In order to perform the necessary checks and verifications and be able to do business with a customer without putting the company or the economy at risk, a customer risk assessment is a standardized technique of determining the level of risk posed by a customer.
Certain regulated business types are obligated to comply with anti-money laundering (AML) regulations, which include determining a customer's identity, location, the source of their funds, their intended use, and other details in order to determine the risk the customer poses.
The organization will thereafter be able to determine and monitor whether;
- they pose a risk for money laundering,
- according to CFT laws, they are said to be financing terrorism,
- they have a close relative who is politically active or are otherwise politically exposed,
- they are either sanctioned individually or collectively as a business,
- they are included on watchlists for criminals and runaways, among other blacklists.
Firms will be better able to choose the appropriate level of customer due diligence (CDD) if they are well-informed. A customer's behavior should be periodically reviewed, especially if it departs from their risk profile. The Financial Action Task Force (FATF) advises businesses to avoid entering into commercial relationships or to stop them when they are unable to apply the proper level of CDD.
Who Should Assess the Customer Risk?
These days, customer risk assessment isn't just used by banks. Any company that conducts business online is aware that not every consumer is equally valuable to the company. Some people will grow to be devoted and keep buying your products or services. You'll wind up spending more than you make because of others.
Online casinos, loan companies, fintech companies, cryptocurrency exchanges, traditional financial institutions; all of these businesses are well aware of the value of customer risk assessment.
In fact, they are required to abide by a number of laws that put them under obligation to verify user information, including:
- USA PATRIOT Act
- JMLSG Guidance
- UK Proceeds of Crime Act 2002
- Third European Money Laundering Directive
- International Money Laundering Abatement and Anti-Terrorist Financing Act
The intention is to stop anyone from engaging in fraud that could negatively affect the business either directly or indirectly.
The Core Elements of Customer Risk Assessment
The CRA's subsequent features act as a crucial guidance for financial organizations. Your organization's CRA process can be optimized and made more standard with the understanding of these principles.
- Customer risk identification
This aspect refers to the factors that can determine a customer's proclivity for fraud or other financial crimes. The financial institution will first need identification proofing documentation. The following components are part of the process of identifying and outlining potential risk factors.
- An individual or organization
Examining an individual or a legal organization calls for various strategies. Individual consumers typically open accounts for their own or their families' use, but their actions may indicate a danger of money laundering. Money launderers, meanwhile, carry out their illicit activities through respectable commercial enterprises.
- The client's affiliations and profile
This entails being aware of a client's previous career experience, social background, and relationships with family and colleagues. A consumer who wishes to deposit a sizable amount of money but has never had a job, for instance, usually raises a red flag. Politicians could be more susceptible to bribery, money laundering, or terrorist financing.
- Geographic risk
People who do not have any ongoing ties to a particular nation could be more vulnerable than its citizens or inhabitants. Further research is required into people who conduct financial transactions at locations other than their residences or places of employment. Money mules that transport large sums of cash frequently open accounts at numerous locations to avoid reporting cash transactions.
- Service types required
A significant risk element is the sort of services that a consumer inquires about. The use of the account may indicate money laundering operations. For instance, queries regarding regular cash deposit procedures or international wire transfers require cautious observation.
- Customer risk scoring
The bank will determine the person's or entity's risk score after looking at the aforementioned risk criteria. A financial institution can identify clients who pose a greater risk of money laundering by using customer risk scoring. This scoring system is legally required in several nations, including the US. The risk categories are as follows:
- Low-Risk Customer
This includes clients whose identities and sources of income can be easily tracked by banks. Additionally, their prior transactions match the profile they have offered.
- Medium Risk Customer
These clients fall under the category of higher-than-average risk clients. It might be made up of individuals or groups whose place of employment or residence has a track record of illegal trading operations.
- High-Risk Customer
Customers falling into this group need to undergo more thorough due diligence, particularly if their source of funding is unknown. High net-worth individuals, nonresidents, or those with political influence may be among them.
- Prohibited
This category is for people or organizations that have engaged in financial crime. They are not permitted to conduct business with banks or other financial institutions.
How to Conduct a Risk Assessment Effectively
The steps will remain the same whether you are a tiny business or a worldwide leader:
- Assign a team member, an entire team, or a specialist to handle the risk assessment
- Identify risks unique to your industry
- Analyze the risks and determine how they will affect the company
- Gather all potential danger factors (or data points relating to the risk)
- Establish KPIs to track and measure risk rates.
A client risk assessment may need to be reevaluated if certain common behaviors are detected, such as:
- Changing banks frequently in a short period of time
- A sizable quantity of private investment provided by a single person who is operating a cash-intensive business
- Requests for shortcuts or transactions that move too quickly
- Involving a third-party financier who is unrelated to the firm
- Attempts to conceal the business's true owner
- A high number of cash transactions that are not consistent with the customer's profile
- Deals are made with nations where there is a high danger of terrorism funding and/or money laundering.
- Excessively convoluted ownership structures
- Use of phony or dubious papers
- Amount of company activity that varies
Businesses should take into account streamlining the architecture of their risk models, keeping an eye out for the red flags we have highlighted above and implementing statistical analysis to supplement expert judgment. While taking into account behavior and other characteristics, machine learning algorithms can enhance the quality of the data and assist in regularly updating client profiles.
