GUIDANCE FOR A RISK-BASED APPROACH THE BANKING SECTOR

Transcription

1 GUIDANCE FOR A RISK-BASED APPROACH THE BANKING SECTOR OCTOBER 2014

2 FINANCIAL ACTION TASK FORCE The Financial Action Task Force (FATF) is an independent inter-governmental body that develops and promotes policies to protect the global financial system against money laundering, terrorist financing and the financing of proliferation of weapons of mass destruction. The FATF Recommendations are recognised as the global anti-money laundering (AML) and counter-terrorist financing (CFT) standard. For more information about the FATF, please visit the website: FATF/OECD. All rights reserved. No reproduction or translation of this publication may be made without prior written permission. Applications for such permission, for all or part of this publication, should be made to the FATF Secretariat, 2 rue André Pascal Paris Cedex 16, France (fax: or contact@fatf-gafi.org).

3 TABLE OF CONTENTS TABLE OF ACRONYMS... 2 INTRODUCTION... 3 A. BACKGROUND AND CONTEXT... 3 B. PURPOSE OF THIS GUIDANCE... 4 C. TARGET AUDIENCE, STATUS AND CONTENT OF THE GUIDANCE... 4 SECTION I THE FATF S RISK-BASED APPROACH (RBA) TO AML/CFT... 6 A. WHAT IS THE RBA?... 6 B. THE RATIONALE FOR A NEW APPROACH... 6 C. APPLICATION OF THE RISK-BASED APPROACH... 7 D. CHALLENGES... 8 SECTION II GUIDANCE FOR SUPERVISORS A. THE RISK-BASED APPROACH TO SUPERVISION B. SUPERVISION OF THE RISK-BASED APPROACH SECTION III GUIDANCE FOR BANKS A. RISK ASSESSMENT B. RISK MITIGATION C. INTERNAL CONTROLS, GOVERNANCE AND MONITORING ANNEX 1 - EXAMPLES OF COUNTRIES SUPERVISORY PRACTICES FOR THE IMPLEMENTATION OF THE RISK-BASED APPROACH TO THE BANKING SECTOR ANNEX 2 - BASEL CORE PRINCIPLES DESIGNATED BY THE FATF AS BEING RELEVANT TO AML/CFT SUPERVISION (R. 26) BIBLIOGRAPHY

4 TABLE OF ACRONYMS AML/CFT Anti-Money Laundering / Countering the Financing of Terrorism BCBS Basel Committee on Banking Supervision BCP Basel Core Principle CDD Customer Due Diligence DNFBP Designated Non-Financial Business and Profession FIU Financial Intelligence Unit INR [] Interpretive Note to Recommendation [] ML Money Laundering PEP Politically Exposed Person RBA Risk-based approach R. [] Recommendation [] TF Terrorist Financing

5 RISK-BASED APPROACH GUIDANCE FOR THE BANKING SECTOR This guidance paper should be read in conjunction with: the FATF Recommendations, especially Recommendations 1 and 26 (R. 1, R. 26) and their Interpretive Notes (INR), and the Glossary. other relevant FATF documents, such as the FATF Guidance on National Money Laundering and Terrorist Financing Risk Assessment, the FATF Guidance on Politically Exposed Persons, or the FATF Guidance on AML/CFT and Financial Inclusion. INTRODUCTION A. BACKGROUND AND CONTEXT 1. The risk-based approach (RBA) is central to the effective implementation of the revised FATF International Standards on Combating Money Laundering and the Financing of Terrorism and Proliferation, which were adopted in The FATF has reviewed its 2007 RBA guidance for the financial sector, in order to bring it in line with the new FATF requirements 2 and to reflect the experience gained by public authorities and the private sector over the years in applying the RBA. This revised version focuses on the banking sector 3, and a separate guidance will be developed for the securities sector. The FATF will also review its other RBA guidance papers, all based on the 2003 Recommendations The RBA guidance for the banking sector was drafted by a group of FATF members, co-led by the UK and Mexico 5. Representatives of the private sector were associated to the work 6 and consulted on the draft revised document 7. 1 FATF (2012) 2 The FATF Standards are comprised of the FATF Recommendations, their Interpretive Notes and applicable definitions from the Glossary. 3 Banking activities are activities or operations described in the FATF Glossary under Financial institutions, in particular 1., 2. and 5. The present guidance is intended for institutions providing these services. 4 Between June 2007 and October 2009, the FATF adopted a set of guidance papers on the application of the RBA for different business sectors: financial sector, real estate agents, accountants, trust and company service providers (TCSPs), dealers in precious metals and stones, casinos, legal professionals, money services businesses (MSBs) and the life insurance sector ( 5 The FATF Project group was composed of representatives from FATF members (Argentina; Australia; Austria; Belgium; Brazil; China; France; Germany; Hong Kong, China; India; Italy; Japan; Mexico; Spain; Switzerland; the Netherlands; the UK; the US), Associate members (Asia/Pacific Group on Money Laundering (APG) - through Bangladesh and Thailand and MONEYVAL - through Poland) and Observers (Basel Committee on Banking Supervision (BCBS), Organization for Security and Co-operation in Europe (OSCE), International Organisation of Securities Commissions (IOSCO), International Association of

