MASTER IN FORENSIC ACCOUNTING & FINANCIAL CRIMINOLOGY

MAF 721 - RISK MANAGEMENT

Individual Assignment Money laundering Regulation and Risk Based Decision-Making

For:Dr Sharifah Khadijah Syed Agil

Prepared by:

Ameer Shafiq Kamalullail

A countrys regime to counter money laundering and the financing terrorism has three primary objectives. The first is to deter money launderers and terrorist financiers from using the countrys financial system for illicit purposes. The second is to detect ML and TF as and when they occur, and the third is to prosecute and punish those involved in such illegal activities.

Money laundering is a serious crime that affects the economy as a while, impeding social, economic, political and cultural development of societies worldwide. The adverse consequences for institutions are generally described as;

Reputational Clients that provide a stable deposit base and make reliable borrowings may lose confidence towards an institution which is connected with money laundering and would result to take their business elsewhere. Transactional Impaired internal processes or relations with other banks impede the institution, or raises its cost of operating and funding Legal There is a risk of lawsuits, adverse judgements, unenforceable contracts, fines, and penalties, which may include license withdrawal and management dismissal.

An effective AML/CFT regime requires significant collaboration and cooperation from the countrys stakeholders in the public sector.

A Risk Based Approach

The purpose of Risk-Based Approach is life insurance companies and intermediaries are able to ensure that measures to prevent or mitigate money laundering (ML) and terrorist financing (TF) are commensurate to the risks identified. This will allow resources to be allocated in the most efficient ways. The principle is that resources should be directed in accordance with priorities so that the greatest risks receive the highest attention. The alternative approaches are that resources are either applied evenly, so that all life insurance companies and intermediaries, customers, products could receive equal attention, or that resources are targeted, but on the basis of factors other than the risk assessed.

The risk-based approach places the responsibility on management to identify and assess the money laundering and terrorist financing risks and to take appropriate measures to identify, manage and monitor those risks. Risk-based approach to money laundering as covering:

Risk identification and assessment identifying the money laundering risks facing a firm (including related legal, regulatory and reputational risks) given its customers, product and services profile and having regard to available information including published typologies and assessing the potential scale and impact of the risks if they were to crystallise.

Risk mitigation identifying and applying measures effectively to mitigate the material risks emerging from the assessment.

Risk monitoring putting in place management information systems and keeping up to date with changes to the risk profile through changes to the business or to the threats.

Documentation having policies and procedures that cover the above and deliver effective accountability from the board and senior management down. Documenting the risk assessments undertaken to provide the rationale for decisions made.Financial institutions that rely on the proceeds of crime have additional challenges in adequately managing their assets, liabilities and operations. The adverse consequences of money laundering are generally described as reputational, operational, legal and concentration risks. They are interrelated, and each has financial consequences, such as:

1. Loss of profitable business2. Liquidity problems through withdrawal of funds3. Termination of correspondent banking facilities4. Investigation costs and fines5. Asset seizures6. Loan losses7. Reduced stock value of financial institutions

Reputational risk is described as the potential that adverse publicity regarding an organizations business practices and associations, whether accurate or not, will cause a loss of public confidence in the integrity of the organization. As an example, for a bank, reputational risk represents the potential that borrowers, depositors and investors might stop doing business with the bank because of a money laundering scandal involving the bank. The loss of high-quality borrowers reduces profitable loans and increases the risk of the overall loan portfolio. Depositors may withdraw their funds. Moreover, funds placed on deposit with a bank may not be able to be relied upon as a source of funding once depositors learn that a bank may not bestable. Depositors may be more willing to incur large penalties rather than leaving their funds in a questionable bank, resulting in unanticipated withdrawals, causing potential liquidity problems.Operational risk is described as the potential for loss resulting from inadequate internal processes, personnel or systems or from external events. Such losses occur when institutions incur reduced or terminated inter-bank or correspondent banking services or an increased cost for these services. Increased borrowing or funding costs are also a component of operational risk.

