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AML - a new era dawns in fighting financial crime
Napier
May 20, 2021

Welcome to our new blog series on the future of fighting financial crime. In collaboration with our partner, RegTech Associates, we shall examine the current state of the financial sector’s AML systems, explain why and how they need to evolve, and carve out the way forward for implementing the necessary changes.

The war on financial crime – a sobering report from the front

Research conducted by our partners, RegTech Associates, reflects an appetite for combatting financial crime more effectively from within the industry itself, although the report indicates differing attitudes as to how. The unbearable cost to economies, societies, and the environment globally cannot be sustained. Money launderers, human traffickers, drug runners, terrorists and environmental pirates wreak havoc upon our world.

Meanwhile the response of the governments, law enforcement agencies, financial institutions, and regulatory bodies charged with countering the criminals is stuttering. Matthew Redhead, an industry expert and consultant on financial crime, summed it up when he noted that “the criminals are doing a lot better than we are.”

It is time for the sector to honestly evaluate current AML capabilities and execute the necessary changes.

Conditions on the AML battleground

The strategies driving the financial sector’s AML tactics draw heavily on the recommendations of the Financial Action Task force’s 2014 guidance document. The global watchdog advocates for a risk-based approach. On the AML frontlines, this translates into the allocation of resources to the three broad strategic areas of potential financial risk, namely customers, products, and transactions.

However, management consulting firm McKinsey’s 2019 report on AML and financial crime demonstrates that most firms fail to achieve the objective of financial compliance. Customer risk ratings are often inaccurate, and data poorly maintained after onboarding. This monitoring malaise hampers other steps in the risk-based AML process since it can and does throw up false red flags in transaction monitoring. These are only cleared through costly and time-consuming investigations. Meanwhile, the same faulty system formations expose chinks in the banks’ armour, which financial criminals often slip through undetected.

A war on two fronts: more financial crime means more AML regulations

External factors exacerbate the problem. Globally, Regulatory frameworks are expanding policies and broadening the scope of frameworks for fighting financial crime at a breathless pace. The EU money laundering directives, discussed in a previous blog, are an example. Intersecting with this is the meteoric growth in cashless transactions in recent years and the development of cryptocurrency trading.

Larger organisations, with more departments and higher numbers of employees, are disadvantaged by their legacy: They were well-established before the surge in AML regulation and often have not re-calibrated their compliance culture timeously.  While they may have the financial and human resources to better counter money-laundering and terrorist funding, the trend over years has seen the development of task specific specialised teams (a fraud team, a transaction monitoring team, a jurisdictional team, etc…) with little of the transversal synchronisation of data sources needed to address the threat.

AML and the financial crimes universe

The complicated, multi-various approach of process-driven AML in large financial institutions prompted our partner, RegTech Associates to develop the Financial Crime Universe. To summarise, this flow chart model depicts the intricacies and difficulties of implementing AML policies and procedures in large banks. It demonstrates the chronological interplay of specialist detection tools and external data sources which has to happen. It further shows the ongoing interplay of the internal ongoing monitoring of internal data and generic crime-fighting technologies. The flow chart speaks to the inevitable fragmentation of a system with so many moving parts, and provides a graphic illustration of why current AML is struggling in the contemporary financial services environment. You can see the graphic, watch and listen to the Financial Crime Universe being explained in detail here.

The war on financial crime - our AML strategies and tactics need to change now, and here is why

Calling for new AML risk management is nothing new, but a recent and intense amalgamation of events is forcing the financial sector to act quickly. The RegTech analysis has isolated four reasons why.

1. Increased criminal sophistication and evolving financial crime typologies

Unfettered by audits, annual reports or compliance inspections, criminals flourish as they exploit the potential of increasingly sophisticated technologies and the digitization of money. The impact is global.  Online gaming is now a mechanism for money laundering, while the use of money mules is on the rise. Recently, ‘cuckoo smurfing’ entered the financial crime lexicon to the dismay of AML practitioners, while the money laundering opportunities of non-fungible tokens in the digital art trade possibly led to the bewilderment of a much wider audience. Additionally, the global pandemic responses by governments throughout the world have been exploited by financial criminals, with the Financial Action Task Force (FATF) noting that the measures put in place to manage the outbreaks can unintentionally “provide new opportunities for criminals and terrorists to generate and launder illicit proceeds.”

     

2. Political pressure on regulatory frameworks governing AML & CFT in USA, UK and EU

Politically, the appetite for tightening regulations designed to combat money-laundering and the financing of terrorism in each of these countries and unions is increasing. Recent sets of legislation passed and/or amended in the USA, the UK,  and the European Union reflect this. The colossal fines meted out to the financial sector in 2020 alone are clear indicators of how serious regulators are, and how imperative it is that AML practitioners rise to the challenge.

             

3. Regulatory enforcement actions are focusing mostly on CDD and ongoing monitoring and AML management

The fines meted out to financial institutions across the globe are often accrued through failures in the client onboarding and KYC monitoring stages. Both stages of the risk-based AML compliance approach which we currently see are subject to the fragmentation and silo effect which we have discussed in a previous blog. It is therefore critical that AML systems of financial institutions all over the world adapt to the dynamism of both the criminal and the regulatory environment.

4. The cost of financial compliance is on the rise, and so are the cost pressures

A 2019 study by LexisNexis revealed that a number of EU countries are experiencing significant annual increases in the average amounts spent on AML/CFT compliance by medium to large financial institutions. The report additionally ranks the UK high on the overall list, and estimates a global cost - among the key markets covered - at $180.9 billion. This is in the face of the threat posed to the sector by the entry of disruptive competitors to the industry, as well as cost/income ratios which are not improving in the long term.

The next step in the fight against financial crime

We have shown in today’s blog how the risks of not starting the journey towards fundamentally improved AML practice outweigh the risks of taking the first steps. We have also explained that the fight against financial crime and terrorism financing is a battle we are not winning, and detailed the reasons for this failing.

Next week, we shall discuss feedback from AML troops on the frontline and outline what the solutions are in the first steps towards countering financial crime.

This article is the first in a series based on a larger paper authored by RegTech Associates in collaboration with Napier. If you would like to read the full paper, you can download it here.

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