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Recent years have seen the financial services industry being bombarded with a
host of regulatory requirements, ranging from anti-money laundering and Sarbanes
Oxley, to MiFID (Markets in Financial Instruments Directive) and regulations
regarding the SEPA (Single European Payments Area). While some are focused on
the global financial industry, others are domain-centric and applicable only if
a bank operates in certain geographies. However, each regulation comes with its
own set of complex requirements with non-compliance proves not only extremely
costly, but also leads to a loss of reputation and goodwill in the industry.
Recently, Dutch banking giant, ABN AMRO agreed to pay $75 mn as fines and its
board members agreed to repay EURO one million in executive bonuses after
admitting to serious flaws in compliance controls at its Dubai branch and the US
dollar clearing center in New York. A report found that between 1997 and 2004,
employees of ABN AMRO in Dubai developed procedures that modified the US dollar
payment instructions sent to the bank's clearing center in New York on behalf
of Libyan and Iranian clients. They excluded country and client-specific
information from the relevant payment instructions so that the payments would
pass through the New York branches' OFAC filter without being detected and
blocked. Rijkman Groenink, ABN AMRO chairman says, “As a global financial
organization, nothing short of the highest standards of compliance is
acceptable. We regrettably recognize that, in the past, our compliance in
certain areas did not meet this standard. Further improving our compliance is
the highest priority of the bank.”
 In another case, Wall Street bank, Morgan Stanley agreed to pay a record $15
mn fine to the US Securities and Exchange commission (SEC) for its failure to
archive e-mails to the SEC's satisfaction. The fine will be the largest ever
levied by the SEC for inadequate record keeping. In 2004, Bank of America had
set a record by agreeing to pay $10 mn fine to the SEC for falling to retain
documents.
Not surprisingly, regulation is often regarded as among the key challenges
facing the banking industry today. In fact, regulatory overkill was identified
as the greatest risk facing the financial sector for the second year running by
the annual 'Banana Skins' survey, conducted by the CSFI (Centre for the
Study of Financial Innovation), a London based non-profit think tank in
association with PricewaterhouseCoopers. Respondents from 60 countries said that
too much regulation was endangering the financial health of banks with its cost
burden and distractions, as they did in the 2005 survey. But this time, many of
them added their concern about growing political interference by governments
seeking to influence banks' behavior and obstruct free markets. John Hitchins,
UK Banking Leader at PricewaterhouseCoopers LLP, said, “The financial sector
is again throwing down a challenge to the regulators as to whether they have the
right balance of cost and benefit.”
According to a report published by the UK Financial Services Authority (FSA),
the UK financial services industry spends about £600 mn a year dealing with
regulatory red tape. The study was commissioned in response to growing business
complaints about the rising tide of regulation. It was found that money
laundering rules account for by far, the largest single set of administrative
burdens on the UK financial services industry, accounting for around 40% of the
total estimated cost. Regular reporting rules were also found to be a
significant drain on management time and resources.
Regulatory Snapshot
Despite ongoing concerns about the bugbear of regulation and the subsequent
costs imposed on the financial industry, it is universally acknowledged that
regulation is essential in today's world. Some drivers for regulations include
the rise of global terror links, accounting scandals and other operational
issues. The following section highlights some of the key areas of regulation
faced by the banking industry.
Ensuring Macro-economic Stability
With memories of the economic meltdown in countries like Japan, Indonesia,
Mexico and Brazil still fresh, one of the main rationales that regulatory
agencies use to justify intervention in markets is prevention of market failure.
Many banks as a result of this meltdown suffered heavily, which resulted in some
of these banks either being wound up or become targets for cheap acquisition and
mergers. The entire episode helped emphasize the importance of good lending
norms, a reliable customer base and proper mix of different segments in the
lending portfolio. These norms along with stringent risk management policies are
often mandated by most central banks globally.
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Regulation
is essential in today's world. Some drivers for regulations include the
rise of global terror links, accounting scandals and other operational
issues |
Risk management is a key factor in assessing the future performance and
condition of a bank and management effectiveness. In this regard, disclosures
may include discussions of overall risk management philosophy, risk
methodologies, sources of risk, risk identification, risk quantification, risk
management, and risk control. It may also be useful to discuss the risk
management structure, risk measurement and monitoring, performance testing, use
of risk-mitigating tools, online limits monitoring and tracking and review of
exposures.
Countering Terrorism
The Financial Action Task Force on Money Laundering (FATF) is an
inter-governmental body founded in 1989 by the G8. The purpose of the FATF is to
develop policies to combat money laundering and terrorist financing. The primary
policies issued by the FATF are the Forty Recommendations on money laundering
and the Special Recommendations on terrorist financing, which set the
international standard for anti-money laundering measures and combating the
financing of terrorism. Both sets of FATF Recommendations are to be implemented
at the national level through legislation and other legally binding measures.
