What Is Transaction Monitoring in AML?

What Is Transaction Monitoring?

Transaction Monitoring is a kind of real time screening of financial transactions. The purpose is identifying the potantial money laundering and other activities that can be led to fraud. Implementing Transaction Monitoring eliminates numerous Anti Money Laundering risks when applied correctly. In this post, we will go over everything related to this process in detail. 

Why Should Firms Use AML Transaction Monitoring?

1. Compliance

First and foremost, Transaction Monitoring is an obligation. Several authorities such as FATF, FinCEN and EU AMLD, have their own requirements and expect firms to comply. Also, transaction monitoring alone is not enough to stay compliant, there are other obligations you must keep in mind such as reporting Suspicious Activity Reports. Let’s give an example from recent times. According to Yahoo Finance, AUSTRAC, Australia’s financial intelligence agency, ordered the Australian arm of Binance to appoint an independent auditor due to vulnerabilities in its crime prevention systems. Among the reasons they have mentioned, it is possible to see ineffective transaction monitoring as well. 

2. Financial Crime Risk

It is always better to tackle any problem before they even escalate, and this is particularly one of the reasons why Transaction Monitoring plays such an important role in AML efforts. 

3. Risk-Based Customer Management

Most of the authorities also expect firms to update customer risk profiles in real-time. Another advantage of this is that you can allocate your resources accordingly and not waste any time. 

4. Regulatory Fines

Ineffective, or absent Transaction Monitoring has several repercussions. You may face severe financial penalties and sanctions. This may even reach a point where your business’s operating licence is revoked. 

5. Supporting Audits

Several monitoring systems can maintain comprehensive audit trails. This proves very helpful for the times you need to file Suspicious Activity Reports (SARs).

6. Fraud Prevention

They can also directly help your business prevent fraud since it detects any anomaly that comes up.

Who Needs AML Transaction Monitoring?

1. Banks & Credit Institutions

Banks and credit institutions are definitely one of the first institutions that come to mind, since they handle high-volume transactions each day. Also, the strictest regulations are usually imposed on these. For example, The German financial authority, BaFin, has requested Deutsche Bank to improve its transaction monitoring.

2. Fintechs & PSPs (Payment Service Providers)

These are definitely faster when it comes to transactions. The speed of these microtransactions through API-based platforms creates one of the ideal environments for fraudsters committing financial crimes.

3. Crypto Exchanges & VASPs (Virtual Asset Service Providers)

Similar to Fintechs and Payment Service Providers, Crypto Exchanges and Virtual Asset Service Providers work in a dynamic and constantly changing landscape. These institutions must conduct proper wallet tracing and comply with FATF Travel Rule as well. 

4. Gambling Platforms

There is no doubt that these platforms witness high cash turnovers but they also allow online anonymity. Thus, fraudsters can easily exploit these for the placement and layering of funds.

5. DNFBPs (Designated Non-Financial Businesses and Professions)

If you are wondering what Designated Non-Financial Businesses and Professions are, we can exemplify these with real estate agents, lawyers, accountants and high-value goods dealers. So, it is basically the same case with previous sectors, which is taking part in complex and large transactions. 

6. MSBs (Money Service Businesses)

MSBs encompass remittance companies, currency exchanges and prepaid card providers. We consider these high-risk due to cash intensity and cross-border movement of funds. So, pretty similar to the previous examples.

7. Wealth Management

Our last example is once again concerned with managing complex investment portfolios, as you may have been expecting. These can get very vulnerable to misuse, since they may be hiding beneficial ownership or moving illicit wealth. 

Why Is Transaction Monitoring So Important, Especially for Banks?

In AML solutions, a single reason is often enough to justify the need for applying a solution. However, Transaction Monitoring presents us many advantages from adhering to laws to protecting your reputation. 

Let’s start with regulatory compliance. There are countless laws such as FATF standards, EU AML Directives, FinCEN rules or even local regulations, which require firms to adhere to strict monitoring processes and file Suspicious Activity Reports (SARs).

One obvious reason is that monitoring helps detect fraud. There is an account takeover? Monitoring could address that. Someone committed trade-based laundering? Monitoring will let you know that. Since it detects fraud early, it can prevent a lot of financial and reputational damage beforehand. For example, criminal groups laundered more than $670 million through TD Bank accounts. According to authorities, this was due to the fact that they didn’t monitor 92% of the bank’s transactions, which resulted in $3 billion in penalties.

It also proves very helpful regarding Customer Risk Management, because a proper Transaction Monitoring system can spot behavior changes and apply Enhanced Due Diligence. For example, a customer that you consider low-risk may make a high-value international transfer, which can seem very unusual. Transaction Monitoring can update their risk accordingly without any manual intervention. 

Last but not least, staying away from fraud is the best possible way you can protect your reputation and this is exactly what Transaction Monitoring can help you with. Even the slightest failure can damage your reputation, which could take years to recover. So, Transaction Monitoring can both prevent these failures and show the customers that you are serious about AML compliance. 

How AML Transaction Monitoring Works

In this part, we will explain how Transaction Monitoring works, step by step. First, the system gathers all details of transaction data (amount, frequency, geolocation, counterparties etc.) and Know Your Customer information (customer identity, risk rating, source of funds etc.). Now, the part where predefined rules and thresholds are applied. Firms are starting to use more and more machine learning in this part because they can identify anomalies more efficiently such as structuring, rapid movement of funds or transactions with high-risk jurisdictions. The next step consists of alert generation. When monitoring system identifies an activity that matches suspicious patterns, it triggers an alert and prioritizes based on risk severity. This part mostly concerns compliance teams. They must investigate alerts, review customer profiles and decide whether activity is legitimate or suspicious. If they indeed find an activity suspicious, they must file a Suspicious Activity Report (SAR) with the relevant authority. Now, the only thing left to do is keeping the relevant reports (activities, alerts, investigations etc.) for at least 5 years due to the regulatory requirements and future audits. 

