Top Risks and Controls for International Banking

The Fastest Growing RISK REGISTER for Banks, Insurance Companies, Brokerage Firms, Money Service Bureaus and Fintechs

Oct 2024

The very complex and dynamic environment in which the international banking industry operates presents a number of hazards that could have an effect on its operations and financial stability. Therefore, it is essential to undertake risk assessments in order to recognise, assess, and manage potential risks.

The international banking department can proactively identify weak points, evaluate the possibility and impact of risks, and put the right mitigation measures in place thanks to risk assessments.

The function can stay ahead of potential risks, ensure compliance with regulatory requirements, and preserve the trust and confidence of their stakeholders by conducting frequent risk assessments.

Correspondent Banking Function

Accountable for overseeing interactions with foreign banks and facilitating cross-border services and transactions.

RISK : Compliance risk
Correspondent banking relationships can expose banks to a range of regulatory risks, including anti-money laundering (AML), counter-terrorist financing (CTF), and sanctions compliance. Banks must ensure that their correspondent banks comply with all relevant regulations and laws.

Controls :

Enhanced Due Diligence (EDD) on Correspondent Banks: Implementing a robust EDD process is crucial to assess the risks associated with correspondent banking relationships. Banks should conduct thorough background checks, including assessing the reputation, financial stability, ownership structure, and AML/CTF controls of potential correspondent banks. This control helps banks make informed decisions and identify any potential risks.
Strong Know Your Customer (KYC) Procedures: Maintaining robust KYC procedures is essential to understand the nature of the correspondent banking relationship. Banks should gather accurate information about the correspondent bank's ownership, customer base, geographical location, and purpose of transactions. Effective KYC procedures enable banks to identify and verify the identities of customers and mitigate the risk of money laundering, terrorist financing, or other illicit activities.

RISK : Credit risk
Correspondent banking relationships can also expose banks to credit risk if the correspondent bank defaults on its obligations.

Controls :

Contractual Agreements: Establishing robust contractual agreements is essential to mitigate credit risk. The agreements should clearly define the obligations, responsibilities, and liabilities of both parties. They should also include clauses that address default scenarios and potential remedies, such as collateral requirements or termination rights.
Due Diligence and Risk Assessment: Conducting thorough due diligence and risk assessment of potential correspondent banks is crucial. Banks should evaluate the financial stability, reputation, and compliance record of the correspondent bank. This control helps identify and avoid high-risk counterparties.

RISK : Money laundering and terrorist financing
Correspondent banking relationships can be exploited by criminals and terrorist organizations to launder money or finance illegal activities. Banks must conduct thorough due diligence on their correspondent banks and monitor transactions for suspicious activity.

Controls :

Due Diligence: Banks should conduct thorough due diligence on their correspondent banks before establishing a relationship, and regularly review the relationship to ensure it remains appropriate.
KYC (Know Your Customer): Banks should obtain and verify the identity of their correspondent banks' customers, including beneficial owners and ultimate beneficiaries.
Risk Assessment: Banks should conduct regular risk assessments of their correspondent banks to identify any potential risks associated with the relationship.
Transaction Monitoring: Banks should implement transaction monitoring systems to detect suspicious activity and report it to the relevant authorities.

RISK : Reputation risk
Correspondent banking relationships can be a source of reputational risk if the correspondent bank is involved in illegal or unethical activities. Any negative publicity can damage the bank's reputation and lead to loss of business.

Controls :

Ongoing Monitoring and Risk Assessment: Establishing an ongoing monitoring system to evaluate the activities of correspondent banks is vital. Regularly reviewing their financial performance, regulatory compliance, and any suspicious transactions can help detect any red flags early on. This ongoing monitoring can involve real-time transaction monitoring, periodic reviews of correspondent bank activities, and assessment of any changes in their ownership or management structure. By continuously monitoring correspondent banks, a bank can proactively identify any potential involvement in illegal or unethical activities, minimizing the risk of reputational damage. Additionally, conducting periodic risk assessments to identify emerging risks and potential issues will enable proactive measures to be taken.
Robust Due Diligence Process: Implementing a thorough due diligence process is crucial to mitigating the risk of correspondent banks being involved in illegal or unethical activities. This process should involve comprehensive background checks, assessments of the correspondent bank's reputation, financial stability, compliance with regulations, and adherence to ethical practices. By carefully selecting correspondent banks with a strong track record, a bank can reduce the likelihood of negative associations and reputational harm.

