Conflict in the Middle East creates a compliance minefield for banks

The Middle East is facing its most serious risk of regional war in decades. The international response to Israel’s “Operation Narnia” against Iran has been deeply divided, exposing U.S. banks to new compliance risks tied to correspondent relationships across the region. Currently, 11 of the top 20 U.S. banks maintain direct correspondent relationships with institutions in the region, opening operational corridors for hundreds of domestic respondent banks and extending compliance vulnerabilities far beyond the immediate conflict zone. The escalation has disrupted SWIFT communications and delayed trade settlements across key hubs, complicating compliance workflows. Traditional boundaries between humanitarian aid, sanctioned actors and legitimate defense payments are rapidly eroding. In this volatile landscape, even routine transactions may carry political weight, reputational risk and regulatory complexity.

For U.S. banks, geopolitical neutrality is no longer an option; effective AML compliance now requires not just diligence, but also agility and a sharpened understanding of regional exposure.

Military conflicts have always distorted market activity, but modern warfare introduces a more intricate risk matrix for financial institutions. Wartime economies foster a surge in opaque procurement chains, emergency budget reallocations and covert funding routes often disguised through legitimate channels. Yet current AML frameworks, shaped by the Financial Action Task Force, the Egmont Group or national U.S. regulations, offer no clear playbook for conflict-driven financial distortions. There are no typologies tailored to active war zones, no sector-specific guidance on correspondent banking tied to belligerent nations and no globally accepted mechanisms for distinguishing lawful defense funding from covert support to illicit networks. As a result, U.S. banks are left to operate with fragmented and discretionary compliance risk models in an environment that changes by the hour.

As the Middle East conflict deepens, American banks are being pulled into a growing web of indirect exposure, often through longstanding correspondent relationships in the region. Even when U.S. institutions avoid onboarding clients from high-risk jurisdictions directly, their foreign correspondents, especially in Lebanon, Jordan, Iraq, the United Arab Emirates and Turkey, may not follow the same risk posture.

With dollar-denominated trade flows across the region in the trillions, the daily compliance risks facing U.S. correspondent banks are sharply defined. Many local banks in these jurisdictions operate with limited AML infrastructure, politically exposed shareholders, or ties to high-risk sectors such as energy and defense logistics. Payments to entities involved in dual-use goods or humanitarian relief can be rerouted or commingled with prohibited flows, particularly where sanctions enforcement is inconsistent or weak. These correspondent partners are frequently engaged in dollar-clearing and trade finance operations involving counterparties whose proximity to sanctioned sectors, military logistics or politically exposed networks requires daily reassessment.

In this context, it is important to understand that U.S. banks depend on the Wolfsberg Group’s Correspondent Banking Due Diligence Questionnaire to assess the compliance risks of correspondent relationships. However, this framework is designed for peacetime conditions and lacks military conflict-specific modules addressing end-use scrutiny, sanctions spillover in tier-2 parties, and escalation triggers for dual-use goods. As a result, U.S. banks are strongly encouraged to independently supplement the questionnaire with bespoke inquiries, daily trade-flow reviews and enhanced controls tailored to conflict-zone exposure.

As new sanctions roll out almost weekly in response to the Middle East conflict, compliance teams at U.S. banks are under growing pressure to track not just listed entities, but entire ecosystems of affiliated actors. Sanctions risk no longer resides solely in direct exposure to named parties; it now includes front companies, dual-use suppliers and humanitarian intermediaries that may be exploited to circumvent restrictions. In this environment, even well-intentioned transactions through Turkey, the UAE or Jordan require heightened scrutiny.

For instance, in the last few weeks alone, OFAC has issued two new waves of designations targeting logistics providers in the Levant and shipping networks believed to facilitate arms transfers to Iranian proxies in Syria and Lebanon. While not all targets are directly named, compliance risk now extends to adjacent networks and subcontractors operating under regional humanitarian umbrellas. Recent designations by OFAC highlight just how complex and fast-evolving this landscape has become.

In February 2025, six firms based in Hong Kong and mainland China were sanctioned for supplying drone components to Pishtazan Kavosh Gostar, a designated Iranian defense company. Then, in June, the U.S. Treasury sanctioned the “Zarringhalam brothers” network, including UAE-registered affiliates, for laundering proceeds in support of Iran’s nuclear, missile and proxy operations. These cases underscore a critical shift: Sanctions compliance can no longer rely solely on screening for known names. U.S. banks must continuously map indirect exposure through logistics chains and corporate linkages that often operate beneath formal reporting thresholds.

In a growing regional war, static lists are not enough. Dynamic, forward-looking risk intelligence has become essential to protect institutions from inadvertent violations and reputational fallout, but any prescriptive guidance from OFAC or Fincen does not govern the development of such systems. Banks should not expect clear methodological directives on implementation timelines or technical parameters. Instead, they must rely on their own internal frameworks built around a self-directed risk assessment that reflects the specific characteristics of their client base, correspondent relationships, service offerings and transactional exposure.

The current escalation in the Middle East is not just a geopolitical crisis; it’s a growing source of compliance volatility for U.S. banks. In an environment where the lines between military supply chains, humanitarian operations and sanctioned networks are increasingly blurred, indirect exposure can have regulatory consequences. Global trade architecture ensures that few transactions remain truly regional; dollar-clearing corridors and correspondent links extend the reach of conflict beyond the immediate theater. As a result, financial institutions must navigate a narrowing path: either restrict engagement and lose market access, or maintain relationships and risk sanctions, missteps, reputational harm and retroactive scrutiny from U.S. authorities. A third and increasingly necessary option is proactively reengineering internal compliance frameworks well ahead of regulatory mandates by integrating conflict-specific risk indicators, strengthening counterparty vetting across correspondent chains and adapting controls to reflect the fluid realities of modern warfare finance.