Where there is crime, there is often dirty money. And when money is dirty, it is hard to spend.
Criminal organizations invest a lot of time, energy and resources into cleaning their ill-gotten money. That’s what money laundering means, and it’s a big business:
- When scammers and fraudsters steal money from consumers, they need to hide the fact that the money they’ve acquired was done criminally.
- When international terrorists organizations get funding, that money will pass through some kind of intermediary processes so that the funder is not directly tied to the terrorist group.
- When gangs make money off of the sale of illegal drugs, they need some kind of system to obscure the source of that income.
The United Nations estimates that global money laundering each year comes to between 2% and 5% of the entire world’s GDP. On the conservative end of that range, that’s $1 trillion in laundered money. Every year.
In this guide, Featurespace describes how financial institutions and other organizations are fighting this particular set of financial crimes. First, we will start with a basic question: What does anti-money laundering mean for financial institutions? Then, we will explore the tactics and tools that financial institutions and other organizations use in their anti-money laundering activities.
What is anti-money laundering?
AML is the combination of policies, procedures and regulations designed to identify criminal funds and patterns, to disrupt illegal financial flows, prevent the funding or pay-off of global economic crime, and ultimately lead law enforcement to identify crimes and stop criminals. To achieve this, financial institutions have to see through the disguises organized criminal groups employ in their transactions, as these groups attempt to integrate this dirty money into the global economy.
In most countries, AML and CFT laws exist to compel financial institutions to detect and report certain kinds of transactions, meaning AML has more than a regulatory component. AML also describes the internal processes that a financial institution uses to detect and report the suspected laundering of money. Indeed, those institutions must comply with the AML regulations in the jurisdictions where they operate – this includes anywhere in the world they may send or receive transactions on behalf of their customers.
Compliance can be complex. That’s why banks and financial institutions devote entire departments to anti-money laundering. In recent years, those teams have begun to work closely with fraud teams because both have the overlapping goal of fighting financial crimes, and we are beginning to see many seasoned fraud professionals join AML teams as internal funding focuses on compliance and transaction monitoring in the financial crime space.
For today’s financial institutions, the detection and reporting of suspicious activity is a challenge of scale. Even small banks must monitor thousands upon thousands of transactions each day, and monitoring those payments for instances of suspected money laundering would be impossible without automated transaction monitoring.
Therefore, it’s important to think of AML as having several facets:
- The internal processes designed to comply with those regulations.
- The teams that are responsible for detecting and reporting money laundering through transaction monitoring.
- The software that supports those teams.
Why is anti-money laundering important?
At the most basic level, money laundering underpins all crime, from banking fraud to drug trafficking to the financing of terrorist networks around the world. Whether it’s an individual consumer being tricked into a get rich quick scheme, or a large organization falling victim to business email compromise and paying fraudulent invoices, money laundering is the process of attempting to wash these illegally obtained funds into the banking system. The laundered money is further used to fund large organized crime or terrorist organizations worldwide. Successful money laundering by these criminals continues the cycle of heinous crimes such as human and drug trafficking, and illegal arms dealing to further their ‘profits’. Fighting money laundering means making sure that crime doesn’t pay.
Practically speaking, as the International Monetary Fund notes, money laundering means resources that could go toward uses that are productive and beneficial for society instead get diverted toward activities that “have a corrosive, corrupting effect on society and the economic system as a whole.”
That’s more than $1 trillion every year that could go to public goods like education, infrastructure or affordable housing — but instead get tied up in criminal activities.
As a result of anti-money laundering’s moral and societal imperative, there is the matter of regulatory compliance. Governments take money laundering seriously, and they put the onus on banks and other FIs sitting at the heart of the international financial system to identify incidents. Governments pursue strong penalties for FIs systematically failing to comply with AML/CFT laws. As an example, Australia’s Commonwealth Bank paid a hefty fine in 2018 – 700 million AUD – for failing to report thousands of suspicious transactions in a timely manner.
