RapidAML Team
2024-06-18
Money laundering risks in the FinTech industry are becoming increasingly prevalent as businesses strive to develop technologies that simplify financial operations. While these advancements offer seamless solutions for clients, they also expose FinTech platforms to illegal activities, such as money laundering. This article addresses the vulnerabilities of FinTech businesses due to criminal exploitation and highlights the methodologies used by such criminals to further their money laundering motives. It also emphasises the importance of implementing strong Anti-Money Laundering (AML) measures to counter these risks.
The word fintech is derived from a combination of two words: one is ‘finance’, and the other word is ‘technology’. It refers to technological advancements that expedite or speed up the processing of traditional financial services and products. FinTech covers a wide range of applications and software, using technology such as blockchain, Artificial Intelligence (AI), Data Analytics, and Automation, which facilitate the creation of a user-friendly interface or platform.
Examples of fintech are digital wallets and mobile banking apps, crypto exchanges, online payment gateways, crowdfunding platforms, RegTech solutions, online or app-based stock trading, digital credit services, and online or app-based portfolio management platforms.
Money laundering is a process that involves introducing illegally procured funds as legitimate profits or gains by carefully layering illegally obtained funds across the financial system, concealing their illicit origin. The crime of money laundering takes place in three stages: placement, layering, and integration.
The use of fintech benefits not only the businesses deploying fintech tools but also the customers or the public who are making use of them. The makers and users of fintech, despite enjoying the benefits of ease in carrying out routine transactions, must exercise caution with regard to the fintech tool being misused as a medium to facilitate money laundering.
The use of fintech brings a significant amount of ease in customer onboarding, servicing, and business relationship life-cycle management. However, such ease comes with its own set of money laundering and financial crime risks.
Since fintech facilitates the financial sector, which is highly vulnerable to money laundering, fintech, by association, becomes vulnerable to being misused by launderers to further their motives.
FinTechs are vulnerable to money laundering due to multiple factors, such as:
1. Easy Onboarding: Many fintech tools facilitate quick customer onboarding with very few customer identity verification protocols; the presence of weakened verification protocols gives money launderers an opportunity to exploit fintech tools such as payment gateways or crypto exchanges providing anonymity, and thus this ends up exposing the fintech to money laundering.
2. Use of Cryptocurrencies: The use of cryptocurrencies by fintech comes with its own set of risks, such as the use of certain cryptos that are non-compliant with crypto exchange regulations, and the lack of unified crypto administration gives room to many criminals to use crypto without fear of transaction tracing back to them.
3. Offers Anonymity: The anonymity offered by a few fintech tools exposes them to the risk of money laundering. The anonymity component, despite being an attractive feature, comes with its own vulnerabilities to money laundering (ML), financing of terrorism (FT), and proliferation financing (PF).
4. Quick Financial Transactions: The speedy customer onboarding facility enjoyed by fintech also poses a threat of missing out on identifying red flags for money laundering.
5. Challenges in Transaction Monitoring: FinTechs are vulnerable to money laundering risks due to challenges faced in the implementation of transaction monitoring mechanisms. The inability to monitor the changes in the profile of existing customers poses the threat of an existing low-risk customer becoming high-risk due to the inclusion of their names in sanctions lists, failing to identify changes in customer profiles or any anomaly in normal, usual, and reasonable customer behaviour would lead to increased money laundering risks.
6. Cross-Border Transactions: FinTechs providing cross-border digital wallets are vulnerable to being exploited by money launderers due to the high-risk nature of cross-border transactions. Criminals are always looking for means to transfer funds internationally without getting caught and exploiting loopholes in vulnerable systems.
The methods deployed for conducting money laundering through fintech are numerous, but the process of money laundering largely remains the same, consisting of placement, layering, and integration of illicit funds. Methods used by money launderers using fintech are:
Use of Money Mules:
Money launderers use money mules. Money mules are persons who let launderers operate their bank accounts to move illicit funds, keeping aside a token amount for their own use. Money mules are usually individuals lured by launderers to either knowingly or unknowingly facilitate the movement of illicit funds. This money mule acts as an intermediary in layering and providing legitimate origin to illicit funds. Many money launderers operate through a network of money mules, involving a high volume of funds transfers through multiple mule accounts spread across various banks and countries before ultimately integrating with the launderers’ account.
Technological Exploitation:
The exploitation of fintech for conducting money laundering is possible due to advancements in the field of technology. Launderers take the help of cybercriminals to exploit fintech’s AML compliances by imitating or impersonating to be a legal entity or a natural person intending to engage in a business relationship.
In addition, launderers, through the help of cyber criminals, may also hack into the Application Programming Interfaces (API) connections of fintech that provide it with AML sanctions screening data. Launderers may exploit technology to block fintech from accessing API data of sanctions lists, which enables criminals to get onboarded, surpassing the compliance mechanisms.
Fake Identities:
The creation of fake identities is an age-old prevailing method through which launderers enter any legitimate financial system. With advancements in technology in identifying fake or counterfeit documents, criminals have also advanced in their methodologies to create fake identities that cannot be differentiated from the original ones, exposing the fintech to money launderers who get onboarded as customers by using fake identities.
