What are the steps of the risk-based approach?

The steps of the risk-based approach are: Identify the potential risks to your business Determine the intensity level of each Assess the probability of the risk event happening Plan the corrective actions Implement and modify

What are the benefits of risk-based approaches?

The primary benefits of risk-based approaches are: They are proactive and not reactive. That means you prepare for threats before the threats affect your business. You have the flexibility to adapt to the changes You implement action plans suited to the type of risks, which improves the value for businesses

The risk based approach to AML - Anti-Money Laundering Compliance

The risk-based approach (RBA) is basically the realization of control in Anti-
money Laundering management according to the risk appetite of the business enterprises, risk perception, and the risk level of the customers. Every business has its own risk-bearing capacity, and in Anti-money Laundering compliance, it becomes essential to adopt a risk-based approach in order to take calculated moves.

Under a RBA, there is no such thing as ZERO risk.

This article is going to talk about the importance of a risk-based approach in AML compliance. So without wasting much of your time, let us begin.

What is risk-based approach in Anti-Money Laundering (AML)?

The risk-based approach (RBA) helps reporting entities effectively identify, assess and tackle ML/TF/PF risks.

Financial Institutions, Designated Non-Financial Businesses and Professions, and Virtual Asset Service Providers should apply appropriate measures and procedures commensurate with the risks of money laundering, terrorist financing, and proliferation financing.

The risk-based approach enables the reporting entities to apply their efforts optimally to mitigate ML/TF/PF and sanctions risks. The RBA provides the risk-sensitive application of AML/CFT measures. Accordingly, companies are able to apply the principle of “higher the risks, higher the controls”.

The application of the risk-based approach helps firms decide on the degree, frequency, or intensity of the ML/TF/PF/ controls.

Step-by-step implementation of Risk-Based Approach

Identify and assess ML/TF/PF risks
Document policies, procedures, and controls to mitigate the identified risks
Implement policies, procedures, and controls to manage and mitigate the identified risks
Monitor the results and make necessary changes to tackle the ML/TF/PF risks better

Principles of The Risk Based Approach to AML Compliance

Acceptance of the existence of risk is the first thing that actually matters when it comes to the principles of the Risk Based Approach to AML. A risk assessment should be carried out according to the intensity of risk, and the risk assessment process should be examined, and the compliance process should be applied.

Inherent Risk: The gross risk assessed by the reporting entity before putting any AML/CFT controls and measures in place

Residual Risk: The residual risk is the risk the reporting entity assesses once AML/CFT controls and measures are in place.

According to the principles of a risk-based approach, the same process of Know Your Customer (KYC) should not be applied to customers who carry
either a high-risk profile or a medium-risk profile. Hence, it is viable only for customers with negligible or low-risk quotient.

For instance, the Customer Due Diligence (CDD) Process for Politically Exposed People (PEPs), which undoubtedly belongs to a high-risk profile, is insufficient. Therefore, the help of Enhanced Due Diligence or EDD procedures might be required for this.

In addition, business enterprises must continuously monitor, analyze, and interpret their pool of data that falls within the scope of anti-money laundering compliance.

Practically implementing all these compliance policies might seem complicated, but with the help of artificial intelligence-supported anti-money laundering software solutions, the facilitation of AML compatibility is possible.

Importance of Risk-Based Approach in Anti-Money Laundering Compliance

As already touched on earlier, the risk appetite and risk-bearing powers differ from one company to another. Therefore, following the same anti- money laundering process for each enterprise or an individual won't fetch healthy results.

Besides that, the risk-bearing appetite of the companies from the same industry also differs because the anti-money laundering laws and economic structure of the countries are not the same.

Here is when the need and importance of a risk-based approach come into the picture. With the help of a risk-based approach, companies from various countries can create an anti-money laundering program that is universally suitable and effectively minimizes their risk.

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Primary Elements of a Risk-Based Approach in AML Compliance

1- Anti-money Laundering Transaction Monitoring

The money laundering risk rating of the customers should be applied appropriately. Monitoring and restricting transactions are considered essential within the scope of application of money laundering risk rating techniques.

