The Risk-Based Approach was first proposed by the British regulator, the FCA, in 2000. With this recommendation, the FATF first applied the risk-based approach in 2007, with international organizations such as FATF member countries, Wolsfberg Group, and International Organization of Securities Commissions adopting the risk-based approach principle. Since then, the "risk-based approach" has undoubtedly become one of the most widely used expressions in the field of anti-money laundering. In addition, it is an indispensable tool for effective AML management
So, what is a risk-based approach? In its simplest definition, the risk-based approach is the realization of control in AML management according to the risk perception, appetite of the organizations, and the customers' risk level.
The Importance of Risk-Based Approach
The importance of a risk-based approach cannot be overstated. Each company has a different risk appetite, and their customers' risks are also not the same. Therefore, initiating the same AML control processes for each company and customer will not yield a healthy result. Additionally, institutions serving in the same sector in different countries have different risk appetites due to factors such as economic structures and AML laws. This is why a risk-based approach is needed. With this approach, countries and companies can create an AML control program that is most suitable for them and can minimize their risks more easily and effectively. Furthermore, applying a risk-based approach is not just a good practice but is also necessary as it is mentioned in the recommendations and regulations of local and global AML regulators.
Principles of Risk-Based Approach
In addition to the importance of accepting the existence of risk, the principles of the risk-based approach also include the need for ongoing monitoring and assessment. A one-time risk assessment is not enough; companies need to continuously monitor and assess the risks associated with their customers and transactions. This is important because the risk level of a customer or transaction may change over time.
Moreover, companies must ensure that their AML compliance policies and procedures are proportionate to the risks they face. For instance, the level of due diligence required for a low-risk customer may not be the same as that required for a high-risk customer. Similarly, the level of monitoring required for low-risk transactions may be different from that required for high-risk transactions.
Finally, it's worth noting that the use of AI-supported AML solutions is becoming increasingly common in the industry. These solutions can help companies to streamline their AML compliance processes, reduce the risk of human error, and identify suspicious transactions more effectively.
Main Elements of Risk-Based Approach
The risk-based approach has not been applied and some basic steps must have been taken for the principles to be realized. Some precautions for a risk-based approach are also specified in the recommendations of regulators such as FATF. These measures are as follows;
- Know Your Customer and Customer Due Diligence: KYC procedures help companies to verify the identity of their customers and ensure that they are not involved in any illicit activities. CDD procedures, on the other hand, involve collecting and analyzing information about customers to assess the level of risk associated with them. Proper KYC and CDD procedures are essential to accurately assess the level of risk associated with a customer, which is a fundamental aspect of a "risk-based" approach to AML management. By identifying and analyzing these risks, companies can take necessary actions to prevent money laundering and terrorist financing activities. It is worth noting that these procedures are not one-time events but are ongoing processes that need to be monitored and updated as necessary. Accurate customer due diligence is essential to ensure that the risk assessment is comprehensive and complete. Failing to perform adequate customer due diligence may lead to incomplete or inaccurate risk assessments, which can leave a company exposed to potential money laundering activities.
- AML Transaction Monitoring: The process is crucial in detecting and preventing money laundering activities. It involves applying appropriate risk ratings to clients and monitoring their transactions in real-time. To increase the effectiveness of monitoring or restricting measures, organizations must combine their risk characterizations for certain types of customers. Due to the high volume of transactions processed by large organizations, manual monitoring is inefficient and time-consuming. Therefore, companies prefer to use AML Transaction Monitoring tools to automate the process. By utilizing a risk-based approach, these tools monitor customer transactions in real-time and can issue warnings in case of suspicious activities. This allows organizations to detect potential money laundering activities early on and take necessary action to prevent financial crimes.
- AML Compliance Officers: They play a crucial role in ensuring that their companies are complying with AML regulations and implementing effective AML controls. Their responsibilities include identifying potential money laundering threats, assessing the risks associated with the company's customers and transactions, and implementing appropriate AML policies and procedures. They also monitor the company's AML compliance program and report suspicious activity to relevant authorities. In addition to their primary responsibilities, AML Compliance Officers must stay up-to-date on changes in AML regulations and adapt the company's AML program accordingly. They may also provide training to employees on AML policies and procedures and conduct periodic AML risk assessments. The AML Compliance Officer acts as a liaison between the company and regulatory authorities, ensuring that the company is in compliance with local and global AML regulations. The role of the AML Compliance Officer is particularly important in the implementation of the risk-based approach, as they are responsible for assessing the company's risk appetite and implementing appropriate AML controls to mitigate those risks. They also play a key role in ensuring that the company is effectively monitoring transactions and reporting suspicious activity to relevant authorities.
- Adverse Media Screening: It is an essential part of the risk-based approach and is used to identify potential risks posed by a customer's reputation. It involves screening customers against negative news and media sources, such as criminal records, regulatory enforcement actions, and negative news articles. Adverse media screening is an effective tool to detect potential money laundering activities, as it can reveal links to criminal organizations or PEPs who may pose a higher risk. Adverse media screening is particularly important for financial institutions, which are obligated to comply with regulations and guidelines for AML and CTF. The screening process can be automated, which helps to reduce the risk of human error and improve efficiency. AML compliance officers must ensure that the screening process is effective and up-to-date, as negative news about a customer can change whether a company will continue to work with them. In addition to screening customers, companies should also perform adverse media screening on their business partners, suppliers, and other stakeholders. This will help to identify potential reputational risks and prevent any association with entities that are involved in criminal or unethical activities. Adverse media screening is an integral part of a comprehensive AML compliance program and should be regularly reviewed and updated to ensure its effectiveness.
The risk-based approach has become an essential tool for effective anti-money laundering management. It allows companies to create an AML control program that is most suitable for them and can minimize their risks more easily and effectively. The principles of a risk-based approach include the importance of ongoing monitoring and assessment, ensuring that AML compliance policies and procedures are proportionate to the risks faced, and utilizing AI-supported AML solutions. The main elements of a risk-based approach include Know Your Customer and Customer Due Diligence, AML Transaction Monitoring, AML Compliance Officers, and Adverse Media Screening. Applying a risk-based approach is not just a good practice but is also necessary as it is mentioned in the recommendations and regulations of local and global AML regulators. Companies should continue to implement and refine their risk-based approach to mitigate risks and prevent financial crimes.