Smurfing and Structuring:
The methods of smurfing and structuring, despite being different from each other, have the similarity of splitting a large sum of illicit proceeds into multiple undetectable portions to avoid threshold-based alerts and regulatory reporting. Many fintechs with weak or flawed transaction monitoring systems may get exploited by money launderers who succeed in smurfing or structuring through a fintech.
Social Engineering:
The concept of social engineering relies on manipulating human beings into sharing personal information or details. Money launderers often use these tactics to build trust with fintech and harvest credentials or details, which further help them create fake identities or open money mule accounts with financial institutions or banks.
Shell Companies:
The creation of shell companies and complex legal ownership structures is how money launderers attempt to confuse and obstruct the actual identities of natural persons responsible for the mobilisation and laundering of illicit proceeds. By creating shell companies which exist only by name, money launderers can succeed in avoiding scrutiny by hiding the actual identities of the ultimate beneficial owners (UBOs) of the shell company.
1. AML/CFT Program: Every fintech intending to strengthen its measures in combating money laundering risks needs to have in place an Anti-Money Laundering and Counter-Financing of Terrorism (AML/CFT) program.
2. AML Software: FinTech, to mitigate money laundering risk, can make use of AML software that covers the entire AML compliance obligations. Starting with customer onboarding measures, encompassing customer Know Your Customer (KYC), Customer Due Diligence (CDD), and Customer Risk Assessment (CRA).
The use of AML software can help fintech to implement AML obligations in a cost-effective manner with enhanced efficiency in adhering to compliance requirements.
3. KYC/KYB: FinTech needs to have in place measures to identify and verify their customers. Such measures include implementing KYC and Know Your Business (KYB) measures for legal entity customers. KYC and KYB measures help identify and verify customers.
4. Sanctions Screening: To ensure that customers and business partners of a fintech are not associated with any terrorist activity or proliferation financing activities, it is essential to screen them against relevant sanctions lists and restricted persons lists applicable to the fintech. Sanctions screening will eventually help ensure compliance with relevant TFS regimes.
5. Transaction Monitoring: Fintech, to ensure its compliance with relevant AML regulations, needs to monitor every existing business relationship with natural persons and legal entities; this will help them identify any anomaly or difference arising in the customer’s existing risk profile and the actual transaction that has taken place.
6. Regulatory Reporting: FinTech needs to ensure that they report to the relevant regulatory authorities any suspicious activity or suspicious transaction they come across, which indicates potential ML, FT, and PF activities. By having regulatory reporting measures in place, fintech can ensure complete AML compliance, as non-reporting or failure to report suspicious activities or transactions can be penalised in many jurisdictions.
7. Independent AML Audit: For any fintech’s AML compliance strategies, policies, and procedures to yield fruitful results, an independent AML audit must be conducted to make sure that the AML compliance measures enforced within the organisation are capable enough to identify potential money laundering threats and mitigate the risk of these financial crimes effectively.
8. AML Training: FinTech must make sure that its personnel receive adequate AML training according to their relevant roles and responsibilities towards client management. AML training is also essential for AML compliance officers to equip themselves with upcoming trends in criminal methods and updates in ever-evolving AML laws and their compliance requirements. AML training is also essential at the senior management level as the senior management is responsible for approving the commencement and continuation of business relationships with high-risk customers, along with having the overall responsibility of ensuring AML compliance within the organisation.
AML compliance is important for fintech due to its vulnerability to being exploited by criminals to conduct money laundering. By ensuring adequate AML compliance measures, fintech can benefit significantly.
Reduced Fines and Penalties: By having adequate and appropriate AML compliance measures in place, fintech can avoid the risk of being fined and penalised due to non-compliance with AML regulations. Reduced fines and penalties and implementation of AML software solutions also significantly help in bringing down operational costs.
Enhanced Branding: When a fintech is compliant with AML laws and portrays an unimpeachable image of integrity, it helps the fintech to enhance its brand value in the market, attracting better business opportunities.
Increased Customer Conversion: With adequate AML compliance measures in place and implementation of AML software and technology solutions, a fintech can experience increased customer conversion as the use of technology solutions in customer onboarding enhances customer experience while ensuring compliance, reducing customer frustration or hesitation over data privacy issues.
Effective Due Diligence: With the implementation of appropriate AML compliance measures, fintech can be rest assured of effective due diligence in business relationships. Also, periodic AML audits help in identifying and remedying any lapses that exist in AML measures, resulting in improved and effective due diligence.
Conclusion
FinTech organisations, to avoid being penalised for unknowingly supporting money laundering activities, must implement adequate AML/CFT measures to mitigate the money laundering risks effectively. FinTech must be mindful of the money laundering methods used by criminals and deploy adequate measures to overcome its vulnerability to being used as a vehicle for money laundering.
Dipali is an Associate member of ICSI and has a Bachelor’s in Commerce and a General Law degree.
She currently assists clients by advising and helping them navigate the legal and regulatory challenges of Anti-Money Laundering Law. She also helps companies develop, implement, and maintain effective AML/CFT and sanctions programs.
She knows Anti-money laundering rules and regulations prevailing in GCC countries and specializes in Enterprise-wide risk assessment, Customer Due-diligence, and Risk assessment.