RISK : Sanctions compliance
Correspondent banking relationships can also expose banks to sanctions risk. Banks must ensure that their correspondent banks are not involved in any activities that violate sanctions laws.

Controls :

Conduct thorough due diligence on potential correspondent banks before establishing a relationship.
Ensure that correspondent banks have strong anti-money laundering (AML) and sanctions compliance programs in place.
Establish clear communication channels with correspondent banks to ensure that any potential sanctions risks are identified and addressed in a timely manner.
Implement transaction monitoring and sanctions screening systems to detect any potential violations.
Provide regular training to employees on sanctions regulations and compliance requirements.
Regularly monitor correspondent banks for any changes in ownership, control, or business activities that may increase the risk of sanctions violations.

Country Risk Management Function

Accountable for determining methods to reduce the hazards of conducting business abroad and for assessing those risks.

RISK : Economic risk
Changes in economic conditions, such as inflation, currency fluctuations, and interest rate fluctuations, can affect the financial stability of commercial banks. These risks can be further exacerbated by factors such as fiscal policies, trade restrictions, and debt levels.

Controls :

Active monitoring of economic indicators such as inflation rates, currency exchange rates, and interest rates, and adjusting the bank's strategies accordingly.
Diversification of the bank's investments and portfolios to spread risks across various asset classes, industries, and regions.
Hedging strategies to manage currency and interest rate risks, such as buying derivatives or entering into forward contracts.
Maintaining adequate capital reserves and liquidity buffers to absorb losses during economic downturns.
Stress testing the bank's financial position to simulate potential economic shocks and assess the bank's ability to withstand them.

RISK : Legal risk
Legal risks include the possibility of litigation, disputes, and breaches of contract. Differences in legal systems and the enforceability of contracts in foreign countries can create challenges for commercial banks.

Controls :

Contract Review and Negotiation: Thoroughly reviewing and negotiating contracts is essential to minimize legal risks. Engaging experienced legal professionals who understand the specific legal requirements and nuances of both domestic and foreign jurisdictions can help identify potential pitfalls, ambiguities, and gaps in contracts. Properly drafted contracts can mitigate the likelihood of disputes and provide a solid foundation for enforceability.
Jurisdiction and Choice of Law Clauses: Including jurisdiction and choice of law clauses in contracts can help manage legal risks. These clauses specify the jurisdiction where disputes will be resolved and which legal system will govern the interpretation and enforcement of the contract. By selecting a favorable jurisdiction and law that offers clarity and enforceability, commercial banks can enhance their legal position and reduce uncertainties.

RISK : Political risk
Political instability, social unrest, and changes in government policies can create uncertainty and increase the risk of financial loss for commercial banks. Political risks can also include the possibility of nationalization or expropriation of assets.

Controls :

Conduct thorough due diligence: Conducting due diligence on the political climate, stability, and regulatory environment in countries where the bank is considering investments can help identify and mitigate potential risks.
Diversify the investment portfolio: Investing in different regions, industries, and sectors can reduce the impact of political risks on the bank's investments.
Monitor political developments: Monitoring political developments and assessing the potential impact of policy changes can help banks anticipate and respond to potential risks.

RISK : Regulatory risk
Banks must comply with various regulations and laws in the countries in which they operate. Changes in these regulations or new regulations can create compliance challenges and potentially lead to penalties or fines.

