Blockchain Integration: A Disruptive Force Against Money Laundering

 In Anti-Money Laundering, Global RADAR, Trending

Anti-money laundering has been a rapidly expanding area of the financial industry for the better part of the last two decades. The World Bank estimates that the volume of money laundering is as much as $3.5 trillion worldwide annually (nearly 5% of global GDP). Given that less than 1% of money laundering activity is actually detected by the banks and financial authorities, the realm of regulatory compliance has grown exponentially in recent years to try to incur better outcomes in this regard. As such, the increasing demands, expectations, and pieces of distinct and often-complex legislation that accompany regulatory compliance have created a need for large, dedicated departments catered specifically to handling these tasks. However, advancements made in various forms of financial technology – specifically blockchain – may offer an alternative and arguably more effective solution than that of even artificial intelligence and machine learning options that have begun to emerge in recent years. These developments have led many of the world’s most renowned and powerful financial institutions – as well as those hampered by bloated and overburdened regulatory compliance departments – to explore the growing capabilities with respect to keeping their respective enterprises secure and up to par with all of the latest regulatory requirements.

Simply put, blockchain is a technology that acts as digital ledger of transactions that is duplicated and distributed across a chain of computer networks. It is a method of recording information that is particularly difficult to hack or alter in a fraudulent way. Popular cryptocurrency options such as Bitcoin and Ethereum use blockchain technology as the basis for their markets.4 Where does this factor into the realm of regulatory compliance one might ask? Well, the integration of blockchain technology into AML efforts could mean trimming the fat off of a significant amount of work for compliance departments. Since the plight against money laundering and other serious financial crimes gained significant traction with the passing of Title III of the USA PATRIOT Act following the 9/11 terrorist attacks, financial institutions have desperately sought ways to lower rising costs associated with hiring large compliance teams, bringing on consultants, and paying for long hours of laborious work in order to keep up with ever-changing financial regulations. This is for good reason, considering that it is estimated that AML compliance spending totals upwards of $30 billion collectively for American financial firms on an annual basis. Compliance personnel operating under financial institutions whose internal operations are not up to par with growing technological standards can spend significant portions of their workdays manually verifying basic customer information and inputting Know-Your-Customer (KYC) information by hand, essentially wasting a company’s time and funds via this outdated and grossly inefficient process. The screening and comprehensive risk mitigation process as a whole is largely overdrawn, though certain aspects can be of significantly high-pressure, creating an environment that can lend itself to error. Unfortunately for American and international financial entities, even the slightest of slip-ups in this regard can lead to costly monetary penalties and other notable repercussions that can impact the bottom-line of banks small and large. Inclusive of regulatory penalties, total AML compliance costs borne by banks amount to ~$18bn annually.2 This is just one of the areas where blockchain can make a significant difference.

One of the world’s top financial staples, Goldman Sachs, was among the first to explore the power of blockchain with respect to finance. In 2016, the company predicted that this technology could spread well beyond solely cryptocurrency and into mainstream finance. In a special report discussing blockchain innovation, the firm noted the potential for this technology to readily address a whole host of business problems – one of these being overstaffing in the banking sector. The Goldman Sachs report revealed that using blockchain technology for KYC procedures alone would result in a significant reduction in the headcount of necessary personnel. This alone makes delving into this still relatively novel tech a lucrative opportunity for financial executives of even the smallest of firms. Blockchain can also enable the onboarding of more customers in the same timeframe as manual processes with far less resources and funds committed to these efforts, allowing business to re-allocate their funds to more pressing needs. This technology can not only streamline compliance requirements by automating many of the aforementioned manual processes tied to regulatory checks and balances, it can be especially useful in providing automatic risk ratings or cross-referencing information that can be verified by using smart contracts. Smart contracts are programs stored directly on the blockchain that run when pre-determined conditions come to fruition. Each time these conditions inserted into the blockchain code by a bank or company are met, an action or series of actions are executed automatically, triggering the next step in the workflow process. These steps do not require any type of manual input aside from the initial coding, allowing them to proceed in real time – creating operational efficiency while cutting out unnecessary manpower needs.3 This means that much of the mindless data input and “chain of command” protocols that require human beings would effectively become obsolete. Additionally, these technologies can cut false-positive rates for the verification of payments or when pertinent information is misrepresented or incomplete during the transaction monitoring process. Altogether, blockchain integration can significantly impact AML monitoring procedures for the better by making financial transaction information more mutual via the creation of distributed ledger which could drive meaningful industry cost savings in transaction surveillance and the KYC/onboarding process.2

There are also many perceived benefits of using blockchain to boost the customer experience. Given that many financial institutions have differing standards and requirements of information needed to verify the true identities of their customers, it can be particularly tedious for clients of multiple banks to have to supply a growing list of varying personal identification and financial information to each respective institution. Blockchain could alleviate this annoyance by having all of that information stored on a distributed ledger that can be accessed by any authorized company that needs to verify a certain customer or relationship. On the flipside, in many cases KYC verification is a duplicative process – with banks generally required to independently vet prospective clientele even when the account has already been vetted by other firms. Should this information be more easily accessed and transferred from one firm to the next, it can lead to even more savings for financial firms while eliminating headaches for virtually all parties involved.

While it appears that financial executives and customers would be happier utilizing blockchain, the same cannot be said for many compliance analysts and even officers. The reality is that further automating manual regulatory-related workflows with blockchain and other forms of potent financial technology would inevitably result in additional lost jobs in an industry already struggling to keep talent. While the analysts that do keep their jobs may enjoy a mass reduction in monotonous data input requirements, many will probably not be so lucky. As these technologies become more sophisticated and require less human intervention, the bubble of the BSA/AML compliance job market is likely to burst at some point in the near future.

Citations

  1. Devanesen, Joe. “Taking the Fight to Financial Crime with Blockchain-Powered AML/KYC.”TechHQ, 30 June 2021.
  2. Schneider, James, et al. “Blockchain: Putting Theory into Practice.”Goldman Sachs | Profiles in Innovation: , 24 May 2016.
  3. “What Are Smart Contracts on Blockchain.”IBM.
  4. “What Is Blockchain?”Blockchain Explained: What Is Blockchain? | Euromoney Learning.

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