17 Feb 2020

Transaction Monitoring - What is It and Why Does It Matter?

In the past few years, transaction monitoring has become a vital part of anti-money laundering (AML) procedures. All banks and other financial institutions should have some form of transaction monitoring in place in order to keep an eye out for any suspicious transactions to and from existing customers. This is very difficult to do manually, and as such, many organizations now have an automated system.

In this article, we break down everything you need to know about transaction monitoring including suspicious activity reports and transaction laundering.

What is transaction monitoring?

Transaction monitoring solutions allow financial institutions to monitor the transactions made by their customers in real-time and/or on a daily basis. These solutions not only look at current transactions, but also analyze a customer’s historical information and account profile. From there, an analysis of a customer can be provided, which can include risk levels and predicted future activity.

You’ve probably been on the receiving end of transaction monitoring at some point. Ever receive a phone call from your bank asking you to confirm that you made certain purchases? That’s because your bank has a rough idea of what your normal financial activities are thanks to transaction monitoring. If they spot abnormal behavior, they can get in touch (if, for example, credit card theft is suspected) or report it to the authorities if they believe it to be criminal activity. 

Transaction monitoring is vital to a financial institution’s AML procedures, as it can detect suspicious activities such as large cash deposits or wire transfers. As a result, transaction monitoring can allow organizations to spot financial crimes before they happen or very early on. AML transaction monitoring software can also include sanctions screening and customer profiling features.

The information obtained from transaction monitoring is primarily used to meet various AML and counter-terrorist financing (CTF) requirements, for filing Suspicious Activity Reports (SARs), and other reporting obligations. Financial regulators around the world are starting to make transaction monitoring a regulatory requirement - it was introduced as part of the 4th Money Laundering Directive in Europe a few years ago. 

Why is transaction monitoring important?

First of all, transaction monitoring is an important first step in any financial institution’s AML and CTF procedures. Being able to spot a suspicious transaction could potentially prevent thousands or millions of dollars from being laundered by criminals. No organization wants to be caught up in a money laundering scandal. 

Additionally, having transaction monitoring in place gives regulators and banking partners confidence. It shows that a financial institution takes AML and CTF regulations seriously and is doing all it can to prevent criminal activity. This creates trust between new and/or current partners.

Transaction monitoring also allows financial institutions to take a risk-based approach. This means that they are able to determine and manage the potential risk of clients. A number of factors go into determining the risk level of a customer such as their type of employment, country of residence, et cetera. 

Once a financial institution has determined the risk level of a customer, they can then adjust their monitoring of said customer. For example, a low risk client will not need as much transaction monitoring as a high risk client. Depending on where they are based and which market segment and products they offer, some organizations will need to apply a higher risk approach to all clients.

The Financial Action Task Force (FATF) sets the standards that are tied to AML and CTF procedures and recognizes the following factors as determinants of the proper extent of AML/CTF controls:

  • The diversity of a financial institution’s operations, including where they operate geographically
  • The nature, scale, and complexity of the business
  • The extent to which the financial institution is dealing through intermediaries, third parties or non face-to-face access (if applicable)
  • The distribution channels that are used
  • The volume and size of transactions
  • The degrees of risk that are associated with each area of the financial institution's operation
  • The customer, product, and activity profiles of the financial institution

Which is better - automated or manual?

Across the board, automated transaction monitoring is far superior to manual transaction monitoring. It is incredibly time intensive (and expensive) to try and attempt to create a manual transaction reporting system. Humans also have a much greater capacity to make errors than a designated software will.

However, there is still a manual aspect to automated transaction monitoring in order for it to be truly successful. For example, a monitoring software may flag a suspicious transaction for an employee to look at and determine if it is indeed suspicious. Real people are needed to ensure that software is working as it should be.

False positives can be an issue when using an automated transaction monitoring solution. The software needs to be adaptive enough to follow unique rules for different types of clients. If the rules aren’t accurate, then too many false positives will occur, which can create a backlog of very tedious work for employees.

A financial institution can choose to build their transaction monitoring software in-house or look for a third party solution. If developing a solution in-house, it may be necessary to bring in an expert in compliance and risk to create an efficient program. 

Whatever you choose, there are a couple of things to keep in mind. The flexibility and scalability of a solution is of utmost importance, as the regulations surrounding transaction monitoring are constantly changing. Additionally, it’s important to be able to create an audit trail of all activity to have a clear understanding of what is happening, and to potentially show to the relevant authorities.

What are Suspicious Activity Reports?

Suspicious Activity Reports (SARs) are a key part of the transaction monitoring process. When a suspicious transaction is detected, it is the duty of the financial institution to report it to the authorities. In most countries, suspicious activities are reported via the submission of a SAR, which is sent to the appropriate financial authority. Given their importance in preventing crime, it is crucial that financial institutions understand when and how to file SARs.

A SAR is necessary whenever a financial institution detects a potentially suspect transaction by a client. Once a suspicious activity is detected, the financial institution usually has 30 days to confirm and then submit a SAR. In some cases, such as if more evidence is needed, the period may be extended to 60 days.

The following situations may trigger a SAR:

  • Unusual transactions or account activity
  • Transactions over a certain value
  • Domestic or international money transfers over a certain value
  • Large cash deposits and/or withdrawals

SARs are not limited to customers; they are also required if an organization detects that employees have engaged in suspicious behaviour, or if their computer systems have been compromised in any way.

What is transaction laundering?

Transaction laundering is a newer type of financial crime which can be prevented by adequate transaction monitoring, but we’ll dive into that a little later. Essentially, transaction laundering occurs when a criminal offers something illegal for sale online under the guise of a legitimate and legal product. Criminals are believed to be laundering billions of dollars every year through this method.

Here is an example: Let’s say a criminal has a website selling books. However, the website is really just a coverup as the criminal is actually selling weapons online on a separate website. To make the weapons purchase appear legal, the criminal will route the payment through their seemingly legitimate book selling website. The transaction goes through smoothly, and the laundered funds land into the criminals account, seemingly from a legitimate source.

Until recently, transaction laundering prevention was in the hands of credit card brands themselves, but this has now changed. Financial institutions are now expected to have sufficient transaction monitoring in place to spot transaction laundering, and can face large fines and reputational damage if they don’t.

Spotting transaction laundering can actually be quite easy with transaction monitoring. For example, a suspected site’s products often won’t match with sales projections. Someone who has an independent online bookshop is not going to be making several hundred thousand dollars a year. It’s also common to see sudden spikes in activity in transaction laundering, and the sales volume won’t match the products that are being sold.

Conclusion

Transaction monitoring is a vital part of AML and CTF regulations, and is key for preventing major crimes before they occur. Malicious actors will usually make a couple of “test” transactions to see if their activity flies under the radar, and transaction monitoring, if used effectively, can spot that. 

While it is not legally required worldwide (yet) for financial institutions to have transaction monitoring in place, not having one could land an organization in a lot of trouble. An inherent part of taking a risk-based approach is the continuous monitoring of clients. Failing to have such a system in place can not only cost a financial institution its reputation, but it can also lead to large fines and other penalties. 

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