Strategic Implementation of an Anti- Financial Crime (AFC) Organization

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Published: 2nd October 2018

In recent years, the number of publications where financial institutions have become a victim of or been involved in financial crimes, especially in money laundering, has increased dramatically. The main problem with such financial crimes is that they usually do not only affect the company itself (e.g. through costly fines or reputational losses), but also have tremendous negative effects on the stability and integrity of global financial markets as well as on the society and economy of a country. This is especially the case when powerful corporations and individuals are involved or when these crimes involve a large amount of money (Tomasic, 2011; Gottschalk, 2010; Buchanan, 2004; Levi & Reuter, 2006; FBI, 2017). Nevertheless, studies have shown that the disastrous and negative consequences of financial crimes are underestimated by the population, although their associated monetary costs are usually higher than the costs of all other types of crime combined (Hansen, 2009).

Although national and international regulatory authorities are constantly publishing new rules and policies to minimize the risks of financial crimes, many companies have difficulty implementing them within the given time period. This is caused by the fact that companies’ current internal processes are inefficient or that the fulfillment of new rules requires either strategic changes within the company or the implementation of new strategies (Ray, 2017; Gill & Taylor, 2004; Ganguli, 2016).

Since financial crime is obviously an important issue for different companies and countries, the purpose of this study is to investigate the extent to which financial institutions in Europe have already implemented general anti-financial crime programs in their organizations. Additionally, this study will explore the extent to which firms are already compliant with the specific requirements of the 4. EU Anti-Money Laundering (AML) Directive. Additionally, the study aims to identify strategies companies can use to make their AML/ Know-Your-Customer (KYC) processes more efficient by either implementing the make-or-buy decision or Robotic Process Automations (RPAs).

The Global Development of AFC and AML

In most industrial and emerging countries around the world, the financial sector is supervised and regulated by a combination of different national and international organizations (e.g. central banks, self-regulatory organizations, or national financial supervisory authorities). All of these entities are constantly trying to combat the different types of financial crime while simultaneously reducing the risk of financial system distress through the implementation of various rules and policies (e.g. Basel Accords) (Carmassi, 2008).
In terms of money laundering, initial initiatives for combatting this type of financial crime began in the late 1970s in the United States (Levi & Reuter, 2006). At first, money laundering controls were mainly used as an additional component in the fight against drug trafficking. Nowadays, money laundering controls have developed into a global network of various sets of controls aimed at preventing not only drug trafficking, but also smuggling, terrorist financing, and corruption among high-level officials (Levi & Reuter, 2006). In addition to that, the number of institutions involved has also increased over the years. Aside from banks and financial institutions, today’s AML controls include monitoring other types of businesses, such as certain insurance companies, casinos, car dealers, jewelers, money transmission businesses, or pawnbrokers (Levi & Reuter, 2006). However, since money laundering was not considered a crime in all countries around the world until the end of the 1980s, the development of policies and rules against money laundering have differed globally (Sharman, 2008; Walker, 1999).

To solve this problem, the Financial Action Task Force (FATF) was established as an inter-governmental body during the G-7 summit in Paris in 1989 (FATF, 2017a). The overall goal of this Task Force is to set global AML standards and policies by publishing a series of recommendations on a regular basis, and to support countries with the implementation of national regulatory, legal, and operational measures for combatting money laundering and terrorist financing (FATF, 2017a). Currently, the FATF has 37 members [1]
and is constantly monitoring its members’ progress in implementing their recommendations on the national level (FATF, 2017b). In order to achieve European-wide consistency with the FATF’s current AML recommendations, the European Commission/European Parliament regularly proposes an AML Directive with rules and laws that must be transposed into the national law of every EU member state within a specific time frame (European Commission, 2016a). The latest version of this Directive is called the 4. EU Anti-Money Laundering (AML) Directive (or 4. EU AML Directive), which was announced in May 2015.

Need for sustainable Anti-Financial Crime organizations

Instant pressure to act implies huge challenges for banks, since organizations, processes and systems are frequently not designed for this.

Figure 1: Anti-Financial Crime organizations.

