Growing challenges in watchlist screening

Recent revelations through major document leaks such as the FINCEN Files, Panama Papers, and Paradise Papers, as well as several instances of regulatory fines and consent orders on financial institutions, have highlighted the shortcomings of the current AML screening regime and drawn heightened attention from regulators, political authorities, media, and the public at large. This has prompted regulators and supervisory agencies to strengthen scrutiny; their emphasis is shifting from technical compliance to improving effectiveness of outcomes.

Geopolitical tension among the major economic blocs is adding to the challenges as sanctions are increasingly used in international relations. This means financial institutions (FIs) now need to monitor individuals, entities, hostile governments, and unfavorable jurisdictions, as well as industries and business practices such as weapons manufacturing or drug trafficking in accordance with continuously evolving laws and regulations. There is added scrutiny on screening ultimate beneficial owners because this has emerged as a popular channel for criminals to obscure their operations.

Digitalization of financial services is creating new products, channels, and business models. New players such as digital banks, payment and remittance providers, and fintechs are emerging and competing with incumbents. Digitalization is also reshaping customer behavior and expectations as they increasingly demand rapid onboarding, instant funds transfer, and a frictionless user experience. The pandemic has intensified these trends.

Growing regulatory scrutiny, continuously changing watchlists, and the complexities of an increasingly interconnected and international financial services ecosystem are exposing the limitations of traditional screening technology. FIs are struggling to screen growing volumes of customer and transaction data against a variety of watchlists.

Legacy technology and approach produce suboptimal outcomes in screening

Traditional screening solutions prevalent in the market today were conceived in the early 2000s, when financial services technology was much simpler and rudimentary. They are not well suited to tackle the challenges of exponentially growing transaction volumes and data complexities of the digital era.

  • Legacy screening tools struggle to effectively deal with the challenges of common names, naming conventions, and operational challenges such as spelling errors, typos, and data quality issues. On the other hand, criminals use spelling or name variants, aliases, and other means of obfuscation to evade detection.
  • Payment messages can contain complex records consisting of multiple fields. Legacy solutions are not well equipped to automatically extract relevant fields needed for screening. They also lack the intelligence for contextual analysis.
  • Another challenge is screening in foreign languages. Most screening engines were built to mainly support name screening in English or Latin characters. However, financial crime has become a global phenomenon and FIs need to screen clients across the world. The traditional approach of translating or transliterating foreign names into English for screening produces suboptimal results because it does not account for linguistic and cultural factors embedded in the data.

The methodological challenges are compounded by continuously changing watchlists. Geopolitical issues are a key trigger of frequent changes in watchlists. To improve coverage, FIs augment government lists with commercial datasets which are much larger and change frequently. Regulators expect FIs to screen transactions against the most recent watchlists and to rescreen clients within a reasonable time of list updates. So FIs must efficiently manage list updates and conduct timely screenings.

List management and frequent screening create technical and infrastructure challenges. Ingesting various watchlists in disparate standards and formats in a unified way is not easy. Another challenge is screening against relevant portions of watchlists rather than the complete lists, because commercial lists are global and exhaustive while an FI’s client base may be more limited—rendering large portions of the watchlists irrelevant. Frequent rescreening of the entire client base against large lists requires significant computing power; FIs struggle to strike the right balance between screening frequency and optimal infrastructure usage.

Growing cost of compliance due to voluminous false positives and case backlogs

Suboptimal screening techniques generate large volumes of alerts, an overwhelming share of which are false positives. Compliance analysts must then investigate and resolve the alerts. Lack of automated workflows in case management makes the investigation process highly manual and inefficient. The situation is made worse by a very high number of duplicate alerts (multiple alerts on the same customer) and repeat alerts (same customer alerted in different screening iterations despite being resolved previously). Sometimes FIs use additional rules, or even a second screening tool, to minimize false positives generated by their main screening engine.

As a result, the current approach relies heavily on optimally tuning the screening engine parameters and thresholds to keep alert generation within manageable range for an FI’s compliance team. This has resulted in a screening paradigm focused on managing workload rather than identifying criminals.

The inefficiencies in the current screening approach have resulted in exploding costs of AML programs. Celent estimates that FIs globally spent US$1.9 billion in 2020 on sanctions screening technology alone. Worse, operational expenses for dealing with and resolving alerts can be two or three times higher. In response to regulatory actions and revelations of major breaches, FIs sought to bulk up operations teams to gain trust of regulators and internal stakeholders. That approach is proving unsustainable amid growing digitalization because, in addition to ballooning costs, the inefficiencies are impacting client experience through delayed onboarding, slow or blocked transaction processing, and constraining of business operations.

Time to reimagine watchlist screening with modern technology

Modern technologies offer the opportunity to reimagine screening by significantly improving efficiency and effectiveness. For a long time, FIs have undertaken short-term, incremental fixes and ad hoc remediation programs to bring their screening processes up to the latest regulatory and technical standards. This approach has left them with little room for systematic planning in preparation for the digital era. The operational costs of maintaining legacy technology and infrastructure have now become unsustainable.

As a new era of hyper-digitalization dawns in the aftermath of the pandemic, it is now time to embrace new technologies to transform and disrupt screening.

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Posted by Arin Ray

Arin Ray is a Senior Analyst with Celent based in the firm's New York office with over a decade’s experience in tracking business, regulatory, and technology trends in financial services. He has published extensively on technology trends in financial crime compliance operations with specific focus on the role of next generation technology in combatting financial crime. His advisory engagements have included developing technology strategy, market entry and expansion strategy, and benchmarking studies for financial institutions and technology providers.