML/CFT compliance issues; and
    - address privacy protection concerns because the financial intelligence unit would have the necessary legal authority and responsibility to collect and protect the data.
  - The utility could:
    - serve as a tool for verifying bank customers’ information;
    - potentially be an important component of financial inclusion efforts, contributing to credit extension, and support banking supervision; and
    - serve as the building block for a national ID system.
- Complementary measures and operational design:
  - Coupled with a FATF compliant AML/CFT regime applied to MTOs, the utility would include verified KYC information on remittance recipients and senders easing correspondent bank concerns.
  - The financial intelligence unit should take the lead in developing the database.
  - Financial and technical assistance for implementation by donors is likely to be needed.
  - Subject to existing legal requirements, access to the database could be provided to:
    - compliant sender and receiver MTOs;
    - correspondent banks; and
    - other financial intelligence units;
    thus reducing the cost of compliance to the MTOs and ensuring satisfactory AML/CFT vetting of beneficiaries in an electronically secured environment.

### Role of technology, mobile money, and blockchain
- Many technology-based solutions—with the exception of blockchain technology—still need to rely to some degree on existing banking infrastructure for the clearing and settlement of funds, and are thus not completely immune to further withdrawal of CBRs or account closures.
- Potential technology combination for small states involves:
  - an adequate mobile phone network;
  - a KYC utility; and
  - blockchain technology.
- Mobile money:
  - Mobile money consists of customers’ stored funds maintained by mobile network operators, obviating the need for an underlying bank account, unlike mobile banking which provides on-line access to an existing bank account.
  - Wider use of mobile money can allow greater access to financial services and foster more financial inclusion given geographical dispersion.
  - Mobile telephone networks offer greater coverage in many Pacific small states, suggesting mobile money can be viable for cross-border transactions; examples exist in West Africa.
  - Connecting technology to a KYC database would help ensure payments system integrity.
- Blockchain and distributed ledger platforms:
  - Have the potential to reduce reliance on the banking system for clearing and settlement.
  - Promise to reduce time, cost, and complexity of cross-border transfers.
  - Will need to take into account:
    - the technology gap in many small states of the Pacific;
    - challenges posed for market supervision; and
    - plans to build on ongoing efforts to address gaps in access to mobile technology in some small states.
  - Central banks and supervisors will need to strengthen and adapt regulatory frameworks in light of concerns about potential vulnerabilities arising from blockchain technology.
- If correspondent banks continue to limit engagement after these measures, a combined platform of blockchain technology, a KYC utility for senders and receivers, and mobile phone networks could provide cross-border transaction capability that would not rely on traditional correspondent banking.

*Source: IMF working paper wp1790 (excerpt).*

### REFERENCES _________________________________________________________ 28

### REFERENCES _________________________________________________________ 28

### Figures, Tables, and Boxes (Inventory)
- Figures: 1. The Role of Remittances in the Small States of the Pacific; 2. Remittance Source Countries for the Small States of the Pacific; 3. Closure of Money Transfer Operator Accounts; 4. Cost of Sending US$200 to the Pacific Islands; 5. Cost of Sending US$200 to the Pacific Islands by Firm and Product Type.
- Tables: 1. Survey on the Consequences of Correspondent Banking Relationship Withdrawal; 2. Commercial Banks in the Small States of the Pacific; 3. Trends in CBRs and Transactions in Selected Small States of the Pacific.
- Boxes: 1. Correspondent Banking Relationships; 2. Marshall Islands: Correspondent Banking Relationship Challenges; 3. Samoa: Anti-Money Laundering and Counter-Terrorist Financing Measures; 4. Key Findings from IMF Staff Discussion Note “The Withdrawal of Correspondent Banking Relationships: A Case for Policy Action”.