What is AML Transaction Monitoring Software?

AML Transaction Monitoring Software is basically a tool that analyzes financial data to detect any suspicious activity while ensuring adherence to AML regulations at the same time. Certain firms like Sanction Scanner also offer additional features such as powerful case management, full audit trails, user-friendly dashboard, live transaction screen and integrated sanction and PEP query. Let’s detail some of these features. 

Key Functions

Real-time monitoring is pretty self-explanatory. It instantly tracks transactions to identify high-risk activity. However, rules engine may benefit from an explanation. Since there are numerous variables for both entities and firms, a certain degree of customization comes very handy. With rules engine, you can apply customizable scenarios and thresholds for detecting potential money laundering patterns. Then, there is alert generation. Again, it is self-explanatory. It flags unusual behavior and prioritizes alerts depending on the rules you have set. Case Management also deserves a mention, which allows your compliance teams to investigate, document and resolve alerts. The two last features of AML Transaction Monitoring Software we will mention are SAR/STR Filing and audit logs. It is not enough to detect and take action on suspicious activities, you also need to report these. These software can help you both report, and keep the necessary logs for audits and reviews. 

Types of Transaction Monitoring Systems

There are several types of Transaction Monitoring Systems. One of the most common methods is Rule-Based. It is very easy to understand and implement into your systems, however there is a high chance that you may encounter high false positives and its adaptation capability remains relatively limited to constantly evolving technologies. This is especially a good fit for banks and MSBs.

Next, there is a behavior-based system which can be ideal for Fintechs. It is particularly based on individual customer profiles to detect unusual behavior. However, it comes with its disadvantages such as its need for strong historical data and dependency on the data quality. There is also a more recent one that we should not ignore: Machine Learning Systems. These are capable of identifying previously unknown or complex threats but this makes them more difficult to audit and explain. Thus, there can be challenges of regulatory transparency despite its efficiency. However, its effectiveness makes it a good contender for crypto businesses and VASPs. If nothing sounds particularly appealing, you may take a hybrid approach, which can combine rule-based and ML approaches. However, it is more complex to implement and maintain, which requires specialized expertise in your compliance team. This is particularly viable for scaling firms. 

What Is the Difference Between Transaction Monitoring and Screening?

We can summarize the differences between transaction monitoring and transaction screening two by underlining that; monitoring looks for suspicious patterns while screening identifies high-risk individuals. So, while the first one is concerned about behavior, the latter examines the individuals. Also, monitoring is an ongoing process, unlike screening. Lastly, their tools differ as well. Monitoring often uses rules and behavior analytics, while screening uses fuzzy matching and watchlists. 

The Differences:

What Are the Challenges of AML Transaction Monitoring?

Compliance teams face many challenges when it comes to AML Transaction Monitoring, but high false positives could be the most common one. These both cause your compliance teams to get overwhelmed and increase operational costs. We have mentioned the types of monitoring systems in the previous paragraphs, as well as their disadvantages. However, traditional monitoring systems often fail to keep up with the constantly evolving methods of money laundering. This is mainly due to their reliance on static rules and thresholds. Also, preferring a conservative approach often comes with risks such as not being able to detect subtle or unusual suspicious patterns. This is exactly why we strongly recommend implementing artificial intelligence and machine learning. In our annual report, it is possible to see that the efforts on improving efficiency with automation and machine learning are on the rise. We can link the tendency of businesses towards these solutions to the analyst shortages and scalability demands of large transaction volumes. Which brings us to our last point: Analyst Resource Shortages. The demand for skillful AML analysts is very high and compliance teams often remain understaffed and under-resourced. All of this causes backlogs, delayed investigations and regulatory risk. 

How to Set Up a Risk-Based Approach in Transaction Monitoring?

1. Segment Risks

The first step consists of identifying and categorizing the risks. There are three key metrics when it comes to segmenting the risks. You can classify customers as PEPs, high-net worth individuals or new-to-bank customers. Then, segment the product/service risk, such as trade finance, prepaid cards or crypto services. Lastly, categorize the geography risk. An entity may be sanctioned or come from high-risk jurisdictions.

2. Set Risk Tiers

In this part, there are risk tiers based on the exposure, such as low, medium or high, that you must assign customers and transactions. You should pay as much attention as possible on this part because doing so can save you both considerable time and resources. 

3. Match Rules

After you set up the risks, there are a few actions that you must take accordingly such as tailor rules, thresholds and scenarios. For example, you may decide to apply a lower threshold for high-risk customer or enhanced monitoring for international transfers.

4. Sync Scores

This part consists of integrating monitoring with Customer Due Diligence (CDD) and Know Your Customer (KYC) scores. If you do this properly, your business can achieve a very dynamic foundation that will allow you to rapidly see changes in customer behavior or risk exposure. 

5. Document Everything

At this point, it shouldn’t be surprising that documentation comes as the last step. So, let’s detail what these documents should include: methodology, thresholds, decisions etc. During audits, you must have a clear rationale for the actions you have taken.

How Sanction Scanner Supports Transaction Monitoring

Here at Sanction Scanner, we offer powerful case management, full audit trails, user-friendly dashboard, live transaction screen, integrated sanction and PEP query, and more. Moreover, you can set rules and create scenarios, which can reduce false positives by up to 96.99% and your workload by up to 80%. Also, we offer peer group analysis and advanced sandbox test environment, which allows you to test your rules. These are just a few examples of what we offer at Sanction Scanner. To learn more, do not hesitate to contact us.