Anti-Money Laundering (AML) is is a term used in the financial industry to describe a set of procedures, laws, and regulations that require financial institutions and other regulated entities to prevent, detect, and report money laundering activities.
How Does Money Laundering Happen in Banking?
Money laundering is the process of making illegally obtained funds (“dirty money”) appear legal. The illegal funds are first introduced into the legitimate financial system to hide their real source. The dirty money is often moved around to create confusion through wire transfers to numerous accounts. Money launderers also deposit cash in small increments or sneak money into foreign countries to avoid suspicion.
Through these multiple transactions, the dirty money appears clean and is integrated into the financial system. Criminals can withdraw the laundered money from legitimate accounts and use it to finance organized crime, drug trafficking, human trafficking, or terrorism.
AML is a set of regulations, laws, and procedures that detect and prevent criminals from disguising illegal funds as legitimate income. AML policies help banks and financial institutions combat financial crimes.
AML regulations require banks to collect customer information, monitor and screen their transactions, and report suspicious activity to financial regulatory authorities. Additionally, the AML holding period requires deposits to remain in an account for at least five trading days. Banks can use this holding period to help in anti-money laundering and risk management.
Why Is AML Important to the Banking Industry?
Banks are among the largest institutions in the field of finance. Since banks worldwide mediate millions of daily transactions, these institutions are at a higher risk of financial crimes. And in fact, criminal organizations often carry out their money laundering activities through banks and other financial institutions.
Banks must identify the 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 require this process.
In addition, the technological shift in financial infrastructure and the rise of online payments has increased 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 to handle AML compliance with greater efficiency.
How Does AML Work in Banking?
There are four key areas banks must address with their anti-money laundering compliance program:
- Know Your Customer (KYC)
- Customer due diligence (CDD)
- Customer and transaction screening
- Suspicious activity reporting
Know Your Customer
Know Your Customer (KYC) involves identifying and verifying a customer’s identity when opening a bank account. Mandatory for banks, KYC is the first critical step in an AML program.
In the KYC procedure, banks collect customer information and check its accuracy. Banks ensure that a customer’s digital identity matches their real-world identity, proving they are who they say they are.
This process can be done using ID document verification, face verification, and proof of address (bills or bank statements). An identity verification solution can help you meet your KYC obligations while delivering protection for your business and convenience to your customers.
Customer Due Diligence
Banks implement a control process called customer due diligence (CDD), through which relevant information of a customer’s profile is collected and assessed for potential money laundering or terrorist financing risk. Although CDD procedures vary from country to country, there is only one goal: to detect risks.
After the KYC control process, banks apply risk assessment to their new customers. Customer information is checked and screened against several online databases, including politically exposed persons (PEPs), government records, watchlists, and sanctions screening.
The people included in these lists carry high risks for money laundering and terrorist financing. In banks that provide global services, a customer’s nationality and record of financial transactions can also affect a customer’s risk rating.
Customer and Transaction Screening
Banks and financial institutions generally have a broad customer portfolio. The transactions mediated by these banks are not limited to their own customers. For instance, one bank customer can transfer money or make payments to another bank’s customer. Throughout the day, an average-sized bank mediates thousands of money transfers.
Banks are obligated to monitor and control the people involved in money transfer transactions. It is a major crime for a bank to mediate payments sent to a sanctioned or banned person.
The consequences of the crimes brought about by the uncontrolled transaction between the sender and the receiver include severe administrative fines. The banks could also lose their credibility and good reputation.
Banks and financial institutions must monitor all customer deposits and other transactions to ensure they are not part of a money-laundering scheme. This includes verifying the origin of large sums of money and reporting cash transactions exceeding $10,000.
With today’s technology, manual money laundering controls are outdated and inefficient. Banks need an automated transaction screening process to carry out customer transactions per AML policies.
Suspicious Activity Reporting
Money laundering investigations by law enforcement agencies often involve scrutinizing financial records for suspicious activity or inconsistency. In the current regulatory environment, extensive records are kept on every significant financial transaction to help law enforcement trace a crime to its perpetrators. Banks must have an immutable audit trail that regulators can trust. But it’s also important that compliance analysts at financial institutions can easily investigate and close cases quickly and efficiently.