### Acronyms (as listed)
- AML/CFT Anti-Money Laundering and Combating the Financing of Terrorism
- ANZ Australia and New Zealand Banking Group
- APG Asia/Pacific Group on Money Laundering
- AUSTRAC Australian Transaction Reports and Analysis Centre
- BIS Bank for International Settlements
- BOMI Bank of the Marshall Islands
- CBR Correspondent Banking Relationship
- CBS Central Bank of Samoa
- FATCA Foreign Account Tax Compliance Act
- IGA Intergovernmental Agreement
- IPO Initial Public Offering
- KYC Know Your Customer
- KYCC Know Your Customer’s Customer
- MTOs Money Transfer Operators
- PICs Pacific Island Countries
- RSP Remittance Service Provider
- SFIU Samoa Financial Intelligence Unit
- SWIFT Society for the Worldwide Interbank Financial Telecommunication
- TCSP Trust and Company Service Providers

### Key Findings and Messages from the Introduction and Overview
- A large-scale withdrawal of correspondent banking relationships (CBRs) is occurring in many regions, including the small states of the Pacific.
- Drivers of banks’ decisions include: cost-benefit analysis; re-evaluation of business models amid evolving regulatory and enforcement landscapes; economic and trade sanctions; AML/CFT policies; and tax transparency regimes (including FATCA).
- Small-state features heightening vulnerability:
  - Weaknesses in AML/CFT regimes and poor compliance by some MTOs.
  - Direct linkages with global banks or indirect linkages via regional correspondents.
  - Presence of offshore financial centers in some jurisdictions.
  - Non-compliance with the U.S. Foreign Account Tax Compliance Act (FATCA) has led in some instances to CBR withdrawal.
- Consequences of CBR withdrawal:
  - Closure of MTO bank accounts both in sender and receiver countries.
  - MTOs operating with a single bank account or with no bank accounts; risk of MTOs ceasing operations or shifting to informal channels (hand-carry cash) or costlier banking channels.
  - Increased concentration in provision of services, raising systemic risk and potential disruption to remittance flows and trade-related financial services.
  - Reduced competition likely to raise cost of financial services, including remittances.
  - Potential to undermine financial system functioning, weaken growth prospects, and reduce resilience to shocks if withdrawals continue without corrective policy action.

### Survey Results and Recent Evidence (summary)
- IMF survey of country teams and authorities (June–October 2016) indicates:
  - Many countries are experiencing greater difficulty maintaining CBRs or are facing rising costs/complexities in money transfers and repatriation of remittances.
  - MTO account closures increasing in Fiji, Samoa, and Tonga (both domestically and in Australia/New Zealand).
  - CBRs have been withdrawn or are increasingly strained in Kiribati, the Marshall Islands, Samoa, Tonga, and Tuvalu.
- Country-specific survey snapshots (authorities’ views, selected points preserved verbatim):
  - Fiji: "CBRs have remained broadly intact." "The cost of remittances to Fiji, especially from New Zealand, has increased since mid-2015."
  - Kiribati: "No, but anecdotal evidence points to increased compliance costs." "No" (on money transfer costs and repatriation).
  - Marshall Islands: "The country’s sole domestic commercial bank is at risk of losing its US correspondent banking relationship."
  - Palau: "The loss of CBRs has not been an issue in Palau ... No. The remittance sector is very small in Palau."
  - Papua New Guinea: "The level of compliance to maintain CBRs is increasing ... Certain institutions lost CBRs, others have had difficulties securing them ... Money transfers ... are becoming costly."
  - Samoa: "Although CBRs have largely been maintained, they are increasingly at risk." "Yes, the cost of remittance has increased recently."
  - Solomon Islands: "The number of CBRs has declined." "The closure of some MTOs is beginning to affect the cost of sending remittances."
  - Tonga: "Establishing CBRs with U.S. banks has become more difficult." "The cost of remittances from New Zealand to Tonga has risen."
  - Tuvalu: "Tuvalu’s largest bank, the NBT, has maintained the key working international CBRs ... Yes No" (on money transfer complexity and repatriation respectively).
  - Vanuatu: "Though the loss of CBRs is not a serious issue, inclusion in the FATF list may pose some difficulties ... The repatriation of remittances to Vanuatu has been costly for seasonal workers ..."