4. EU AML Directive

The 4. EU AML Directive was officially adopted by the European Parliament on May 20, 2015 under the name “Directive (EU) 2015/849 of the European Parliament and of the Council of 20 May 2015”. It must be fully transposed into the national laws of its member states by the end of June 2017 (European Commission, 2016a; European Union, 2015a; International Monetary Fund, 2016).

The main purpose of the 4. EU AML Directive is to make the European Union’s legal framework compliant with the latest FATF recommendations/standards from 2012, such that the risk of money laundering and terrorist financing within the European Union’s financial system can be further reduced (International Monetary Fund, 2016; European Commission, 2016b). According to the European Union (2015a, Art. 2), the requirements of the 4. EU AML Directive should be applied to all member states’ credit institutions, financial institutions, auditors, external accountants, tax advisors, notaries & other independent legal professionals, trust or company service providers, estate agents, providers of gambling services and persons who make or received cash payments of more than 10,000 Euro. Compared to the previous EU AML legislation, namely the 3. EU AML Directive, which was implemented in 2005, the 4. EU AML Directive introduces a series of adaptations and changes, especially in terms of a risk-based approach, ongoing monitoring, beneficial ownership, customer due diligence (CDD), and politically exposed persons (PEPs) (European Commission, 2013; European Union, 2015a; Deloitte, 2016).

 

Methods of the passcon GmbH Study

In order to find answers about the various responses to the new directive, a web-based survey among different European financial institutions was conducted. This survey was available online for participants from March 7, 2017 until April 17, 2017 (5 weeks and 5 days). During that time period, 30 participants answered all the questions sufficiently and completed the survey. Since the content of the survey is very specific in terms of anti-financial crime topics, the personal and professional background of the participants is crucial for the analysis of this survey in order to achieve a high level of usable qualitative data. Hence, the target group of this study is managers of different financial institutions. Generally, 50% of the participants were from German-speaking countries (Germany, Austria & Switzerland = DACH), 26% from Scandinavian countries (Denmark, Norway & Sweden), 14% from the Baltic countries (Latvia & Lithuania), and 10% from other countries (United Kingdom & Albania).

 

Discussion of General (Anti-) Financial Crime Findings

In recent years, an increasing number of frauds and financial crimes have been detected (especially during the global financial crisis). Therefore, the pressure to combat these types of crimes has become critical for companies in the financial services sector (Tomasic, 2011; Gottschalk, 2010). The findings of the survey show that financial crime and its prevention are (very) important topics for companies. In fact, 83.33% of the companies in the survey have already started an anti-financial crime program within their respective companies.

Figure 2: Overview of banks who have already started an AFC organization.

Furthermore, 40% of the companies that have not implemented an anti-financial crime program yet are planning to start one shortly. However, the findings reveal that 16% of the companies need at least two to three years and 36% of the companies even more than three years to fully implement an AFC organization program.

Figure 3: Estimations of how long a full implementation of an AFC organization will take.

Consequently, it follows that these companies are not fully protected against potential financial crimes or may not be able to detect them as long as these programs are not implemented. In particular, current developments in digitalization and other technologies can be exploited by criminals if anti-financial crime programs do not work properly. Since the negative effects and costs of financial crimes are tremendous for the entire population, society, and economy, the aim of all companies should be a rapid implementation of their anti-financial crime programs (Hansen, 2009).

In this context, the findings of the survey reveal another potential problem related to the strategic implementation of anti-financial crime programs. Most of the companies in the survey were not able to estimate the associated costs (i.e. internal and external personnel costs and investments in software and hardware) that are necessary for a successful program implementation. Where such estimations exist, they tend to be rather vague and imprecise. Estimates for the total cost of implementing such programs vary between less than 0.5 million Euro and more than 100 million Euro; hence, companies may not be truly aware of the costs. Accordingly, it is difficult for them to specify which steps still need to be taken for establishing an anti-financial crime program. Problems in estimating costs can lead to expensive planning errors as well as financing problems. Therefore, given the risk of failure due to planning errors, companies need to make precise strategic plans. Everyone in the company should know which steps are needed and how much effort they require to complete a strategic implementation of an anti-financial crime program (e.g. Raps, 2004; Grant, 2013; Mišanková and Kočišová, 2014).

