Anti-money laundering and transaction monitoring in times of a pandemic
The fight against money laundering (ML) and terrorist financing contributes to global security, the integrity of the financial system and sustainable growth. In recent years, financial institutions have been under more regulatory pressure when it comes to the detection and prevention of financial crime. Financial institutions have therefore stepped up their measures against fraud, money laundering, terrorist financing and other forms of financial crime. In this fight, transaction monitoring is a crucial tool to detect unusual transactions and patterns.
The goal of transaction monitoring is to identify the transactions to and from individuals and organizations that have an increased risk of being involved in financial crime. Prior to the COVID-19 pandemic, financial institutions were already under pressure from regulators to improve their anti-money laundering (AML) and transaction monitoring processes. Laws to combat ML and the financing of terrorism are designed to prevent the financial market from being misused for these purposes. The 5th EU Anti-Money Laundering directive (5AMLD) is effecting more institutions.
Transaction monitoring and the pandemic
In the current pandemic, financial institutions face an even larger challenge in terms of AML and terrorist financing. In December 2020, the Financial Action Task Force (FATF) released the COVID-19-related Money Laundering and Terrorist Financing report. This report shows some interesting and insightful case studies of different scams and fraud cases. The cases show:
- The struggles of teams of financial institutions working remotely and weakened controls caused by disjointed processes.
- The challenges involved with the increased use of digital platforms.
- Criminals exploiting conditions following the pandemic in their attempt to gather and launder funds.
The pandemic and the lockdowns that have followed leave a substantial amount of people jobless and desperately looking for income opportunities. There is therefore an increased risk of people becoming (knowingly or unknowingly) involved with money mule scams.
Europol, in cooperation with the law enforcement authorities of 26 different countries, launched a worldwide operation against money mule schemes. Between September and November 2020, the European Money Mule Action (EMMA), resulted in the identification of 4,031 money mules, 227 money mule recruiters and the arrest of 422 individuals worldwide.
This means that the impact of the pandemic continues to evolve. Consequently, the changes in both money laundering and terrorist financing as a result of the pandemic are likely to continue to evolve as well. Another challenge for financial institutions is that, while there are some globally consistent trends, other risks may be specific to countries or regions.
Identified challenges during the new normal
Regulators require financial institutions to determine a risk profile for their customer and/or customer peer groups. The client risk profile includes a description of expected transaction behavior based on static data, behavioral patterns, historical data and network information. This is achieved during a process that is referred to as Customer Due Diligence (CDD), enabling an institution to (among other things) continuously monitor the client’s information, business relationships and transactions. To achieve this, institutions must make every effort to stay abreast of the techniques and methodologies used in money laundering and terrorist financing. These, and the latest developments and relevant risk indicators, must be taken into account in its policy, procedures and measures. With regards to transaction monitoring, financial institutions must implement new controls (including rule sets) for assessing the risk of on-boarding customers in a timely and adequate manner during and after their CDD processes. This is challenging, specifically due to the changing environment as a result of the pandemic. An institution’s transaction monitoring system should also limit the number of false positive alerts. The used rule set should address (amongst others):
- Whether a client is expected to be affected by the pandemic.
- Large amounts amount of in- and outgoing transactions.
- Spikes in deposit accounts.
Another challenge is that financial institutions must develop efficient policies for transaction monitoring and adequately implement these in the underlying procedures and operating processes. Therefore a dedicated team should be appointed and sufficient time should be allocated to review their AML and CFT policies, procedures and processes in line with the changing climate of financial activities.
With the ever-changing new normal, regular training programs should be set-up. New and potential cases of financial crimes should be addressed during such these training sessions. In addition, guidelines on assessment processes, what to do when a suspicious transaction is spotted during checks, and where to report findings should also be included. The aim of these trainings is to maintain a high-level of awareness by a the institutions’ employees.
Staying complaint to the regulation is challenging from time to time. Therefore, setting up an an automated transaction monitoring system and an adequate set of rules with scenarios and threshold values to detect money laundering and terrorist financing will provide the support needed. Additionally, they must conduct periodical tests for the effectiveness of these rules. Financial institutions should evaluate what they require and expect from a Anti-money Laundering system. Now that remote work is more common, on-premises solutions may be difficult to manage and thus cloud service providers have stepped in. Another interesting development is the usage of artificial intelligence (AI) and self-learning tools. Criminals learn how rule sets are designed and find new ways to act undetected. AI and machine learning models provide insights on how to create new rules to mitigate this risk.
Areas of improvement in the fight against financial crime
Considering the challenges and developments affecting transaction monitoring, it will remain an important topic in 2021.
Key areas to review and improve are:
- Reviewing end-to-end AML/CFT strategy frameworks: this addresses how well the current risk assessments reflect the new normal and how the (implementation of) control processes should be updated accordingly.
- Operational effectiveness on transaction monitoring: financial institutions are expected to have an effective and efficient system in place for monitoring transactions (either a manual, in-house or 3rd party solution). In addition, this system should generate alerts for unusual transaction patterns. Furthermore, these alerts should be reported effectively. A comprehensive assessment should be conducted to measure the effectiveness and efficiency of existing controls, procedures, and operational processes.
- Compliance by technological transformation: real time payments need to be processed without losing control. AML transaction monitoring in combination with screening solutions can increase efficiency by reducing time, effort, and human errors during transaction monitoring. The European Forum for Innovation Facilitators (EFIF) has added the use of innovative technology for CDD, and transaction monitoring in their 2021 work program.
- The identification of:
- Geographical diversity of an organization’s operations and how well the software can access data for transaction monitoring.
- Volumes of transactions because the focus differs per volume. For high volumes it is expected that the focus should be on safeguarding consistency and time efficiency whereas for low volumes different rules and cost structures can apply.
- Data quality management (DQM), which is a critical aspect of effective transaction monitoring. To allow for in-depth analysis, data coverage of the client must be sufficient (this includes information on a client, the provided service(s), transaction information etc.). Machine learning software can also be a useful tool to gather and reconcile data from various source systems. This enables the transaction monitoring process, regulatory reporting and Know Your Customer (KYC) and CDD activities.
- Audit trail and alert management. To be compliant to applicable regulation, transparent and auditable systems must be in place.
- Leveraging AI systems for risk assessment and due diligence process. This will allow for pattern analysis, recognition and network analysis for unusual transactions while reducing false positive alerts.
A financial institution’s own policies and processes to combat financial crime can themselves prove to be very challenging. Criminals continuously find new techniques with regards to financial crime. To counter this, a thorough understanding and efficient use of an institutions’ transaction monitoring and additional mitigating controls are required. Financial institutions have installed defences to monitor unusual activities. Some financial institutions choose to manually monitor and report unusual activity. Some have opted for an in-house solution whereas others prefer a third-party solution. The impact of the pandemic shows that now is the time to re-tune AML/CFT frameworks to identify the risk profile of clients and detect suspicious transactions. With the ever-changing environment, this will continue to require dedicated focus, knowledge, and resources from an institution.