### Remittances: Magnitude, Sources, and Vulnerabilities (key statistics preserved)
- In 2015, remittances averaged about 10 percent of GDP in the Pacific islands relative to 5 percent on average for low-income countries.
- Dependency highlights:
  - Tonga peaked at 27 percent of GDP.
  - Countries with high dependency include Kiribati, Marshall Islands, Samoa, Tonga, and Tuvalu.
- Aggregate and country remittance amounts (as presented):
  - Total remittances to the small states are about US$600 million annually, with Fiji, Samoa, and Tonga representing the largest markets.
  - Remittances (US$ millions, 2015): Fiji 222; Samoa 154; Tonga 118; Vanuatu 28; Marshall Islands 27; Micronesia 24; Solomon Islands 19; Kiribati 16; PNG 10; Tuvalu 4; Palau 2; (order preserved as in source).
- Source countries:
  - Main sources of remittances are Australia, New Zealand, and the United States, with about 25 percent for each country on average.
  - Country-level differences noted: Fiji, Solomon Islands, Samoa, and Tonga are more dependent on Australia and New Zealand; Kiribati, Marshall Islands, Micronesia, and Palau receive more from other countries including the United States.

### Drivers of Strain on CBRs (concise list)
- Banks’ heightened scrutiny of respondent banks’ interaction with the remittance sector, leading to MTO account closures.
- AML/CFT weaknesses and compliance failures by some MTOs raising monitoring costs.
- Offshore financial sectors increasing perceived AML/CFT risk.
- Non-compliance with FATCA prompting CBR termination in some instances.
- Regional correspondents’ closer connections with global banks amplifying respondent banks’ CBR challenges.

*REFERENCES _________________________________________________________ 28*

### 10.  Weak compliance by some MTOs with AML/CFT requirements also contributes to

### 10.  Weak compliance by some MTOs with AML/CFT requirements also contributes to 

### MTO compliance weaknesses and drivers of account closures
- MTOs’ compliance with formal Know-Your-Customer (KYC) requirements is sometimes weak or absent, particularly where customers are known personally to the proprietor in small communities.
- KYC compliance is hampered by the lack of formal means of identification in many small states that do not issue national IDs and where many individuals do not have driver’s licenses or passports.
- Banks report concerns about their ability to respond to requests for information about underlying remittance customers (Know Your Customers’ Customer, KYCC). Although KYCC is not formally required, banks often perceive it as a requirement because of:
  - banks’ understanding of the consequences of U.S. regulatory requirements;
  - reputational risk concerns;
  - increased oversight by correspondent banks; and
  - the need to satisfy domestic legislation.
- To avoid perceived KYCC obligations or the compliance cost, banks may opt to close MTO bank accounts.

### Operational structure of MTOs and AML/CFT risks
- MTOs vary widely in operational models, size, and sophistication across and within small states; some MTOs are very small and may have only the owner as the lone employee, often operating in partnership with a single operator in another country, implying no separate compliance officer.
- The MTO business model often involves accumulating a large number of two-way transfers that are then netted out; a low fee is charged to the customer and profits are determined by transaction volume.
- Example statistic: In Samoa, MTOs handle just over half a million inward money transfers a year, with an average size of just US$270.
- Typical practice: an MTO uses its bank accounts for bank-to-bank cross-border transfers of the net amounts (first shopping around for the lowest cost transfer on any given day). From banks’ perspective, bundling cross-border transfers into a single transaction complicates monitoring.
- Banks are not required to perform due diligence on their customer’s customer; however, uncertainty about the strength of an MTO’s systems and the need to apply a risk-based approach make banks concerned about responding to information requests, prompting account closures.

