Reuters: 1% Illicit Funds Uncovered in Financial System Raises Question About Whether Banks Need to Do More

Thursday, August 8, 2019

Concerns that the international financial system only managed to uncover just 1% of illicit funds has raised questions about whether banks need to do more, but some officials said it is not banks' job to uncover illicit funds.

A United Nations Office on Drugs and Crime (UNDC) report released in October 2011 revealed that less than less than 1% of global illicit financial flows had been seized and frozen with the remaining 99% untraceable. The UNDC has so far not released the most updated report on the same topic, but various parties including development banks, NGOs and law enforcers have continued to make reference to the October 2011 report, indicating their concerns that the financial system remains as a conduit for illicit fund flows.

Questions have therefore been raised about whether banks need to step up their financial crime compliance processes although much investment and resources have already been deployed in this area.

Banks have been asked to do much more and thousands of dollars have been spent in technology, according to Tim Phillipps, APAC leader - financial crime network at Deloitte in Singapore.

"They have to comply with all the rules to make sure there is no breach of sanctions or money laundering rules. And they have to make sure the transactions are consistent with customers' risk profile — what type of transactions they do, what type of business they are in, what is the source of wealth. Banks are asked to make sure the transactions are consistent with the profile [of their customers]," he said.

Are banks assisting or enabling regulators in identifying financial crime?

Phillipps described it as "imprecise" to say that the global financial system uncovered only 1% of illicit funds. It is not the job of banks to uncover illicit funds but to report suspicious transactions to regulators, he said. "There are many meanings that this can take. Banks do need to report. There are tens of thousands of reports going out from banks to regulators everyday. That's the way banks report. If there is anything that is being investigated, the funds won't be unfrozen until regulators say they can. The question really should be: are banks assisting regulators or are they enablers for regulators to identify suspicious transactions," he said.

The different levels of investment, sophistication of technology and the number of people deployed in financial crime prevention at international and regional banks may explain the gaps, resulting in failure to detect financial crime, Phillipps said. There is also less sophistication at banks in the smaller countries such as Cambodia and Vietnam, he said.

"You need to have adequate framework. You need to have controls, processes and governance. Banks have to want to do this and spend time in getting this right," he said.

The law enforces a degree of responsibility on banks

But others have argued that it is still incumbent on banks to get their financial crime controls right, notwithstanding the large amount of investments that they have already put in.

The law enforces a degree of responsibility on financial institutions to identify financial crime and take reasonable effort to do so, said Brandon Daniels, president, global technology markets at Exiger in New York.

"There are laws that require banks to report instances of suspicious activity and prohibit transactions from occurring like transactions with parties that are subject to sanctions. If you take the reported figures of how much the illicit funds are and what gets seized, you still end up with one to 2.5 percent at most. That's what is seized and frozen. We know these are funds that are related to some sort of criminal behaviour or tax evasion. These funds are not found by today's legacy AML and sanctions compliance practices," he said.

Compliance needs to do things differently

Notwithstanding the fact that banks and law enforcers have continuously invested in systems and processes for the purposes of financial crime prevention, the 99% illicit fund flows that remain untraceable suggests there is a need to carry out financial crime compliance differently, Daniels said.

Compliance needs to focus on the identification and apprehension of criminally derived funds instead of focusing on the compliance process itself, according to Daniels. For instance, instead of focusing on the volume of data, banks should focus on the quality of the alerts.

"It's better to focus on 10 real cases of suspicious activity rather than thousands of peripheral cases or cases that are simply false positives," he said.

Regulators should encourage banks to spend time on the risk indicators that are more problematic instead of a narrow focus on policies and procedures alone, Daniels said.

Using technology

Daniels also pointed out that regulators want financial institutions to explore and try new methods of assessing and managing financial crime including using technology and through public-private partnerships to make it more cost effective for institutions.

Rule-based systems that flag out suspicious activities or outdated systems that screen names against watchlists may need to be replaced by new forms of technology, Daniels said.

He cited a few examples. To make connections between problematic activities, technology can direct different types of analysis such as previously known activities to identify networks of politically exposed persons as opposed to just using rule-based systems to flag out suspicious activities. Using technology will enrich banks' data which will allow them to continuously monitor their customer activity. Artificial intelligence can be used to monitor published articles or investigative blogs to identify areas where there may be gaps or risks attached to their customers.

The illicit fund flows related to troubled sovereign wealth fund 1Malaysia Development (1MDB) across an international network revealed many of the associates of Jho Low, the central figure who allegedly masterminded the flow of funds through 1MDB, were not found in the books of many banks until years after the scandal came to light.

"This was because some of the banks embroiled in the 1MDB case did not have access to technology that can help to carry out their assessments in a broader and more accurate fashion. These networks are too hard to uncover using manual processes," Daniels said.

Partnerships between regulators and financial institutions

Collaboration between regulators and financial institutions is a third way that allows the latter to reduce their compliance costs, according to Daniels. Such partnerships facilitate information sharing which will increase transparency and allows better management of financial crime, while creating a richer environment to identify potential connections to financial crime activity.

"The issue is not necessarily that only 1% of illicit funds are being uncovered in the global regulated financial market but rather the fact that an enormous amount of money, time and resources have been spent in identifying and mitigating financial crime and yet the result does not appear to commensurate with the level of investment that has been put in," he said.

- Written by Patricia Lee, chief correspondent, banking and securities regulation, Asia

This article first appeared on Thomson Reuters Regulatory Intelligence

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By Patricia Lee, Thomson Reuters Regulatory Intelligence