In terms of preventing money laundering, the findings demonstrate that all participants of the survey have at least general knowledge about the actual regulations and requirements of the 4. EU AML Directive. All the requirements of this directive had to be transposed into national law and implemented by companies by the end of June 2017. The fact that all participants of this study are aware of the 4. EU AML Directive reflects the importance of the requirements and their implementation. However, the ambitious implementation deadline of June 2017 was immediately criticized by most governments. In reality, most countries (e.g. Germany) had not even provided a legislative proposal to transpose the requirements of the 4. EU AML Directive into national law by November 2016 (Ganguli, 2016). This is consistent with the findings of the survey.

Figure 4: Banks’ level of compliance with the requirements of the 4. EU AML Directive.

Consequently, it follows that these companies are not fully protected against potential financial crimes or may not be able to detect them as long as these programs are not implemented. In particular, current developments in digitalization and other technologies can be exploited by criminals if anti-financial crime programs do not work properly. Since the negative effects and costs of financial crimes are tremendous for the entire population, society, and economy, the aim of all companies should be a rapid implementation of their anti-financial crime programs (Hansen, 2009).

In this context, the findings of the survey reveal another potential problem related to the strategic implementation of anti-financial crime programs. Most of the companies in the survey were not able to estimate the associated costs (i.e. internal and external personnel costs and investments in software and hardware) that are necessary for a successful program implementation. Where such estimations exist, they tend to be rather vague and imprecise. Estimates for the total cost of implementing such programs vary between less than 0.5 million Euro and more than 100 million Euro; hence, companies may not be truly aware of the costs. Accordingly, it is difficult for them to specify which steps still need to be taken for establishing an anti-financial crime program. Problems in estimating costs can lead to expensive planning errors as well as financing problems. Therefore, given the risk of failure due to planning errors, companies need to make precise strategic plans. Everyone in the company should know which steps are needed and how much effort they require to complete a strategic implementation of an anti-financial crime program (e.g. Raps, 2004; Grant, 2013; Mišanková and Kočišová, 2014).

In terms of preventing money laundering, the findings demonstrate that all participants of the survey have at least general knowledge about the actual regulations and requirements of the 4. EU AML Directive. All the requirements of this directive had to be transposed into national law and implemented by companies by the end of June 2017. The fact that all participants of this study are aware of the 4. EU AML Directive reflects the importance of the requirements and their implementation. However, the ambitious implementation deadline of June 2017 was immediately criticized by most governments. In reality, most countries (e.g. Germany) had not even provided a legislative proposal to transpose the requirements of the 4. EU AML Directive into national law by November 2016 (Ganguli, 2016). This is consistent with the findings of the survey.

Figure 5: Participants’ current preferences regarding outsourcing or in-house solution. 

In-house Solution

The main advantages of controlling operations internally are preventing the loss of tacit and operational knowledge as well as maintaining better control and monitoring of activities, which is especially important when confidential data is involved (Ellram et al., 2008). Additionally, companies can not only avoid the costs of managing and monitoring external service provider contracts, thereby eliminating dependence on third parties, but they can also increase the employees’ motivation through job preservation (e.g. Belcourt, 2006; Ketler and Walstrom, 1993; Elmuti and Kathawala, 2000; Weidenbaum, 2005). The findings suggest that one of the most important reasons why so many companies prefer the in-house solution is the belief that they are achieving a higher level of security for their customer data. According to Ray (2017), banks’ or financial institutions’ processes generally involve a high degree of confidential customer information. Consequently, it can be assumed that companies are not convinced that the same high level of customer data security can be guaranteed when these activities would be done by an external service provider. However, the findings also show that the decision to keep operations in-house is influenced by other important considerations, such as a better quality control, no reliance on third parties, or the possibility of controlling ongoing monitoring. Thus, the reasons why institutions may opt for the in-house solution are in line with the literature. Another important aspect is higher motivation among the company’s workforce, as jobs can be preserved; however, the findings imply that the preservation of jobs is the least important reason for choosing the in-house solution.