### Regional remittance origins (as reported)
- Australia: 26%
- New Zealand: 26%
- U.S.: 26%
- Rest of the World: 22%

### Marshall Islands: Correspondent Banking Relationship (CBR) challenges (Box 2)
- The Marshall Islands’ sole domestic commercial bank (Bank of the Marshall Islands, BOMI) has a CBR with a U.S.-based bank (First Hawaiian Bank, a subsidiary of BNP Paribas) enabling access to U.S. settlement and payment services.
- In 2015, the U.S.-based bank notified BOMI that it may terminate its correspondent banking accounts with BOMI by end-2016, owing to concerns about the cost of complying with new U.S. regulations and after penalties stemming from BNP Paribas’ violations of U.S. sanctions laws.
- The U.S.-based bank agreed to continue its CBR with BOMI until BOMI finds a new U.S.-based correspondent bank or resolves outstanding compliance issues.
- Remittances to the Marshall Islands have not been affected because almost all remittances come through two large operators (MoneyGram and Western Union) with partnerships with domestic banks; small MTOs are not active in the Marshall Islands.
- Authorities’ actions and timeline:
  - Drafting new AML legislation in line with FATF standards and United Nations Convention Against Corruption rules.
  - Reviewing and rectifying deficiencies identified in the 2011 Mutual Evaluation Report, including strengthening the Domestic Financial Intelligence Unit (DFIU).
  - Engaging consultants from the U.S. Financial Services Volunteer Corps to help draft legislation.
  - Meeting with relevant U.S. regulators—including the U.S. Federal Reserve in April 2016—to seek guidance on strengthening the bank supervisory framework.
  - Senior managers of the Banking Commission attended a workshop on implementing international AML/CFT standards in April 2016, organized jointly by the IMF’s Legal Department and the Singapore Training Institute.
- Policy advice from the 2016 Article IV consultation: IMF staff encouraged strengthening AML/CFT framework, particularly KYC requirements, and urged open and regular dialogue with U.S. regulators.

### Role of foreign banks and regional vulnerabilities
- The Pacific hosts many foreign-owned banks, including from the United States and Australia, increasing vulnerability to operational decisions by global and regional banks.
- Marshall Islands, Micronesia, and Palau have direct banking relationships with the U.S. banking sector through U.S.-owned banks.
- In countries with significant remittance flows—Fiji, Samoa, and Tonga—MTOs are facing account closures both domestically and in remittance-source countries.

### AML/CFT regime weaknesses and supervisory responses
- AML/CFT regimes in many small states are lagging in framework and effectiveness; offshore financial centers (Marshall Islands, Samoa, Vanuatu) contribute to strains on CBRs.
- Example: Samoa’s 2015 APG assessment found:
  - Rated low or moderately effective in 10 out of 11 immediate outcomes assessing effectiveness.
  - Non-compliant or partially compliant with more than half of the 40 FATF recommendations.
  - Offshore sector scale at end-2014: 34,000 international business companies, 155 international trusts, and 7 international banks.
- Samoa-specific risks identified:
  - International (offshore) sector: anonymity, concerns about beneficial ownership transparency, complexity, tax-exempt status; TCSPs capture beneficial ownership at company creation but supervision and ongoing detection/reporting capacity are limited.
  - MTO sector: large channel for remittances, generally aware of risks; large MTOs have reasonably robust identity/verification and originator/beneficiary information measures; low suspicious-transaction-reporting relative to sector size.
  - Cross-border movement of cash: border declaration regime technically sound; coordination among SFIU, Customs, and Immigration exists but would benefit from further coordination with police.
  - Domestic banking system: money laundering risks linked mainly to materiality; domestic proceeds-generating crimes appear low.
- High-priority recommended actions for Samoa included:
  - Offshore sector reforms: Amend International Companies Act, Trust Act, Companies Act, Money Laundering Prevention Act and regulations; issue additional guidance; increase scope and intensity of AML/CFT supervision of the offshore sector, including international banks, insurance companies and TCSPs; enhance accuracy and timeliness of beneficial ownership information held by TCSPs.
  - AML/CFT supervision: Ensure supervision of financial institutions and designated non-financial businesses and professions is risk-based; strengthen frequency and intensity of on-site inspections; increase engagement by supervisors with financial institutions and DNFBPs.
  - Enhanced implementation: Strengthen resources of the Central Bank of Samoa and Samoa Financial Intelligence Unit; pursue money laundering investigations and confiscation action in more serious/complex cases; improve effectiveness of the cross-border declaration system.