Various types of customers and business enterprises must combine their risk characterization in order to increase the efficiency of monitoring along with restriction measures within their business operating systems.

Considering the big business enterprises mediate multiple transactions in a single day, performing all these controls manually will waste a lot of your time and efforts.

Because of its inefficiencies with manual processing, many businesses prefer to leverage the power of anti-money laundering transaction monitoring tools. Customer transactions are being instantly monitored, and a direct intimation has been sent in case of any doubt.

2- Know Your Customer or Customer Due Diligence (CDD)

Knowing your customer and the customer due diligence process are carried out in order to identify who your customers really are and also to verify their identity and work.

These procedures are one of the most fundamental building blocks of efficient and effective anti-money laundering compliance management.

Within the scope of these procedures, you can determine your first relationship with the customer and afterward take necessary actions in order to mitigate those probable risks.

Assessing the risk level of your customers accurately is an undeniable prerequisite for the risk-based approach. However, without accurate customer due diligence, thoroughly analyzing risk is going to be a challenge.

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3- AML Compliance Officer

The primary role of an anti-money laundering compliance officer in business enterprises is very important.

An AML compliance officer identifies threats related to anti-money
laundering threats and also has the authority to report suspicious cases to the concerned authorities.

Thus, an AML compliance officer is an integral part of the implementation of the risk-based approach.

4- Adverse Media Screening

Any negative news about an individual customer or a business enterprise can broadly impact the decision to work together.

Plus, keeping an eye on such news is the best way to protect your organization from any potential risks that might come into the picture upon dealing with clients with high-risk profiles.

How Does the Risk-Based Approach Work in AML?

An anti-money laundering program incorporates a number of essential measures which are designed to identify individual customers and companies accurately and the business enterprises in which they are involved. In addition to that, a financial institution (FI) must include the following.

Build and develop suitable customer due diligence (CDD) and know your customer (KYC) measures to verify the authenticity and legitimacy of the business they are involved with.

CDD and KYC are the foundational principles of the risk-based approach of anti-money laundering compliance.

More information might be required for people who belong to a high- risk category and might also require enhanced due diligence or EDD.
Screening of new and existing customers against the international and domestic sanctioned lists.
Screening the new and the existing customers against the politically exposed personnel (PEPs) list. When the political status of an individual changes, the risk of money laundering also changes.
Screening the new and the existing customers against the adverse media. This becomes crucial if your customer is subject to negative news or a part of the group that was accused of manipulative activities.
Appoint a dedicated AML compliance officer. An AML compliance officer has sufficient authority to identify any activity directly or indirectly signals to money laundering threats.

Final words

The UAE AML CFT Law requires FIs, DNFBPs, and VASPs to employ a risk-based approach that is tailored to their business. The controls employed by a reporting entity should be in sync with the risks it is exposed to. Money Laundering and Terrorist Financing risks differ from organization to organization and industry to industry. Therefore, DNFBPs need to assess and understand ML/TF risks associated with each customer, supplier, and third party.

The adoption of a risk-based approach does not mean that the organization will be able to eliminate all risks related to financial crime. It only means that ML/TF risks are managed but the organization is still vulnerable to various risks that it couldn’t identify and assess. As risks, by their very nature, are dynamic.

With this, we now understand what social and economic impact money laundering has on the economy of the country and how to overcome or reduce the adverse effects of the same on the economy. For this,AML UAE can help, as an expert, in better implementation of AML/CFT policies in one's organization and contribute towards minimizing the negative socio-economic impact of money laundering activities.

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FAQs - Importance of a Risk-based Approach

Here are a few frequently asked questions when it comes to establishing the importance of a risk-based approach in AML compliance.

A risk-based approach to AML is adopting the AML risk mitigation measures aligned with the risk envisaged by the Company. It helps in the effective utilization of resources, ensuring better controls are implemented for higher-risk aspects while standard controls are in place of normal risk scenarios. This methodology helps the company fight the money laundering and terrorism financing risk most effectively and manage the risk within its risk appetite.