The current (2003) Forty Recommendations require states, among other things,
to implement relevant international conventions, criminalize money laundering
and enable authorities to confiscate the proceeds of money laundering, implement
customer due diligence (eg: identity verification), record keeping and
suspicious transaction reporting requirements for financial institutions and
designated non-financial businesses and professions, establish a financial
intelligence unit to receive and disseminate suspicious transaction reports, and
cooperate internationally in investigating and prosecuting money laundering.
One of the regulations targeted at countering terrorist money networks is the
USA PATRIOT Act. The Uniting and Strengthening America by Providing Appropriate
Tools Required to Intercept and Obstruct Terrorism Act of 2001, commonly known
as the USA PATRIOT Act, is one of fastest executed Acts in US history. The Act
was passed in the aftermath of the September 11 attacks in 2001, and places
responsibility on banks and financial institutions to take utmost care in
carrying out banking transactions. Further, the regulation requires financial
institutions covered by this Act to share information to deter money laundering
and terrorist activity, maintain financial records and report currency and
foreign transactions, institute anti-money laundering programs and conduct due
diligence programs for correspondent accounts of foreign financial institutions
and private banking accounts for non-US persons.
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Role
of Technology in Managing
Regulatory Requirements |
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To comply with the
ever-increasing set of regulatory requirements, banks need to effectively
increase their effort and make investments in both skilled personnel and
technology to reduce any potential risks that may arise because of
non-compliance. They also need to develop mechanisms to assess and analyze
compliance requirements such that they can reduce their risk exposures and
to protect themselves from potential losses.
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To meet KYC norms,
every customer acquired by a bank should be analyzed for the
background, nature of business, credit rating, customer's previous
financial records, financial history, and relationship with existing
customers in the bank. The system capturing such information should be
able to trigger and guide the user and the concerned persons about
such information and raise alarms and alerts to handle the same. It
should support customer identification, provide alerts for blacklisted
customers and defaulting customers and monitor customer accounts for
abnormal behavior.
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Technology has a
major role to play when it comes to addressing the requirements of
'anti money laundering' and 'preventing terrorist financing'
as suggested by FATF. The systems should be able to analyze and report
all suspicious transactions. There should be controls to prevent such
transactions. The system should be able to detect and report on a
continuous basis so that the banks can take corrective actions
accordingly.
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Areas such as
credit risk and default risk can be effectively managed by technology
solutions that monitor and track all borrowed accounts. These systems
should provide support for online and real-time monitoring of funds
utilization and the real-time valuation of collateral along with
report overdues. The system should also support automatic
classification of assets based on the bank guidelines. Once classified
as non-performing, the system should keep track of all transactions in
that account, further the system should support prudent income
recognition norms prescribed by the regulatory authorities.
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Although it is
considered as one of the risk management tool and many central banks
have placed greater importance for an effective Asset Liability
Management (ALM) system within banks, not many banks have realized the
importance of an ALM system. It is impossible to manually keep track
of all the inflows and outflows in any bank, the size also adds to the
complexity which necessitates a proper system to be in place for
managing liquidity risks, interest rate risks. Technology has proved
very effective in this area since banks are thrown with many choices.
Today, ALM systems not only handles the required cash flows, but are
also capable of analyzing the trends in such flows, alerts on mismatch
and triggers on stressed buckets among others.
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Solutions to ensure
operational risk management are essential in any bank today. There are
many instances to show how organizations have collapsed due to the
absence of better operational risk management tools. Operational risk
management takes on greater significance since banks deal with public
money. To control operational risk, your banks should maintain a
system of comprehensive policies and a control framework designed to
provide a sound and well-controlled operational environment. The
technology solution should be based on a recognized and approved
internal controls framework and help track important risk management
metrics.
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Customer Identification
Know Your Customer (or 'KYC') is the due diligence and bank regulation
that financial institutions and other regulated companies must perform to
identify their clients and ascertain relevant information pertinent to doing
financial business with them. Typically, KYC is a policy implemented to conform
to a customer identification program mandated under FATF and the USA PATRIOT
Act. Know your customer policies have in fact become increasingly important
globally, to prevent fraud, money laundering and terrorist financing. One aspect
of KYC checking is to verify that the customer is not on any list of known
fraudsters, terrorists or money launderers. Beyond name matching, a key aspect
of KYC controls is to monitor transactions of a customer against their recorded
profile, history on the customer's account(s) and with peers.
Ensuring Transparency
In response to major corporate and accounting scandals such as Enron and
WorldCom, there is a growing need for transparency and greater disclosures. In
the US, the Sarbanes Oxley (SOX) Act was instituted that established new or
enhanced standards for all US public company boards, management, and public
accounting firms. SOX is also applicable to banks and financial institutions
that have raised funds from the US capital markets or have branches or
representative offices within the US.
To ensure transparency for banks, the Bank for International Settlements (BIS)
has also identified six broad categories of information, each of which should be
addressed in clear terms and appropriate detail. This includes financial
performance; financial position (including capital, solvency and liquidity);
risk management strategies and practices; risk exposures (including credit risk,
market risk, liquidity risk, and operational, legal and other risks); accounting
policies; and basic business, management and corporate governance information.
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