### Evidence of CBR withdrawal and data caveats
- IMF bilateral surveillance gathered information pointing to withdrawal or risk of withdrawal of CBRs in some Asia-Pacific small states (e.g., Marshall Islands, Tonga). Non-compliance with FATCA resulted in termination of a CBR in Samoa.
- SWIFT data (2012–2015) indicate global declines in active correspondents while transaction volumes grew, increasing concentration in CBRs. Caveats to interpreting these data include:
  - Changes in global, regional, and local CBR volumes can reflect many causes (economic activity fluctuations, financial sector developments).
  - Payments rerouted through third countries after account closures can raise measured correspondent banking activity (creating two transactions instead of one).
  - If two-way remittances previously netted by MTOs shift to direct bank transfers, measured volume/value of CBR transactions can increase.
  - As the data compare 2015 with 2012, they may underestimate impacts that escalated in the latter half of the sample and continued into 2016.

### Policy implications and suggested responses (from IMF staff discussions)
- Drivers of CBR withdrawal include re-evaluation of banks’ business models and changes in regulatory/enforcement landscape (prudential requirements, sanctions, AML/CFT, tax transparency), shaping risk and reputational cost perceptions.
- Coordinated public-private efforts are needed to mitigate financial exclusion risks and potential negative impacts on financial stability:
  - Enhanced understanding, improved data collection, and continued stakeholder dialogue are critical to tailor responses to country circumstances.
  - Timely implementation of the Financial Stability Board’s 2015 action plan (endorsed by the G20) is important.
  - Home authorities of global banks should communicate regulatory expectations; affected countries should strengthen regulatory and supervisory frameworks to meet international standards with technical assistance where needed.
  - Clarifying standards, including AML/CFT, could help promote a baseline for regulatory expectations.
  - Industry initiatives could facilitate customer due diligence and reduce compliance costs.
  - In severe cases of lost CBRs, public sector may consider temporary mechanisms (regional arrangements to public-backed vehicles) to provide payment clearing services.
- IMF staff have been supporting member countries in addressing CBR withdrawal to promote financial inclusion and ensure financial stability.

*Source: wp1790 - 10.  Weak compliance by some MTOs with AML/CFT requirements also contributes to (IMF working paper excerpt).*

### 17.  Bearing these caveats in mind, the BIS-CMPI analysis of the SWIFT data suggests

### wp1790 - 17.  Bearing these caveats in mind, the BIS-CMPI analysis of the SWIFT data suggests

### BIS-CMPI / SWIFT evidence on correspondent banking relationships (CBRs) in Oceania
- Sharpest fall in active correspondents has occurred in Oceania (BIS evidence using BIS country grouping classifications).
- Between 2012 through 2015, Melanesia, Micronesia, and Polynesia experienced declines in active CBRs in almost all years, with net losses of more than 10 percent in 2012 in Australia and New Zealand, and in Melanesia, and Micronesia.
- Country-level losses in selected small Pacific states (Table 3: Trends in CBRs and Transactions in Selected Small States of the Pacific (2012–15)):
  - Fiji: Change in number of active correspondents: -1.5; Change in transaction volume: 18.8; Change in transaction value: 114.2
  - Kiribati: Change in number of active correspondents: 10.6; Change in transaction volume: 8.3; Change in transaction value: 8.5
  - Papua New Guinea: Change in number of active correspondents: -11.6; Change in transaction volume: 31.6; Change in transaction value: -13.4
  - Samoa: Change in number of active correspondents: 4.5; Change in transaction volume: 25.5; Change in transaction value: 44.5
  - Solomon Islands: Change in number of active correspondents: -18.3; Change in transaction volume: 8.7; Change in transaction value: -8.7
  - Tonga: Change in number of active correspondents: -8.3; Change in transaction volume: 3.2; Change in transaction value: -15.9
  - Tuvalu: Change in number of active correspondents: -15.5; Change in transaction volume: 47.7; Change in transaction value: 12.0
  - Vanuatu: Change in number of active correspondents: -4.2; Change in transaction volume: -1.7; Change in transaction value: -33.2
- Interpretation caveat: changes in transactions value and volume are not straightforward; some small states saw increases in transaction volume and value (examples: Samoa and Fiji).