Controls :

Compliance Training and Awareness Programs: Conducting regular training programs for employees on relevant regulations and laws is crucial. These programs should educate employees about their responsibilities and the potential risks associated with non-compliance.
Regulatory Compliance Monitoring and Reporting System: Implementing a robust and comprehensive system to monitor and report on regulatory compliance is essential. This system should track changes in regulations, ensure timely updates to policies and procedures, and facilitate accurate reporting to regulatory bodies. It helps banks stay informed about regulatory changes, identify gaps in compliance, and take prompt corrective actions.

RISK : Reputational risk
Negative publicity or events, such as money laundering or sanctions violations, can damage a bank's reputation and result in a loss of business.

Controls :

Enhanced Due Diligence (EDD) and Know Your Customer (KYC) Procedures: Strengthening customer due diligence and KYC procedures is vital to mitigate the risk of money laundering and sanctions violations. Banks should implement thorough screening processes to identify high-risk customers, conduct enhanced due diligence on such customers, and regularly update customer information. This helps in preventing illicit activities and maintaining a strong reputation.
Robust Compliance and Risk Management Framework: Implementing a comprehensive compliance and risk management framework is crucial to identify and address potential risks. This includes having strong internal controls, policies, and procedures in place to prevent money laundering and sanctions violations. Regular risk assessments and internal audits should be conducted to ensure compliance and identify any potential gaps or weaknesses.

Foreign Exchange Function

Liable for controlling the bank's exposure to foreign exchange and offering customers spot and forward contracts, currency swaps, and options as well as other foreign exchange services.

RISK : Country risk
Country risk arises from political and economic instability in a foreign country that may affect the value of a bank's investments or assets in that country. For example, a bank that has loaned money to a foreign government or company may face losses if the country experiences political turmoil or economic instability.

Controls :

Diversification of Investments: By diversifying their investment portfolio across multiple countries, banks can reduce the impact of political and economic instability in a single foreign country. This control spreads the risk and limits potential losses if one country experiences turmoil or instability.
Rigorous Risk Assessment and Due Diligence: Banks should conduct comprehensive risk assessments and due diligence before investing or lending money to foreign governments or companies. This includes evaluating the political and economic stability of the country, analyzing its legal and regulatory frameworks, and assessing the creditworthiness.

RISK : Economic risk
Economic risk arises from changes in exchange rates that affect the value of a bank's investments or assets in a foreign country. For example, a bank that has invested in a foreign country may face losses if the exchange rate of the foreign currency declines relative to the bank's domestic currency.

Controls :

Diversification of Investments: By diversifying their investments across different countries and currencies, banks can reduce their vulnerability to adverse exchange rate movements in a single foreign country. Diversification helps spread the risk and ensures that losses in one investment can be offset by gains in another. This strategy involves investing in a range of assets across various geographic regions, thereby reducing the impact of exchange rate fluctuations on a bank's overall investment portfolio. By spreading their investments across different currencies, banks can potentially benefit from favorable exchange rate movements in some countries while mitigating losses in others.
Hedging Strategies: Hedging involves using financial instruments to offset potential losses resulting from adverse exchange rate movements. Banks can employ various hedging strategies, such as forward contracts, options, or futures, to mitigate the impact of exchange rate fluctuations on their investments. These instruments allow banks to fix or limit their exposure to foreign currency fluctuations and protect their investments.

RISK : Transaction risk
Transaction risk arises from the uncertainty about the exchange rate at the time of settlement of a transaction. For example, a bank that has sold goods to a customer in a foreign country will receive payment in the foreign currency, which may fluctuate in value before the bank converts it into its domestic currency. This can result in a loss or gain on the transaction.

Controls :

Develop and maintain relationships with reputable foreign exchange counterparties to reduce counterparty risk and ensure timely and reliable settlement of foreign exchange transactions.
Implement robust foreign exchange risk management policies and procedures to ensure consistent and effective risk management practices across the bank.
Set and monitor limits on foreign currency exposure to manage risk and reduce the impact of fluctuations on the bank's financial performance.
Use currency hedging techniques such as forward contracts, options, and futures to lock in exchange rates and protect against adverse movements in foreign currency values.

