Introduction
Correspondent banking relationships form the backbone of international financial transactions, enabling cross-border payments, trade finance, documentary credits, and the settlement of foreign exchange transactions between financial institutions across jurisdictions. For a country with India’s volume of international trade, diaspora remittances, and foreign investment flows, the health and breadth of its correspondent banking relationships are matters of systemic importance. Yet correspondent banking globally is under pressure: the phenomenon of “de-risking,” whereby global correspondent banks exit relationships with counterparty banks in jurisdictions perceived as high-risk from an AML/CFT perspective, has reduced the availability of correspondent banking services across the developing world. India’s FATF Mutual Evaluation results, the regulatory obligations imposed on Indian banks operating correspondent relationships, and the implications of FATF greylisting for India’s trading partners, together constitute a critical dimension of India’s AML compliance landscape that is distinct from the domestic enforcement challenges addressed elsewhere in this series.
Legal Framework
Correspondent banking, in its simplest form, is a banking service arrangement where one bank (the correspondent) provides services to another bank (the respondent) to facilitate the execution of financial transactions for the respondent’s customers. The correspondent holds accounts for the respondent (nostro/vostro accounts), processes wire transfers, provides documentary credit confirmations, and extends credit. In the international context, correspondent banking is indispensable because no single bank maintains direct relationships in all jurisdictions; the network of correspondent relationships is what makes it possible to settle an import payment from India to Brazil through a chain of institutions.
The RBI’s AML/CFT Master Direction for Banks, most recently consolidated in 2023, imposes specific obligations on Indian banks maintaining correspondent banking relationships. These include Customer Due Diligence (CDD) on the respondent bank itself (not merely on individual customers), with enhanced due diligence for respondent banks in high-risk jurisdictions or shell bank characteristics; ongoing monitoring of transactions through correspondent accounts for patterns inconsistent with the respondent bank’s stated business; and prohibition on maintaining correspondent relationships with shell banks, defined as banks incorporated in a jurisdiction where there is no physical presence and the bank is not affiliated to a regulated financial group.
FATF Recommendations 13 and 16 are the primary international standards governing correspondent banking AML. Recommendation 13 requires countries to ensure that their financial institutions apply specific AML measures in correspondent banking relationships, including gathering sufficient information about the respondent bank, obtaining senior management approval before establishing new relationships, and understanding the nature of the respondent bank’s AML controls. Recommendation 16 (the Wire Transfer Rule or “Travel Rule” for financial institutions) requires that originator and beneficiary information accompany wire transfers, a requirement that is operationally complex in the context of multi-hop correspondent chains.
PMLA’s application to correspondent banking arises where a correspondent account is used to layer criminal proceeds from one jurisdiction through the Indian banking system to another. Where an Indian bank’s correspondent account is used as a transit for funds of criminal origin, the bank’s officers may face PMLA liability for failing to file STRs, and the bank itself faces regulatory action from the RBI for AML compliance failures.
Judicial Developments
Indian courts have had limited opportunity to develop correspondent banking-specific PMLA jurisprudence, partly because the most significant correspondent banking-related money laundering cases involve sophisticated international structures that are difficult to prosecute domestically. The few cases that have reached the courts have largely concerned the liability of Indian banks for transactions processed through their nostro accounts without adequate monitoring.
The ED’s investigation into the Punjab National Bank (PNB) fraud of 2018, involving Nirav Modi and Mehul Choksi, had a correspondent banking dimension: fraudulent Letters of Undertaking (LoUs) were used to obtain credit from foreign banks, with Indian banks’ SWIFT systems used to send false communications to correspondent banks. The prosecution under PMLA focused on the attachment of assets in India and abroad, rather than on the correspondent banks’ liability. The Supreme Court’s approval of the issuance of Letters Rogatory to foreign jurisdictions in this case established the procedure for pursuing assets in correspondent banking-linked fraud cases.
The RBI’s enforcement actions against Indian banks for AML compliance failures in correspondent accounts, while not part of PMLA jurisprudence, are relevant context. The RBI imposed penalties on several major Indian private sector banks between 2021 and 2024 for deficiencies in correspondent banking due diligence, including failure to conduct enhanced due diligence on high-risk respondent banks and inadequate transaction monitoring of correspondent accounts.
Contemporary Issues and Analysis
De-risking is the central challenge for India in the correspondent banking domain. Following the imposition of multi-billion dollar fines on global banks by US and European regulators for AML failures in correspondent banking (HSBC’s USD 1.9 billion fine in 2012, Standard Chartered’s repeated penalties, BNP Paribas), global correspondent banks have significantly reduced their correspondent banking relationships, particularly with smaller banks and banks in jurisdictions assessed as high-risk. While India as a jurisdiction is not generally characterised as high-risk, Indian cooperative banks, regional rural banks, and smaller urban cooperative banks face difficulty maintaining correspondent banking relationships with top-tier global banks.
The consequence of de-risking for smaller Indian banks is twofold: first, they are unable to directly offer international transaction services to their customers; second, they are forced to rely on larger Indian private sector banks as sub-correspondents, creating a layered structure that can reduce transaction transparency. For India’s export sector, particularly small and medium exporters who rely on community and cooperative banking, the inaccessibility of direct correspondent banking relationships increases transaction costs and reduces competitiveness.