6 3. The FATF adopted this updated RBA Guidance for the banking sector at its October 2014 Plenary. B. PURPOSE OF THIS GUIDANCE 4. The purpose of this Guidance is to: Outline the principles involved in applying a risk-based approach to AML/CFT; Assist countries, competent authorities and banks in the design and implementation of a risk-based approach to AML/CFT by providing general guidelines and examples of current practice; Support the effective implementation and supervision of national AML/CFT measures, by focusing on risks and on mitigation measures; and Above all, support the development of a common understanding of what the risk-based approach to AML/CFT entails. C. TARGET AUDIENCE, STATUS AND CONTENT OF THE GUIDANCE 5. This Guidance addresses countries and their competent authorities, including banking supervisors. It also addresses practitioners in the banking sector. 6. It consists of three sections. Section I sets out the key elements of the risk-based approach and needs to be read in conjunction with Sections II and III, which provide specific guidance on the effective implementation of a RBA to banking supervisors (Section II) and banks (Section III). 7. This Guidance recognises that an effective RBA will build on, and reflect, a country s legal and regulatory approach, the nature, diversity and maturity of its banking sector and its risk profile. It sets out what countries should consider when designing and implementing a RBA; but it does not override the purview of national competent authorities. When considering the general principles outlined in the Guidance, national authorities will have to take into consideration their national context, including the supervisory approach and legal framework. Insurance Supervisors (IAIS), Group of International Finance Centre Supervisors (GIFCS), International Monetary Fund (IMF) and World Bank). 6 Amex, the Association of Development Financing Institutions in Asia and the Pacific (ADFIAP), the European Association of Co-operative Banks (EACB), the European Association of Public Banks (EAPB), the European Banking Federation (EBF), the European Banking Industry Committee (EBIC), the Latin American Banking Federation (FELABAN), the International Banking Federation (IBFed), SWIFT, the Banking Association of South Africa, the Wolfsberg Group, the Union of Arab Banks (UAB), the World Council of Credit Unions (WOCCU) and the World Savings Banks Institute/European Savings Banks Group (WSBI/ESBG) appointed representatives to the Project Group. 7 Comments were received from the Banking Association of South Africa, EBF, EBIC, EAPB, EACB, FELABAN, WOCCU, WSBI/ESBG, as well as from the International Council of Securities Association, the International Association of Money Transfer Networks, the International Consortium of Real Estate Associations, and the Russian e-money Association

7 8. This guidance paper is non-binding. It draws on the experiences of countries and of the private sector and may assist competent authorities and financial institutions to effectively implement some of the Recommendations

8 SECTION I THE FATF S RISK-BASED APPROACH (RBA) TO AML/CFT A. WHAT IS THE RBA? 9. A RBA to AML/CFT means that countries, competent authorities and financial institutions 8, are expected to identify, assess and understand the ML/TF risks to which they are exposed and take AML/CFT measures commensurate to those risks in order to mitigate them effectively. 10. When assessing ML/TF risk 9, countries, competent authorities, and financial institutions should analyse and seek to understand how the ML/TF risks they identify affect them; the risk assessment therefore provides the basis for the risk-sensitive application of AML/CFT measures 10. The RBA is not a zero failure approach; there may be occasions where an institution has taken all reasonable measures to identify and mitigate AML/CFT risks, but it is still used for ML or TF purposes. 11. A RBA does not exempt countries, competent authorities and financial institutions from mitigating ML/TF risks where these risks are assessed as low 11. B. THE RATIONALE FOR A NEW APPROACH 12. In 2012, the FATF updated its Recommendations to strengthen global safeguards and to further protect the integrity of the financial system by providing governments with stronger tools to take action against financial crime. 13. One of the most important changes was the increased emphasis on the RBA to AML/CFT, especially in relation to preventive measures and supervision. Whereas the 2003 Recommendations provided for the application of a RBA in some areas, the 2012 Recommendations consider the RBA to be an essential foundation of a country s AML/CFT framework. 12 This is an over-arching requirement applicable to all relevant FATF Recommendations. 14. According to the Introduction to the 40 Recommendations, the RBA allows countries, within the framework of the FATF requirements, to adopt a more flexible set of measures in order to target their resources more effectively and apply preventive measures that are commensurate to the nature of risks, in order to focus their efforts in the most effective way. 8 Including both physical and natural persons, see definition of Financial institutions in the FATF Glossary. 9 FATF (2013a), par FATF (2013a), par. 10. See also Section I D for further detail on identifying and assessing ML/TF risk. 11 Where the ML/TF risks have been assessed as low, INR 1 allows countries not to apply some of the FATF Recommendations, while INR 10 allows the application of Simplified Due Diligence measures to take into account the nature of the lower risk see INR 1 para 6, 11 and 12 and INR 10 para 16 and R

