ML/TF Risk Management: Risk Universe, Risk Tolerance, and Risk Appetite
ML/TF Risk Management: Risk Universe, Risk Tolerance, and Risk Appetite
Taking risks is an important part of business growth, while managing those risks is the backbone of business sustainability. Balancing between risk taking and risk controls is what defines effective risk management. It is the same for Money Laundering/ Terrorism Financing (ML/TF) Risk Management, which is an indispensable component of a Regulated Entity’s Anti-Money Laundering (AML) framework. Â
In this infographic, we have discussed the concepts of Risk Universe, Risk Tolerance, and Risk Appetite in the context of ML/TF Risk Management. Understanding these concepts enables Regulated entities under UAE’s AML regulatory regime to build and implement sound ML/TF Risk Management practices in their organisations and effectively detect, manage, and mitigate financial crime risks.Â
Let us discuss these concepts in detail.Â
Risk Universe
A Risk Universe is the broadest concept out of three we seek to discuss here. It means the full range of Money Laundering (ML), Terrorism Financing (TF), and Proliferation Financing (PF) risks that a Regulated Entity may face during its business operations. These include:
- Foreseeable ML/TF and PF risks, for example, risks assessed during the AML Enterprise-Wide Risk Assessment (EWRA) process
- Unforeseeable ML/TF and PF risks
- Known ML/TF and PF Risks
- Unknown ML/TF and PF Risks
- Inherent Risks, or the Gross ML/TF and PF Risks that exist when no risk control measures are in place
- Residual Risks or the Net ML/TF and PF risks that exist after risk control measures have been out in place
- Any other risk contributing to ML/FT and PF risks.
Risk Tolerance
Risk Tolerance is the outer boundary that defines the extent of a Regulated Entity’s ML/TF and PF risk bearing capacity. It is the boundary beyond which the Regulated Entity is not willing to venture and take risks. Within this boundary, the Regulated Entity can handle the financial crime risks through its AML risk controls in place.
In effect, Risk Tolerance is the absolute limit which a Regulated Entity cannot cross without exposing itself to unmanageable risks, breach of AML obligations, consequential loss of reputation, etc.
Risk Appetite
Risk Appetite is the assessed amount of ML/TF and PF risks that a Regulated Entity is willing to undertake to pursue and fulfil its business objectives. These risks are well within the Regulated Entity’s risk management capabilities. Risk Appetite is an important component of the risk-based approach, allowing Regulated Entities to take informed decisions regarding AML control measures to adopt as per the degree of ML/TF and PF risks it faces.
Since Risk Appetite is the amount of risk that the Regulated Entity accepts to conduct its business operations while remaining compliant with laws and balancing business opportunities, the Risk Appetite should be clearly defined in Regulated Entity’s AML program so that the exercise of AML risk management is in alignment with the Risk Appetite of the Regulated Entity.
Defining Risk Appetite should not be a superficial process. It should be measurable, and quantifiable. It should not be empty statements created in a vacuum and must take into account all relevant data and factors at all levels of the Regulated Entity, including strategic, tactical and operational.
The ML/TF and PF factors that should be considered while drafting the Risk Appetite includes the following:
- Customer Related Risks
- Geographic Risks
- Products/Services/Transactions Related Risks
- Delivery Channel Risks
- Other Risks
Risk Appetite should be aligned with Risk Universe identified during EWRA, ensuring that all ML/TF and PF risks assessed during the EWRA process are adequately addressed in the Risk Appetite.
For instance, during the Customer Risk Assessment, Regulated Entities should assess whether the ML/TF and PF risks associated with a customer fall within the Risk Appetite of the Regulated Entity.
Interlinking factors amongst Risk Universe, Risk Tolerance, and Risk Appetite
Risk Universe, Risk Tolerance, and Risk Appetite are closely linked concepts. Risk Universe is the broadest concept, representing all ML/TF and PF risks to which any Regulated Entity is exposed, Risk Tolerance represents specific risks within the Risk Universe, that the Regulated Entity can manage with its existing AML controls, and Risk Appetite represents that part of Risk Tolerance which represents risks that the Regulated Entity can comfortably absorb, given the reliance on ML/FT and PF risk mitigation measures it has in place to facilitate the Regulated Entity achieve its business goals.
ML/TF and PF risks that fall within Risk Tolerance and Risk Appetite can be managed by the Regulated Entity by implementing adequate qualitative and quantitative AML controls. These controls include Customer Due Diligence, Name Screening, Enhanced Due Diligence, etc, to name a few.
ML/TF Risk Management: Way Forward
Establishing an ML/TF Risk Management culture and adopting effective Risk Management practices helps Regulated Entities take quick and informed decisions regarding challenges and opportunities in an effective manner. However, to be effective, the ML/TF Risk Management strategies should be communicated through the organisational structure of the Regulated Entity. Further, Risk Appetite and Risk Tolerance are temporal concepts and vary over time, therefore these should be regularly revised and updated. Â
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