### Evidence: disruption in remittances and MTO account closures
- Closure of MTO bank accounts has added to fragility of the remittance sector.
- Current account data does not suggest a fall in remittances; a 2015 AUSTRAC study finds no overall reduction in remittance transfers.
- Multiple sources (IMF bilateral surveillance, roundtable with MTOs in Samoa, World Bank survey, AUSTRAC, Australian Remittance and Currency Providers Association survey) point to widespread closure of MTO accounts.
- Australian small-scale survey (October 2015, 63 responses):
  - 60 percent now have just one account
  - 20 percent have no accounts
  - Most respondents had been in operation for more than 5 years (65 percent); money transfers were their core activity (85 percent); had no adverse AUSTRAC opinion/conditions (94 percent); and had conducted an independent review of their business (63 percent).
- AUSTRAC data: at least 719 bank accounts belonging to remittance businesses were closed by banks in Australia between January 2014 and April 2015 (AUSTRAC, 2015).
- World Bank survey shows closure of MTO accounts has intensified since 2010; a large share of MTOs responding in the United States and Australia report closure of at least one bank account.
- Reported operational impacts on MTOs:
  - Some MTOs now have at most one bank account compared with several previously.
  - A few MTOs without a business bank account are using personal accounts.
  - New restrictions include caps on amounts and frequency of transfers.

### Remittance costs and price structure
- The cost of remittances appears to be rising again, reversing an earlier declining trend.
- Average cost of sending remittances to Pacific island countries:
  - From Australia: about 12–13 percent
  - From New Zealand: 10–11 percent
  - G20 target: 5 percent by 2020
- High remittance costs are driven by both high fees and high foreign exchange margins; pricing is not transparent and varies by destination, product, and whether the migrant uses a bank or an MTO.
- Relative cost by provider and product:
  - Costs are much lower for remittances by MTOs than by banks (lower fees and smaller FX margins).
  - Account-to-account services (banks) are the most expensive means of transferring money.
  - Online, mobile, and card services charge much less and are largely offered by MTOs.
- Policy suggestion: authorities may wish to consider the feasibility of a payments cost study to understand relative costs and drivers.

### Potential consequences for small Pacific states
- Increase in systemic risk in the financial system:
  - Small number of banks implies loss of CBRs or closure of MTO accounts can quickly create systemic risk as services concentrate in a single entity.
  - Small banks rely on correspondent banks to offer a broader range of services; loss of a CBR could leave local businesses without access to some services.
- A more fragile remittance sector:
  - Closures of MTOs’ bank accounts and MTO exits increase fragility of remittance corridors.
  - Remittances could be deceptively stable as flows are diverted through alternative channels; but number and reliability of MTOs have fallen.
- Increased use of more expensive or non-transparent channels:
  - Shift toward unregulated channels or increased hand-carry of cash has been reported.
  - Reduced transparency limits authorities’ ability to monitor and investigate transactions.
- Increase in the cost of remittances:
  - Continued strain in CBRs could raise remittance costs further.
  - Weaker competition and closure of MTO bank accounts limit MTOs’ ability to find lowest transfer costs, pushing up average costs.
  - Shift of flows into banks will further boost average costs.
- Negative consequences for financial inclusion:
  - Closure/curtailment of MTOs could significantly impact financial inclusion.
  - Example: Samoa is a cash-based society and about 85 percent of remittances are channeled through money transfer operators (MTOs).
  - Reach comparison: largest MTO has 30 branches outside of Apia, compared with 15 for the four banks combined.
- Decline in growth and reduced resilience to shocks:
  - Remittances support household consumption; Samoa: remittances amount to 20 percent of GDP.
  - Any decline in remittances could have a significant impact on GDP and reduce longer-term growth prospects.
  - Remittances play a key role in immediate assistance after natural disasters.

