Digital Identity: Anti-Money Laundering and Risks

Blog / Digital Identity: Anti-Money Laundering and Risks

In recent years, as the world has moved more quickly online than ever before, fraudsters have also advanced due to the growing number of digital opportunities. As a result, the usage of digital identities has grown in popularity and significance, and so has digital identity verification.

According to Statista's Intel on Digital Payment growth, the segment's total transaction value will amount to US$8.49 trillion in 2022.

Money laundering methods are evolving as digital payment technology becomes more prevalent. As a result, many financial institutions are looking for ways to include digital identification procedures in their AML/CFT systems to tackle these emerging dangers. Digital ID systems bring new compliance concerns and improve the accuracy and efficiency of customer identification for businesses. 

What is a Digital ID?

A digital identity is an online collection of data of an individual. This data can be used to create a digital image of a person when it is collected. That information can be used by businesses to identify their clients.

importance of identity verification in preventing financial crimes such as money laundering, bribery, and terrorist financing

What Makes Digital ID Crucial in AML?

When all of a person's online data is gathered together, it paints a picture of who they are in real world. Digital identity verification is the process of identifying someone online using their digital identity. Businesses wouldn't be able to recognize their virtual clients without this procedure.

The area of banking and financial institutions may be where the benefits of creating a digital identification network are most obvious. Digital identities offer more rapid methods of adhering to regulations and establishing trust in financial brokers at a lower cost and with higher accuracy than traditional screening procedures.

It's crucial to confirm clients' identity for a number of reasons;

  • Compliance with regulations: Regulated industries must comply with know-your-customer (KYC) rules and perform customer due diligence (CDD). In order to help avoid things like money laundering and other financial crimes, they are required by law to do this when they establish business-customer connections.
  • Better customer service: Companies are able to provide their clients with more specialized, individualized services when they have a clearer understanding of who they are, what they are interested in, and how they typically make purchases.
  • Fraud prevention: With a more accurate understanding of their clients, businesses are better prepared to combat fraud. For instance, it may be an indication of account takeover fraud if the person trying to log into an account doesn't match the profile of the person to whom the account belongs.
  • Lowering the expense of attracting new clients: More internal operations could be automated with a more efficient identity verification process. In turn, this not only enables companies to onboard more clients but also to do so more successfully, hence reducing the cost of client acquisition.

Challenges Faced by Firms

Many firms find it challenging to adhere to compliance standards. A recent poll found that manual compliance evaluations were the biggest concern for 44% of the organizations surveyed. 63 percent of businesses claimed to use subpar knowledge management software to maintain compliance, and 76 percent claimed to manually monitor regulatory websites to stay abreast of new compliance requirements, running the danger of being out of date and subject to hefty fines.

Attempting to stop money laundering while keeping a smooth client experience is another challenge, as 42% of users have given up on online onboarding procedures because they are too time-consuming.

As digital identity becomes more valuable, criminals are finding new ways to exploit it

The FATF's Digital ID Guidelines

The Financial Action Task Force (FATF) replaced the previous draft version distributed for public consultation in 2019 with its official Guidance on Digital Identity (Digital ID Guidance), which was released on March 6, 2020.

FATF, a global organization that monitors money laundering and terrorist financing, has created technology-neutral recommendations to assist governments, financial institutions, virtual asset service providers, and other regulated entities in determining whether a digital identity is adequate for KYC or due diligence purposes.

Who Should Read It and Why?

The Ministry of Justice and the AML/CFT supervisors might be the most interested in the Digital ID Guidance in regard to future developments within the AML/CFT framework because it improves understanding of global standards.

The Digital ID Guidance is also valuable to any reporting organizations that use digital tools to carry out or support CDD processes mandated by the Anti-Money Laundering and Countering Financing of Terrorism Act 2009 (AML/CFT Act).

The Risk-Based Approach 

The FATF warns against a one-size-fits-all approach to KYC, instead suggesting a risk-based strategy that tailors KYC measures to the risks associated with various consumers. According to Krishnan, "A risk-based strategy affects the intensity and extent of the requirements for customer and transaction information and the processes we utilize to guarantee that these [FATF] standards are met."

According to FATF, the best systems can increase access to financial services and CDD at the same time.

A rigid approach to CDD and electronic KYC verification could effectively exclude many prospective customers of banking and finance, warns Fredes Montes, Senior Financial Specialist at the World Bank Group. Risk-based approaches are intended to ensure that low-income users are not excluded from accessing financial services (which has FATF observer status).

Dependable Digital Verification

The FATF claims that reliable digital IDs can make individual customer verification quicker, less expensive, and more secure. Additionally, they can assist providers in meeting transaction monitoring standards and substantially reduce the chance of human error.

"We highlight the benefits of digital ID in terms of reducing costs, increasing convenience to the consumer, but also to the private sector, whilst not compromising on security," the FATF Secretariat's policy analyst, Shana Krishnan, said.

Because of the quick evolution of systems, FATF advises governments, financial institutions, and other stakeholders to comprehend the level of assurance that can be achieved with each ID solution before evaluating the dependability of any particular technology and governance combination to track transactions and stop money laundering.

Identity Verification is a tool for businesses since it may drastically limit cybercrime attack vectors.

Additional Recommendations For the Government

  • Examine if current CDD guidelines and regulations are compatible with digital ID systems, and make any necessary revisions based on the jurisdictional situation.
  • When determining the necessary characteristics, supporting materials, and procedures for establishing official identity, adopt principles, performance-, and/or outcomes-based criteria.
  • Create a multi-stakeholder integrated strategy to recognizing potential and hazards related to digital identification, and create the necessary rules and guidelines to reduce the risks.
  • To assist in identifying important identity-related opportunities, hazards, and mitigation strategies, consider implementing channels to improve communication and collaboration with relevant business industry stakeholders.
  • When creating and implementing a government-provided Digital ID, use the proper frameworks and technological standards for assurance of Digital ID.
  • Why Is AML Compliance So Important?

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