From a capabilities perspective, researchers argue that sourcing strategies (i.e. in-house or outsourcing) are mainly driven by the firm’s internal resources and attributes like knowledge, previous experience, technologies, skilled personnel, efficient procedures, etc. (Wernerfelt, 1984; Parmigiani, 2007; Hart, 1995; Peteraf, 1993; Teece, Pisano and Shuen, 1997; Grant, 2013). 70% of the participants who voted in favor of the in-house solution are convinced that they already have all the necessary resources and capabilities for conducting AML/KYC activities internally. On the one hand, this implies that financial services companies that decide to go with in-house operations are indeed influenced by their existing internal resources. On the other hand, this also indicates that most companies already have the resources required to implement the changes in AML/KYC activities required by the 4. EU AML Directive.

Due to the tight time frame given to implement the requirements of the 4. EU AML Directive and existing internal resources, it seems to be reasonable that so many companies choose the in-house solution from a short-term perspective. However, many companies also believe that outsourcing is an interesting strategic option for them in the future.

 

Outsourcing solution

Although 80% of the companies in the survey indicated that outsourcing is at least a slightly important option for the future execution of their AML/KYC activities, only 33% would choose this strategic option right now. The advantages of outsourcing are cost savings through economies of scale, avoidance of specific investments in technologies or employee trainings, staff reduction, shift from fixed costs to variable costs, increase of firm’s flexibility, and concentration on core activities or increases of the overall efficiency (Belcourt, 2006; Ketler & Walstrom, 1993). The results of the survey suggest that companies choose the outsourcing option in order to achieve lower costs, focus on their core capabilities, and increase efficiency. Additionally, the findings reveal other important reasons such as an increase of flexibility, shift from fixed to variable costs, possibility to use external expertise, and an increase in transparency. In fact, the reasons mentioned by the participants are largely consistent with the literature. Surprisingly, avoiding employee trainings is not seen as the least important factor for the outsourcing strategy.

However, geographical location seems to affect the choice of the outsourcing partner. 50% of the participants would choose an outsourcing partner in the same country where they operate (i.e. onshore outsourcing) (see Figure 6). In contrast, only 30% of the participants can imagine cooperating with an outsourcing partner located nearshore, e.g. in a neighboring country (i.e. Poland, Spain, etc.). The remaining 20% are uninterested in the location of the outsourcing partner. In fact, these findings provide evidence that none of the participants would currently actively choose an outsourcing partner from a foreign country such as China, India or Bangladesh (i.e. offshore outsourcing). This is partly in line with the literature. Outsourcing to these countries can lead to large cost savings; however, it can be also very risky to outsource activities to service providers in these countries due to cultural, legal, or geopolitical differences, as well as different time zones and higher travel costs (Gonzalez et al., 2006; Ellram et al., 2008; Lacity et al., 2008; Rao, 2004). Since none of the companies would choose foreign countries for outsourcing their AML/KYC activities, it can be assumed that companies in the financial services industry value the quality and control mechanisms (e.g. the security of customer data) more than cost reductions. Another reason against offshore outsourcing could be the lack of trust in outsourcing partners in these foreign countries. For instance, the fact that Bangladesh is one of the most corrupt countries in the world[2] implies that companies might fear that they cannot guarantee the security and confidentiality of their customers’ data when sourcing the AML/KYC activities there (Transparency International, 2017).

 

Figure 6: Preferences of geographical locations of outsourcing partner.

In terms of outsourcing, it is of utmost importance that companies set a price limit. This must reflect the willingness to pay for services in order to evaluate whether the outsourcing solution truly outweighs the in-house solution regarding costs. Interestingly, the findings show that 50 – 60% of the companies have difficulties in estimating the costs per customer that are required to pay to an outsourcing service provider. Nevertheless, the data reveals that companies expect the highest AML/KYC outsourcing costs for ‘individual corporates’ (20% of the companies estimate costs of 10,000 Euro – 15,000 Euro per customer and 10% estimate costs of 7,500 Euro – 10,000 Euro per customer) and the lowest costs for ‘mass market retail customers’ (30% of the companies estimate costs of less than 5,000 Euro per customer and 20% estimate costs of 5,000 Euro – 7,500 Euro per customer). These findings imply that the AML/KYC effort for individual corporates is probably higher and requires more time than for mass market retail customers. In addition, it can be assumed that the necessary data and information required to conduct a review of the existing and new customers is easier to collect for mass market retail customers than for individual corporates given the lower expected costs.

