Intro: Commercial Banking & Services
Commercial banking refers to financial products and services designed to support corporations and municipalities in their banking operations. Many of the products found in a commercial bank are similar to retail or community banking, like deposit accounts, but with a key difference of the coverage scale and complexity of the products offered. As such, there are needs for a greater focus on liquidity, return, operations, and regulations that come with supporting multiple markets across geography and currency.
One of the services provided by Commercial Banks is the transaction of foreign currency. This can take the simplest form of buy/transfer to more complicated delivery like buy/hedge and investments like FOREX.
This article seeks to answer a few high-level questions with intent to dig further into the details over time. Questions like: how does Foreign Currency Exchange function in a commercial bank? What are the technologies behind delivery? What is done to regulate the industry?
Foreign Currency Exchange (FX)
A commercial bank facilitates foreign currency exchange by offering a range of services to its customers, including buying and selling foreign currencies, currency conversion, and international money transfers. Banks typically buy and sell foreign currencies at exchange rates that are slightly different from the interbank rate, but still competitive. They use these exchange rates to convert one currency to another for customers who are traveling abroad, making international purchases, or receiving payments from foreign sources. Banks also offer foreign currency accounts, which allow customers to hold and transact in a foreign currency.
Additionally, banks facilitate international money transfers, allowing customers to send money to other countries in the currency of the recipient’s country. Banks charge fees for these services which vary depending on the institution and the type of service.
The technology behind how commercial banks transact foreign currency is typically a combination of electronic systems and traditional banking infrastructure. Electronic systems include online platforms, mobile apps, and APIs that allow customers to access the bank’s foreign currency services remotely. These systems are integrated with the bank’s core banking systems, which are responsible for maintaining customer accounts, processing transactions, and managing the bank’s foreign currency reserves.
One of the key technologies used in foreign currency transactions is the SWIFT (Society for Worldwide Interbank Financial Telecommunication) network, which enables banks to securely exchange financial messages and conduct transactions with other banks around the world. Banks use SWIFT to send and receive payment instructions, confirmations, and other financial messages related to foreign currency transactions.
Another technology commonly used by commercial banks is the Foreign Exchange Electronic Trading (FXET) system, which enables banks to trade foreign currencies electronically, including spot, forwards, swaps, and options. These systems allow banks to access real-time foreign exchange rates and execute trades automatically, improving the efficiency and speed of foreign currency transactions.
In addition, Banks uses technology such as Blockchain, AI, and Machine Learning to improve their foreign currency transactional efficiency, reduce frauds and also to comply with regulatory and compliance requirements. These latter technologies are interesting but have not yet achieved latent adoption in the mainstream.
Though the USA has historically hesitated to regulate its markets, enough time and bad actions have passed that there are more than a few regulatory considerations when commercial banks transact foreign currency. Some of the main ones include:
- Anti-money laundering (AML) and countering the financing of terrorism (CFT) regulations: Banks are required to implement AML and CFT measures to prevent illegal activities such as money laundering and terrorist financing. They must conduct customer due diligence, monitor transactions for suspicious activity, and report any suspicious activity to the relevant authorities.
- Foreign exchange controls: Some countries impose restrictions on the amount of foreign currency that can be bought or sold by banks, or on the use of foreign currency for certain types of transactions. Banks must comply with these restrictions to avoid penalties.
- Sanctions compliance: Banks must comply with sanctions imposed by governments and international organizations. This includes screening transactions against lists of individuals and organizations that are subject to sanctions, and blocking or rejecting transactions that involve sanctioned parties.
- Capital and reserve requirements: Banks are required to maintain a certain level of capital and reserves to ensure their financial stability. These requirements may be different for foreign currency transactions, and banks must ensure they have sufficient capital and reserves to support their foreign currency activities.
- KYC and AML regulations: Banks are required to know their customers and perform due diligence on them, including verifying their identity and assessing their potential money laundering or terrorist financing risks.
