The FCA's Investigation into Challenger Banks Reveals Weaknesses In Financial Crime Controls

Blog / FCA Exposes Crime Control Flaws in Challenger Banks

The popularity of challenger banks in the UK has grown exponentially in recent years, according to the financial services industry. Customers who want to manage their finances with ease and convenience will appreciate digitally-driven, technologically innovative, and efficient onboarding processes. However, the Financial Conduct Authority's (FCA) recent review found that some challenger banks still have room to improve in terms of anti-money laundering (AML) and sanctions compliance.

What is a Challenger Bank?

A challenger bank is a brand-new retail bank that competes directly with well-known traditional banks. The word is most generally used in the United Kingdom, where challenger banks seek to service populations that the "Big Four" (Barclays, HSBC, Lloyds Banking Group, and NatWest Group) usually fail to. However, the word has gained global recognition over time.

In certain circumstances, traditional banks establish challenger banks to serve consumers that they are unable to perform. In other cases, traditional banks that "collapse" become challenger banks.

Challenger Banks and AML Compliance: Ensuring Regulatory Compliance in the Digital Era

Why did the Financial Conduct Authority (FCA) Investigate Challenger Banks?

HM Treasury underlined the potential hazards that challenger banks faced due to their faster onboarding processes in a separate whitepaper, National risk assessment of money laundering and terrorism financing 2020 (NRA).

Though all banks are needed to conduct customer due diligence (CDD) checks, the NRA report discovered that criminals might be more attracted to the fast onboarding processes offered by challenger banks, particularly when establishing mule networks, as they seek to capitalize on looser controls for the benefit of money laundering activity.

In light of the concerns identified in the NRA study, the Financial Conduct Authority undertook an examination of financial crime controls at challenger banks using a sample of six retail challenger banks representing about 8 million clients.

The investigation focused on numerous significant topics regarding FCA regulations, including:

  • Governance and management information;
  • Policies and procedures;
  • Risk assessments;
  • Identification of high-risk and or sanctioned individuals or entities;
  • Ongoing monitoring and due diligence;
  • Communication, training, and awareness.

While it is accepted that challenger banks have successfully used data and technology to simplify the onboarding process for their customers according to FCA regulations, the findings indicate that greater emphasis should be placed on reinforcing their financial crime control frameworks to ensure they are reliable and fit for purpose.

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Areas That Need Improvement According to the FCA Report

The FCA has highlighted the following issues that need to be improved:

  • Customer risk assessment - It was discovered that certain challenger banks had insufficient customer risk assessments that were unsuccessful in analyzing the risk of engaging into and maintaining business relationships with their clients. In one case, the challenger bank had no client risk assessment at all, which severely limited its capacity to conduct customer due diligence measures proportionally and effectively.
  • CDD and EDD (enhanced due diligence) - Some challenger banks failed to implement the needed CDD processes throughout the client onboarding process, demonstrating an overreliance on transaction monitoring technology to detect higher-risk consumers. "No matter how good a transaction monitoring system is, firms must still comply with the relevant CDD requirements. Moreover, inadequate CDD will mean a less effective transaction monitoring system," the research stated. In high-risk situations, such as managing politically exposed persons (PEPs), EDD must be applied regularly and documented as a formal procedure.
  • Financial crime change programs - Some challenger banks' ability to manage, monitor, and regulate financial crime change initiatives were found to be lacking. As a result, certain control frameworks were misaligned with developing business models. It was underlined that clear project plans would be necessary to support rapid control augmentation, as well as proper governance mechanisms and monitoring from top management throughout the project.
  • Ineffective transaction monitoring alert management and SAR filings - The review also found insufficient handling of transaction monitoring alerts, raising a number of issues, including an inconsistent and insufficient rationale for discounting alerts, a lack of basic information recorded in the investigation notes, a lack of holistic reviews of the alerts, and alerts not being reviewed in a reasonable timeframe due to insufficient resources. This affected companies' capacity to file Suspicious Activity Reports (SARs) on time, as required by the Proceeds of Crime Act of 2002. In this connection, the Report also said that a number of businesses' SAR quality needs to be improved.
  • Principle 11 Notification - Some challenger banks failed to notify the FCA of known significant financial crime control deficiencies in compliance with their duties under Principle 11 of the FCA Regulations Handbook.


Key Takeaways From The Report

While the action points described here are most closely applicable to challenger banks, the lessons learned may be generalized to all businesses subject to the AML regime and, more broadly, to UK-authorized enterprises currently managing the integration of elevated sanctions risk into their policies and procedures.

From a positive standpoint, the Financial Conduct Authority recognized several challenger banks' inventive use of technology, particularly when it came to locating and onboarding new clients. This remark reflects the FCA's stance on modernization: technology may be a beneficial instrument for simplifying and modernizing the practical implementation of long-standing compliance standards.

However, the evaluation reflects a broader concern that FCA-regulated firms must be equipped to update their financial crime and AML controls quickly in response to current events and business model changes in the present climate of fast-paced regulatory change.

In practice, this means that banks and firms must review their compliance frameworks in terms of FCA regulations to ensure that customer due diligence measures are sufficiently adapted and adequate for heightened sanctions risks, as well as that they adequately address the AML challenges identified in the National Risk Assessment for Money Laundering and Terrorist Financing.

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