RISK : Translation risk
Translation risk arises from the conversion of foreign currency-denominated assets and liabilities into the bank's domestic currency for financial reporting purposes. This risk can arise when a bank has subsidiaries or branches in foreign countries, and their financial statements need to be translated into the bank's domestic currency.

Controls :

Diversify currency holdings: The bank can hold a diversified portfolio of currencies to mitigate risks associated with any one currency.
Hedge foreign exchange risk: The bank can use hedging strategies to offset any potential losses due to exchange rate fluctuations.
Monitor exchange rates: The bank can monitor exchange rates and use forward contracts to lock in favorable rates.
Use translation methods: The bank can use different translation methods, such as temporal and current rate methods, to determine the appropriate exchange rate for financial reporting purposes.

International Cash Management Function

Accountable for overseeing the bank's worldwide cash management services and products, including foreign exchange accounts, international wire transfers, and global payment systems.

RISK : Credit risk
International banking transactions may involve borrowers with different credit ratings, which can increase the risk of default and non-repayment of loans.

Controls :

Credit Risk Assessment and Due Diligence: Conduct thorough credit risk assessments and due diligence procedures to evaluate the creditworthiness and repayment capacity of borrowers. This involves analyzing financial statements, credit history, collateral, and other relevant factors. By accurately assessing credit risk, banks can make informed decisions and avoid lending to high-risk borrowers.
Diversification of Loan Portfolio: Diversify the loan portfolio by distributing lending across borrowers with varying credit ratings and sectors. This approach helps mitigate concentration risk and reduces the impact of default.

RISK : Foreign exchange risk
Commercial banks deal with multiple currencies in international banking, and exchange rates can be volatile, leading to potential losses or gains on currency positions.

Controls :

Diversification: Diversifying currency exposures can reduce the risk of losses due to exchange rate fluctuations. Banks can hold a diversified portfolio of currencies to mitigate the impact of adverse movements in any one currency.
Hedging Strategies: Implementing hedging strategies is the most effective control measure to mitigate currency risk. Banks can use various hedging instruments such as futures, options, swaps, or forward contracts to offset potential losses or gains on currency positions. Hedging helps in stabilizing cash flows and minimizing the impact of exchange rate fluctuations.

RISK : Liquidity risk
Banks may face liquidity issues when managing cross-border payments, especially in situations where the timing of payments or settlement is uncertain.

Controls :

Develop stress-testing scenarios: Banks should develop and regularly conduct stress testing scenarios to assess the potential impact of different liquidity scenarios on their cross-border payment activities.
Establish a robust liquidity management framework: A comprehensive liquidity management framework can help banks identify, measure, monitor and manage liquidity risk across all business lines, including cross-border payments.
Establish an appropriate funding strategy: An appropriate funding strategy should be developed to ensure that sufficient liquidity is available to meet any expected or unexpected cross-border payment obligations.

RISK : Operational risk
There may be operational risks associated with managing international transactions, including issues related to communication, compliance with local regulations, and infrastructure.

Controls :

Conduct regular compliance training: Train employees regularly on local regulations and compliance requirements. Develop a compliance program that includes risk assessment, monitoring, and reporting procedures to ensure that all transactions are compliant with local regulations.
Develop a robust communication strategy: Establish clear communication channels and protocols for all parties involved in international transactions, including banks, customers, and regulatory bodies. Ensure that communication is timely, accurate, and secure.
Implement a strong infrastructure: Establish a reliable infrastructure that supports international transactions, including robust IT systems and technology that can handle large volumes of data and transactions.

International Compliance Function

Accountable for ensuring that all applicable laws and rules, especially those concerning money laundering, sanctions, and terrorism funding, are followed by the bank's overseas operations.

RISK : Data privacy and cybersecurity
Commercial banks must ensure that they protect the privacy and security of customer data, particularly in countries where data protection laws are less stringent. Failure to protect customer data can result in financial penalties and reputational damage.