9 15. The application of a RBA is therefore not optional, but a prerequisite for the effective implementation of the FATF Standards 13. C. APPLICATION OF THE RISK-BASED APPROACH 16. Recommendation 1 sets out the scope of the application of the RBA. It applies in relation to: Who and what should be subject to a country s AML/CFT regime: in addition to the sectors and activities already included in the scope of the FATF Recommendations 14, countries should extend their regime to additional institutions, sectors or activities if they pose a higher risk of ML/TF. Countries could also consider exempting certain institutions, sectors or activities from some AML/CFT obligations where specified conditions are met, such as an assessment that the ML/TF risks associated with those sectors or activities are low 15. How those subject to the AML/CFT regime should be supervised for compliance with this regime: AML/CFT supervisors should consider a bank s own risk assessment and mitigation, and acknowledge the degree of discretion allowed under the national RBA, while INR 26 further requires supervisors to themselves adopt a RBA to AML/CFT supervision; and How those subject to the AML/CFT regime should comply: where the ML/TF risk associated with a situation is higher, competent authorities and banks have to take enhanced measures to mitigate the higher risk. This means that the range, degree, frequency or intensity of controls conducted will be stronger. Conversely, where the ML/TF risk is lower, standard AML/CFT measures may be reduced, which means that each of the required measures has to be applied, but the degree, frequency or the intensity of the controls conducted will be lighter The effectiveness of risk-based prevention and mitigation measures will be assessed as part of the mutual evaluation of the national AML/CFT regime. The effectiveness assessment will measure the extent to which a country achieves a defined set of outcomes that are central to a robust AML/CFT system and will analyse the extent to which a country s legal and institutional framework is producing the expected results. Assessors will need to take the risks, and the flexibility allowed by the RBA, into account when determining whether there are deficiencies in a country s AML/CFT measures, and their importance - FATF(2013b). 14 See FATF (2012) Glossary, definitions of Financial institutions and Designated non-financial businesses and professions. 15 INR 1, paragraph R. 10; INR 10, footnote

10 D. CHALLENGES 17. Implementing a RBA can present a number of challenges: ALLOCATING RESPONSIBILITY UNDER A RBA 18. An effective risk-based regime builds on, and reflects, a country s legal and regulatory approach, the nature, diversity and maturity of its financial sector, and its risk profile. Banks identification and assessment of their own ML/TF risk should consider national risk assessments in line with Recommendation 1, and take account of the national legal and regulatory framework, including any areas of prescribed significant risk and any mitigation measures defined at legal or regulatory level. Where ML/TF risks are higher, banks should always apply enhanced due diligence, although national law or regulation might not prescribe exactly how these higher risks are to be mitigated (e.g., varying the degree of enhanced ongoing monitoring) Banks may be granted flexibility in deciding on the most effective way to address other risks, including those identified in the national risk assessment or by the banks themselves. The banks strategy to mitigate these risks has to take into account the applicable national legal, regulatory and supervisory frameworks. When deciding the extent to which banks are able to decide how to mitigate risk, countries should consider, inter alia, their banking sector s ability to effectively identify and manage ML/TF risks as well as their supervisors expertise and resources, which should be sufficient to adequately supervise how banks manage ML/TF risks and take measures to address any failure by banks to do so. Countries may also take into account evidence from competent authorities regarding the level of compliance in the banking sector, and the sector s approach to dealing with ML/TF risk. Countries whose financial services sectors are emerging or whose legal, regulatory and supervisory frameworks are still developing, may determine that banks are not equipped to effectively identify and manage ML/TF risk and any flexibility allowed under the riskbased approach should therefore be limited. In such cases, a more prescriptive implementation of the AML/CFT requirements may be appropriate until the sector s understanding and experience is strengthened Institutions should not be exempted from AML/CFT supervision even where their capacity and compliance is good. However, the RBA may allow competent authorities to focus more supervisory resource on higher risk institutions. IDENTIFYING ML/TF RISK 21. Access to accurate, timely and objective information about ML/TF risks is a prerequisite for an effective RBA. INR 1.3 requires countries to have mechanisms to provide appropriate information on the results of the risk assessments to all relevant competent authorities, financial institutions and other interested parties. Where information is not readily available, for example where competent authorities have inadequate data to assess risks, are unable to share important information (i.e. due to its sensitivity) on ML/TF risks and threats, or where access to information is 17 R This could be based on a combination of elements described in Section II, as well as objective criteria such as mutual evaluation reports, follow-up reports or FSAP

