illustration of how North American challenger banks can improve the CDD portion of their AML compliance

Many US challenger banks (also called neobanks or fintechs) focus on onboarding as many customers as possible when they first launch. This helps build a strong base, demonstrate aggressive growth, and show a strong ROI to investors. It also helps secure a high valuation from potential investors to grow the business further. But if challenger banks don’t take their customer due diligence (CDD) responsibilities seriously, they could find their plans to scale throttled by anti-money laundering (AML) regulators.

New regulations recently issued by the US Treasury Department will only add to challenger banks’ obligations. 

What New US Treasury Rules Mean for Challenger Banks

In May, the United States Treasury Department unveiled its 2022 National Illicit Finance Strategy. It  highlights four key priorities to close loopholes that criminals exploit. These measures are intended to bring greater transparency to the US financial system while reducing the threat of money laundering and terrorist financing.

The Treasury Department’s priorities include:

  1. Close legal and regulatory gaps in the US anti-money laundering/counter the financing of terrorism (AML/CFT) framework that criminals use ‒ including all-cash real estate purchases and the use of shell companies. 
  2. Make US AML/CTF regulatory framework for financial institutions (FIs) more efficient and effective by providing clear compliance guidelines, encouraging information-sharing, and fully funding enforcement and supervision. 
  3. Help law enforcement and other US government agencies combat illicit finance more effectively and deny criminals and bad actors safe havens for their operations. 
  4. Enable the benefits of technological innovation while mitigating risks and anticipate new opportunities for crime presented by emerging virtual assets. 

The aim is to get FIs to invest more in controls and to understand the beneficial ownership of the assets under their portfolio. As relative financial newcomers, US-based challenger banks need to understand what these regulations mean for their organization. 

Why Criminals Target Challenger Banks

Challenger banks make tempting targets for criminals looking to launder the profits of their criminal activities for two important reasons: a lack of customer scrutiny and a focus on onboarding speed.

  • Challenger banks often fall behind on regulatory compliance. Criminals with large sums of illegally-obtained money are always looking to exploit vulnerabilities in banks’ anti-money laundering (AML) controls. In their early days of operation, it’s very common for challenger banks to fall outside regulatory oversight because they do not have banking licenses in place at the time their products launch. In fact, some banks will not have their banking licenses in place until after a 24 hour waiting period. Criminals will seize this opportunity and use challenger banks to move their illegal funds – putting challenger banks’ entire operation at risk in the process.
  • Challenger banks focus on faster onboarding. As digital-native platforms, challenger banks often prioritize a frictionless onboarding and screening process that enables them to quickly build a customer base. At the same time, without sufficient CDD controls it also gives criminals an opening to launder illegal money.

Why CDD Needs To Be a Challenger Bank Priority

To put it mildly, this strategy carries serious risks for challenger banks – especially as they work to build their brands early. But treating CDD and AML compliance requirements as an afterthought can have serious consequences down the road. If challenger banks don’t make CDD a top priority, it could jeopardize their longer-term growth plans.

Here are three things that challenger banks should remember about CDD.

1. Financial Regulators Will Inevitably Look Into Challenger Bank Operations

While regulatory compliance may not be necessary on the first day of a bank’s operations, it will be eventually. The day will come when regulators look into how challenger banks operate. When that happens, these younger financial institutions must be prepared to explain why criminals or high-risk individuals are using their system. If CDD controls are too lax or ineffective, the banks will face serious fines, lengthy investigations, and will lose the trust of customers and investors alike.

2. Fixing Compliance Issues Is Expensive

Demonstrating strength to investors early on is important. But these efforts will prove fruitless if regulators find CDD controls are insufficient. A regulatory review could result in numerous failed control issues that could take roughly 12 months (or possibly longer) to address. This is a costly fix from a financial standpoint. It will also be a public one once the regulatory agency’s findings are released. This means challenger banks risk both financial damage and reputational damage that will put their long-term scaling plans at risk.

3. AML Non-Compliance May Result in Cease and Desist Orders 

In the worst possible situation, CDD and AML controls will be so neglected that regulators close the bank. Regulators can issue cease and desist orders to stop the bank’s operations if the bank’s controls are deemed inadequate. This is an extreme scenario, however, and would likely only apply to FIs that willfully ignore their AML obligations. Nevertheless, this is a situation no bank, challenger or legacy, ever wants to encounter.

4 Steps for Challenger Banks to Embrace Strong CDD Practices

The consequences of not taking CDD seriously can not only harm challenger banks’ ability to compete and grow. If neglected for too long, non-compliance issues threaten the ability to operate entirely. Here’s how challenger banks can embrace strong CDD practices immediately.

1. Build CDD Into Customer Onboarding

The best way for challenger banks to navigate their priorities of building their brand and fulfilling their compliance obligations is to get ahead of it. This means integrating CDD into the onboarding process. Not only will thinking about the downstream impact of CDD upfront help challenger banks save money. It will also position them to achieve regulatory compliance at a later stage.

2. Follow Best Compliance Practices  

As challenger banks focus on compliance, it’s tempting to look at what other banks have done and follow their example. It’s also tempting to treat compliance as a check-the-box task. Don’t assume that what works for one organization will work for your own or that compliance isn’t an ongoing responsibility. Consult advisory boards and experienced teams on the best compliance practices to implement for your specific organization.

3. Hire an Experienced Compliance Officer

Like all other banks, challenger banks must build a culture of compliance from the ground. This starts with hiring an experienced chief compliance officer. This individual will be responsible for setting the organization’s policies and procedures for the bank to practice. They will also be responsible for training bank staff on the importance of compliance.

4. Train Employees in Best Practices

It’s tempting to think of compliance as solely a compliance officer’s job. A vital part of any compliance officer’s job is to educate bank staff that compliance is a shared responsibility. This means that AML compliance must be understood across an organization, from the board of directors to the staff who interacts directly with customers. At each level, staff must understand their compliance obligations – from filing SAR reports to what kind of information can be shared with customers. Just as importantly, what kind of information can NOT be shared (especially for customers with suspicious activity) to avoid tipping them off.

Challenger banks may start out as smaller organizations. But they have big ambitions. Following these steps will help challenger banks meet the latest US regulatory requirements and avoid potential problems down the road. Remember not to let your organization’s growth ambitions distract you from your compliance goals. 

If you are looking for a fraud solution that provides strong digital trust, we’d like to help you. Schedule a demo with us today to see how our experts and our technology can help establish digital trust for you and your customers.