Reducing bank risk is, well, a risky business. Complex and costly – at least that’s the perception.
Not if you ask Jose Caldera, IdentityMind Global’s VP of Product.
“Over the past few years, the rise of new financial marketplaces, globalized eCommerce, cross-border payments, international remittances, and cryptocurrencies have become significant opportunities for banks,” Caldera wrote in a recent report.
“At the same time, these new areas represent a significant risk, and regulatory penalties for ineffective transaction monitoring and reporting are on the rise, even as increased pressure spurs the de-risking of multiple industries. Banks seeking to tap into new revenue streams by onboarding high-risk merchants must stay ahead of the challenges by collecting and analyzing information on high-risk transactions in real time.”
Using a term like “high risk,” has what he calls a “sinister undertone,” which is why he breaks down this seemingly complex topic into four categories of high-risk industries by size.
1. Payday loans: $46 billion
2. Online gaming: $36.7 billion
3. Multi-level marketing: $32 billion
4. Money transfer networks: $25 billion
What That Really Means
Caldera considers these segments “high risk” since the transactions they enable are more susceptible to fraud and money laundering. Criminals worldwide do things like create fake bank accounts or use stolen credentials to make illegal transfers and payments. Their motivations range from stealing money for themselves or laundering funds for terrorist groups and other criminal organizations, he explains.
As a result, he says, regulators are on “high alert” and can impose harsh penalties when financial institutions don’t follow proper risk management strategies. Beyond that, there are other regulatory bodies heavily scrutinizing high-risk transactions, Caldera noted, sometimes delivering a few unintended consequences along the way.
Caldera cites the example of Operation Choke Point — an initiative by the DOJ that investigates U.S. banks and their relationships with payday lenders, and other high-risk businesses.
“One significant vehicle for increased scrutiny of high risk merchants and their bankers is Operation Choke Point. Despite remaining, for the most part, behind the scenes, Operation Choke Point was, in fact, one of the key reasons that high-risk merchants started to lose their bankers,” Caldera writes.
But, there was an issue with that initiative, he points out. The regulations were vague, and were more like guidelines. As a result, banks took their own vision of how to enact the “regulations,” which, according to Caldera, created an environment where banks were unsure what could trigger regulatory action. Transaction monitoring itself also proved to be an expensive task for banks.
“In response, many took a highly conservative approach to derisking their portfolios by simply terminating their high-risk accounts. However, banks also layered on an additional approach where they implemented monitoring technology that allowed bank compliance teams to satisfy their AML programs,” he said.
Caldera’s advice is to avoid “wading headlong” into high-risk financial services without effective controls and protection in place. While he acknowledges that these represent opportunities to generate new revenue and top-line growth, banking partners to high-risk merchants must collect and analyze vital information behind each transaction to ensure they aren’t enabling a business that is a front for bad businesses.
“It’s great to serve these new and growing markets that the regulators think are high risk, understanding that the only way to avoid the crippling penalties that they can impose is to have a well-defined and implemented monitoring program,” he concludes.