- Reporting requirements: Banks are required to report foreign currency transactions to regulatory authorities, and they may also be required to provide regular financial statements and other reports.
- Compliance with International Financial Reporting Standards(IFRS): Banks are required to comply with IFRS standards and regulations, which sets the standards for financial reporting.
It’s important to note that regulations and compliance requirements can vary depending on the country, region and jurisdiction, and banks must ensure they are fully compliant with all relevant regulations in order to avoid penalties and reputational damage.
Regulation: Compliance Controls
So how do Commercial banks control their sanctions compliance? How have governments and banks adapted to the recent leaps in technology like APIs?
There are several controls to ensure sanctions compliance when using APIs to transact foreign currency. Some of the main controls include:
- Screening: Banks use automated screening software to check transaction details against lists of individuals and organizations that are subject to sanctions. The software compares the names, addresses, and other identifying information in the transaction against the names on the sanctions lists.
- Watchlist filtering: Banks use watchlists to filter and flag transactions that may be related to sanctioned parties. They use various attributes such as name, address, and country to identify transactions that match the watchlists.
- Risk-based approach: Banks use a risk-based approach to sanctions compliance by assessing the risk profile of their customers and transactions. This allows them to identify and prioritize higher-risk transactions for further scrutiny.
- Compliance rules: Banks use compliance rules to define the conditions that trigger a transaction to be flagged for sanctions compliance review. These rules can be based on the transaction amount, the type of transaction, or the countries involved.
- Continuous monitoring: Banks use continuous monitoring to detect any changes in the sanctions lists, or in the circumstances of customers or transactions. This allows them to quickly identify and respond to new sanctions or changes to existing sanctions.
- Training and education: Banks provide training and education to their employees to raise awareness of sanctions compliance and the importance of following internal procedures and controls.
- Audit and testing: Banks conduct regular audits and testing of their sanctions compliance controls to ensure they are working as intended and identifying all relevant transactions.
- Incident response: Banks have incident response procedures in place to address any issues or violations of sanctions compliance. They investigate and report any violations to the relevant authorities, and take appropriate action to prevent them from happening again in the future.
By implementing these controls, banks can effectively identify and flag transactions that are subject to sanctions, and take appropriate action to comply with regulations and avoid penalties.
Example Training Agenda for Compliance Controls
An example agenda for a commercial bank providing training and education to its employees regarding sanctions compliance and the use of APIs to deliver FX transactions might include the following topics:
- Introduction to sanctions compliance: An overview of the importance of sanctions compliance and the potential consequences of non-compliance.
- Overview of current sanctions: A review of the current sanctions and embargoes in place, including the countries, individuals, and organizations that are subject to sanctions.
- Role of APIs in FX transactions: An explanation of how APIs are used to deliver FX transactions and the benefits of using them.
- Sanctions compliance controls: An in-depth look at the various controls that banks use to ensure sanctions compliance, including screening, watchlist filtering, risk-based approaches, and compliance rules.
- Procedures for identifying and reporting suspicious activity: A step-by-step guide to identifying and reporting suspicious activity, including the use of automated systems, watchlists, and risk-based approaches.
- Case studies and scenarios: A review of real-life case studies and scenarios to help employees understand the potential risks and how to identify and respond to them.
- Testing and monitoring: An explanation of how banks test and monitor their systems and controls to ensure they are working as intended.
- Incident response: A review of the bank’s incident response procedures and the steps employees should take if they suspect a violation of sanctions compliance.
- Q&A session: An open forum for employees to ask questions and get further clarification on any topics covered during the training.
- Certification and refresher training: Provide employees with certification and schedule regular refresher training to ensure that the employees are aware of the latest sanctions and compliance regulations.
This agenda is just an example and the actual content and duration of the training may vary depending on the bank’s specific needs and regulatory requirements. However, the key is to provide employees with the knowledge and skills they need to identify and report suspicious activity and to comply with sanctions regulations.