11 restricted by, for example, censorship or data protection provisions, it will be difficult for banks to correctly identify (i.e., find and list) ML/TF risk and therefore may fail to assess and mitigate it appropriately. ASSESSING ML/TF RISK 22. Assessing ML/TF risk means that countries, competent authorities and banks have to determine how the ML/TF threats identified will affect them. They should analyse the information obtained to understand the likelihood of these risks occurring, and the impact that these would have, on the individual banks, the banking sector and possibly on the national economy for large scale, systemic financial institutions, if they did occur 19. As a result of a risk assessment, ML/TF risks are often classified as low, medium and high, with possible combinations between the different categories (medium-high; low-medium, etc.). This classification is meant to assist understanding ML/TF risks and to help prioritise them. Assessing ML/TF risk therefore goes beyond the mere collection of quantitative and qualitative information: it forms the basis for effective ML/TF risk mitigation and should be kept up-to-date to remain relevant. 23. Assessing and understanding risks means that competent authorities and banks should have skilled and trusted personnel, recruited through fit and proper tests, where appropriate. This also requires them to be technically equipped to carry out this work, which should be commensurate with the complexity of the bank s operations. MITIGATING ML/TF RISK 24. The FATF Recommendations require that, when applying a RBA, banks, countries and competent authorities decide on the most appropriate and effective way to mitigate the ML/TF risk they have identified. This implies that they should take enhanced measures to manage and mitigate situations in which the ML/TF risk is higher; and that, correspondingly, in low risk situations, exemptions or simplified measures may be applied 20 : Countries looking to exempt certain institutions, sectors or activities from some of their AML/CTF obligations should assess the ML/TF risk associated with these financial institutions, activities or designated non-financial businesses and professions (DNFBPs) and be able to demonstrate that the risk is low, and that the specific conditions required for one of the exemptions of INR 1.6 are met. The complexity of the risk assessment will depend on the type of institution, sector or activity, product or services offered and the geographic scope of the activities that stands to benefit from the exemption. Countries and banks looking to apply simplified measures should conduct an assessment of the risks connected to the category of customers or products targeted and establish the lower level of the risks involved, and 19 Banks are not necessarily required to perform probability calculations, which may not be meaningful given the unknown volumes of illicit transactions. 20 Subject to the national legal framework providing for Simplified Due Diligence

12 define the extent and the intensity of the required AML/CFT measures. Specific Recommendations set out in more detail how this general principle applies to particular requirements 21. DEVELOPING A COMMON UNDERSTANDING OF THE RBA 25. The effectiveness of a RBA depends on a common understanding by competent authorities and banks of what the RBA entails, how it should be applied and how ML/TF risks should be addressed. In addition to a legal and regulatory framework that spells out the degree of discretion, banks have to deal with the risks they identify, and it is important that competent authorities and supervisors in particular issue guidance to banks on how they expect them to meet their legal and regulatory AML/CFT obligations in a risk-sensitive way. Supporting ongoing and effective communication between competent authorities and banks is an essential prerequisite for the successful implementation of a RBA. 26. It is important that competent authorities acknowledge that in a risk-based regime, not all banks will adopt identical AML/CFT controls and that a single isolated incident of insignificant, crystallised risk may not necessarily invalidate the integrity of a bank s AML/CFT controls. On the other hand, banks should understand that a flexible RBA does not exempt them from applying effective AML/CFT controls. 27. Countries and competent authorities should take account of the need for effective supervision of all entities covered by AML/CFT requirements. This will support a level playing field between all banking service providers and avoid that higher risk activities shift to institutions with insufficient or inadequate supervision. FINANCIAL INCLUSION 28. Being financially excluded does not automatically equate to low or lower ML/TF risk; rather it is one factor in a holistic assessment. Financial exclusion can affect both individuals and businesses, and have many reasons. For individuals, this can include a poor credit rating or a customer s criminal background and institutions should not, therefore, apply simplified due diligence measures or exemptions solely on the basis that the customer is financially excluded. 29. A RBA may help foster financial inclusion, especially in the case of low-income individuals who experience difficulties in accessing the regulated financial system. When applying a RBA, countries may therefore establish specific cases for exemptions in the application of FATF Recommendations (based on proven low risks) 22, or allow financial institutions to be more flexible 21 For example, R. 10 on Customer Due Diligence. 22 As a general rule, CDD measures including the prohibition for financial institutions to keep anonymous accounts or accounts in obviously fictitious names, have to apply in all cases. Nevertheless, paragraphs 2 and 6 of INR 1 provide that: Countries may also, in strictly limited circumstances and where there is a proven low risk of ML/TF, decide not to apply certain Recommendations to a particular type of financial institution or activity, or DNFBP and Countries may decide not to apply some of the FATF Recommendations requiring financial institutions or DNFBPs to take certain actions, provided: (a) there is a proven low risk of ML and TF; this occurs in strictly limited and justified circumstances; and it relates to a particular type of financial institution or activity, or DNFBP (para.6). This exemption has been implemented by different countries in the interest of financial inclusion policies. See also paragraphs

13 in their application of CDD measures in case of lower ML/TF risks. In this context, financial inclusion will contribute to greater transparency and traceability of financial flows. and 57 of the FATF Guidance on Anti-Money Laundering and Terrorist Financing Measures and Financial Inclusion on the main challenges for countries seeking to make use of the proven low risk exemption