The tight time frame for fulfilling the requirements of the 4. EU AML Directive may result in sanctions, penalty payments, and reputational losses in case of non-compliance. Hence, the execution of AML/KYC activities within the company makes more sense for companies in the short-run. In addition, implementing a new strategy (e.g. outsourcing) requires sufficient time. However, time is a crucial and scarce factor for success in the current regulatory environment. In the long-term, it can be recommended that companies try to outsource their AML/KYC activities to an external KYC-Factory, as tremendous cost advantages can be achieved, and the overall flexibility of the company increased. An increase in flexibility could be especially important for companies, as ongoing changes in future AML/KYC activities are expected (see e.g. announcement of 5. EU AML Directive). Since the findings suggest that offshoring to a foreign country is not an option, it follows that companies should search for an outsourcing partner (i.e. a KYC-Factory) that is preferably located in Eastern European countries (e.g. Poland). Salaries in these countries are usually lower compared to Western European countries, leading to significant cost reductions. Furthermore, cultural and language differences are rare, and the experience and knowledge of KYC specialists in these countries is qualitatively high. Thus, it can be assumed that the general service quality and data protection offered by these KYC-Factories are positively correlated.

Robotic Process Automation Discussion

The findings of the survey have revealed that 63.33% of the companies in the survey believe that their internal KYC functions need to be improved, especially in terms of internal processes, organizations, and IT systems & data. In addition to that, the findings illustrate that the current KYC activities of 80% of the companies are heavily based on manual processes, which are time consuming and lead to a high error-rate. In this context, the KYC processes for the ‘individual corporates’ customer group are still mostly conducted manually, meaning that the costs for conducting the KYCs for this customer group are expected to be the highest. Thus, it can be concluded that this customer group needs improvements, for example in the form of further automation, as this can reduce costs and increase efficiency.

In terms of the KYC process itself, the findings reveal that especially the ‘evaluation’ aspect of the KYC is a part of the process which is not conducted by any of the represented companies automatically. Rather, this process is still executed fully manually by 6 of the companies in the survey. Additionally, the on-boarding process during the KYC due diligence is still conducted fully manually by 7 companies in the survey, and by 5 companies for event management. Hence, it can be concluded that the three parts of the KYC process (evaluation, on-boarding process, and event management) need improvements and should be more automated to increase efficiency and reduce potential human error.

One specific type of automation that could be interesting for the execution of AML/KYC activities is the Robotic Process Automation (RPA) (Accenture, 2017). 90% of the participants believe that implementing a RPA has at least a slight importance for the execution of their future AML/KYC activities (see Figure 7).

Figure 7: Companies opinion of implementing RPA for future AML/ KYC processes.

More precisely, 46.67% of the companies in the survey are convinced that RPA will be implemented in their company within the next few years. 16.67% even assume that RPA will be implemented to a large extent (see Figure 7). These findings imply that RPA is considered to be an interesting strategic option for the execution of future AML/KYC activities.

 

Figure 8: Overview of to what extent companies believe that RPA will be implemented in their company.

According to the literature, there are some process parts within a financial institution where the implementation of RPA would especially make sense (Accenture, 2017). These processes include, for example, client on-boarding (i.e. checking and documenting all required data), identification and compliance checks, AML/KYC authentications (i.e. collecting and analyzing basic customer information or matching names against PEP lists), fraud detection, or consistent data mapping (Accenture, 2017). Half of the participants claim that the screening process for PEPs or negative news can be improved greatly through RPA. In addition to that, participants are convinced that the validation of existing client information, the on-boarding and CDD processes, as well as the off-boarding and reporting processes can be markedly improved through RPA. In fact, the findings provide evidence that companies expect that all of the above-mentioned AML/KYC activities can be improved through RPA to at least a small degree. Thus, consistent with the literature, it can be concluded that companies expect mostly the same improvements across the board through RPA within AML/KYC processes.

Besides the advantages of cost reductions and efficiency improvements, RPA can also help improve general service quality, provide scalable solutions, reduce delivery times, maintain internal competencies, and increase the overall level of compliance (Lacity et al., 2015; Accenture, 2017). The study reveals that cost savings and productivity increases are the most important advantages of RPA for most firms. Furthermore, the possibility of having better operational control and improving overall quality are also crucial factors for the implementation of RPA for AML/KYC activities. In contrast to the literature, however, the short implementation time of only 3 to 6 months is not considered as important by the companies.