Controls :

Access Controls: Implement robust access control measures to restrict and manage user access to customer data. This includes employing techniques such as role-based access control (RBAC), strong authentication methods, and regular access reviews. Limiting access to only authorized personnel reduces the risk of data breaches and enhances data privacy.
Encryption: Implement strong encryption mechanisms to protect customer data both during transit and at rest. Encryption ensures that even if the data is compromised, it remains unreadable and unusable to unauthorized individuals. This control is crucial for safeguarding sensitive information.

RISK : Foreign corrupt practices
Commercial banks must ensure that they do not engage in foreign corrupt practices, such as bribery, extortion, or other forms of illegal payments. Violations of these laws can result in criminal penalties and damage to a bank's reputation.

Controls :

Anti-bribery and corruption policy: Establish an anti-bribery and corruption policy that outlines the bank's commitment to preventing bribery and corruption. The policy should identify high-risk areas and describe the steps that the bank will take to prevent and detect corruption.
Code of conduct: Develop and communicate a code of conduct that explicitly prohibits bribery, extortion, and other forms of illegal payments. The code should be easily accessible to all employees and should clearly outline the consequences of violating it.

RISK : Money laundering and terrorist financing
Commercial banks are required to comply with international anti-money laundering (AML) and counter-terrorist financing (CTF) regulations, such as the Financial Action Task Force (FATF) recommendations. Failure to comply with these regulations can result in significant fines and reputational damage.

Controls :

Robust Customer Due Diligence (CDD) Procedures: Implementing strong customer due diligence procedures is crucial to identify and verify the identities of customers, including their sources of funds and the nature of their transactions. This includes conducting Know Your Customer (KYC) checks, collecting relevant documentation, and performing risk assessments based on the customer's profile. Effective CDD procedures help detect and prevent potential money laundering and terrorist financing activities.
Transaction Monitoring and Reporting: Implementing advanced transaction monitoring systems can help banks detect suspicious activities and patterns, such as large or frequent transactions, unusual transaction destinations, or sudden changes in customer behavior. Automated systems can flag such activities for further investigation.

RISK : Sanctions compliance
Commercial banks must comply with international sanctions regimes, which restrict business dealings with certain countries, individuals, or entities. Failure to comply with these sanctions can result in severe penalties, including the loss of a bank's license to operate.

Controls :

Automated Sanctions Screening System: Deploying an automated sanctions screening system is crucial to enhance the effectiveness of compliance efforts. This system should be capable of screening customer information, transaction details, and other relevant data against updated sanctions lists, including those maintained by international bodies.
Robust Compliance Program: Implementing a comprehensive compliance program is the most effective control to mitigate the risk of non-compliance with international sanctions regimes. This program should include policies, procedures, and controls that address the specific requirements of the sanctions regimes, such as identifying restricted countries, individuals, and entities. It should also involve regular monitoring, screening of customers and transactions, and ongoing employee training to ensure awareness and adherence to the sanctions regulations.

RISK : Tax compliance
Commercial banks must comply with international tax regulations, including the Foreign Account Tax Compliance Act (FATCA) and the Common Reporting Standard (CRS). Failure to comply with these regulations can result in financial penalties and reputational damage.

Controls :

Assign a dedicated compliance officer or team responsible for overseeing the bank's tax compliance program.
Develop a comprehensive tax compliance program that includes policies and procedures to identify and monitor accounts subject to FATCA and CRS reporting requirements.
Ensure that all staff are trained on tax compliance regulations and the bank's compliance policies and procedures.
Establish a system for monitoring and reporting of accounts that are subject to FATCA and CRS reporting requirements.
Implement due diligence procedures to identify accounts that are subject to FATCA and CRS reporting requirements.

Trade Finance Function

Liable for offering financial services, such as trade finance loans, guarantees, and letters of credit, to support international trade transactions.

RISK : Compliance risk
Commercial banks must comply with international trade regulations such as anti-money laundering (AML), counter-terrorist financing (CTF), and sanctions regulations. Failure to comply with these regulations can result in significant fines and reputational damage.

