fraud detection

8 Red Flags To Detect Money Laundering In The Finance Sector

Money laundering is a global problem. Digitization has made it more convenient for us to make transactions and facilitated online shopping, but it has also created opportunities for illegal activities such as money laundering. This illicit practice involves disguising the origins of illegally obtained funds and supporting criminal activities. Money laundering is a significant issue, estimated to account for a substantial portion of the world's GDP, ranging from 2% to 5%

What is money laundering?

While large amounts of money may be made through criminal activities such as drug trafficking, the money cannot be used until it is cleaned to appear as though it were sourced through legal means. Processing funds to make them appear clean is known as money laundering.

The terms took off in the 1920s during the prohibition era. In simple terms, the process involves placing ‘dirty money’ into the financial sector, concealing the source of these funds and transactions through bookkeeping tricks and withdrawing the funds from legitimate accounts in the form of ‘cleaned money’.

Protecting your organization from money launderers

Fighting money laundering is important as it deters criminals from illegal activities and keeps them from funding activities linked to smuggling, terrorism, extortion, etc. The responsibility of keeping criminals from marking their illegal cash as legitimate money falls to regulatory bodies in the financial sector and financial institutions.

Every financial organization must comply with Anti-Money Laundering (AML) regulations to identify people and activities that could be linked to money laundering. AML practices are designed to detect disreputable account holders and suspicious transactions. This involves verifying that every account holder is who he/ she claims to be, assessing their risk factor based on criteria such as political exposure, source of funds, screening against global blacklists and sanctions, etc. and tracking transactions on an ongoing basis.

The question is how do you identify money launderers – here are 8 red flags to be aware of.

  1. The customer is reluctant to share personal information

Before opening an account, financial institutions must verify the individual’s identity. For this, the customer needs to share certain personal information and provide documentary proof of their identity, address, etc. In some cases, additional due diligence may be required. Most customers have no issue with sharing such information about themselves. However, if a customer is reluctant to share this data or provide the required documents, it should set off an alert. Customers should never be onboarded without completing the required KYC verification.

  1. Irregularities in due diligence reports

When clients are evasive about sharing personal documentation, their profiles may be scheduled for additional due diligence as part of the onboarding process. This allows financial institutions to assess the client’s risk profile and verify their identity. Inaccuracies in these reports such as invalid street addresses should be taken as red flags.

  1. Addresses from high-risk countries

Though money laundering is not limited to any particular geographic region, the risk is higher in some countries. The Basel AML Index sources data from 15 publicly available databases to score countries according to their risk of money laundering.

According to the 2022 report, countries like The Democratic Republic of Congo, Haiti, Myanmar, Mozambique and Madagascar have high money laundering risks. Hence, a customer with an address from any of these countries may be flagged as a high-risk account holder.

While it may not be possible to check every customer’s address manually, you can use address verification tools to automate the process. Customer addresses are checked against global databases at the time of onboarding to ensure that they are accurate, complete and valid while also screening them against sanctions lists to assess a risk value.

  1. Unclear ultimate ownership

When it comes to company-owned accounts, accounts may be red-lighted if the ownership structure is unnecessarily complicated and the ultimate beneficiary is unknown. To be identified as an ultimate beneficial owner, an individual must meet certain criteria such as owning at least 25% of the share capital and exercising 25% voting rights. Accounts with unclear ultimate beneficiaries may be set up as fronts or shell companies or to disguise criminal transactions.

  1. Suspicious transactions

One of the ways to identify money launderers is by studying the transaction patterns. Suspicious patterns include weekly or monthly transactions of questionable amounts, large sums of money rapidly moving in and out of the account, funds being transferred from or to accounts in sanctioned countries or blacklisted accounts or multiple high-value transactions in a short span of time.

  1. Immediate cash withdrawals

One of the common ways to launder money is to have someone transfer money into an account and then withdraw the cash. For this reason, all financial institutions must monitor accounts where money is transferred in and then quickly withdrawn. Fraudsters could then use this money to invest in a legal business or acquire other assets to introduce ‘clean’ money.

Alternatively, criminals may convert funds received in their accounts into virtual assets. Recurring conversions of virtual assets into legal currency may also be seen as red flags.

  1. Multiple accounts

While some people may have multiple bank accounts to control their spending, fraudsters open multiple accounts in a bank to launder money through smurfing scams. Since large transfers are immediately noted by financial regulators, fraudsters may break up a large transaction into several smaller transactions under the regulatory reporting limits through their different accounts.

  1. Adverse media mentions

In some cases, in addition to verifying the account owner’s identities, financial organizations must also keep track of media references connected to the customer. Account holders who are subjects of negative news reports may be at a higher risk of being money launderers. This is especially important for people with significant political exposure.

Summing It Up

During 2022, financial institutions were fined more than $8 billion for failing to prevent money laundering. In addition, the institutions lost the trust of their customers. Paying attention to AML compliance and money laundering red flags as listed above protects financial organizations from being fined and builds a trustworthy reputation. It’s time to start paying more attention to your customer profiles and their transactions.

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