On the 22nd April 2022, the Financial Conduct Authority released its outcome of a review into management of financial crime prevention measures in six unnamed challenger retail banks. While the review did identify some strengths in the regimes implemented by these challenger banks, a number of crucial weaknesses were also identified, raising concerns these weaknesses may attract exploitation from criminals and lead to increased financial crime rates.
Origins of the Review
The financial crisis of 2008 led to the emergence of a number of smaller banks, who adopted the role of challenging the four major high street banks in the financial sector (HSBC, Barclays, Lloyds Banking Group and NatWest Group). These challenger banks predominantly conduct business online rather than using traditional high street branches, allowing them to keep business expenditure low by saving costs on premises and personnel. This subsequently helps keep the costs of financial services at a competitive rate for consumers. The role played by these challenger banks facilitates the development of a number of benefits being adopted throughout the financial market, such as competition operating to keep overall costs lower for the consumer and promoting innovation in the banking sector, particularly in the use of technology. This competition encourages high street banks to adapt and modernise their approaches to continue to appeal to consumers of financial services. In addition to direct competition, the online nature of operations grants challenger banks advantages when onboarding customers. Their growing influence in the personal current account market can be owed to their simple and fast onboarding approach, appealing to the customer’s convenience, which has played an important role in banking services during the COVID-19 pandemic and the rising market share of challenger banks.
While these challenger banks bring a number of benefits to the consumer, their rapid onboarding procedures may come at the cost of their legal obligations in regards to preventing money laundering and financial crime. The absence of conducting business face-to-face presents difficulties in conducting customer due diligence and simplicity in the onboarding process will appeal to money launderers and money mules seeking to disguise the proceeds of crime behind genuine origins. The National Risk Assessment of money laundering and terrorist financing 2020 highlighted both challenger banks and traditional high street banks to be a high risk category for money laundering and financial crime, emphasising the rapid growth of challenger banks should not come at the detriment of countering financial crime. The rapid onboarding process and risk highlighted in the NRA prompted the FCA to undertake a review into the prevention measures adopted by challenger banks to ensure their compliance with money laundering regulations. The review investigated the activities of six unnamed challenger banks which were relatively new to the financial market and emphasised a quick and easy application process. The banks were primarily digital banks who were conducting the majority of their business online and offered similar services to traditional retail banks. Areas of particular interest to the investigations were governance and management information, policies and procedures, risk assessments, identification of high-risk or sanctioned individuals and entities, due diligence and ongoing monitoring and communication, training and awareness. The major concern of the review is to ensure compliance with firms’ money laundering obligations does not become a lower priority in favour of onboarding clients through a quick and simple process. Weaknesses in financial crime programs and frameworks were identified as being unable to adapt and progress with the business models of challenger banks.
The FCA’s Conclusions
The FCA was complimentary about some practices implemented by challenger banks. Good practices were found in the innovative and non-traditional use of data and information collected to mitigate risks; tailored stand-alone financial crime policies and procedures regularly updated to adapt to the risks faced by firms, and mitigation of fraud risk through additional monitoring for known fraud typologies.
Conversely, the FCA identified a number of major areas needing improvement: customer risk assessment; customer due diligence and enhanced due diligence; financial crime change programs; transaction monitoring alert management; Principle 11 notifications and Suspicious Activity Reports (SARs), in addition to the risks faced by traditional high street banks. Customer risk assessment frameworks were found to be either absent entirely or poorly developed and lacking sufficient detail, preventing effective due diligence and ongoing effective and proportionate monitoring to the risks posed by the customer. When conducting customer due diligence, some firms did not obtain full customer information such as income and occupation to determine a customer’s risk, resulting in insufficient assessment as to the purpose and intended nature of the customer’s relationship with the firm and an incomplete understanding of the risk posed by the customer. Some firms were also found to have insufficient due diligence procedures when onboarding customers and were instead reliant on transaction monitoring systems to identify higher risk customers. Enhanced due diligence was not being applied consistently, meaning higher risks could not be mitigated effectively and high risk customers were not being consistently identified. The FCA found inadequate handling of transaction monitoring alerts such as “inconsistent and inadequate rationale for discounting alerts by alert handlers”, “a lack of basic information recorded in the investigation notes” and “a lack of holistic reviews of the alters”. The FCA highlighted that a lack of resources led to transaction monitoring alerts not being reviewed in a timely manner affecting the ability to make Suspicious Activity Reports (SARs) as soon as practicable as required under the Proceeds of Crime Act 2002. The FCA discovered occasions where there had been significant financial crime control failures which had not been disclosed, showing non-compliance with Principle 11 of the FCA handbook. The FCA identifies a number of issues with Defence Against Money Laundering (DAML) reports to the UK Financial Intelligence Unit. The FCA’s stance is that a number of exiting customers identified by DAML reports should not have been onboarded and better controls and risk assessment may have identified them sooner. In addition, the FCA identified that where a DAML report is submitted, the appropriate action was not taken, meaning the customer could continue transactions due to a “disconnect between the relevant function receiving court orders and processing SARs, and the relevant compliance teams”. The FCA also criticised the quality of the reports being submitted, highlighting some challenger banks were submitting volumes of transactional data with no clear basis on why the transactions are suspicious, vagueness of reports as to the suspicious circumstances raising concerns for money laundering and some SARs being used incorrectly to report fraud rather than suspicious activity, creating a reasonable yet inaccurate suspicion of funds being from the proceeds of crime.
What wider implications do these findings indicate?
While there are clear implications for increased financial crime rates if these weaknesses are not rectified, there is also the potential for innovation. Many traditional banks offer online services and with the development on technology, many will consider offering a greater range of online services, and the innovative data management and monitoring solutions adopted by challenger banks has the potential to encourage high street banks offering online services to adapt and modernise in order to efficiently compete in the online market whilst simultaneously meeting financial crime prevention obligations. However, this innovation cannot replace the current financial crime preventions in force, but has the potential to supplement these provisions and create a more robust and flexible system.
There are also possible negative implications to these weaknesses. Customer and business growth should not be prioritised at the cost of financial crime prevention obligations. If the weaknesses identified by the FCA are not rectified, there is a potential that these weaknesses will become subject to exploitation by criminals favouring the lack of regulation implemented by firms. The onus falls on firms to rectify these weaknesses and implement robust systems and procedures to effectively counter financial crime. If not rectified, the possibility of increased rates of financial crime becomes more prevalent issues. This may make engaging in financial crime more attractive and lucrative, it will also affect the reputation of challenger banks, driving away legitimate business and further skewing the market in favour of high street banking, ultimately limiting the competition benefitting the financial market. Failure to comply with legal obligations to prevent financial crime will also lead to financial penalties, which may be made more likely as a result of the weaknesses identified by the FCA. It is therefore in the interest of challenger banks to review their policies and procedures to ensure they maintain effective measures against financial crime and follow the remedial programs suggested by the FCA.
Written by Charlotte Read