### Policy recommendations — broad strategy and collective action
- Collective action needed across authorities in small states, remitter countries, and home countries of global correspondent banks.
- Core collective actions:
  - Affected countries must upgrade regulatory and supervisory frameworks to comply with international standards on AML/CFT and tax transparency; ongoing donor support will be needed in many cases.
  - Regulators should continue outreach and dialogue with global banks and with regulators in countries whose banks serve as intermediaries for affected jurisdictions.
    - Objective: clarify compliance frameworks to ease correspondent bank concerns and ensure home country regulators consistently communicate expectations.
    - Encourage correspondent banks to upgrade information gathering so a well-informed risk-based assessment drives termination decisions.
  - Financial industry engagement:
    - Deploy new tools (for example, KYC utilities) to help lower compliance costs for banks.
    - Support training of bankers in implementing AML/CFT in remote jurisdictions to achieve consistent application of standards.

### Policy actions for affected countries (short-term mitigation and medium-term development)
- Focus areas: upgrade legislation, improve implementation, increase capacity, and reduce compliance costs.
- Specific measures:
  - Establish a national database — a KYC utility — to reduce costs and enhance compliance.
  - Develop the digital economy and new financial technologies (Fintech) to create low-cost remittance channels while ensuring payments system integrity.
  - Upgrade payments systems and legally accept electronic signatures to support Fintech.
  - Conduct a payments cost study to identify drivers of high costs and suggest ways to lower costs in the remittance sector.
- Efforts to upgrade the domestic compliance framework should include:
  - Address shortcomings in domestic AML/CFT frameworks and effectiveness; implement recommendations from Mutual Evaluation Assessments by APG where completed.
  - Increase awareness and capabilities for AML/CFT compliance:
    - Develop a broad-based national AML/CFT approach and scale up the number of AML/CFT specialists across central bank, Ministry of Finance, Customs, judiciary, Attorney General’s Office, police, financial sector, and MTOs.
    - Create a local capacity AML/CFT Specialists Certification Program via a cost-effective training-for-trainers program; donor assistance may be needed.
  - Increase dialogue with key stakeholders: communicate progress to foreign regulators, financial intelligence units, and correspondent banks; where appropriate, emphasize limited links between MTO remittance channels to small states and the offshore financial sector.
  - Upgrade the sanctions regime to ensure UN Security Council resolutions and financial sanctions are properly enforced; implementing a terrorism financing sanctions framework could support foreign bank confidence with minimal cost.
  - Ensure compliance with FATCA:
    - Central bank could negotiate an intergovernmental agreement (IGA) with the U.S. Treasury on FATCA implementation.
    - FATCA compliance is essential to ensure continued correspondent relationships in U.S. dollars and to avoid a 30 percent automatic withholding by U.S. banks of any non-compliant bank’s U.S. dollar transfers.
    - By signing an IGA, domestic central banks could reduce risks, complexity, and cost for local banks and lower risks of foreign bank exit and correspondence withdrawal.
    - Samoa has begun negotiations on such an IGA.