14 SECTION II GUIDANCE FOR SUPERVISORS 30. The RBA to AML/CFT aims to develop prevention or mitigation measures which are commensurate to the ML/TF risks identified. In the case of supervision, this applies to the way supervisory authorities allocate their resources. It also applies to supervisors discharging their functions in a way that is conducive to the application of a risk-based approach by banks. A. THE RISK-BASED APPROACH TO SUPERVISION 31. Recommendation 26 requires countries to subject banks to adequate AML/CFT regulation and supervision. INR 26 requires supervisors to allocate supervisory resources to areas of higher ML/TF risk, on the basis that supervisors understand the ML/TF risk in their country and have onsite and off-site access to all information relevant to determining a bank s risk profile. Box 1. Additional sources of information Report by the European Supervisory Authorities In October 2013, the European Supervisory Authorities (European Insurance and Occupational Pensions Authority (EIOPA) for insurance and occupational pensions, European Banking Association (EBA) for banking and European Securities and Markets Authority (ESMA) for securities) published a Preliminary report on anti-money laundering and counter financing of terrorism risk-based supervision. This report builds on the FATF Standards and sets out what the RBA to AML/CFT supervision entails. It also lists a series of self-assessment questions supervisors may ask themselves when reviewing their approach. BCBS Guidelines In January 2014, the Basel Committee on Banking Supervision (BCBS) published a set of guidelines to describe how banks should include the management of risks related to money laundering and financing of terrorism within their overall risk management framework, Sound management of risks related to money laundering and financing of terrorism. These guidelines are intended to support the implementation of the International Standards on Combating Money Laundering and the Financing of Terrorism and Proliferation issued by the FATF in In no way should they be interpreted as modifying the FATF standards, either by strengthening or weakening them 1. The FATF s present Guidance provides a general framework for the application of the RBA, by supervisors and the banking sector. More detailed guidelines on the implementation of the RBA by supervisors can be found in the BCBS document. 1. BCBS (2014a), par

15 UNDERSTANDING ML/TF RISK 32. Supervisors should understand the ML/TF risks to which the banking sector is exposed 23, and the ML/TF risks associated with individual banks and banking groups. Supervisors should draw on a variety of sources to identify and assess ML/TF risks. 33. For sectoral risks, these are likely to include, but will not be limited to, the jurisdiction s national risk assessments, domestic or international typologies and supervisory expertise, as well as Financial Intelligence Unit (FIU) feedback. 34. For individual banks, supervisors should take into account the level of inherent risk including the nature and complexity of the bank s products and services, their size, business model, corporate governance arrangements, financial and accounting information, delivery channels, customer profiles, geographic location and countries of operation. Supervisors should also look at the controls in place, including the quality of the risk management policy, the functioning of the internal oversight functions etc. 35. Some of this information can be obtained through prudential supervision. Other information, which may be relevant in the AML/CFT context, includes the fit and properness of the management and the compliance function 24. This involves information-sharing and collaboration between prudential and AML/CFT supervisors, especially when the responsibilities belong to two separate agencies. 36. Information from the bank s other stakeholders such as other supervisors, the FIU and law enforcement agencies may also be helpful in determining the extent to which a bank is able to effectively manage the ML/TF risk to which it is exposed. 37. Supervisors should review their assessment of both the sector s and banks ML/TF risk profile periodically and in any case when a bank s circumstances change or relevant new threats emerge. Examples of different ways banking supervisors assess ML/TF risk in the banking sector and in individual banks can be found in Annex 1. MITIGATING ML/TF RISK 38. The FATF Recommendations 25 require supervisors to allocate more supervisory resources to areas of higher ML/TF risk. This means that supervisors should determine the frequency and intensity of periodic assessments based on the level of ML/TF risk to which the sector and individual banks are exposed. It also means that where detailed supervision of all banks for AML/CFT purposes is not feasible, supervisors should give priority to the areas of higher risk, either in the individual banks or to banks operating in a particular sector. 23 Consistent with Basel Core Principle (BCP) 8 (BCBS, 2011). 24 As specified in BCP In line with BCP

16 39. Examples of ways in which supervisors can adjust their approach include: a) Adjusting the intensity of checks required to perform their authorisation function: supervisors can adjust the level of information they require when working to prevent criminals or their associates from holding a significant or controlling interest in a bank. For example, where the ML/TF risk associated with the sector is low, the opportunities for ML/TF associated with a particular business activity may be limited and thus supervisors may decide to base their approval decisions on a review of relevant documentation. Where the ML/TF risk associated with the sector is high, supervisors may ask for additional information. b) Adjusting the type of AML/CFT supervision: supervisors should always have both on-site and off-site access to all relevant risk and compliance information. However, to the extent permitted by their regime, supervisors can determine the correct mix of on-site and off-site supervision of banks. Off-site supervision alone may not be appropriate in higher risk situations. c) Adjusting the frequency and nature of ongoing AML/CFT supervision: supervisors should adjust the frequency of AML/CFT supervision in line with the risks identified and combine periodic reviews and ad hoc AML/CFT supervision as issues emerge, e.g., as a result of whistleblowing, information from law enforcement, or other supervisory findings resulting from, for example, general prudential supervision or a bank s inclusion in thematic review samples. Examples of different ways banking supervisors adjust the frequency of ML/TF supervision in line with the risks identified can be found in Annex 1. d) Adjusting the intensity of AML/CFT supervision: supervisors should decide on the appropriate scope or level of assessment in line with the risks identified 26, with the aim of assessing the adequacy of banks policies and procedures that are designed to prevent them from being abused 27. Examples of more intensive supervision could include: detailed testing of systems and files to verify the implementation and adequacy of the bank s risk assessment, CDD, reporting and record keeping policies and processes, internal auditing, interviews with operational staff, senior management and the Board of directors and AML/CFT assessment in particular lines of business. Examples of different ways banking supervisors adjust the intensity of ML/TF supervision in line with the risks identified can be found in Annex Supervisors should use their findings to review and update their ML/TF risk assessments and, where necessary, consider whether their approach to AML/CFT supervision and their AML/CFT rules and guidance remain adequate. Whenever appropriate, and in compliance with 26 BCP 11 considers early intervention to correct problems. 27 In line with BCP

