PMLA

Role of Financial Institutions in Tackling Money Laundering

Money laundering is the process of concealment of illegally obtained funds (Illegal Money) and portraying the same as legal. Illegal funds are first introduced into the legitimate financial system for hiding their real source. Illegal money is often moved around through financial institutions like banks, insurance firms, real estate, and investment brokers to further legitimize the money. Money launderers also deposit cash in small increments or sneak money into foreign countries for the purpose of avoiding suspicion.

Through these multiple transactions, the illegal money appears clean and is integrated into the financial system, which can be withdrawn by the criminals from legitimate accounts and put toward the financing of terrorism, organized crime, drug trafficking, human trafficking, or terrorism. The present article shall discuss the Role of Financial Institutions in Tackling Money Laundering.

Why Financial Institutions Play a Huge Role in Tackling Money Laundering?

Financial Institutions are among the largest institutions in the field of finance. Due to these institutions mediating millions of transactions throughout the day worldwide, they are at a higher risk of financial crimes. And in fact, criminal organizations often conduct their money laundering activities through banks and other financial institutions.

It is important for Financial Institutions to identify risks by fulfilling their AML obligations and taking necessary precautions. The AML process is critical for the financial and reputational standing of banks. Auditors and regulators legally need this process.

Additionally, owning to the technological shift in financial infrastructure and the rise of online payments, there has been an increase in the demand for more rigorous customer identity protection. In response to new and more stringent directives, Banks and financial institutions adopt emerging trends in AI-based AML solutions for handling AML compliance with greater efficiency.

Role of Financial Institutions in Tackling Money Laundering

There are four key areas that are addressed by the Financial Institutions for tackling money laundering with their anti-money laundering compliance program:

• Know Your Customer (KYC)
• Customer due diligence (CDD)
• Customer and transaction screening
• Suspicious activity reporting

All of these are discussed in detail below-

Know Your Customer

Know Your Customer (KYC) involves the identification and verification of a customer at the time of their bank account opening. KYC is the initial critical step in an AML program and is mandatory for Financial Institutions

In the KYC procedure, Financial Institutions start the process by collecting customer identification and checking its accuracy in order to ensure that the customer’s digital identity matches their real-world identity, proving they are who they say they are.

This process can be completed using ID document verification, face verification, and proof of address (bills or bank statements). An identity verification solution can help in meeting KYC obligations while delivering protection for the business of the entrepreneur and convenience to your customers.

On 5^th January 2023, The Reserve Bank of India (RBI) issued a periodic updation of KYC (Know Your Customer) details for customers. The RBI has stated that a fresh process of KYC can be done by visiting a bank branch or remotely through a video-based Customer Identification Process (V-CIP).

The RBI further stated that a fresh KYC process or documentation might have to be undertaken in certain cases wherein the KYC documents available in bank records don’t conform to the present list of officially valid documents.

Customers can do re-KYC online except in cases of a change of address, the governor said while addressing a press conference.

Customer Due Diligence

 Customer Due Diligence is a control process implemented by Financial Institutions for the collection of the relevant information of the customer profile for assessment with regard to potential money laundering or terrorist financing risk. Although CDD procedures vary from country to country, there is only one goal, i.e. the detection of risks.

After the KYC control process, Financial Institutions apply risk assessment to their new customers wherein the customer information is checked and screened against several online databases, including politically exposed persons (PEPs), government records, watch lists, and sanctions screening.

The people included in these lists have high risks for money laundering and terrorist financing. In Financial Institutions providing global services, a customer’s nationality and record of financial transactions can also affect a customer’s risk rating.

Customer and Transaction Screening

Financial Institutions and banks generally have a broad customer portfolio. The transactions mediated by these Financial Institutions aren’t limited to their own customers. For instance, one customer of a bank can transfer money or make payments to another bank’s customer. Throughout the day, an average-sized bank mediates thousands of money transfers.