At the time, this was the biggest corporate settlement in the country’s history. And the government’s case against the bank was not that it failed to identify and report suspicious transactions, but that it failed to meet reporting deadlines which would have enabled investigative agencies to use this intelligence in a timely fashion.
This is why financial institutions must be so diligent in their approach suspicious activity monitoring and reporting. The costs of not doing so can be enormous for the institutions and continue to grow as global powers crack down on money laundering and the crime it finances.
What is the Anti-Money Laundering Act and other key regulations?
Recently, the United States Financial Crimes Enforcement Network passed The Anti-Money Laundering Act of 2020, which expanded protections and rewards for AML whistleblowers.
In addition, the act helped to reinforce the Bank Secrecy Act and the capabilities of FinCEN. More to the point, the recent call
for responses on proposed modernizations of these acts is a clear sign that American law enforcement officials have given new priority to fighting money laundering.
Many other countries have similarly elevated the priority of AML enforcement:
- In the UK, the Money Laundering Regulations of 2017 and Money Laundering Regulations of 2019 have put more responsibility on financial institutions to track and report certain transactions.
- In the summer of 2021, the European Commission proposed a package of legislation to bolster the EU’s rules for anti-money laundering and fighting the financing of terrorism
- Turkey has likewise bolstered its Law on the Prevention of Laundering Proceeds of Crime No. 5549 to expand the scope of AML compliance, putting new responsibilities on legal professionals and crypto asset service providers.
- In 2020, the Australian Government passed the Anti-Money Laundering and Counter-Terrorism Financing and Other Legislation Amendment Bill 2020, of which the changes to cross-border movements of money come into force on 18 June 2022.
Which organizations are bound by AML regulation?
A large part of the economy is covered under the scope of AML laws. It’s not just banks and financial services that must be compliant. Casinos, insurance providers, even precious metals dealers shoulder some regulatory responsibility in fighting money laundering and economic crime.
AML in banking and finance
Banks and financial institutions initiate and receive millions of transactions every day, and they are on the front lines of preventing financial crimes. They share many of the AML obligations for detecting and reporting suspicious activity. This can include monitoring customer activity and reporting customers to authorities when necessary. This is not limited to the first or last institution in a transaction flow, correspondent banks within a flow bear very similar regulatory overhead. This poses
major challenges, as transaction information needed to perform effective AML can be truncated, incomplete or compromised within long correspondent banking flows, or when processing cross-border transaction between multiple payment systems.
AML in fintech and neobanks
Fintechs, including newly licensed e-money institutions (EMI), Payment Service Providers (PSPs), merchant acquirers, and new neobanks are still liable within many AML frameworks. For these smaller institutions, many without an existing AML department or system, the challenge is to quickly and efficiently implement AML transaction monitoring to minimize risk without disrupting business as usual.
AML in business
Domestic and foreign businesses can be subject to AML reporting requirements because money launderers have the ability to simply create shell companies for concealing or obscuring the movements of money from authorities. Many regulators are now mandating financial institutions in relation to initiating or accepting transactions on behalf of shell corporations, meaning for genuine organizations there is an onus on them to provide complete and accurate information in their payment instructions to their corporate banking provider to facilitate AML transaction monitoring (AML TM) and ensure smooth business operations.
AML in other sectors
Most regulators will impose AML obligations on a variety of other sectors in which money laundering could take place. This includes:
- Casinos, where ill-gotten funds could be laundered through bets or even the purchase of casino tokens.
- Mortgage brokers, where illegal cash could be used to purchase real estate assets and cash-only transactions
present a vulnerability to criminals.
- Jewelers and precious metal brokers, where illicit income could be laundered through the purchase of diamonds or
gold, which are both easy to transport across borders, change ownership and are much easier to carry given same monetary value than suitcases of bank notes.
How does anti-money laundering work?
