BankingToday Rohan Bedi

Journal of The Hong Kong Institute of Bankers

AML RISK MODELS

Anti-Money
Laundering Risk Models
The three AML Risk Models are at the core of the AML/CFT
argument with regulators expecting the adoption of this holistic
approach in transactions monitoring.

tailor customer identification and

A risk-based approach in anti-money verification processes taking into account
the different categories of customers, the
laundering (AML) and combating the
financing of terrorism (CFT) involves an size of the customer, the types of
accounts maintained, and whether the
understanding of geography and country
customer does financial transactions for
risk, business and entity
its own customers;
risk, and product (and
The Three Bases identify risky accounts
linked distribution channel) for EDD in account
and transaction risk. opening and on an on-
Financial institutions need Financial institutions need to take a
going basis including to
to take a systematic systematic approach to risk that covers adjust early alert and
approach to risk that covers all three bases rather than just one or the transaction monitoring
all three bases rather than other.
systems as risks change;
just one or the other. These ensure proper allocation
risk models are then of resources for
applied to due diligence example, to prioritise
Geography and Country Risk
activities at account accounts for periodic
opening and the ongoing Business and Entity Risk updating of customer
monitoring process information, to apply
including enhanced due Product and Transaction Risk resources while
diligence (EDD). monitoring including
EDD; and
Importance of a Risk- ensure that the risks are taken into
Based Approach account in a consistent manner across the
organisation.
A risk-based approach helps to:

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BankingToday Rohan Bedi
Journal of The Hong Kong Institute of Bankers
AML RISK MODELS

The UK FSA expects banks to have good the FATF black-list of high-risk for
basics a really sound foundation dealing money laundering countries (and also
with the low risk customers and products, on those recently removed);
which the risk-based approach can then be FATF mutual
built. evaluation reports, Dont have 170
World Bank & countries on the
Geography and Country Risk IMF reviews. high-risk list
the USA this distracts
Firms that have a significant proportion of PATRIOT Act
their customer base located in countries Section 311
from risk-focus!
without adequate AML strategies - where 1) designated countries as primary money
cash is the normal medium of exchange; 2) laundering concern;
there is a politically unstable regime with OECD black-list of countries for
high levels of public or private sector adverse tax practices;
corruption; 3) that are known to be drug US list of drug producing and drug
producing or drug transit conduit countries;
countries; or 4) have US list of state
been classified as sponsors of
countries with terrorism;
inadequacies in their US Department of
AML strategies - will State annual reports
need to consider what on country money
additional 'know your laundering risk and
customer' (KYC) and global terrorism;
monitoring procedures Reports by Council of
might be necessary to Europe/ similar
manage the enhanced bodies, Transparency
risks of money International; and
laundering. In particular, The banks' internal
additional monitoring of country risk
inward payments from management rating.
countries without
equivalent AML Business and Entity Risk
strategies should be
considered. The characteristics that
make businesses high risk vary. Casinos,
This risk model ranks countries around the gaming, brokers-dealers for example, are
world as high, medium or low risk for popular money laundering targets because a
susceptibility for money laundering and mature AML culture is yet to develop in
terrorist financing. It is based on publicly these businesses. Such businesses with a
available information such as: high volume of cash activity need to be
watched carefully.

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BankingToday Rohan Bedi
Journal of The Hong Kong Institute of Bankers
AML RISK MODELS

Offshore banks provide financial services that are Hence, an Asian financial institution faces
conducted behind the shield of strict banking and this risk when it carries out a transaction with
corporate secrecy laws. Professionals facilitate a US party. The UK has adopted this list for
the creation of laundering vehicles and schemes monitoring against and Suspicious
including real estate linked. Car, boat and Transaction Reports (STRs) are filed with the
airplane dealers, as well as jewel, gem and FIU.
precious metal dealers, provide launderers access The World Bank's debarred list shows firms
to 'big ticket items', which often can be purchased and individuals ineligible for contracts for
with little or no customer identification and later fraud and corruption violations.
sold to provide a 'legitimate' source of cash The US Department of Commerce's Bureau
proceeds. Import and export companies provide of Industry and Security has a denied
cover for international money laundering persons list which points out firms that have
operations through false trade pricing schemes. been denied export privileges.
Cash intensive Designated entities as per the USA
Understand your businesses allow PATRIOT Act Section 311 as a primary
customers launderers to disguise money laundering concern impacting
business cash derived from illegal transactions with US firms.
including what is activities in deposits Negative entities highlighted by regulatory
normal for the containing cash derived queries and court orders. Sharing such
from regular, legitimate information cross-border may be prohibited
business business activity. The by law and it may need to be shared in terms
US Office of Comptroller of the Currency has of underlying risk as part of a larger database,
come out with a list of such high-risk businesses. rather than with specific attribution to source.
Entity risk typically refers to either the risk of
The above list is by no means comprehensive.
facilitating a terrorist financing transaction with
Other sources of negative information include
an individual or organisation, or dealing with a
media searches and/or KYC databases such as
politically exposed person (PEP) without proper
IntegraScreen Online, World-Check etc.
controls, and also other entities as stipulated by
local regulations or regulations in other countries
To monitor transactions against lists of such
with which transactions are done, for example,
entities, financial institutions would do well to
the US. Other entities that could impact Asian
adopt KYC check software that interrogates
operations include:
transactions against lists of such names.
The Office of Foreign Assets Control PEPs The PEP
(OFAC) list. OFAC administers and enforces regulatory
economic and trade sanctions against The June 2003 revised definition is too
international narcotics-traffickers, targeted FATF 40
foreign countries, and terrorists and terrorism-
wide - using a
recommendations
sponsoring organisations, based on US good third-party
define a PEP to include
foreign policy and national security goals. family members and KYC database is
Any business that doesn't check the OFAC close associates, but essential
list and conducts business with a prohibited clarifies that it is not
party faces civil and criminal penalties. intended to cover middle ranking or more

