Commonality among crime, corruption, drug, human trafficking, tax evasion and terrorism is Money. Money in these activities can be in the form of laundering, financing or proceeds. As per United Nations Office on Drugs and Crime (UNODC), the money in these transactions globally is roughly estimated between US $1 and $2 trillion and less than 1% of it traceable/seized by authorities.
As per Mar 2016 report of US government accountability office, the collections of fines, penalties and forfeitures from financial institutions for the violations of Banking Secrecy Act (BSA)/Anti Money Laundering (AML) from Jan 2009 to Dec 2015 period was about US $5.1 billion.
However, this phenomenon is not confined to US. Since 2008, globally banks paid US $321 billion in fines for regulatory failings from AML to terrorist financing according to Boston Consultant Group (BCG). Not only banks, any organization that facilitates financial transactions such as digital/mobile payment services, life insurers and foreign exchanges money transferors are also coming within the scope of AML legislation worldwide.
As business moves towards digitalization, the money laundering is also growing fast to support hatred, terrorism and drug machinery. Is disruptive fintech based business up to speed on the compliance they must meet?
Approach and Challenges to compliance
Money laundering generally happen in three steps. Placement – Placing illegal money into legitimate financial system, Layering - Pushing the transaction by doing multiple transactions over the placed money, Integration – Use money to create legitimate assets whose value is not easier to assess, for example real estate.
Financial institutions can meet the regulations through proactive supervision/study of specific branch of business or reactive/event driven actions. It is essential as illicit money destroys value, impacts bottom line, and puncture and at times tear their reputation.
Financial institutions traditionally implement AML through profiling (knowing customer), transaction monitoring and data match with negative lists. The challenges faced in this approach are manifold. These include, large volume of transactions, pattern and limit avoidance, false positives, data quality, limited common pool of data, manpower and training. This approach reduces money laundering but the manual work and subjective elements reduce the effectiveness. Hence this approach to compliance looks inefficient.
As AML regulations are avoided or breached in more than a way, compliance regulations deepen and the cost of compliance increases. The global spend for compliance expected to be US $8 billion in 2017 which includes operations and technology. Around 25% of the expected spend is on technology alone. Many institutions pull back the programs looking at cost notwithstanding the cost of regulatory actions. Per PWC global study more than 25% firms not conducted AML risk assessments and 1 in 5 FS institutions faced enforcement actions.
Not alone cost, the quality of data, having right people with right skills at right place and mechanism to leverage right technology is a real challenge to these institutions. The need of the hour is to use right technology that will reduce compliance cost, ensure quality of data and facilitate quick interpretation for seamless conduct of business. The breach of trust by institutions rings bell that it is time for regulator to look for a right gatekeeper in the form of technology.
Blockchain - Technology to overcome challenges
Technology is not a panacea to all problems. But it is sure to lead a way to safe zone Block Chain is a new kit in the AML armor.
Blockchain records transactions in a block in a chronological order there by produces equivalent of ledger, that can be shared and usable by anyone with appropriate permissions.
- When a block is filled with certain number transactions, then the block is considered as page or folder and locked. Once verified and locked a transaction cannot be updated without agreement of all in the group with same credentials.
- Copies of block chain are distributed across databases of multiple participants after encryption.
- This limits the role of intermediaries. So, the institutional fraud cannot happen unless entire group is ready to manipulate.
- The certainty about original info is hugely beneficial to regulators, financial institutions or law enforcement agencies because they can verify the transactions and credentials of parties involved in a transaction using one of the original copies.
- The delay in transactions because of verification, screening, and productivity wastage due to wrong positives are avoided/saved or minimized to a great extent.
- The encryption restraints hacking, means hacker has to change every copy.
Blocks to blockchain
Absence of centralized entity - decentralized transaction record maintenance cause doubt on trustworthiness of group. Trust is pivotal to financial institutions and this will be a primary concern of financial institutions.
Privacy - despite encryption, restriction on the data accessible to people who have no direct relationship with financial institution will be expected
The miniscule traceability of the illicit transactions and hefty fines on financial institutions are attributable to imitations of traditional financial and AML systems. Also, it is an indication of systemic breach of trust on which the business of finance is built over the years. This makes it imperative to democratize the financial system by limiting the role of these institutions as intermediaries. This is possible using fintech like blockchain. Before that the digital technologies are to be made robust and versatile to meet the business, regulatory and privacy needs. It is time for change in regulations to support fintech. More swift action is required from governments and regulatory bodies to adopt this model of transaction keeping with adequate representation from regulators in each group. The final onus is on financial institutions to come clean taking the help of technology in the ongoing war against fraud and crime.