Tackling financial crime: challenges facing UK challenger banks

August 2022  |  FEATURE | BANKING & FINANCE

Financier Worldwide Magazine

August 2022 Issue

From the largest corporates to the smallest companies and enterprises, financial crime is a major concern across the globe – multifaceted, multinational and often invisible criminality that is hard to identify, measure and combat.

In the UK, while the precise scale of financial crime – such as money laundering, fraud and corruption – is unknown, received wisdom is that it runs into tens or hundreds of billions of pounds per year, with the financial services (FS) sector bearing the brunt and London characterised as a ‘laundromat’ for dirty money.

However, despite the extent of such crime, detection and prevention expenditure across the sector appears almost frugal in comparison. According to recent research by DWF, a UK financial institution (FI) spends an average of £374,000 every year on detecting and preventing financial crime.

“Our report indicates that FIs with a revenue of around £10m per year are likely to spend in the region of 1.72 percent on financial crime prevention and deterrence,” says Andrew Jacobs, head of regulatory consulting at DWF. “Larger firms are typically spending less than 1 percent, particularly those with revenue of £50m or greater. As a cross-section of the FS sector, this tells us that proportionately, smaller firms are spending a greater share of their turnover on financial crime preclusion.”

Despite this, a recent review by the Financial Conduct Authority (FCA) – which was preceded and compelled by the 2020 ‘National Risk Assessment (NRA) of money laundering and terrorist financing’ – indicates that smaller FIs, and challenger banks in particular, are especially vulnerable to financial crime.

Challenger banks

Although there is no universally agreed definition of the term ‘challenger banks’, according to the FCA, such banks belong to a sub-sector of retail banks that aim to reduce the market concentration of traditional high street banks through the use of technology and up to date IT systems. Some banks may be more established, although others are smaller recent entrants to the retail banking market, including online-only banks (which already account for 27 percent of the market).

“UK challenger banks offer greater flexibility than their ‘brick and mortar’ counterparts’,” states Ripjar in its ‘FCA review finds weaknesses in UK challenger banks’ AML compliance’ blog. “Research suggests that the value of the challenger bank market will continue to grow rapidly, reaching an estimated global value of $471bn by 2027.

However, the opportunities that challenger banks bring also represent new regulatory challenges, with disruptive services increasing the risk of money laundering and other financial crimes.

Drilling down, the FCA suggests that fraudsters may be attracted to the fast onboarding process that challenger banks advertise, particularly when setting up money mule networks. In addition, where these challenger banks promote the ability to open accounts very quickly to attract customers, there is a risk that information gathered at the account opening stage is insufficient to identify higher risk customers.

All things considered, the FCA has concluded that many UK challenger banks need to improve the way they manage financial crime risk, with a specific focus on the robustness of their AML compliance solutions.

Problems and solutions

Given the obstacles that challenger banks face, many practitioners believe that recourse to technology represents the best solution toward improving AML controls.

While some challenger banks manage their AML obligations by building bespoke risk management solutions, difficulties are often encountered in balancing compliance responsibilities with a focus on delivering technological innovation. Things are further complicated by a changing threat landscape and the emergence of fresh legislation.

That said, according to Ripjar, UK challenger banks have options when it comes to meeting their due diligence and risk assessment obligations. Rather than relying on a potentially-vulnerable and untested bespoke solution, challenger banks may instead draw on the expertise of established, industry-trusted platforms with dedicated customer due diligence (CDD) and enhanced due diligence (EDD) resources, and multifaceted AML and know your customer (KYC) screening tools.

“Built on smart technology, AML compliance solutions enable challenger banks to be proactive about threats, integrating customer data from sources across the world quickly and efficiently, and adapting in real time as the risk landscape changes,” says Ripjar. “AML solutions may include multiple language screening capabilities, helping challenger banks better manage CDD and EDD for international customers without generating unmanageable amounts of false positive alerts.”

Fit for purpose

As if the financial crime landscape was not challenging enough for FIs, since Russia’s invasion of Ukraine in late February 2022, the attention paid to firms’ compliance with AML regulations has increased dramatically.

In light of this escalation, the FCA is keen to make clear that sanctions risk is very much part of FIs’ AML controls and, given the increased focus, challenger banks need to ensure they have effective and consistent systems and controls in place.

“UK challenger banks should keep evaluating their approach to identifying and assessing the financial crime risks they are exposed to,” concludes the FCA. “They need to ensure that they develop their defences against financial crime as their customer base grows or they expand into new business areas, so that their control framework remains fit for purpose.”

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Fraser Tennant