Jo Ann Barefoot from the Alliance for Innovative Regulation (AIR) explains how the emergence of regtech companies that provide data-driven solutions to implement the 2020 anti-trafficking law in the US can be new AML tools.
More than half a century ago, the US Congress passed the Bank Secrecy Act (BSA) to regulate how banks, regulators, and law enforcement agencies deal with financial crimes. Financial institutions have spent the intervening five years seeking to comply with its anti-money laundering (AML) regulations.
Unfortunately, their efforts yielded little success. The United Nations estimates that less than 1 percent of the world’s illicit money flows are caught and stopped, even though the industry spends tens of billions of dollars each year in compliance. AML is considered to be the most expensive part of the financial system, accounting for more than half of banks’ payment costs.
Two recent developments have the potential to reverse this trend. One is the emergence of Regtech (regtech) companies that provide data-driven solutions for all aspects of the AML compliance process. The second, in the United States, is the passage of the Anti-Money Laundering Act of 2020 (AMLA), which is the most profound reform of the BSA since the USA PATRIOT Act became law after 9/11. Just like sowing the seeds of innovation, Congress passed this new law and encouraged the government to deploy new technologies.
Regtech as a new tool for AML
The same technology that is transforming money in the digital age is also transforming the financial system. Digitization opens up opportunities for both controllers and industrial risk managers to access vast amounts of information. Read also : Stability in times of upheaval – a challenge the Israeli high-tech industry may face. At the same time it allows them to analyze this new data with algorithmic tools that did not exist until recently. This technological revolution has led to the rise of fintech and, following it, the emergence of Regulated Technology, or regtech.
AML is the leading use of regtech in the US and around the world because of the widespread agreement that the current system is failing and expensive. The AML regtech market includes large publicly traded companies that specialize in customer relationship management (CRM), but most are startups. After being valued at more than $5 billion in 2019, the total size of the global regtech market is predicted to exceed $28 billion by 2027. In recent years, some hunts in the AML space have seen their valuations rise. 1 billion dollars.
The BSA requires banks to perform several duties. Before accepting new customers, the bank must be careful to verify their names and ensure that they are not sanctioned by the government. Once a customer is on board, the bank must monitor that person’s transactions for suspicious behavior. When a flag is raised, the bank must investigate and, if warranted, file a Suspicious Activity Report (SAR) with the Financial Crimes Enforcement Network (FinCEN). In addition, institutions must file Cash Transaction Reports (CTRs) for cash transactions exceeding USD 10,000. Depository institutions recorded more than SAR 1.4 million in 2021, about 18% more than 2020.
Regtech companies have emerged to help with every aspect of these needs. Others focus on Know-Your-Customer laws, helping with identifying new customers. KYC systems allow banks to make automated customer decisions while still complying with government-required sanctions and user regulations. They also use application programming interfaces (API) to allow financial institutions to use software tools from technology partners, such as digital identity providers.
Another class of AML regtech companies offer better digital transaction monitoring. Traditionally, monitoring has tended to be as predictable as possible and is often rules-based, designed to provide alerts when certain types of situations arise. Those alerts result in an alarming 90% false positive rate. Banks are looking to add staff to handle endless paper reviews, investigating large volumes of cases that turn out to be bad. Digital regtech companies, in contrast, bring human intelligence to the process. They use tools such as Machine Learning (ML) and Natural Language Processing (NLP) to analyze transaction patterns that may contain subtle clues, reducing both positive and negative fraud.
The third class of regtech solutions specializes in research and litigation management. These companies combine data from across bank databases and from external sources, often using AI to detect signs of crime and relationships between accounts. In the United States, for example, transactions can occur near the southern border at a rate comparable to the cost of cross-border human trafficking. In another example, brokers offer AML software that monitors cryptocurrency transactions to detect when a money smuggler mixes cryptocurrencies with other types of money flows to hide their source.
The impact of the new US AML Act
These technological advances, meanwhile, are encouraged by new legislative changes in the AMLA, which became law as part of the U.S. defense spending bill on January 1, 2021. The law could create and sustainable changes in KYC compliance, greater visibility for regtech. This may interest you : The United States and Canada seek consultations on Mexico’s energy policies under the USMCA. solutions, and reforming the way law enforcement uses suspicious transaction reporting. The law requires FinCEN and other US agencies to establish a technical advisory committee and appoint people to lead the innovation process. It requires increased cooperation between FinCEN and US banking regulators to strengthen the link between BSA compliance and crime prevention.
Another reform is a directive to FinCEN to set up feedback mechanisms with the industry. Today, banks file SARs and usually have no way of knowing whether the report is useful. This lack of understanding makes their systems difficult to get ‘smart’, and even hinders the ability of Machine Learning tools to achieve accuracy. The creation of feedback loops has a great opportunity to reduce both on large false positives and, again, on false negative cases in which no fault is detected.
The market for KYC certified vendors will further grow after the passage of AMLA. The new law requires companies to disclose their ‘true ownership’ directly to FinCEN, rather than to financial institutions, a provision that would create a database that reflects the ownership of businesses and will likely lead to more new technologies .
Finally, AMLA also requires FinCEN to hire a BSA Innovation Officer and report to Congress on the use of emerging technologies and direct the Treasury to study the impact of fintech on AML compliance.
The combination of digital innovation and government mandates for better technology opens up real potential for progress in the fight against financial crime.
This editorial was originally published in the Financial Crimes and Fraud Report 2022, which highlights the creation and development of best practices and tools used by financial institutions in their anti-fraud activities, to improve the digital entry system of their customers while fighting financial crime. .
Jo Ann Barefoot is the CEO of AIR & Co-founder and Senior Fellow Emerita at the Harvard Kennedy School Center for Business & Government. She is the first female Deputy Comptroller of the Currency, a partner at KPMG, Co-Chairman of Treliant Risk Advisors, and a staff member on the US Senate Banking Committee.
AIR is an independent, non-profit organization that works to make the financial system more transparent, fair, and resilient through the use of innovative technologies. By bringing together regulations, finance, technology, and society, AIR is driving global innovation and collaboration to overcome the legacy of the system and prepare it for rapid technological change.