17 relevant confidentiality requirements, these findings should be communicated to banks to enable them to enhance their RBA. 41. In line with Recommendation 26 and the application of the Basel Core Principles relevant for AML/CFT 28, banking supervisors should consider the results of other prudential or financial supervision in their AML/CFT supervisory activities. Similarly, they should check that the broader prudential findings that drive the overall supervisory strategies of banks are informed by, and adequately address, the findings of the AML/CFT supervisory programme. B. SUPERVISION OF THE RISK-BASED APPROACH GENERAL APPROACH 42. It is important that supervisors discharge their functions in a way that is conducive to banks' adoption of a risk-based approach. This means that supervisors have to take steps to check that their staff are equipped to assess whether a bank s policies, procedures and controls are appropriate in view of the risks identified through the risk assessment, and its risk appetite 29. Supervisors should make sure that the bank adheres to its own policies, procedures and controls, and that decisions are made using sound judgment. It also implies that supervisors articulate and communicate clearly their expectations of the measures needed for banks to comply with the applicable legal and regulatory framework. The aim is that supervisory actions are in most cases predictable, consistent and proportionate and to this end, training of supervisory staff and the effective communication of expectations to banks are key. 43. To support supervisors understanding of the overall strength of measures in the banking sector, carrying out comparisons between banks AML/CFT programmes could be considered as a means to inform their judgment of the quality of an individual bank s controls. Supervisors should, however, note that under the RBA, there may be valid reasons why banks controls differ: supervisors should be equipped to evaluate the merits of these differences, especially when comparing banks with differing levels of operational complexity. 44. Supervisors should understand the ML/TF risks faced by the sector and by the banks. They should, in particular, have a thorough understanding of higher and lower risk lines of business, leading to a sound judgment about the proportionality and adequacy of AML/CFT controls. Supervisors should engage in a dialogue with individual banks about their views on AML/CFT controls set up by that institution. 45. The general principles outlined above in relation to domestic banks and domestic banking groups also apply to international banking groups. The application is, however, more complex as it involves legal frameworks and risks of more than one jurisdiction and also supervision by more 28 Basel Committee on Banking Supervision (BCBS) Principles 1-3, 5-9, 11-15, 26, and 29, see Annex See also Financial Stability Board (2014)

18 than one national supervisory body 30. The BCBS s Sound management of risks related to money laundering and financing of terrorism contains more information. 31 TRAINING 46. INR 26 provides that supervisory staff in charge of the supervision of banks in their implementation of a risk-based approach should understand the degree of discretion a bank has in assessing and mitigating its ML/TF risks. In particular, supervisors should check that staff have been trained to assess the quality of a bank s ML/TF risk assessments and to consider the adequacy, proportionality and effectiveness of the bank s AML/CFT policies, procedures and internal controls in light of this risk assessment. 47. Training should allow supervisory staff to form sound judgments about the adequacy and proportionality of a bank s AML/CFT controls. It should also aim at achieving consistency in the supervisory approach conducted at national level, in case of multiple competent supervisory authorities or because of the national supervisory model. GUIDANCE 48. Supervisors should communicate their expectations of banks compliance with their legal and regulatory obligations 32, after considering engaging in a consultative process with relevant stakeholders. This guidance may be in the form of high-level requirements based on desired outcomes, risk-based rules, information about how supervisors interpret relevant legislation or regulation, or more detailed guidance about how particular AML/CFT controls are best applied. Supervisors should also consider issuing guidance to banks on how to comply with their legal and regulatory AML/CFT obligations in a way that fosters financial inclusion. 49. Where supervisors guidance remains high-level and principles-based, guidance written by industry sectors on how to meet the legal and regulatory obligations may be useful for explanatory and operational purposes. Banks should note, however, that the private sector guidance they take into consideration should be consistent with national legislation, based on international standards, and guidelines issued by competent authorities. Examples of different approaches to banking supervisory guidance can be found in Annex Supervisors should consider liaising with other relevant domestic regulatory and supervisory authorities to secure a coherent interpretation of the legal obligations and to minimise disparities. This is particularly important where more than one supervisor is responsible for supervision (for example, where the prudential supervisor and the AML/CFT supervisors are in different agencies, or in separate divisions of the same agency). Multiple guidance should not create opportunities for regulatory arbitrage, loopholes or unnecessary confusion among banks. When possible, relevant regulatory and supervisory authorities should consider preparing joint guidance. 30 General supervisory standard set out in BCPs 12 and Part IV. See also BCBS (2010b), and BCBS (2014a) (Consultative document) on collaboration and exchanges of information between home and host supervisors. 32 R