Legal risk is the potential for lawsuits, adverse judgments, unenforceable contracts, fines and penalties generating losses, increased expenses for an organization, or even the closure ofthe organization. For instance, legitimate customers may become victims of a financial crime, lose money and sue the organization for reimbursement. There may be investigations conducted by regulators and/or law enforcement authorities, resulting in increased costs, as well as fines and other penalties. Also, certain contracts may be unenforceable due to fraud on the part of the criminal customer.

Concentration risk is the potential for loss resulting from too much credit or loan exposure to one borrower or group of borrowers. Regulations usually restrict a banks exposure to a single borrower or group of related borrowers. Lack of knowledge about a particular customer or who is behind the customer, or what the customers relationship is to other borrowers, can place a bank at risk in this regard. This is particularly a concern where there are related counter-parties, connected borrowers, and a common source of income or assets for repayment. Loan losses can also result, of course, from unenforceable contracts and contracts made with fictitious persons.

Most significant laundering and terrorist financing risks in the insurance industry are found in life insurance and annuities products. While many life insurance policies are generally structured to pay a certain sum upon the death of the insured, others have an investment value which can create a cash value if the policyholder wishes to cancel the policy. Life insurance policies that have an investment feature, which can increase the death benefit as well as the cash value of the policy, are often referred to as whole life or permanent life. Vulnerabilities in the insurance sector include:

Lack of oversight/controls over intermediaries

Insurance brokers have a great deal of control and freedom regarding policies.

Decentralized oversight over aspects of the sales force

Insurance companies may have employees (captive agents) who are subject to the full control of the insurance company. Non-captive agents, those who offer an insurance companys products, but are not employed by an insurance company (i.e., the noncaptive agent will often work with several insurance companies to find the best mix of products for their clients) may fall between the cracks of multiple insurance companies or may work to find the company with the weakest AML oversight if they are complicit with the money launderer.

Sales-driven objectives The focus of brokers is on selling the insurance products and, thus, they often overlook signs of money laundering, such as a lack of explanation for wealth or unusual methods for paying insurance premiums.

Impact of Non-Compliance

1. Economic Distortions

Due to money laundering, the development is distorted as products are supplied at a price lower than production cost, making it difficult for others to stay alive in the competition. The overall productivity of the economy of a country can be decreased. The demand for money in our country will unpredictably fluctuate and the international exchange rates and cash flow will also become unstable. Studies from The BASEL AML Index, Country Risk Ranking shows that Malaysia AML Risk is moderate where Malaysia was ranked 102 out 162 countries and our risk score is 5.41 which is classified as moderate. Assessment from BASEL and APG is very important in order to have the confidence level of foreign investor to invest in Malaysia which would however affect our economy as a whole. Weak law enforcement to anti-corruption and bribery, heighten the risk of money laundering in the country. It was mentioned that the amount of worldwide money laundering is problematic, the International Monetary Fund has estimated that between 2% and 5% of global GDP per year is generated annually as the proceeds of crime (in US funds that is an amount in the trillions of dollars), the largest sources of which are illicit drug manufacturing and trafficking, arms and people smuggling, corruption, fraud, extortion, kidnapping and theft.

2. Erosion of Financial Sector

The cash flow of laundered money that runs into and out of our financial system will weaken our financial markets. Financial institutions will lose their reputation and subsequently the stakeholders will lose trust and goodwill in these institutions. Severe cases of money laundering might cause bank failures and financial collapse.

3. Reduction in Government Revenue

The tax income is reduced due to money laundering and the government finds it is difficult to meet up the expected revenue target (loss of government income) that can be collected from the illegal transactions of money laundering.

4. Socioeconomic Costs

Dirty money coming from criminal acts are laundered to be a cleaned. Current criminal operations are expanding and new criminals are being funded using the laundered money. Money laundering also can affect the economic power of the government and citizens to the criminals initiating more corruption and crimes.2