Risk-Based Approach: 3 Steps to Mitigate AML Risk

A risk-based approach is a proactive framework where financial institutions identify, assess, and understand money laundering risks, then apply controls proportionate to each client’s risk level. By combining customer risk profiling, targeted due diligence, and continuous monitoring, it enables firms to focus resources on higher-risk relationships and detect suspicious activity earlier. This approach reduces compliance risk, strengthens regulatory alignment, and helps prevent financial crime more effectively.

What is a Risk-Based Approach?

The Financial Action Task Force (FATF) defines “risk-based approach” as a process where “countries, competent authorities, and banks identify, assess, and understand the money laundering and terrorist financing risk to which they are exposed, and take the appropriate mitigation measures in accordance with the level of risk.” This approach is commonly applied in various fields, including business, finance, security, and regulatory compliance.

For firms operating in the banking sector, this means enforcing customer risk profiling, a process that involves identifying, mitigating, and monitoring the risks associated with each client relationship. Consequently, organizations must manage their banking clients throughout every stage of their lifecycle - from initial KYC and onboarding through ongoing reviews and offboarding. This can keep financial firms and the wider financial services industry safe from financial crimes such as money laundering and terrorism financing.

To safeguard clients against these risks and to help them with the relevant due diligence implementation efforts, Fenergo’s Client Lifecycle Management solution allows organizations to digitize end-to-end client journeys from onboarding through offboarding. In addition, our Client Onboarding solution automates due diligence, risk scoring, and compliance for streamlined onboarding. For more details on key considerations regarding risk-based approaches to AML and KYC, visit Fenergo's Client Risk Assessments FAQs.

The Three-Step Risk-Based Approach to AML and KYC

An effective risk-based approach involves three key steps:

1. Identify and assess risk factors
2. Mitigate these risk factors by applying relevant management controls 
3. Monitor and review changes to the residual risk profile

Let's explore each step in more detail.

Step 1: Identify & Assess the Risk

This first step helps organizations understand the breadth and depth of the threats they face. It occurs before conducting Customer Due Diligence (CDD), and determines the client's risk profile. To do so, organizations must gather pertinent information by asking questions, such as:

• What industry does the client operate in?
• What jurisdictions are they operating in?
• What types of transactions are involved? Are they cash-intensive businesses?
• What is the volume and value of transactions?
• What types of third parties do they deal with?
• Who are the beneficial owners? 

The answers build a holistic client profile, which provides organizations with a panoramic view of potential risks, visualizing risks across multiple areas, including client risk, product/service risk and country risk. Once the risk factors are evaluated, clients are classified into high, medium and low-risk categories. At this stage, companies should introspect and ask themselves if they have the capabilities and expertise to handle the risk? In doing so, organizations can subsequently decide if the client is aligned with their risk appetite and proceed with the engagement or terminate the relationship.

Step 2: Risk Mitigation and Contingency Planning

Step 1 spotlights priority risks, Step 2 lays out a roadmap for their mitigation. Mitigation measures form a diverse toolkit that encompass a range of tactics, from the implementation of risk management controls to the adoption of preventive measures, risk transfer through insurance, and contingency planning:

• Risk management controls: These include Enhanced Due Diligence (EDD) practices, whereby high-risk clients undergo extensive background checks including ongoing transaction monitoring to detect any signs of suspicious activity and sanctions screening to ensure compliance with global watchlists.
• Preventive measures: These are employed in tandem with risk management controls to fortify an organization's defense against potential risks. Measures include the ongoing assessment of potential customer threats, address emerging vulnerabilities, AML training for staff and performing proactive audits to verify protocols are functioning.
• Risk transfer through insurance: This serves as a strategic maneuver to lessen potential financial impacts. For example, organizations can secure cyber insurance as a safety net against the costs of data breaches, or purchase errors and omissions insurance to absorb liability claims.
• Contingency planning: This equips the organization with the necessary knowledge to enhance its readiness for unforeseen events. Examples include emergency response plans for crisis scenarios, and testing incident response procedures through simulations.

Risk mitigation and contingency planning hinges on the effectiveness of the controls within the toolkit. The organization's attention to detail is therefore paramount, as companies will have to introspect and confront certain realities like the effectiveness of their governance structures, their policies and procedures, their KYC and due diligence functionalities, and their integration with other relevant risk assessments. In doing so, companies will gain an unbiased perspective to evaluate their contribution to compliance, risk management, stakeholder confidence, and effective decision-making.

Step 3: Monitor and Review the Residual Risk Profile

This step allows the organization to assess how well its mitigation methods match the identified risks. At the core of this phase lies the concept of residual risk – the risk that remains after inherent risks have been reduced.

Regular monitoring and reviews must occur to detect changes that affect the residual risk profile. To do so, organizations must conduct periodic reviews of their client profiles. These reviews take the form of ongoing screening for sanctions, Politically Exposed Persons (PEPs) and adverse media. They can uncover new, escalation-worthy red flags such as change of ownership, new products/services, new geographies, unusual transactions and more. Higher-risk clients undergo more frequent reviews and any red flags or alerts are escalated for further investigation. As a result, this step ensures the client profiles always align with the company's risk appetite.

Financial institutions should implement ongoing monitoring of the residual risk profiles and periodic reviews to assess the threat landscape and ensure mitigation practices remain pertinent and robust over time.

Automate Client Risk Assessment with Fenergo’s KYC’s Risk Engine

Combined with the right technology, organizations can avoid spreading their efforts and budgets thin by automating critical risk-based AML components. Technology solutions that automate risk scoring facilitate more accurate and efficient ongoing monitoring throughout the customer lifecycle, not just at onboarding. Fenergo KYC’s Risk Engine dynamically responds to inputs from a client’s KYC profile to automatically calculate risk assessments. This drives appropriate levels of due diligence, including enhanced measures for higher-risk clients. Fenergo also offers a risk-based approach to KYC compliance that efficiently focuses resources on higher risk clients and ensures lifecycle compliance with local and global KYC regulations.

Find out how our Know Your Customer-solution can improve your customer onboarding process.