On various occasions, the Kenyan banking sector has been hit by fraud, resulting in significant losses and reputational damage.
Rampant fraud can result in bank failure and decreased profitability. When it happens on a grand scale, the increased collapse of banking institutions can be a precursor to an economic crisis akin to the 2008 global financial crisis that was largely attributed to the collapse of banks and mortgage financing institutions. Effective implementation of anti-money laundering (AML) measures is one of the antidotes.
One of the main incentives of implementing AML measures is to avoid regulatory sanctions and reputational damage. However, the utility of AML measures to an institution transcends the narrow focus of avoiding regulatory sanctions.
The starting point in implementing AML measures is understanding the risks. With increased fraud, it is expected that an AML risk analysis will identify fraud as a key predicate offence (an offence that generates proceeds of crime), which banks should earmark and design effective anti-fraud measures.
This can include getting up-to-date fraud detection software and effective transaction monitoring tools to ensure they are in tandem with emerging risks. At this stage, AML measures come in handy to ensure effective risk identification, resource allocation and mitigation.
Second, when onboarding customers, AML tools like know your customer (KYC) and customer due diligence (CDD) require banks to know and verify the identity of customers they are dealing with but also to verify their identity. Where it is a company, it is important to identify beneficial owners to enhance the transparency of legal entities.
Third, AML requirements like identifying beneficial owners of legal persons help banks fully know the nature of their clients to avoid concentration risks. Concentration of risk occurs when a bank has a significant debit/credit exposure to one customer or a group of related customers.
Failure to identify beneficial owners could cause a bank to issue huge loans to fraudulent borrowers trading in related entities, thus exposing the bank to significant losses in case of default. In some cases, the collaterals procured by proceeds of crime can be confiscated as proceeds of crime, resulting in losses.
The risk can also occur where a significant part of customer deposits are criminal proceeds that are at risk of being confiscated or unexpectedly withdrawn, thus resulting in liquidity challenges.
Fourth, complementing the KYC/CDD and beneficial ownership measures are other obligations, such as record keeping and reporting suspicious transactions. In Kenya, banks have an obligation to keep records for atleast seven years from the transaction date.
Given the nature of business transactions, the obligation to obtain and keep records does not stop at the onboarding stage. There is a need to periodically verify ownership of companies, especially where there are significant variations in the nature of business, shareholding, among others.
Verification of owners, especially in the case of companies, can be done in cases of change of signatories, among other activities. Finally, reporting suspicious transactions to the Financial Reporting Centre would help the bank allay its suspicion, especially when it receives feedback that a transaction is legitimate.
The above measures are some of the key benefits that will accrue to banks by implementing effective AML measures as an anti-fraud solution. For the above reasons, banks are expected to consider AML measures as part of their anti-fraud arsenal rather than a regulatory sanction tool.
A decrease in cases of fraud and other nefarious activities also comes with increased benefits to banks, such as an increase in customer and investor confidence and increased profitability, which cumulatively enhances the stability of the banking industry.
Such a change of attitude towards AML measures would incentivise banks to implement AML laws consistently and support the country’s concerted efforts to get off the FATF grey list.
