Over half a century ago, the US Congress passed the Bank Secrecy Act (BSA) to govern how banks, regulators, and law enforcement agencies combat financial crime. Financial companies have spent the five intervening decades seeking to follow its anti-money laundering (AML) requirements.
Unfortunately, their efforts have produced very low rates of success. The United Nations has estimated that less than 1% of the worldwide flow of illicit money is captured and stopped, despite the industry spending tens of billions of dollars each year complying with the law. AML is estimated to be the single most expensive realm of financial regulation, accounting for more than half of banks’ compliance costs.
Two recent developments have the potential to turn this tide. One is the emergence of digital Regulatory Technology (regtech) firms that are offering data-driven solutions for every facet of the AML compliance process. The second, in the US, is the enactment of the Anti-Money Laundering Act of 2020 (AMLA), which is the deepest reform of the BSA since the USA PATRIOT Act became law in the wake of 9/11. As if scattering seeds of innovation, Congress has infused this new law with encouragement for the government to deploy new technology.
The same technology that is transforming finance in the digital age is also transforming financial regulation. Digitisation is opening the ability for both regulators and industry risk managers to access vast volumes of information. It is simultaneously enabling them to analyse this new data with algorithmic tools that did not exist until recently. This wave of technology change has led to the rise of fintech and, following in its wake, the emergence of Regulatory Technology, or regtech.
AML is arguably the leading use case for regtech in the US and globally due to the widespread agreement that the current system is failing at a high cost. The AML regtech market includes large, publicly-traded firms specialising in customer relationship management (CRM), but most of the innovation has been driven by newer startups. After being valued at over USD 5 billion in 2019, the total size of the global regtech market is projected to exceed USD 28 billion by 2027. In recent years, some startups in the AML space have achieved valuations exceeding USD 1 billion.
The BSA requires banks to perform a range of activities. Before accepting new customers, a bank must perform due diligence to confirm their identities and ensure that they are not subject to government sanctions. Once a customer is onboarded, the bank must monitor the person’s transaction activity for suspicious behaviour. When suspicion is flagged, the bank must investigate and, if warranted, file a Suspicious Activity Report (SAR) with the Financial Crimes Enforcement Network (FinCEN). In addition, institutions must file Currency Transaction Reports (CTRs) for cash transactions exceeding USD 10,000. Depository institutions filed over 1.4 million SARs in 2021, about 18% higher than 2020.
Regtech firms have emerged to help with each facet of these requirements. Some focus on the Know-Your-Customer rules, helping with screening new customers. KYC firms allow banks to make automated customer onboarding decisions while still complying with government-required sanctions screening and beneficial-owner rules. They also employ application programming interfaces (API) to let financial institutions use software tools from technology partners, such as digital identity verification providers.
Another class of AML regtech firms provides smarter digital transaction monitoring. Traditionally, monitoring has favoured casting as wide a net as possible and is largely rules-based, programmed to generate alerts if certain types of situations arise. Those alerts produce a shockingly high 90% false-positive rate. Banks resort to adding staff to manage an endless paper chase, investigating large volumes of flagged situations that turn out to be benign. Digital regtech firms, in contrast, are bringing artificial intelligence to this process. They utilise tools like Machine Learning (ML) and Natural Language Processing (NLP) to analyse transaction patterns that may contain subtle signs of crime, reducing both false positives and false negatives.
The third class of regtech solutions specialises in investigations and case management. These firms integrate data from across the bank’s records and from outside sources, often using AI to detect patterns of crime and connections between accounts. In the US, for example, transactions may occur near the southern border in amounts that match the going price for cross-border human trafficking. In another example, vendors offer AML software that monitors cryptocurrency transactions to detect when a money launderer is mixing crypto funds with other types of money flows to obscure their source.
These technology advances, meanwhile, are being reinforced by the new legislative reforms in the AMLA, which became law as part of a broader US defence spending package on 1 January 2021. The statute could lead to lasting changes in KYC compliance, greater visibility for regtech solutions, and reforms in how suspicious transaction reporting is used by law enforcement. The law requires FinCEN and other US agencies to set up technology advisory panels and appoint people to lead innovation work. It requires heightened collaboration between FinCEN and the US bank regulatory agencies to tighten the correlation between BSA compliance and actual crime prevention.
Another reform is a mandate for FinCEN to set up feedback mechanisms with the industry. Today, banks file SARs and usually have no way to know whether the report is useful. This opacity makes it difficult for their systems to get ‘smarter’, and even hinders the ability of Machine Learning tools to gain accuracy. The creation of feedback loops has huge potential to cut down both on high rates of false positives and, again, on the false-negative scenarios in which crime goes undetected.
The market for vendors specialising in KYC will evolve further after the passage of AMLA. The new law requires companies to identify their ‘true owners’ directly to FinCEN, rather than to their financial institution, a provision that will create a centralised database showing the ‘beneficial ownership’ of businesses and will almost certainly spark more technology innovation.
Finally, AMLA also requires FinCEN to hire a BSA Innovation Officer and report to Congress on the use of emerging technologies and instructs Treasury to study the impact of fintech on AML compliance.
The combination of emerging digital innovation and government mandates for better technology opens real possibilities for progress in the fight against financial crime.
This editorial was first published in our Financial Crime and Fraud Report 2022, which showcases the innovation and development of the best practices and instruments used by financial institutions in their fraud prevention activities, to improve the digital onboarding process of their customers while fighting against financial crime.
About Jo Ann Barefoot
About AIR
AIR is a nonprofit, non-membership organisation working to make the financial system fully inclusive, fair, and resilient through responsible use of new technology. By connecting regulation, finance, technology, and society, AIR drives global innovation and collaboration to overcome the system’s legacy shortcomings and prepare it for rapid technology change.
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