India’s FATF Mutual Evaluation, conducted in 2023 with the report published in 2024, is a landmark event in India’s AML compliance history. The evaluation assessed India’s technical compliance with all FATF Recommendations and the effectiveness of its AML/CFT system. India received “largely compliant” or “compliant” ratings on the majority of Recommendations, including Recommendations 13 and 16 on correspondent banking. India was placed in the “Regular Follow-Up” category, which is assigned to countries with a satisfactory evaluation result; this is distinct from and better than the “Enhanced Follow-Up” assigned to countries with significant deficiencies. India was not greylisted.
The significance of not being greylisted is substantial. Pakistan’s greylisting by FATF from June 2018 to October 2022 had demonstrable negative effects on its international financial relationships: correspondent banks reduced services, trade finance became more expensive, and cross-border payment flows were disrupted. Pakistan’s experience serves as the relevant cautionary example for India, particularly because India shares the subcontinent’s banking geography and has significant trade and remittance flows with countries whose FATF status varies.
The evaluation did identify areas for improvement in India’s AML/CFT system, including the effectiveness of STR analysis by FIU-IND and the prosecution rate in money laundering cases. The prosecution rate for PMLA offences has been low relative to the number of ECIR registrations and attachments, a point of structural concern that FATF evaluations consistently flag as an indicator of effectiveness limitations.
Comparative and International Perspective
The EU’s 6th Anti-Money Laundering Directive and the European Banking Authority’s Guidelines on correspondent banking (EBA/GL/2022/03) represent the most detailed international framework for correspondent banking AML. The EBA guidelines require European banks to conduct enhanced due diligence for correspondent relationships with banks in third-country jurisdictions, including assessment of the respondent bank’s AML framework, regulatory environment, and ownership structure. The guidelines also require European banks to document their AML risk assessment of each correspondent relationship and to review it at least annually.
The Wolfsberg Group’s correspondent banking principles, published by a consortium of major global banks, provide voluntary industry standards for correspondent banking AML. The Wolfsberg Principles include requirements for understanding the respondent bank’s anti-corruption posture, its sanctions compliance, and its ultimate beneficial ownership. Indian banks that are respondent banks to major international correspondents are expected to demonstrate compliance with Wolfsberg Principles, in addition to RBI’s regulatory requirements.
The US Financial Crimes Enforcement Network (FinCEN) uses its authority under Section 311 of the USA PATRIOT Act to designate foreign financial institutions as “institutions of primary money laundering concern,” which triggers enhanced due diligence obligations for US banks maintaining correspondent relationships with the designated institution and can effectively sever the institution’s access to the US dollar correspondent banking system. A Section 311 designation of a major Indian bank, while not currently in prospect, would be highly disruptive to India’s international financial relations.
Practical and Policy Implications
For Indian banks, particularly those seeking to expand their correspondent banking networks or to maintain existing relationships with major US and European correspondent banks, the RBI’s AML/CFT Master Direction compliance programme is the baseline requirement, but market expectations frequently go beyond regulatory minima. Global correspondent banks conduct annual due diligence on their respondent banks, including review of AML policies and procedures, transaction monitoring capabilities, and staff training programmes. Indian banks that cannot demonstrate robust AML compliance to correspondent bank satisfaction risk having relationships terminated on a commercial basis, independently of any regulatory finding.
The implications for small and medium Indian enterprises engaged in international trade are indirect but significant. Where their bank lacks correspondent banking access to the jurisdiction of their trading partner, they face longer settlement times, higher transaction fees, and in some cases inability to obtain documentary credits acceptable to foreign counterparties.
For the RBI, the correspondent banking de-risking phenomenon creates a regulatory dilemma: tightening AML requirements on Indian banks can accelerate the de-risking process by increasing compliance costs for respondent banks; loosening requirements risks attracting regulatory criticism from FATF and from correspondent banks’ home-country regulators.
Suggestions and Reforms
A tiered correspondent banking risk assessment framework should be introduced for Indian banks, analogous to the risk-tiered approach applied in EU regulation. Small cooperative and regional rural banks that handle primarily domestic transactions and maintain correspondent accounts only for limited foreign trade financing should face proportionate correspondent banking due diligence requirements, rather than the uniform standards that apply to large international commercial banks. This tiering would reduce compliance costs for smaller institutions without compromising the integrity of the overall system.
A shared correspondent banking compliance utility, potentially hosted by the RBI or a designated industry body, would allow smaller Indian banks to pool resources for correspondent due diligence, AML staff training, and transaction monitoring technology. Similar utilities have been discussed in the EU context and partially implemented through the Euro Banking Association’s collaborative compliance initiatives.
The RBI and FIU-IND should jointly develop and publish an annual correspondent banking risk assessment, identifying specific jurisdictions, correspondent bank types, and transaction corridors that present heightened money laundering risk, providing guidance to Indian banks for their correspondent due diligence. This would improve consistency in how Indian banks manage correspondent risk and would demonstrate to foreign correspondents that India has a systematic approach to correspondent banking AML.
Conclusion
Correspondent banking AML compliance sits at the intersection of India’s domestic regulatory obligations under PMLA and RBI’s Master Directions, and the international expectations of FATF and major correspondent banks. India’s FATF Mutual Evaluation result is a significant reputational and practical asset that must be actively maintained through continued enforcement effectiveness and regulatory improvement. The de-risking phenomenon, while not creating acute problems for major Indian commercial banks, poses a structural challenge for smaller institutions and, through them, for their customers engaged in international trade. Addressing this challenge requires both regulatory proportionality within India and active engagement with the FATF and Wolfsberg processes to ensure that India’s AML standards are recognised internationally as adequate, reducing the justification for risk-averse correspondent banks to apply blanket de-risking policies to Indian institutions.
