Financial institutions are facing a growing range of money laundering threats, with threat actors holding a variety of tools to make these worse. How does a risk-based approach help?
In a recent post by Flagright, the company outlined the importance of a risk-based approach in getting to grips with these challenges as well as achieving balance between human judgement and technology in the compliance process.
According to the firm, the most effective way to tackle financial crime is to use a risk-based approach, which means ‘developing an AML compliance program that is tailored to the unique levels of risk exposure that each customer presents’.
The company added, “A risk-based approach to AML compliance involves assessing the risk of potential money laundering activities and taking appropriate steps to identify, prevent, and mitigate that risk. This could include activities such as customer due diligence checks, transaction monitoring, and analysing customer data.
It is key that risk-based approaches should be tailored to the particular risk profile of an institution, its services, products, customers and geographic location.
Before the introduction of risk-based approaches to AML, many banks and financial institutions like FinTechs and neobanks would manage their compliance obligations through a simple approach, Flagright claims, that involved merely fulfilling a standardised set of AML requirements for each customer.
Flagright said, “While that standardised approach was prevalent in the 1990s, the UK’s Financial Services Authority (FSA) proposed a ‘risk-based’ approach for the first time in its 2000 publication, A New Regulator for the New Millennium.”
“The Financial Action Task Force first implemented risk-based AML in 2007, and it was further structured in its 2012 update to the International Standards on Combating Money Laundering and the Financing of Terrorism and Proliferation – also known as the ‘40 Recommendations’.
The firm added that a risk-based approach to AML changes the focus of AML compliance away from data analysis and towards proactive assessment. “Financial institutions need to work continuously to understand the money laundering threats they face and implement appropriate risk management measures.”
In practice, this can mean that customers can be classified based on their risk exposure, with customers who are higher risk subject to increased AML scrutiny.
In general, the risk-based approach to AML enables financial institutions to identify the existence of risk, conduct risk assessments, create and implement risk-management strategies.
“When properly implemented, the risk-based approach allows for a balanced integration of human judgment and modern technology in the AML compliance process,” said Flagright.
Financial institutions’ compliance efforts are guided by two distinct categories of risk. The first is the concept of geographical risk – which refers to a country’s vulnerability to money laundering threats at the national level.
The second concept is the concept of individual risk, which refers to the specific risks that financial institutions face from their customers and how their internal AML process manages those risks.
What are the components of an effective risk-based AML compliance program? Flagright said FIs should implement a risk-based AML program that includes a number of important measures designed to accurately identify individual customers, as well as the businesses in which they are involved, in order to comply with the FATF recommendations.
More specifically, financial institutions need to create and implement proper KYC and CDD procedures, implement transaction monitoring, screen new and existing customers against sanctions lists, screen against PEP lists, screen for adverse media and schedule AML training for employees.
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