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BankingToday Rohan Bedi
Journal of The Hong Kong Institute of Bankers
AML RISK MODELS

junior individuals. Transactions involving PEPs identity of the third

may involve the proceeds of foreign official parties being taken. Offshore shell and
corruption and hence can expose the financial The product or trust ownership
institution to significant reputational and legal services could support
risks. Private banks are significantly exposed to high-speed movement structures -
PEP risk. PEPs from select countries have also of funds or along with especially if
been known to have links with terrorists. Firms a high volume of layered - can
can use public lists like the CIAs online transactions, or both, highlight risk
directory of 'Chiefs of State and Cabinet and could conceal the
Members of Foreign Governments' albeit this is source of those funds. It may facilitate a higher
by no means enough and is only a starting degree of anonymity, or involve the handling of
point. The Heads of high volumes of
State will probably not currency or currency
hit a financial equivalents. It could
institution, their allow a customer to
subordinates and links readily convert cash to
will the KYC a monetary instrument.
databases of private
vendors such as Factiva Some of the highest-risk
and World-Check are products are those
more relevant to offering money transfer
identify links and loops. facilities though
One source of chequebooks, monetary
information for establishing a risk-based instruments, USD drafts, telegraphic transfers,
approach to managing PEP risk is to first look SWIFT, CHAPS, automated clearing house
at country risk based on Transparency (ACH), deposits from third parties or other
International Corruption Perceptions Index means, electronic cash (e.g., stored value and
2005 and their corresponding Bribe Payers
payroll cards), payable upon proper
Index (BPI) 2002.
identification (PUPID) transactions, third-party
Product and Transaction Risk payment processors, automated teller machines
(ATMs), and electronic banking.
The UK Joint Money Laundering Steering
Group notes give us some insights to this Corporate and private current accounts fall within
aspect of money this category because unlimited third party funds
Look out for laundering/ terrorist are continually received for credit to the account
nominee financing risk. The and it would be impractical to identity all
directors, notes say that products providers of such funds. Private banking both
shareholders and or services with the domestic and international - can be particularly
highest risk are those vulnerable just as trust and asset management
authorised services, is.
where unlimited third
signatories party funds can be
freely received, or where funds can regularly be Similarly, other products and services that
paid to third parties, without evidence of constitute high-risk include:

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BankingToday Rohan Bedi
Journal of The Hong Kong Institute of Bankers
AML RISK MODELS

Foreign correspondent accounts pouch owner of the funds deposited or invested is

activity, payable through accounts, and U.S. always the same.
dollar drafts.
International trade finance (letters of In developed financial centres like the UK,
credit). these features are true of unit trusts, insurance
Special use or concentration accounts. products, retail credit business, some asset
Lending activities, particularly loans to finance and some deposit/savings accounts. In
small and medium enterprises secured by other centres, unit trusts and life insurance
cash collateral, marketable securities; and (including annuities) may not have protective
funding/payments rules and they can be high -
credit card lending.
risk for money laundering. Low-risk products
Nondeposit account services (e.g.,
include those which have low aggregate
nondeposit investment products, insurance
balances considering the velocity of the
and safe deposit boxes). account, a low volume of activity, accounts for
minors, retail/passbook savings/checking
Risks increase if the money launderer can hide accounts, household accounts and other similar
behind corporate structures such as private accounts. In its comments to the FATF 2002
limited companies, offshore trusts, special consultation report on the 40 principles, the
purpose vehicles and nominee arrangements Wolfsberg group of banks pointed out that
that increase anonymity. Company formation certain transactions or activities have a minimal
agents offer nominee director, shareholder and risk of money laundering or terrorist financing.
authorized signatory services. Offshore shell They give some examples:
company ownership by another offshore bearer
share company is a favourite. Another favourite
transactions where a financial is acting as a
is where assets are conveyed to an offshore principal rather than on behalf of third-
company 100% of whose shares are held by an parties (such as foreign exchange,
offshore Asset Protection Trust which has as its
derivatives, capital market transactions and
sole beneficiary a second trust this is called a some extensions of credit);
Layered Trust structure. Hence, understanding accounts established for a specific purpose
the ownership and control structure for
with funds received or disbursed under
companies and trusts is critical. limited defined circumstances to identified
third-parties, such as escrow, corporate
When devising their internal procedures, firms trusts, paying agency and custody accounts;
should consider how their customer base and accounts for the investment of funds that
operational systems impact upon their staff's are subject to a regulatory scheme, such as
capacity to identify suspicious transactions. investment of funds of regulated pension or
retirement plans; and
Some of the lowest risk products are those accounts held by other financial institutions
where funds can only be received from a that are themselves subject to a robust AML
named investor by way of payment from an regime.
account held in the investor's name and where
the funds can only be returned to the named There are also customer categories where the
investor. No third party funding or payments risk of money laundering or terrorist financing
are possible and, therefore, the beneficial

