The complex regulatory reforms inspired by the financial crisis in 2008 and ongoing headline-grabbing money laundering and corruption scandals have disrupted compliance operations for financial institutions, forcing them to adopt more rigorous Know Your Customer (KYC) rules. From stricter due diligence in the on-boarding phase, to the more rigorous monitoring and reporting demands of an expanding Bank Secrecy Act (BSA), firms of all sizes are struggling to keep up with the new laws and rising costs of compliance.
Other reforms like Dodd-Frank and FACTA, have also strained KYC obligations in order to mitigate growing counterparty risks. Specifically, new KYC on-boarding and reporting provisions are designed to limit client risk in the form of anti-money laundering (AML), terrorism financing, tax evasion and politically exposed persons. The recent Panama Papers leak has fueled even stricter KYC reforms with the May enactment of the Customer Due Diligence Final Rule, designed to identify the real owners of business bank accounts.
While the administrative burdens and high costs of implementing a compliant KYC program can be overwhelming, especially for smaller firms, the obstacle has also created an opportunity for organizations to enhance their competitive advantage. The new value proposition reverts back to trust - the old and oft-touted keystone of the financial industry. Nowhere is the issue of trust more relevant than consumer protection.
Deficient counterparty risk management adversely affects consumer protection. While recent cases have shown that the on-boarding of high-risk and unlawful clients can lead to increasingly punitive fines and severe reputational damage, legitimate clients also incur disturbing "privacy taxes". Specifically, regulatory action against non-transparent or delinquent firms may involve the auditing and disclosure of private client data from valid accounts that would otherwise remain undisturbed.
This breach of client trust only compounds operational and reputational harm, causing some customers to close their accounts with the delinquent institution and seek new banking partners. Alternately, heightened regulatory scrutiny over large firms may drive bad actors to smaller banks that have weaker compliance controls. Despite reduced compliance demands relative to larger firms, the proportional costs incurred by smaller regional and community operators render them particularly vulnerable to cost challenges.
A 2015 survey of 974 community banks, sponsored by the Federal Reserve System and the Conference of State Bank Supervisors, found that these firms spent a combined $4.5 billion in 2014 solely on compliance costs. 48 percent of these costs were attributed to the hiring of outside consultants to help implement new compliance rules. These exorbitant expenses threaten to put smaller banks out of business.
Obstacles aside, institutions must rise to the challenge and turn stricter KYC demands into a competitive advantage. New automated solutions can help optimize on-boarding due-diligence efficiencies and reduce investigative costs for overwhelmed operators. If KYC is to drive value for your firm, it is crucial that you stay current on new regulations, create contingency plans to meet new compliance deadlines and leverage technology to do the heavy lifting.
Initially conceived in the 80s, KYC, AML and BSA laws have since evolved and intensified on the heels of the 2008 financial crisis. New KYC reporting requirements, in the form of currency transaction reports involving transactions of $10,000 or more, and suspicious activity reports, which flag anomalous account activity, are redirecting banks' focus towards detecting terrorism financing. Moreover, high-profile cases of political graft in the developing world are also shifting regulators' attention towards the corruption of government officials.
Recent crackdowns on correspondent banks in Latin America, inquires into the flow of sovereign wealth funds in Southeast Asia and the Panama Papers scandal highlight the expanding regulatory octopus reforming the banking industry worldwide. Banks have responded to the relentless wave of legislation by investing heavily in modern technology solutions to flag suspicious activity with greater accuracy.
But, with regulators primarily focused on large institutions, undesirable clients and the illicit flow of their funds have shifted to smaller community and regional banks. Community banks are especially attractive to money launderers because they are off the radar, have reduced reporting demands and possess less sophisticated due diligence and monitoring resources. And while a bulge-bracket firm has the reserves to absorb large monetary penalties for KYC negligence, the increasingly punitive nature of regulatory fines could potentially bankrupt a smaller operator.
Financial operators can avoid costly KYC legal problems by staying on top of continuously evolving bank secrecy laws, the legal standing of clients, OFAC sanctions, high-risk jurisdictions and reporting requirements. These objectives can be achieved by vetting new compliance hires for expertise in high-priority legislation.
Furthermore, firms need to leverage digital solutions capable of cross-referencing and monitoring the legal and financial standings of clients across domestic and international jurisdictions to mitigate counterparty risks. Big data technology can help large institutions address volume, while optimizing efficiency, accuracy and cost reduction for smaller operators.
Create a contingency plan
The most recent amendments to the Bank Secrecy Act order banks to update their compliance guidelines by May 11, 2018, according to the Financial Crimes Enforcement Network (FINCEN). The identification and disclosure of all accountholders who own 25 percent or more of a corporate entity is just the latest compliance deadline burdening institutions already trying to accommodate Dodd-Frank and FACTA compliance dates.
Financial institutions must organize themselves and ensure that compliance objectives are aligned with the goals of senior management and the board of directors. Repurposing KYC and regulatory data to drive business value is a bank-wide enterprise that will not work without the support of bank leadership. Secondly, bank silos needs to be dissolved to make client data more readily available and sharable throughout the organization without compromising legitimate privacy concerns. This undertaking requires the judicious determination of relevant KYC data assets.
Thirdly, financial institutions’ business goals need to be strategically aligned with KYC objectives and deadlines so that each enterprise process signifies a step closer towards full compliance. Additionally, banks must train and recruit qualified personnel capable of grasping the business, data and regulatory dimensions of KYC in an ever-expanding climate of BSA Bank Secrecy Act legislation. Establishing clearly defined metrics for KYC compliance success and testing pilot programs in pre-deadline phases also help guide optimal KYC revenue-growth strategies. Ultimately, these provisions cannot be properly employed without a cultural repurposing, which bank leadership must always exemplify.
Pick the right technology partner
In 2016, it’s nearly impossible for any bank to demonstrate an honest commitment to KYC compliance without investing in appropriate data technology. Data collection, analysis, provision and sharing are central to the KYC dilemma. Today, banks have access to law enforcement-grade investigative software capable of scanning millions of data points simultaneously and across jurisdictions – domestic and foreign. The technology of today allows banks to pull data from utilities records, DMV files, property ownership, public records, private records, watch lists, criminal cases, business information, healthcare provider content and social media data.
Additionally, the solutions of today enable the intuitive navigation of KYC queries and relationships through centralized dashboard interfaces. The holistic, “one-view” benefits of modern investigative software speed up the learning curve for the technology training of relevant personnel. Furthermore, today’s resources are able to capture adverse changes in client risk profiles in real-time, flag suspect accounts and escalate issues to compliance managers. Beyond real-time risk tracking, more sophisticated investigative software grants banks access to comprehensive social media, cell phone, VoIP, landline, and pager coverage of all 50 U.S. states, Puerto Rico, various territories, and even Canada.
The investigative innovation of today enables large organizations to process high data volumes more efficiently and intelligently. Smaller banks can leverage these new software tools to cover gaping regulatory blind spots and use state-of-the-art tech to detect illicit funds migrating to their remote branches. What’s more, smaller operators can leverage sophisticated tech to drastically reduce their rising compliance cost burdens. As banks struggle to realign themselves with the KYC compliance regime, a consistent, comprehensive and defensible technology solution is key. Firms of all sizes should be reassured that the right solution exists and that this resource is well within their means.