Anti-money laundering works by untangling the complex layers of financial transactions someone can make to obscure the origins or the ownership of money. Anti-money laundering involves the use of software, processes, expertise and laws to reveal whether a source of funds is illicit or illegal.
The various facets of AML come together to combat financial crime::
- Regulations, such as the US’s reporting requirement for any transaction of $10,000 or more, or Australia’s additional information requirements for cash transactions over AUD 10,000, make it harder for someone to disguise large sums of money.
- An organization’s internal processes align with those regulations and also outline what AML teams need to do to find the source of laundered money.
- AML teams monitor, detect and report any suspected instances of money laundering.
- The team’s software supports that work by knowing what patterns to look for in transactions.
What is the AML process?
The AML process mirrors the various stages of money laundering. Money launderers rely on complex, overlapping layers of transactions to obscure the origins of their money. The AML process peels those layers back one by one to reveal the money’s origins.
It’s important to understand the three stages of money laundering to see how the AML processes works:
- Placement. This is the first stage of money laundering, in which a criminal places ill-gotten proceeds into a legitimate financial instrument. This could be done through the payment of an invoice or putting money into an offshore banking account, for example.
- Layering. With the money in the system, the money launderer must make a series of transactions to decouple funds from their source. This could involve the purchase of foreign money orders or the purchase of assets like real estate.
- Integration. This is the final stage, when the laundered money comes out of the wash and goes back into legitimate financial accounts. With the sale of a real estate purchase, for example, the organization’s money now has a new, seemingly legitimate source.
The AML process works within these three stages. It flags instances of placement, it investigates the layering of potentially ill-gotten funds, and it analyzes whether a trail of legitimately integrated funds has an illicit origin.
A financial institution manages detection, investigation and risk management at each stage, and can draw different conclusions depending on the stage. Artificial Intelligence (AI) and machine learning can now be deployed to support the correct divination for a transaction holistically across all three stages and support more effective and efficient decision making.
How do financial institutions ensure AML compliance?
Any organization responsible for AML compliance must create a compliance program. This creates a formal basis upon which you can build compliance norms (e.g. transaction monitoring, policies for reporting). When thinking of the various facets of AML, selecting the right technology partner to support this program is crucial.
Featurespace anti-money laundering solution
Featurespace’s software, ARIC™ Risk Hub, has been built to give organizations a holistic view of financial crimes risk. Powered by Adaptive Behavioral Analytics, ARIC™ Risk Hub keeps the costs of compliance down and reduces the number of false positives.
Its applications span the various sectors responsible for AML:
- In retail banking, our solutions can surface unknown threats with artificial intelligence that remains explainable to any regulators or auditors.
- In the payments sectors, ARIC™ Risk Hub helps companies instantly detect anomalous behavior because Adaptive Behavioral Analytics allows it to constantly learn about normal customer behavior.
- In insurance, ARIC™ Risk Hub pulls insightful data points from customers, brokers, agents and carriers to create dynamic behavior profiles. It’s within that context that our solutions spot illicit behavior.
Machine Learning in AML for a Global Bank
A few years ago, HSBC recognized inefficiencies in the transaction monitoring capabilities of its insurance business. Insurance products with investment value can be exploited by criminals and incumbent transaction monitoring solutions don’t traditionally cater for this sector.
HSBC reached out to Featurespace for help. Our team began a cloud-based implementation of ARIC™ Risk Hub that eventually became the first AML application in the entire HSBC organization that used both rules-based and machine learning models to monitor transactions and generate alerts automatically.
That implementation allowed HSBC to prioritize alerts so its AML teams could commit resources strategically and efficiently, not lose their time aggregating and collating alert information.
Further, the continuous learning that ARIC™ Risk Hub brings to HSBC’s AML stack means new rules can be added and existing rules optimized as needed at no additional cost.
To learn more, have a look at our HSBC video case study.
Find out how we can help you
Our team has worked with numerous leading banks and financial institutions to bolster their AML capabilities. To see how we could do the same for you, request a demo of our ARIC™ Risk Hub.
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