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BankingToday Rohan Bedi
Journal of The Hong Kong Institute of Bankers
AML RISK MODELS

is lower. Generally large public listed

companies subject to regulatory disclosure
Case Study
requirements are regarded as lower risk than
Mr B is the Managing Director of an offshore
unlisted companies. Government company incorporated in country A in June
administrations or enterprises are also 2000. He seeks to open an account for moving
potentially lower risk. Pooled accounts held by his business from another bank that he claims
designated non-financial businesses or is providing bad service.
professions regulated to FATF standards may
Mr B wants to set up a trade financing line to
also be lower risk. import microprocessors from the US for his
computer business. He provides details of the
Bank staff should be well versed with the Letter of Credit to be set-up that he says would
products and services that have been be fully secured with cash assets.
categorised as high-risk by the industry bodies
Geography and Country
or by the regulators. They should question
Country A is in the Caribbean, which is a hot-bed
themselves whether the nature of the client's for laundering drug money coming out of the US
account or business justifies the products or both directly and indirectly.
services the client is asking for. For example, You are aware that the country A was removed
privately or closely held businesses with from the FATF black list in June 2001 but your
private banking or trust relationships may serve AML officer advises that regimes that are
as money laundering conduits by distributing removed from the FATF black list may also be
vulnerable for historical reasons.
illegally derived income from the business to
Furthermore, Country A was involved in recent
the beneficial owners of the private banking
high-profile corporate scams, increasing the
account. The underlying transaction may be discomfort.
unusual for example, a request to route fund
transfers coming in from country A onward to Business and Entity
country C through a suspense account rather You are aware that import-export businesses are
than the actual account for reasons of tax a key high-risk business for money laundering.
management. Bank staff should also note that You further do a search on your PEP
although some products present a lower risk, no commercial database that shows a match. Mr B
is a distant relative of a key politician in a country
financial sector product or service is immune
known for corruption. Mr B concealed this fact.
from the laundering process. Mr B is unable to provide an introduction to
facilitate account opening and can only provide
Incorporating the Models in the KYC identification documentation. Given the risks, you
Review Process feel uncomfortable with this fact.

The above risk models are not an academic Product and Transaction
exercise. They can add real value in a review of You know that over-valued imports are a
mechanism for laundering money. From your
any customer account opening or transaction. Internet research you note that the price is
Some American banks have established risk- higher by 30 percent from various online quotes
scoring mechanisms to assist in retail account for the same quantity and brand.
openings. To illustrate the models' application, His offer of full security also raises discomfort
here is an example of an account opening: for in your experience, customers do not do so
easily.

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BankingToday Rohan Bedi
Journal of The Hong Kong Institute of Bankers
AML RISK MODELS

Also, why is he not using a local supplier for [Updated March 2006 version of an article first
microprocessors? All the other computer published in Banking Today, Journal of The Hong
assemblers who have accounts with your bank, Kong Institute of Bankers, May/June 2004.
source such parts locally as all the major
manufacturers have local suppliers in the
country.

In the above case, there are enough 'unusual'

aspects to justify further questioning while
avoiding 'tipping off' the potential customer. If
you are not satisfied with the customer's
answers, you should refuse account opening
and file a Suspicious Transaction Report.

The Asian Picture

As can be seen from the above, it is important

to consider all dimensions of money laundering Written originally by Rohan Bedi as Head of AML
risk when assessing an account opening or a Services, PricewaterhouseCoopers Singapore.
transaction. In our experience many financial
institutions rarely take such a holistic approach
Email: [email protected]]
to AML with the exception of the Asian
operations of a few leading American banks.
Financial institutions need to create their own
risk models for their business, review their
firms business profile, flag the accounts of
high-risk customers and use the above models
to evaluate laundering risk on an ongoing and
comprehensive basis, where needed using
AML/CFT software.

*****************

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