A basic Know Your Customer (KYC) procedure is enough for a low-risk customer. For a medium risk client, the entity must conduct Customer Due Diligence (CDD). If the client is a PEP, terrorist, or features in any government Sanction lists, Enhanced Due Diligence (EDD) becomes essential.

To monitor your transactions, you can apply a risk-based approach to them. For that, entities can create risk-based rules and scenarios to bifurcate transactions into different risk categories. Sudden rise in transactions, transactions with PEPs or Sanctioned individuals, or questionable transaction jurisdiction are some risk scenarios.

The steps of the risk-based approach are:

Identify the potential risks to your business

Determine the intensity level of each
Assess the probability of the risk event happening
Plan the corrective actions
Implement and modify

The primary benefits of risk-based approaches are:

They are proactive and not reactive. That means you prepare for threats before the threats affect your business.
You have the flexibility to adapt to the changes
You implement action plans suited to the type of risks, which improves the value for businesses

Identifying the business operations, dealings with the customers/clients, and monitoring the nature and behavioral traits of your clients gives you a fair idea about whether it is safe to transact or professionally collaborate with a particular client or not.

However, throughout the process, if you experience any unusual activity, you can ask the client or potential client to provide additional information about certain things along with legal documents to support that claim.

If the concerned individual is able to provide all the proof, he or she is out of the woods. But, if they fail to, this is when it gets crystal clear that something unethical or illegal is happening, and you file STRs.

In order to successfully implement the risk-based approach, businesses are required to shift their attention and focus to anti-money laundering management from judgment and post-analysis to proactive management.

With this said, Financial Institutions and DNFBPs should naturally integrate risk control mechanisms and ideas in the development and management of business.

DNFBPs and DPMS are required to build strict and rigid AML compliance principles, enforce the entire process, and unified risk management mechanisms to establish a compliant and sound management culture within the operational and functional areas of the business.

An AML Compliance Officer is basically in charge of personal data compliance requirements, ensuring that the company’s AML policies effectively correspond to internationally acceptable standards.

In addition to that, an AML compliance officer is also responsible for screening & monitoring, prevention of payment frauds, and transaction monitoring for cryptocurrency and fiat.

Besides this, an AML compliance officer is responsible for performing the following functions.

Assisting in the implementation of an AML program within the scope of the organization

Arranging inspections or interrogations from a third-party organization and eliminating all the potential mistakes

Looking after the records of high-risk clients and report all the suspicious activities without wasting any time

Read More – Must Have Skills of An AML Compliance Officer

AML risk assessment allows the entities to understand what are the risks they are exposed to and their probability of occurrence, what is their risk appetite, what would be the impact if the such risk materializes, how they can mitigate such risks, what the effectiveness of the controls deployed to mitigate such risk. The entire risk assessment exercise clears the picture of a company’s vulnerability to money laundering and terrorism financing risk and how effectively it can mitigate it.

The following are the key risk areas to be managed to prevent money laundering:

– Risk associated with the customer (customer being PEP, uncooperative customer, etc.)

– Risk associated with products/services and transactions (high value, products associated with ML/FT typologies, etc.)

– Risk about geographies of business operations as well as customer locations (customers coming from high-risk countries, etc.)

– Delivery channel-related risk (involvement of third parties, etc.)

– Technology-related risk (involvement of virtual assets for payment settlement, etc.)

The following are the critical controls under AML regulations:

– Effective implementation of AML policies, controls, and procedures

– Robust KYC and customer due diligence process

– Appointing AML Compliance Officer to oversee and ensure an effective AML compliance framework

– Adequate staff training on AML issues

– Timely reporting of suspicious activities and transactions

– Independent review of AML framework periodically

– Complete and adequate AML-related documentation

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About the Author

Pathik Shah

FCA, CAMS, CISA, CS, DISA (ICAI), FAFP (ICAI)

Pathik is a Chartered Accountant with more than 22 years of experience in compliance management, Anti-Money Laundering, tax consultancy, risk management, accounting, system audits, IT consultancy, and digital marketing.

He has extensive knowledge of local and international Anti-Money Laundering rules and regulations. He helps companies with end-to-end AML compliance services, from understanding the AML business-specific risk to implementing the robust AML Compliance framework.