*Source: IMF working paper wp1790 (excerpt).*

### 27. Establishing a centralized national KYC utility by island authorities and actively

### 27. Establishing a centralized national KYC utility by island authorities and actively

### Rationale and scope of a centralized KYC utility
- Collecting KYC Data on individuals receiving or sending remittances through money transfer operators and possibly including KYC data on bank customers as well beneficial ownership information for companies is possible given the relatively small population sizes of the islands.
- Housing the utility within the Financial Intelligence Units (already established in many jurisdictions) would:
  - help satisfactorily address correspondent banks AML/CFT compliance issues; and
  - address privacy protection concerns because the financial intelligence unit would have the necessary legal authority and responsibility to collect and protect the data.
- Recognition that ‘know your customers’ customer’ approach is not a regulatory requirement and noting recent clarifications by US regulators and FATF that it is not a requirement 15, the utility nevertheless could:
  - serve as a tool for verifying bank customers’ information;
  - potentially be an important component of financial inclusion efforts, contributing to credit extension, and support banking supervision; and
  - serve as the building block for a national ID system.

### Complementary AML/CFT measures and operational design
- Coupled with a FATF compliant AML/CFT regime applied to MTOs, the utility would include verified KYC information on remittance recipients and senders easing correspondent bank concerns.
- The financial intelligence unit should take the lead in developing the database.
- Financial and technical assistance for the implementation of such a system by donors is likely to be needed.
- The database would help increase compliance and ease the cost of customer due diligence by improving the information available on the customer.
- This database along with other components of the CDD process, such as ongoing monitoring of the business relationship, will help reassure regulators and correspondent banks.
- Subject to existing legal requirements, access to the database could be provided to:
  - compliant sender and receiver MTOs;
  - correspondent banks; and
  - other financial intelligence units;
  thus reducing the cost of compliance to the MTOs and ensuring satisfactory AML/CFT vetting of beneficiaries in an electronically secured environment.

### Role of technology and interaction with mobile money and blockchain
- Many technology-based solutions—with the exception of blockchain technology—still need to rely to some degree on existing banking infrastructure for the clearing and settlement of funds, and are thus not completely immune to further withdrawal of CBRs or account closures.16
- A potential technology combination for small states involves:
  - an adequate mobile phone network;
  - a KYC utility; and
  - blockchain technology.
- Mobile money distinctions and opportunities:
  - Mobile money consists of customers’ stored funds maintained by mobile network operators, obviating the need for an underlying bank account, unlike mobile banking which provides on-line access to an existing bank account.
  - Given geographical dispersion, wider use of mobile money can allow greater access to financial services and foster more financial inclusion.
  - Mobile telephone networks offer greater coverage in many Pacific small states, suggesting mobile money can be a viable tool to further widen access to financial services, including in cross-border transactions.17
  - Mobile money facilities can potentially be expanded to allow cross-border mobile money transfers as an alternative to traditional money transfer operators and banks, as demonstrated in some countries in West Africa.18
  - The use of technology to connect with a KYC database would help ensure the integrity of the payments system.
- Blockchain and distributed ledger platforms:
  - Have the potential to reduce reliance on the banking system for clearing and settlement of financial transactions.
  - Promise to reduce the time, cost, and complexity of financial transactions—including cross-border money transfers.
  - Will need to take into account:
    - the technology gap in many small states of the Pacific;
    - challenges posed for market supervision; and
    - plans to build on ongoing efforts to address gaps in access to mobile technology in some small states.
  - Central banks and financial supervisors will need to strengthen and adapt the regulatory framework accordingly in light of concerns about potential vulnerabilities arising from blockchain technology.19

### Policy implications and collective action
- Collective action will be needed to mitigate negative consequences of correspondent banking relationship withdrawal on small states of the Pacific.
- Measures outlined can help ease correspondent bank concerns in the short run while laying the foundation for a payments system that is more cost effective yet fully AML/CFT compliant.
- Donor support will often be needed for implementation.
- If correspondent banks continue to limit engagement after these measures, a combined platform of blockchain technology, a Know Your Customer utility for senders and receivers, and mobile phone networks could provide cross-border transaction capability that would not rely on traditional correspondent banking.

*Source: IMF working paper content unit "27. Establishing a centralized national KYC utility by island authorities and actively" (excerpts).*

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_Source: https://www.imf.org/-/media/files/publications/wp/2017/wp1790.pdf_