19 SECTION III GUIDANCE FOR BANKS 51. The RBA to AML/CFT aims to support the development of prevention and mitigation measures that are commensurate to the ML/TF risks identified. In the case of banks, this applies to the way banks allocate their compliance resources, organise their internal controls and internal structures, and implement policies and procedures to deter and detect ML/TF, including, where relevant, at group level. 52. Banking encompasses a wide range of financial products and services, which are associated with different ML/TF risks. These include, but are not limited to: Retail banking, where banks offer products and services directly to personal and business customers (including legal arrangements), such as current accounts, loans (including mortgages) and savings products; Corporate and investment banking, where banks provide corporate finance and corporate banking products and investment services to corporations, governments and institutions; Investment services (or wealth management), where banks provide products and services to manage their customers wealth (sometimes referred to as private banking); and Correspondent services, where banking services are provided by one bank (the correspondent bank ) to another bank (the respondent bank ) Banks should be mindful of those differences when assessing and mitigating the ML/TF risk to which they are exposed. A. RISK ASSESSMENT 54. The risk assessment forms the basis of a bank s RBA. It should enable the bank to understand how, and to what extent, it is vulnerable to ML/TF. It will often result in a stylised categorisation of risk, which will help banks determine the level of AML/CFT resources necessary to mitigate that risk. It should always be properly documented, maintained and communicated to relevant personnel within the bank. 55. A bank s risk assessment need not be complex, but should be commensurate with the nature and size of the bank s business. For smaller or less complex banks, (for example where the bank s customers fall into similar categories and/or where the range of products and services the bank offers are very limited), a simple risk assessment might suffice. Conversely, where the bank s products and services are more complex, where there are multiple subsidiaries or branches offering a wide variety of products, and/or their customer base is more diverse, a more sophisticated risk assessment process will be required. 33 See FATF Glossary (FATF, 2012)

20 56. In identifying and assessing the ML/TF risk to which they are exposed, banks should consider a range of factors which may include: The nature, scale, diversity and complexity of their business; Their target markets; The number of customers already identified as high risk; The jurisdictions the bank is exposed to, either through its own activities or the activities of customers, especially jurisdictions with relatively higher levels of corruption or organised crime, and/or deficient AML/CFT controls and listed by FATF; The distribution channels, including the extent to which the bank deals directly with the customer or the extent to which it relies (or is allowed to rely on) third parties to conduct CDD and the use of technology; The internal audit and regulatory findings; The volume and size of its transactions, considering the usual activity of the bank and the profile of its customers Banks should complement this information with information obtained from relevant internal and external sources, such as heads of business, relationship managers, national risk assessments, lists issued by inter-governmental international organisations and national governments, AML/CFT mutual evaluation and follow-up reports by FATF or associated assessment bodies as well as typologies. They should review their assessment periodically and in any case when their circumstances change or relevant new threats emerge. Box 2. Examples of ML/TF risk associated with different banking activities 1 : Retail banking: provision of services to cash-intensive businesses, volume of transactions, high-value transactions, diversity of services. Wealth management: culture of confidentiality, difficulty to identify beneficial owners, concealment (use of offshore trusts), banking secrecy, complexity of financial services and products, PEPs, high value transactions, multiple jurisdictions. Investment banking: layering and integration, transfer of assets between parties in exchange for cash or other assets, global nature of markets. Correspondent banking: high value transactions, limited information about the remitter and source of funds especially when executing transactions with a bank located in a jurisdiction that does not comply or complies insufficiently with FATF Recommendations, the possibility that PEPs are involved regarding the ownership of a bank. 1. The proposed categorisation of banking activities is purely indicative (see par. 52) and the list of identified risks is illustrative and non-exhaustive. 34 INR 1 and

21 58. The risk assessment should be approved by senior management and form the basis for the development of policies and procedures to mitigate ML/TF risk, reflecting the risk appetite of the institution and stating the risk level deemed acceptable. It should be reviewed and updated on a regular basis. Policies, procedures, measures and controls to mitigate the ML/TF risks should be consistent with the risk assessment. B. RISK MITIGATION IDENTIFICATION, VERIFICATION AND THE PURPOSE AND INTENDED NATURE OF THE BUSINESS RELATIONSHIP 59. Banks should develop and implement policies and procedures to mitigate the ML/TF risks they have identified through their individual risk assessment. Customer due diligence (CDD) processes should be designed to help banks understand who their customers are by requiring them to gather information on what they do and why they require banking services. The initial stages of the CDD process should be designed to help banks assess the ML/TF risk associated with a proposed business relationship, determine the level of CDD to be applied and deter persons from establishing a business relationship to conduct illicit activity. 60. Based on a holistic view of the information obtained in the context of their application of CDD measures, banks should be able to prepare a customer risk profile. This will determine the level and type of ongoing monitoring and support the bank s decision whether to enter into, continue or terminate, the business relationship. Risk profiles can apply at the individual customer level or, where groups of customers display homogenous characteristics (for example, clients with similar income range, or conducting similar types of banking transactions) can be applied to such groups. This approach is particularly relevant for retail banking customers. 61. Initial CDD comprises: Identifying the customer and, where applicable, the customer s beneficial owner; Verifying the customer s identity on the basis of reliable and independent information, data or documentation to at least the extent required by the applicable legal and regulatory framework; and Understanding the purpose and intended nature of the business relationship and, in higher risk situations, obtaining further information. 62. In addition, banks should take measures to comply with national and international sanctions legislation by screening the customer s and beneficial owner s names against the UN and other relevant sanctions lists. 63. As a general rule, CDD measures have to apply in all cases. The extent of these measures may be adjusted, to the extent permitted or required by regulatory requirements, in line with the ML/TF risk, if any, associated with the individual business relationship as discussed above under Risk Assessment. This means that the amount and type of information obtained, and the extent to which this information is verified, must be increased where the risk associated with the business relationship is higher. It may also be simplified where the risk associated with the business