Financial Institutions must monitor and control the people involved in money transfer transactions. It is considered a major crime for a bank to mediate payments sent to a sanctioned or banned person.

The consequences of the crimes due to the uncontrolled transaction between the sender and the receiver can have severe administrative fines. The Financial Institutions could also lose their credibility and good reputation.

Banks and financial institutions should monitor all customer deposits and other transactions to ensure they aren’t part of a money laundering scheme. This includes verification of the origin of large sums of money and reporting cash transactions exceeding $10,000.

With today’s technology, manual money laundering controls have become outdated and inefficient. Therefore, Financial Institutions need an automated transaction screening process for conducting customer transactions per AML policies.

Suspicious Activity Reporting

Money laundering investigations by law enforcement agencies often involve the scrutinization of financial records for suspicious activity or inconsistency. In the present regulatory environment, extensive records are kept for every important financial transaction to assist law enforcement in tracing a crime to its perpetrators. It’s essential for Financial Institutions to have an immutable audit trail that regulators can trust.

What Does an AML Compliance Program Need?

It is important for financial institutions to devise an effective AML compliance program that meets the regulatory requirements and manages money laundering risks, and any failure in devising such a program can result in Financial Institutions being punished by the regulators.

AML compliance programs consist of all controls and directives applied to ensure banks’ adherence to the prescribed obligations by the Financial Institutions in order to avoid penalties. An effective AML compliance program includes the following procedures:

 Appointment of an AML Compliance Officer –Banks and other financial institutions must appoint a compliance officer that provides oversight for the AML compliance program and acts as a liaison for the financial authorities. Such an officer should be a senior employee having expertise and authority to carry out their role effectively.

AML Training – Bank employees should undergo AML training to remain capable of the identification of suspicious transactions for potential money laundering or terrorist financing. The bank’s policies must also include ongoing AML training and keeping employees well-informed about adapting to new legislation and emerging trends in criminal methodologies.

Record Keeping – The record-keeping practice is essential at every stage of the AML process. Financial Institutions must carry out the evaluation of financial risks based on their customer records. The AML compliance program must cover the need for effective record-keeping and documentation from onboarding to monitoring, screening, and submission of SARs.

Risk-Based Approach – Financial Institutions should perform a risk assessment with KYC and CDD procedures on every customer at the time of their onboarding. With greater knowledge of customer criminal activity risk levels, such Institutions can more strategically focus their efforts.

Customer Identity Verification – Financial Institutions must know the customer they are dealing with and ensure the customer is who they say they are. General information to be collected includes beneficial ownership, the nature of the business, as well as the customer’s personal information, including full name and any aliases,  mailing and residential addresses, specimen signature and place and date of birth.

Sanctions Screening – Financial Institutions must also ensure that they don’t involve in business with individuals, companies, or countries included in international sanctions lists. A bank’s AML compliance program should take all relevant sanctions lists into account, including those lists issued by national and international authorities. For example, Financial Institutions in the United States must screen customers against the U.S. Office of Foreign Assets Control (OFAC)¹ sanctions list.

PEP Status – Such Institutions must establish the status of the customer and check if the same is a politically exposed person (PEP). Because of their positions, PEPs are at a higher risk of being engaged in money laundering. Clients who are PEPs are subject to enhanced due diligence measures.         

Conclusion                           

The increasing frequency of regulatory changes has rendered traditional AML controls ineffective, posing a significant risk to businesses. In response to this challenge, there are various solutions for companies for AML control problems, including issues with excessive workload and false positives.

By automating the AML checking process, companies can streamline their operations, along with reducing the risk of financial crimes. Customers can select the country or regulator data they want to use in their fight against money laundering, providing them with the flexibility they need to comply with changing regulations. It is therefore established that the role of financial institutions to prevent money laundering is quite significant.

FAQ

   

Read Our Article: Decoding the Role of Financial Institutions and Technology in Preventing Money Laundering

1. https://ofac.treasury.gov/