Anti-Money Laundering (AML)

I. Understanding Anti-Money Laundering (AML)

What is Anti-Money Laundering (AML)?

Anti-Money Laundering (AML) refers to the framework of regulations designed to prevent criminals from disguising illegally obtained funds as legitimate income. AML requirements help detect and deter money laundering, terrorist financing, fraud, and other financial crimes that threaten the financial system's integrity.

The foundation of U.S. AML requirements is the Bank Secrecy Act (BSA), enacted in 1970 to establish recordkeeping and reporting requirements for financial institutions, helping law enforcement track potential money laundering activity. Amendments including the USA PATRIOT Act in 2001 and the Anti-Money Laundering Act of 2020 have expanded these requirements, creating the robust AML framework financial institutions follow today.

How does AML relate to KYC and KYB?

AML represents the overarching regulatory framework for preventing financial crimes, while Know Your Customer (KYC) and Know Your Business (KYB) are specific tools within that framework. Think of AML as the comprehensive strategy and KYC/KYB as tactical processes that help achieve AML objectives.

KYC and KYB are components of AML compliance. By verifying customer identities and understanding beneficial ownership of businesses, these processes enable financial institutions to assess money laundering risks and detect suspicious activity. Without effective KYC and KYB procedures, credit providers cannot fulfill their broader AML obligations to prevent their services from being exploited for illicit purposes.

What types of financial institutions must comply with AML?

Banks, credit unions, and other depository institutions face AML obligations. Requirements also extend to non-bank lenders, fintech companies, money services businesses, and others.

Credit card system operators and loan or finance companies, including online and alternative lenders, must maintain AML programs. The scope continues expanding as regulators recognize new categories of financial service providers, including cryptocurrency exchanges and virtual asset service providers.

Who enforces AML requirements?

Operating under the U.S. Department of the Treasury, the Financial Crimes Enforcement Network (FinCEN) is the primary regulator for AML compliance. FinCEN issues regulations, provides guidance, and imposes civil monetary penalties for violations. The agency also receives and analyzes Suspicious Activity Reports and other financial intelligence.

Federal banking regulators including the Office of the Comptroller of the Currency, Federal Reserve, and Federal Deposit Insurance Corporation examine AML programs during routine examinations. The Department of Justice prosecutes criminal violations of money laundering laws. State regulators also enforce AML requirements for state-chartered institutions and money services businesses.

II. Key Requirements and Components

Written AML compliance program requirements

Credit providers must establish and maintain a written AML compliance program, designed to detect and report suspicious activity and ensure BSA compliance. It must be tailored to the institution's specific risk profile, considering customer base, products and services offered, and geographic locations served.

The program must designate an AML compliance officer responsible for coordinating and monitoring day-to-day compliance. Regular updates are necessary to address changing risks, new products or services, and evolving regulatory expectations.

Customer Due Diligence (CDD) and Customer Identification Program (CIP)

AML programs must include Customer Due Diligence procedures to understand the nature and purpose of customer relationships and develop risk profiles. The Customer Identification Program component requires collecting and verifying customer identification information before establishing accounts or relationships.

CDD includes identifying and verifying beneficial owners of legal entity customers, understanding the expected nature of the relationship, and conducting ongoing monitoring appropriate to the customer's risk profile. Enhanced Due Diligence procedures apply to higher-risk customers, requiring additional information and more intensive monitoring.

Suspicious Activity Reporting (SAR)

Financial institutions must file Suspicious Activity Reports with FinCEN when they detect known or suspected violations of federal law or suspicious transactions related to money laundering. SARs must be filed within 30 days, with an additional 30 days if no suspect is identified.

Institutions must identify patterns or transactions that lack business purpose, are inconsistent with customer profiles, or involve unusual circumstances. The SAR filing requirement continues throughout the suspicious activity period, requiring ongoing monitoring even after initial filing.

Transaction monitoring and recordkeeping

AML programs must include systems for monitoring customer transactions to identify suspicious patterns. This includes monitoring for transactions structured to avoid reporting thresholds, unusual wire transfers, rapid movement of funds, or activity inconsistent with the customer's stated business purpose.

Financial institutions must maintain comprehensive records of customer information, transaction data, and compliance activities for five years and make them available to regulators upon request.

Independent testing and auditing

AML programs must include independent testing conducted by qualified internal staff or external auditors. The testing should assess program adequacy, regulatory compliance, and effectiveness of policies and procedures. Testing frequency should be risk-based but occur at least every 12-18 months.

Independent testing identifies weaknesses or deficiencies before they become significant compliance failures. Testing results should be documented and reported to senior management and the board, with remediation plans developed to address identified issues.

III. Compliance and Common Violations

Common AML violations and inadequate practices

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Rather than intentional misconduct, creditors often stumble into AML violations through operational gaps:

• Inadequate compliance programs that fail to address the institution's specific risks, or don't include all required components, leaving gaps in their compliance framework.
• Inadequate customer due diligence procedures that fail to identify customers, assess risks, or conduct sufficient ongoing monitoring to detect changes in customer behavior or risk profiles.
• Failure to file Suspicious Activity Reports due to inadequate monitoring systems, insufficient staff training, or poor procedures.
• Inadequate transaction monitoring systems that don't scale with business growth, lead to backlogs, miss suspicious patterns, or  create excessive false positives.
• Insufficient resources and staffing for compliance, leaving AML programs understaffed, creating backlogs and preventing effective monitoring and investigation of suspicious activity.

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Penalties and enforcement consequences

AML violations carry severe consequences. Federal banking regulators can impose civil monetary penalties ranging from $5,000 to $1 million per violation or 1% of the institution's assets (whichever is greater) for each day a violation occurs. Criminal penalties for money laundering convictions can include fines up to $500,000 and imprisonment up to 20 years.

Beyond monetary penalties, credit providers face consent orders requiring expensive remediation programs, restrictions on business activities, and enhanced regulatory supervision. Executives and compliance officers can face personal liability, including removal from banking and criminal prosecution for willful violations. Reputational damage from publicized AML failures can devastate customer confidence and business relationships.

How lenders can ensure AML compliance

Successful AML compliance requires comprehensive programs with adequate resources. Credit providers should conduct thorough risk assessments identifying specific money laundering and terrorist financing risks based on their customer base, products, services, and geographic locations. Programs must be tailored to address these specific risks rather than relying on generic templates.

Investment in technology and staff is essential. Transaction monitoring systems must be calibrated and resourced to investigate alerts. Regular training ensures staff understand their AML responsibilities and can recognize red flags, and independent testing identifies areas needing improvement.

IV. Bottom line

AML continues to evolve, requiring ongoing attention to changing requirements and sophisticated systems to manage detection, reporting, and monitoring obligations.

LoanPro's platform incorporates AML features that help document compliance activities and maintain detailed transaction records. If you're looking to strengthen your AML program, reach out to us. We'd love to discuss your strategy and what's worked well for our clients.