22 relationship is lower. Banks therefore have to draw up, and periodically update, customer risk profiles 35, which serve to help banks apply the appropriate level of CDD. Box 3. Examples of Enhanced Due Diligence/Simplified Due Diligence measures (see also INR 10) Enhanced Due Diligence (EDD) obtaining additional identifying information from a wider variety or more robust sources and using the information to inform the individual customer risk assessment carrying out additional searches (e.g., verifiable adverse media searches) to inform the individual customer risk assessment commissioning an intelligence report on the customer or beneficial owner to understand better the risk that the customer or beneficial owner may be involved in criminal activity verifying the source of funds or wealth involved in the business relationship to be satisfied that they do not constitute the proceeds from crime seeking additional information from the customer about the purpose and intended nature of the business relationship Simplified Due Diligence (SDD) obtaining less information (e.g., not requiring information on the address or the occupation of the potential client), and/or seeking less robust verification, of the customer s identity and the purpose and intended nature of the business relationship postponing the verification of the customer s identity Box 4. CDD and financial inclusion considerations The application of a RBA to CDD may support financial inclusion objectives by providing for a more flexible application of CDD measures to certain categories of financial products or customers who might otherwise struggle to meet banks CDD requirements. However, financial exclusion in itself is not an indicator of low ML/TF risk and banks have to take an informed decision, based on a holistic assessment of ML/TF risk, whether exemptions or SDD measures may be appropriate. 64. Where banks cannot apply the appropriate level of CDD, Recommendation 10 requires that banks do not enter into the business relationship or terminate the business relationship. 65. The BCBS s guidance on the Sound management of risk related to money laundering and financing of terrorism provides detailed guidance to banks on the management of money laundering 35 based on the bank s own risk assessment and taking into account risk factors such as those outlined in the FATF standards, e.g., in INR 10 and Recommendations/INR

23 risk in correspondent banking and in situations where banks rely on third parties to carry out all, or part, of their initial CDD. ONGOING CDD/MONITORING 66. Ongoing monitoring means the scrutiny of transactions to determine whether those transactions are consistent with the bank s knowledge of the customer and the nature and purpose of the banking product and the business relationship. Monitoring also involves identifying changes to the customer profile (for example, their behaviour, use of products and the amount of money involved), and keeping it up to date, which may require the application of new, or additional, CDD measures. Monitoring transactions is an essential component in identifying transactions that are potentially suspicious. 67. Monitoring should be carried out on a continuous basis or triggered by specific transactions. It could also be used to compare a customer s activity with that of a peer group. It need not require electronic systems, although for some types of banking activity, where large volumes of transactions occur on a regular basis, automated systems may be the only realistic method of monitoring transactions. However, where automated systems are used, banks should understand their operating rules, verify their integrity on a regular basis and check that they address the identified ML/TF risks. 68. Banks should adjust the extent and depth of monitoring in line with their institutional risk assessment and individual customer risk profiles. Enhanced monitoring should be required for higher risk situations, while banks may decide to reduce the frequency and intensity of monitoring where the risks are lower. The adequacy of monitoring systems and the factors leading banks to adjust the level of monitoring should be reviewed regularly for continued relevance to the bank s AML/CFT risk programme. 69. Banks should document and state clearly the criteria and parameters used for customer segmentation and for the allocation of a risk level for each of the clusters of customers. Criteria applied to decide the frequency and intensity of the monitoring of different customer segments should also be transparent. Box 5. Examples of monitoring in high/lower risk situations Monitoring in high risk situations: daily transaction monitoring, manual transaction monitoring, frequent analysis of information, considering the destination of funds, establishment of red flags based on typologies reports, reporting of monitoring results to senior management etc. Monitoring in lower risk situations: thresholds, low frequency, automated systems The BCBS s guidance on the Sound management of risk related to money laundering and financing of terrorism sets out in Section II 1 (d) what banks should consider when assessing whether their monitoring system is adequate. It stresses that a bank should have a monitoring system in place that is adequate with respect to its size, its activities and complexity as well as the risks present in the bank. For most banks, especially those which are internationally active, effective monitoring is likely to necessitate the automation of the monitoring process