AML: what is it and how does it work?
Money laundering is a serious financial crime, which is the legalization of money obtained illegally. There are various methods of money laundering, and these methods are increasing and evolving as technology advances. Anti-Money Laundering (AML) includes policies, laws, and regulations to prevent financial crimes. AML is the global term for preventing money laundering. Global and local regulators have been created around the world to prevent financial crime, and these regulators develop policies to combat this type of misconduct.
How does money laundering happen in banking?
Illegal funds are first introduced into the legitimate financial system to hide their real source. Illegal money is often moved to create confusion through bank transfers to multiple accounts. Money launderers also deposit small amounts of cash or move money secretly to foreign countries to avoid suspicion.
These numerous transactions make the illegal money appear legitimate and integrate into the financial system. Criminals can withdraw laundered money from legitimate accounts and use it to finance organized crime, drug trafficking, human trafficking or terrorism.
AML is a set of rules, laws and procedures that identify and prevent criminals from disguising illicit funds as legitimate income. AML policies help banks and financial institutions fight financial crime. AML rules require banks to collect customer information, monitor and audit their transactions, and report suspicious activity to financial regulators. In addition, the AML retention period requires deposits to remain in the account for at least five trading days. Banks can use this holding period to help combat money laundering and manage risk.
AML: what is it and how does it work?
Why is AML important to the banking industry?
Banks are some of the largest institutions in finance. Because banks around the world broker millions of transactions throughout the day, these institutions are at higher risk for financial crime. Moreover, criminal organizations often conduct their money laundering activities through banks and other financial institutions.
Banks must identify risks by fulfilling their obligations and taking necessary precautions. The AML process is critical to the financial and reputational health of banks. Auditors and regulators require this process by law.
In addition, the technological shift in financial infrastructure and the growth of online payments have increased the need for stricter customer privacy protections. In response to new and stricter guidelines, banks and financial institutions are adopting new trends in artificial intelligence-based AML solutions to improve AML compliance. As part of their anti-money laundering program, banks are acting according to four main areas:
- Know Your Customer (KYC) - identifying and verifying a customer's identity when opening a bank account;
- Customer Due Diligence (CDD) - collecting relevant information about a customer's profile and assessing for potential money laundering or terrorist financing risks;
- Customer and Transaction Verification - tracking and monitoring people involved in money transfer transactions and monitoring deposits and other transactions;
- Suspicious Activity Reporting - extensive records of every major financial transaction to help law enforcement agencies track criminal activity.
How do AML policies affect financial institutions?
Financial institutions are held to a high standard when it comes to money laundering detection procedures. Employees are trained to detect and track suspicious customer transactions. Transactions and processes are carefully recorded to help law enforcement track financial crimes.
Although financial institutions are required by law to comply with anti-money laundering regulations, not all institutions agree. Many banks believe that implementing policies is costly, time-consuming, inefficient and not worth the money. But in recent years, the number of regulatory inspections of institutions has increased. Non-compliant organizations are paying huge administrative fines.
In 2018, $4.27 billion in fines were imposed on organizations that failed to comply with AML regulations. The amount of fines in 2019 nearly doubled to $8.14 billion. And fines paid in 2020 totaled more than $10 billion. In addition to serious administrative fines, institutions that fail to comply with AMLs can damage their reputation and lose customers. A financial institution's image suffers if it is associated with corrupt individuals or businesses.
AML in the cryptocurrency and digital asset industry
Cryptocurrency often means cheaper and faster international transactions, but it also makes the crypto sector ripe for criminal activity such as money laundering and terrorist financing.
To get ahead of this, regulators are enacting tough AML legislation. This helps prevent money laundering through cryptocurrency exchanges and other platforms. AML programs include robust KYC processes to identify and verify users. With this, authorities hope to stamp out suspicious activity in the crypto sector. However, for cryptocurrency exchanges and digital wallets, this also means the possibility of being vulnerable to data breaches.
For cryptocurrency exchanges, AML programs are mandatory, both to protect against financial crime and to comply with stricter regulations. This means implementing an effective AML program that includes a Customer Acceptance Policy (CAP), a Customer Identification Program (CIP), continuous transaction monitoring and risk management procedures.
CAP refers to the process of identifying new customers using official documentation. CIP is the process of verifying a customer based on this documentation and official databases. Continuous monitoring means that crypto exchanges must have systems in place to identify suspicious transactions and ensure that customer information is up-to-date.
In the EU, legislation is different for exchanging fiat funds for cryptocurrency and exchanging cryptocurrency for cryptocurrency. Any digital asset service that allows a customer to exchange fiat currency for cryptocurrency must implement KYC. Exchanges that deal exclusively with cryptocurrency do not. Meanwhile, in the U.S., FinCEN classifies all cryptocurrencies the same way. This means that all cryptocurrency exchanges must implement KYC and install effective AML programs, regardless of the currencies they support.