 

Conclusion and Suggestions for Further Research

Financial crime and especially its subcategory money laundering are complex topics that have concerned many countries and companies in recent years because of its costly and negative effects on the entire population and economy. Hence, national and international regulatory authorities are constantly introducing new rules, policies, and requirements with the aim of combating financial crimes in general and reducing the risk of money laundering specifically. Since the given implementation periods often are rather restricted and the effort and costs for strategic implementation usually are larger than expected, companies are struggling to implement all the required changes within the given time frame, which is resulting in costly penalty payments and reputational losses.

In order to find sufficient answers to these specific topics, a web-based survey among different European financial institutions was conducted, whereby the data of 30 completed data records was evaluated.

After having evaluated and discussed the collected data, it can be concluded that anti-financial crime is still of the utmost importance for many companies. However, most companies are expecting that full implementation of their anti-financial crime initiatives will still take at least two years. In terms of the 4. EU AML Directive, it can be concluded that all companies in the survey have at least general knowledge about the content of this directive and most of the companies are also convinced that they are at least largely compliant with the most important changes of the 4. EU AML Directive. However, since the companies believe that there is still a need for improvement to become fully compliant with the requirements, it can be generally recommended that they need to make their AML/KYC processes more efficient and standardized, especially in terms of the adaptability of systems/databases, the availability of data (in terms of time) as well as in terms of general Know-Your-Customer (KYC) functions. From a general perspective, KYC activities are part of most AML processes. Thus, in accordance with the findings of this survey, it can be concluded that to become compliant with the requirements of the 4. EU AML Directive, companies need to improve their internal KYC activities, especially with respect to processes and reviews.

In terms of the make-or-buy decision, it can be concluded that especially from a long-term perspective, the strategic implementation of an outsourcing solution for AML/KYC activities does make sense due to the fact that costs can be reduced and flexibility as well as efficiency can be increased. Thereby, it can be recommended that financial institutions should choose a KYC-Factory specialized on the execution of AML/KYC activities. Moreover, it would be advantageous if this KYC-Factory is located in a low-wage country, such as Poland, where the costs are lower and cultural and/or quality issues can be avoided. From a short-term perspective, it can be concluded that the most beneficial strategic solution for companies in the Financial Services industry is the execution of necessary AML/ KYC activities in-house. The reasons for the in-house solution from a short-term perspective are that most of the companies already possess the necessary resources and most of them are confronted with the limited time frame to fulfill the requirements of the 4. EU AML Directive. As the strategic implementation of an outsourcing solution takes a certain period of time due to a series of strategic planning processes, it is reasonable to assume that this solution is not the most suitable solution from a short-term perspective.

Regarding the strategic implementation of RPA, it can be concluded that this is a very interesting opportunity for companies in the Financial Services industry to make their AML/ KYC processes more efficient. The implementation of RPA can definitely be recommended for all companies in the Financial Services industry due to its short implementation time, the increase of data security, and cost reductions. This strategic implementation makes sense especially in the short-term, as the efficiency of AML/KYC activities and processes can be increased quickly. This is especially important considering the time pressure to fulfill the requirements of the 4. EU AML Directive.

However, since this study has focused mainly on investigating money laundering, which is only one small subsection of the overall topic ‘financial crime’, it would also be interesting for further research to investigate other subsections of financial crime in order to figure out if the strategic implementation of outsourcing or RPA would make sense. In addition to that, further research is needed to examine the possible role of new block chain technology, particularly in connection to automating AML/KYC processes. Consequently, whether this new technology is capable of making the fight against money laundering and financial crimes more efficient needs to be investigated. 

[1] These 37 members represent the most important financial centers around the world, such as Germany, the United States, Australia, the Russian Federation, etc. (FATF, 2017a).

[2] Listed in Transparency International’s Corruption Perceptions Index 2015 on rank 139 of 167.

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Corinna Reibchen

CEO | passcon GmbH

Mobile +49 152 042 809 86
Corinna.Reibchen@passcon.de

Jean Marc Bieger

Senior Consultant | passcon GmbH

Mobile +49 174 3176566
JeanMarc.Bieger@passcon.de

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