Fighting financial crime

Banks wading through regulation on anti-money laundering and fraud recognise the importance of compliance. Keen to avoid fines and keep their reputation intact, especially in the current economic climate, they are investing in financial crime risk management technology, which is revealing extra benefits, Fiserv’s Richard McCarthy explains to Jim Banks.

A recent report from Cifas, the UK’s fraud prevention service, suggests that the country saw a 16% increase in cases of fraud in 2008, and the press is littered with the names of financial institutions that have been sanctioned by regulators.

Misuse of account fraud, where existing accounts or policies are used fraudulently by criminals, is rising sharply, as is the success rate of frauds that stem from identity theft. The worsening economic climate could well lead to further rises.

‘There has been criticism that personal accounts are not well enough protected.
There was the Madoff fraud, and in the UK and parts of Europe the figures for online fraud are astronomical,’ observes Richard McCarthy, chairman of the Fiserv Fraud & Compliance Product Advisory Council.

Fiserv is a global provider of financial crime management, anti-money laundering (AML) and compliance solutions for the financial services industries. In the many years the company has been supplying technology to banks McCarthy has seen the evolution of the methods by which financial crime is committed.

Insider fraud has emerged as a hot topic, with some analysts suggesting that it accounts for as much as 60% of bank fraud cases that involve data breaches or stolen funds. Virtual money laundering is a more recent arrival in the world of financial crime, with the online community - particularly gamers – at risk from fraudulent transactions or theft of personal information.

The rising tide of financial crime has been met with a seawall of regulation, but this has left the banking industry with the huge task of implementing the directives. The question is whether the regulation is having the desired impact on how the industry behaves.

‘While not everyone’s perception has changed there is ongoing pressure from regulators like the UK’s FSA. A couple of years ago, AML and fraud were approached as compliance issues, but now the industry realises that they are ongoing processes and its mindset is maturing,’ says McCarthy.

He believes that the banking sector has had no choice but to look more closely at fraud and AML in a wider context, largely because of the penalties that have been imposed on organisations that fail to comply with regulation. In January, for instance, two units of online brokerage E*Trade were fined $1 million by the Financial Industry Regulatory Authority (Finra) for failures in their AML policy and procedures.

A lack of IT systems that ‘could reasonably be expected to detect and cause the reporting of suspicious securities transactions’ were said not to be in place at E*Trade, which ‘did not have an adequate AML programme based on its business model’, according to Finra. E*Trade had already been fined $1 million by the Securities and Exchange Commission in 2008 for similar breaches of AML regulations in the US.

Lloyds TSB has also been forced to forfeit $350 million after owning up to breaking international sanctions and channelling money from accounts in Sudan and Iran into the US banking system over a 12-year period. The bank was accused of stripping international wire transfers of information that would have raised a ‘red flag’ under the US system.

Responding to risk
With such incidents firmly in mind there has been a predictable response from banks, which have fuelled rapid growth in the market for financial crime risk management technology, a market that Chartis Research estimates could be worth nearly $4 billion by 2012.

‘There is more and more pressure from regulators, who have shown that they are not easing up on financial crime. In the UK, the FSA has star ted charging individual managers, so senior management takes it very seriously. Despite the financial crisis, regulators continue to do what they were already doing. They are not stopping at AML, and they are not looking only at retail banks, but insurance too,’ McCarthy remarks.

Over the years, there has been a subtle but powerful shift in the dynamics of regulation.

‘Banks do sometimes have issues with regulators. Many were not ready for the
Red Flag Regulations, for instance, and they want clarification on regulations such as MiFID. But they must consider this: several years ago the onus was on government regulators to sort out these issues, but now it rests on the banks,’ McCarthy explains.

‘The market is maturing, however, and in AML a process of trial and error is helping banks learn what to detect. There is a move away from treating it just for compliance to just wanting to do it well,’ he adds.

Banks are now more mature in handling examples of AML such as structuring. When a high value deposit is made it must be raised as a potential case of AML or fraud, but if it is broken into a series of smaller deposits it becomes harder to detect. Best practices are emerging from many implementation projects, but there is still the challenge of getting these programmes to work globally.

More and more attention is being centred on the shift to ‘ongoing due diligence’, which set banks on a proactive rather than reactive footing. When an account is initially opened, a risk estimate is carried out based on factors such as the volume of money that will pass through it. The problem is that banks often rely on the information provided by the prospective customer. By continually monitoring the volumes of money going through an account based on the customers profile, banks can now change the risk scores of customers based on their account behaviour and not just on what they filled in on the application form to open the account.

‘It can’t just be a rules-based approach, but has to look more widely at customer behaviour. Risk scores for customers must change in line with their behaviour,’ stresses McCarthy. ‘We are also seeing a move to a risk-based approach. Banks can’t monitor every single account, so they need to look at the most likely ones. For that kind of approach they must have ongoing due diligence. They must ensure that customers are in the right risk group and that they move between those groups as their transactions change,’ he adds.

Maintaining momentum
Ongoing due diligence projects are progressing well, generating fewer false positives. McCarthy believes that alongside such technology developments it is important for banks to abolish the silo approach that has kept compliance and fraud teams separate. These capabilities are starting to converge.

‘They are increasingly being merged into a single financial crime centre, and the bigger organisations in Europe are leading the way on this. The US is starting to adopt the label of financial crime, under which AML and fraud are addressed together. Even if these departments are not combined, they are at least talking to each other. We have never seen this kind of convergence before,’ says McCarthy. This convergence could provide a firm platform for enterprise-wide financial crime management solutions, on which technology providers like Fiserv can implement a range of solutions.

‘Different case management tools have been used for different areas of AML and antifraud, so we need a single case management tool that can handle the demand of both. Dashboards are also important, as senior managers want to see how many alerts are coming in,’ adds McCarthy.

In a growing number of cases banks are looking to leverage AML technology to combat fraud. As well as improving compliance, they are increasingly focused on generating tangible results. They also see an opportunity to save money.

‘Finding a cost-effective way to combat money laundering and fraud means facing the problem of resources. The US is leading the way on running AML on an application service provider basis, so the client does not install any software. We expect great demand for this from smaller banks, and we are already seeing it in Europe and Asia,’ McCarthy observes.

Fiserv recently installed its AML solution at a large European bank, which uses it to monitor over four million accounts and two million transactions each day for suspicious activity. With fewer alerts and a higher detection rate the solution has enabled the bank to reduce staffing resources, improve operational efficiency and reduce cost while more effectively managing the risk of financial crime.

Despite such successes, McCarthy accepts that there is still a long way to go. ‘AML technology is still in its infancy, though that may sound hard to believe, but it has matured a lot in the last ten years. Tackling financial crime is still a big challenge for many organisations. Banks still struggle with it. They see the benefits, but they are still facing problems with culture and implementation,’ he remarks.

At least the industry is starting to understand just how important it is to surmount those problems.

read more about our compliance solutions here