Effective sanction screening can curb money laundering

An effective sanction screening process goes a long way in identifying individuals/entities who pose money laundering threats and prevent them from misusing the financial system infrastructure. Globally, failure in the sanction screening area has cost major banks hundreds of millions of dollars, and regulators are pressing ahead with new powers and initiatives.

Post the Financial Action Task Force (FATF), there has been increased regulatory sanctions in India by the regulator for non-compliance with Know Your Customer (KYC) guidelines. According to media reports, as many as 46 banks have been fined for non-compliance with KYC guidelines in the last year alone. So, what does this indicate about the robustness of the sanction screening process in the country?

In India, the financial Institutions are required to screen their customers/entities against the United Nations Security Council (UNSC) list. Similarly, in the US, the Treasury?s Office of Foreign Asset Control (OFAC) has extra jurisdictional powers as it requires even non-US banks to comply with their list wherever US dollar payments are concerned.

A Economist Intelligence Unit study, sponsored by Deloitte Development LLC in 2009, which looked at the sanctions challenge facing the financial services industry and was based on an online survey of 388 executives and managers in the sector, as well as in-depth interviews with experts and corporate leaders, indicates that despite a measure of apparent confidence, financial services executives recognise that there is a lack of awareness in sanctions compliance that needs to be addressed.

It also indicated that more than half of the respondents have seen an increase in the level of time, money, and personnel devoted to supporting the sanctions with more than two-thirds of the respondents indicating increased senior management attention committed to this programme. So, what are some of the common issues that Indian financial institutions must deal with to ensure a strong sanction screening compliance programme?

One of the first and major issues is screening for multiple lists. With financial institutions mandated to comply with the local regulatory requirements as well as their domiciled regulatory requirements, it is becoming increasingly complex, especially for institutions that operate out of multiple jurisdictions. For example, a bank in India with branches in the US and the UK will have to comply with the UNSC, OFAC and Her Majesty?s Treasury (HMT) list, respectively. But OFAC screening becomes mandatory for all transactions in US dollars and many banks in India and outside have realised that, much to their discomfiture, when their customer?s payments were blocked by their US counterparts as beneficiaries of the payments appeared in the OFAC list, but not in the country list from where the transactions originated.

The second area of challenge is the inconsistent method of transliteration of names. This is especially true in the Indian context where partial names, aliases, transliteration, different spellings of names, name reversal, shortened names, etc, are common. The degree of fuzzy logic threshold definition may lead to either increased false positives or missing the name altogether. This leads to a situation where the banks are put in a quandary to decide on increased cost of investigating false positives or non-compliance to regulatory requirements. This issue gets compounded by the incomplete information on the sanctioned entities in the list.

The third area of challenge is technology. With the increase in volume of transactions, it is imperative for the financial institutions to seek the help of IT solutions. But, unfortunately, just implementing an IT solution is not the panacea for this problem and can introduce a host of other difficulties as well. The biggest issue for a software solution is the inherent difficulty of the screening process, i.e., calibrating the fuzzy logic programme and integrating data that may reside in silos.

An effective solution needs to cater to multiple lists with varying degrees of data quality and also incorporate fuzzy logic to catering to these variations. A calibration of the fuzzy logic algorithm is fraught with danger, as a broad parameter definition can lead to inundation of false positives resulting in huge manual efforts.

However, making the logic less vague can lead to a breach which can have legal implications. Due to legacy issues, many Indian financial institutions may have a host of systems with siloed data repository.

A good screening system should be able to integrate multiple data sources with different data formats and content, which can itself be a difficult task.

Interestingly, the same survey indicated that nearly half the respondents do not believe that the solution meets current requirements without the help of substantial manual processes.

One of the prerequisite of an effective sanction screening process is the quality and sufficiency of data. Even though swift messages do incorporate information on the beneficiaries and originator, the jury is still out on how effectively financial institutions are exploiting this facility rather than placing reliance on originating bank for the due diligence compliance on third-party payees.

Finally, all the investment and efforts will not bear fruit if the organisation fails to instill the compliance culture. Technology can be an enabler, but it is only one part of a comprehensive programme. There is no alternative to a team of well-trained sanctions specialist as there is a substantial manual process involved for not only processing the false positives but also monitoring behaviours/patterns that may not be caught by the technology solutions alone. With Indian financial institutions going global, elements of sanction compliance can be centralised or decentralised at regional levels.

However, having a central sanctions unit can ensure adequate resources, staffing and expertise easily in addition to consistency of approach and central oversight. An often unrecognised weakness in compliance is hiring the right staff and adequately training them. With Indian financial institutions going global, they should look at investing in external training to equip the team adequately to cater to various regulatory requirements.

Sanctions screening represents a significant regulatory risk that cannot be wished away, but with attention to the details and robust implementation of comprehensive sanctions programmes, the risks can be mitigated substantially. Sanction compliance programmes can and are costly and there are enough war stories of how they have failed. However, in an era of increased globalisation and regulatory scrutiny, Indian financial institutions will have to learn to live with the uncomfortable fact of life that ?sanctions compliance is no longer an option?.

The author is director at Deloitte Touche Tohmatsu India