What Does an AML Compliance Program Require?
Banks must create an effective AML compliance program that meets the regulatory requirements and manages money laundering risks. Failures in the AML compliance program can result in banks being punished by the regulators.
AML compliance programs consist of all controls and directives that ensure banks meet obligations and are protected against regulatory penalties. An effective AML compliance program includes several key features as described below.
Customers have different financial circumstances and risks. Banks are obligated to apply a risk-based approach in customer account opening processes and perform a risk assessment with KYC and CDD procedures. Banks must also control their customers’ transactions based on their risk levels.
A risk-based approach is an essential element of an effective AML compliance program. Banks must implement AML responses that are specific and proportional to the criminal risks they face.
A crucial component of risk-based AML compliance is identity verification. Banks must know the customer they are dealing with and ensure they are who they say they are.
An AML compliance program should prioritize identity verification through customer due diligence procedures and enhanced due diligence (EDD) measures for higher-risk customers. General information to be collected includes the following:
- The customer’s personal information, including full name and any aliases, residential and mailing addresses, specimen signature, and place and date of birth
- Beneficial ownership of a business or company where the owner is not the client or customer
- The nature of the business in which the customer is involved
Banks must establish whether a customer is a politically exposed person (PEP). Because of their positions, PEPs are at a higher risk of being involved in money laundering.
Clients who are PEPs are subject to enhanced due diligence measures. A bank’s AML compliance program should feature PEP screening during onboarding and throughout the business relationship to detect any status changes.
Banks must also ensure that they do not do business with individuals, companies, or countries included in international sanctions lists. A bank’s AML compliance program should include a sanctions screening process that considers all relevant lists, including those issued by national and international authorities. For example, banks in the United States must screen customers against the U.S. Office of Foreign Assets Control (OFAC) sanctions list.
AML compliance programs must monitor customer transactions for suspicious activities and evaluate their client’s risk profiles. Transaction monitoring should detect the following:
- Transactions above regulatory thresholds
- Unusual transaction patterns
- Transactions involving unexpectedly high amounts or a large volume of transactions
- Transactions with PEPs or with sanctioned individuals
- Transactions with high-risk countries
- Adverse media stories involving customers
Suspicious Activity Reports
AML compliance programs should include the process of submitting a suspicious activity report (SAR) to financial authorities if potential money laundering is observed. The submission process of SAR should be straightforward and inclusive of input from senior management.
The record-keeping practice is essential at every stage of the AML process. Banks must evaluate financial risks based on their customer records.
A bank’s AML compliance program should cover the need for effective record keeping and documentation from onboarding to monitoring, screening, and submission of SARs.
Bank employees should undergo AML training to remain capable of identifying suspicious transactions for potential money laundering or terrorist financing. The bank’s policies should also include ongoing AML training, keeping employees well-informed to adapt to new legislation and emerging trends in criminal methodologies.
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. The AML compliance officer should be a senior employee with the expertise and authority to carry out their role effectively.
How Do AML Policies Affect Financial Institutions?
Financial institutions are held to high standards when it comes to following procedures that identify money laundering. Employees are trained to detect and monitor suspicious customer transactions. Transactions and processes are recorded extensively to help law enforcement agencies trace the financial crimes back to the source.
Although financial institutions are legally obligated to follow anti-money laundering regulations, not all institutions agree with them. Many institutions believe that implementing policies is costly, time-consuming, ineffective, and not worth the money.
But in recent years, audits made by regulators to organizations have increased. Organizations that did not comply with their AML obligations paid hefty administrative fines.
In 2018, a total of $4.27 billion in penalties were imposed on organizations that failed to comply with AML regulations. The penalty amount nearly doubled in 2019 to $8.14 billion. And the AML penalties paid in 2020 were over $10 billion.
Aside from facing steep administrative penalties, organizations that do not meet AML compliance can damage their reputation and lose customers. The financial institution’s image is affected once it has been associated with corrupt individuals or businesses.