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Rethinking AML: A Call for Innovation and Efficiency

In the financial services sector, Anti-Money Laundering (AML) continues to be a topic of intense debate. Discussions oscillate between advocating for stricter regulations and questioning the extent of banks' responsibilities in overseeing (policing) financial transactions.

AML regulations are pivotal in preventing the use of financial institutions for facilitating crimes such as money laundering and terrorist financing. However, the effectiveness of these measures is often under scrutiny, especially considering their impact on legitimate customers and banks' financial models. Despite rigorous AML frameworks, a significant gap persists between their intended outcomes and actual results, i.e.

  • The United Nations estimates that around $2 trillion, equivalent to the GDP of a major economy like France, circulates annually through money laundering channels. Alarmingly the detection and interception rates are disconcertingly low, with only about 2% of this amount being detected, , and merely a fraction of that effectively halted. This highlights the shortcomings of current KYC and AML processes in addressing major financial crimes.

  • Legitimate customers face substantial repercussions due to the billions invested in compliance each year, which escalates costs for consumers and potentially excludes them from essential banking services. For instance, SMEs may face serious business disruptions due to blocked payments, migrants might struggle to provide the necessary identity proofs for KYC, and low-income consumers might be unfairly flagged as high-risk.

  • Dozens of financial institutions have already been fined for enormous amounts for non-compliance with KYC and AML procedures. In 2023 alone, several financial institutions, including Binance ($4 billion), Crown Resorts ($450 million), Deutsche Bank ($186 million) and Bank of Queensland ($50 million), were fined significant amounts for non-compliance with KYC and AML procedures, contributing to over $403 billion in penalties since 2008.

Enhancing AML processes requires a shift away from prescriptive governmental measures towards fostering innovation and efficiency. This entails moving beyond a "check-the-box" mentality to solutions that effectively identify and mitigate money laundering risks, a challenge compounded by the complexity of measuring AML effectiveness. E.g. a bank identifying a lot of AML cases, does not necessarily have good practices in place. They might also have been lucky or might have a business model which attracts a lot of money-laundering (making it easier to detect the tip of the iceberg).

Financial institutions can navigate the AML landscape more effectively by implementing best practices that minimize disruption and enhance compliance, such as:

  • Adopting a Risk-Based Approach: Instead of applying the same level of scrutiny to every transaction, financial institutions should adopt a risk-based approach that focuses on transactions that are most likely to be high risk. This will allow the bank to prioritize its efforts and reduce the number of false positives.

  • Leveraging Technology: Many financial institutions still use simple rule-based AML systems implemented on outdated and siloed systems, which logically result in bad results. The adoption of advanced, often AI-based systems offered by various RegTech companies (like ComplyAdvantage, Chainalysis, Unit21, Discai, Alessa, Fraudio) can improve however detection accuracy, reducing both false positives and false negatives without significantly impacting user experience. RegTech can offer a beacon of hope for overburdened compliance departments.

  • Fostering a Culture of Compliance: Continuous education and training ensure that all bank employees are well-versed in AML regulations and understand their role in the compliance process, maximizing the benefits of RegTech innovations.

  • Continuous Policy and Procedure Review:: Ensuring AML policies and procedures remain effective and aligned with current regulatory standards through regular updates.

  • Monitoring and Reporting: Ongoing monitoring and reporting on AML compliance efforts help identify areas for improvement, ensuring ongoing effectiveness.

AML is about more than preventing money laundering; it also encompasses combating corruption (i.e. individuals or corporations taking bribes), sanction evasion (i.e. individuals or corporations moving money that should not be allowed to), and fraud (i.e. attempting to steal or scam money from someone else). Criminals use sophisticated techniques to launder illicit funds, complicating detection and intervention efforts by financial institutions, i.e.

  • Placement : depositing illegal money in the financial system. This is done via different techniques, e.g. via cash businesses with little or no variable costs (e.g. car washes, casinos, tanning studios…​), via false invoicing, via smurfing (splitting up in small amounts, which stay below certain AML thresholds), via trusts and offshore companies or foreign bank accounts, via aborted transactions…​

  • Extraction: this consists of getting the money out, so it can be used. Often this is done by techniques, on which the criminals will pay taxes, as this increases the legitimacy. Typical techniques consist of paying salaries to fake employees, loans to directors or shareholders which are not repaid or pay out of dividends.

Due to the variety of types of financial crime and the techniques used for placement and extraction, it becomes very complex for financial institutions to properly detect and stop these activities. The main reasons for that being:

  • Lack of comprehensive data available to banks, often due to privacy regulations like GDPR. This limitation makes effective AML akin to finding a needle in a haystack. Enhanced, more fine-grained data collection and sharing, subject to stringent security measures, could significantly improve AML efforts.

  • Every bank implements AML on its own and tries to ensure compliance within its organization. This isolated approach of banks to AML compliance, coupled with the exploitation of this by criminals, underscores the need for a legal framework facilitating data sharing and collaboration among financial institutions. RegTechs can play a crucial role in this ecosystem by offering resources like sanction screening lists and regulatory compliance tools, which are shared in a SaaS model across its customers.

  • Given the international nature of financial crime, the development of global AML standards and increased international cooperation are imperative. Money laundering is a global issue that demands a unified response.

  • Regulators do very little to support financial institutions in their mission. Instead of just defining strict (often outdated) rules and imposing sanctions, they could also offer tooling to support financial institutions in having better AML. E.g. up-to-date and easily accessible sanction screening APIs, good (API-based) access to company and UBO registers or the setup of regulatory sandbox, in which (anonymized) examples of recently detected fraud and common false positives are included, would all help players to be more effective in AML compliance. Additionally regulators can organize trainings and knowledge sharing forums to facilitate the exchange of crucial expertise.

Ultimately, the journey toward more efficient and effective AML practices demands collective action. Financial institutions, regulators, and RegTech providers must collaborate closely, sharing insights and data to enhance AML efforts.

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