Controls :

Customer Due Diligence (CDD): Conducting thorough customer due diligence is crucial to identify and verify the identity of customers and assess the potential risks they pose. This involves obtaining relevant customer information, conducting risk assessments, and implementing enhanced due diligence measures for high-risk customers. CDD helps banks identify suspicious activities and mitigate the risk of money laundering, terrorist financing, and sanctions violations.
Robust Compliance Program: Implementing a comprehensive and robust compliance program is the most effective control. This includes having clear policies and procedures in place to ensure compliance with relevant regulations. The program should encompass ongoing monitoring, risk assessment, due diligence processes, and employee training. Regular reviews and updates to the program are necessary to stay abreast of evolving regulations.

RISK : Credit risk
Commercial banks face the risk of non-payment by importers or exporters, which can result in a significant loss. The risk can be mitigated by conducting credit checks on the parties involved in the transaction and requiring collateral.

Controls :

Collateral requirements: Commercial banks can require importers or exporters to provide collateral to secure the payment obligation, such as a letter of credit, bank guarantee, or other forms of security.
Contractual agreements: Commercial banks can enter into contractual agreements with importers or exporters that include payment terms and conditions.
Credit checks: Commercial banks can perform credit checks on the parties involved in the transaction to assess their creditworthiness and their ability to fulfill their payment obligations. The credit checks can include reviewing the financial statements, payment history, credit scores, and credit reports of the parties.

RISK : Currency risk
International trade involves transactions in different currencies, which exposes commercial banks to currency fluctuations. Commercial banks can mitigate this risk by using currency hedging instruments such as forwards, options, and swaps.

Controls :

Hedging with forwards: This involves the use of forward contracts to lock in an exchange rate for future transactions. The bank enters into a contract with a counterparty to exchange a specific amount of currency at a fixed exchange rate on a specific date in the future. This reduces the risk of adverse currency movements in the interim.
Hedging with options: This involves the use of options to give the bank the right (but not the obligation) to buy or sell currency at a predetermined exchange rate. This provides flexibility and protects the bank from the downside risk of unfavorable exchange rate movements.

RISK : Legal risk
Commercial banks face the risk of legal action by parties involved in a trade finance transaction, such as breach of contract or fraud. Commercial banks can mitigate this risk by conducting due diligence on the parties involved in the transaction and having appropriate legal documentation in place.

Controls :

Due Diligence on Parties Involved: The most effective control is conducting thorough due diligence on the parties involved in the transaction. This involves assessing their reputation, financial stability, and legal compliance. By carefully evaluating the background and track record of the parties, banks can minimize the risk of engaging with potentially fraudulent or unreliable counterparts.
Robust Legal Documentation: Having appropriate legal documentation in place is crucial for mitigating the risk of legal action. Banks should ensure that trade finance transactions are supported by well-drafted contracts, agreements, and other legal documents.

RISK : Operational risk
Trade finance involves a complex web of transactions, documentation, and communication between various parties. Operational risk arises from errors or fraud in the process, which can result in financial loss.

Controls :

Automation and Digitization: Implementing automated systems and digitizing the trade finance processes can significantly reduce the risk of errors and fraud. Automation minimizes manual intervention, eliminates human errors, improves transaction accuracy, and enhances overall efficiency. Digital platforms provide real-time visibility, better traceability, and improved communication between parties involved, reducing the likelihood of operational risks.
Robust Internal Controls: Establishing strong internal controls is crucial to mitigate operational risks. This includes implementing segregation of duties, dual controls, and regular internal audits.

RISK : Political risk
International trade transactions can be affected by political instability, including changes in government policies, sanctions, and war. Political risk insurance can be used to mitigate this risk.

Controls :

Diversification of Markets: One effective way to mitigate the risk of political instability in international trade is to diversify markets. By expanding operations and targeting multiple countries, businesses can reduce their reliance on a single market.
Political Risk Insurance: Political risk insurance is specifically designed to mitigate the risk associated with political instability. It provides coverage for losses arising from political events such as government policy changes, sanctions, and war. This insurance can help protect businesses against financial losses and provide a safety net during uncertain times.