It’s said that money makes the world go around—and banks are the premier institutions in society that deal with money. So it follows that governments and regulators have put all sorts of laws and rules in place to help prevent money from going where it’s not supposed to. When banks talk about regulatory compliance, they are referring to the processes used to adhere to applicable laws and regulations in the banking sector.
But what are the regulations modern banks have to comply with, and why do they exist? Why is compliance beneficial for banks and their customers alike? What can happen if a bank doesn’t comply with regulations? How should a bank go about building a compliance program? And what new risks might banks soon have to deal with? This guide has the answers.
First, we’ll give a more specific definition of what bank compliance is.
Bank regulatory compliance is a general term for banks designing their policies and practices to align with any rules they are required to follow. This includes any applicable local government or international laws, as well as any local or international rules from financial regulatory agencies.
The main reason why compliance is important in banking is that it serves to protect a bank’s reputation and operational integrity. If money or data is stolen from a bank—or the bank is used for illegal or unethical activities, such as money laundering or tax evasion—it hinders the bank’s ability to function properly. It also damages the trust consumers, governments, and regulators have in the bank. This can lead to regulatory fines, lost business, and even sanctioning or criminal charges.
Beyond this, individual banks' contribution to compliance efforts safeguard the entire financial system. If too many banks are non-compliant, and are used for financial crime or have their assets stolen, then the entire financial system loses consumer trust. And that can cost all banks business—even those doing their part to be compliant.
Managing compliance should be straightforward enough—all organizations have to do is adhere to compliance laws and regulations. But how do organizations manage this when there are different state, federal, regional, and even industry-specific rules and regulations they have to follow?
One of the first things banks need to do is understand the types of compliance regulations that apply to their business operations and service offerings, and then analyze what controls need to be in place to meet compliance standards. To help organizations do this more effectively, we’ll break down the main types of banking compliance that apply to banks.
Risk Assessment and Management
A key part of banking compliance is understanding the problems that laws and regulations are intended to address. So a bank’s compliance team plays a critical role in identifying and evaluating all the possible inherent risks that a bank could face.
The 2008 financial crisis is often cited as a turning point regarding the increasing strictness of financial laws and regulations, along with escalating fines for non-compliance. Thus, it has also necessitated bank compliance teams becoming more involved in proactively limiting the risks they identify, rather than just pointing them out in advisory roles.
Tax Evasion Prevention
People and corporations can use certain unethical accounting practices to avoid paying taxes. These include concealing assets behind a false or stolen identity, or in a shell corporation that doesn’t have any actual business operations. Thus, bank fraud compliance teams are responsible for developing KYC/KYB policies and procedures in order to verify that clients are individuals or entities that legitimately exist and are acting in their own capacity.
Financial customers may also use fake/stolen identities, fake companies, and other tricks to make it seem like ill-gotten money is coming from legitimate sources. So as with tax evasion, bank compliance departments need to make sure customers are legitimate and are acting as themselves. They also need to monitor and analyze transactions to look for patterns where valid customers may be making fraudulent money moves on behalf of another entity.
Data security is about ensuring that sensitive information about a bank and its customers is properly protected, and is only accessed by authorized personnel in appropriate situations. If this information is stolen, leaked, or otherwise misused, it can allow certain people to impersonate others, steal money, or unethically manipulate the bank’s systems to work in their favor.
In addition to being responsible for a bank complying with its legal and regulatory obligations, the compliance team should also enforce a bank’s ethical code. It should train employees on what internal controls are in place, including explaining what unethical behavior they’re there to prevent. It should also develop a system for reporting potential ethics breaches in order to minimize non-compliance within the bank’s corporate culture.
Two of the biggest current regulatory compliance issues in banking are bank failures and bank runs. We’ll explore both—and look at real-life examples—to understand how businesses can avoid falling victim to these threats.
Banks fail when they are closed by federal or regional regulators because they cannot meet their financial obligations. These obligations can be to entities that finance them, to their customers, or both. This can happen when a bank loses too much money on its investments, so that its liabilities outvalue its assets (especially its liquid ones for meeting short-term obligations).
It’s common for a few banks to fail every year, but there are times when a high number of banks—or multiple prominent ones—fail within a short period of time. An example is the 2008 financial crisis in which over 400 banks failed within a 3-year period. More recently, in early 2023, several large regional banks—Silicon Valley Bank, Signature Bank, and First Republic Bank in the US, and Credit Suisse in Switzerland—all failed within the same month.
It’s not always easy to tell when a bank will fail. However, risk management and regulatory compliance—or lack thereof—play key roles. For example, a bank may be in trouble if:
- It delays releasing its financial statements
- There is talk about it being bought or sold
- It lays off significant numbers of non-essential employees
- It announces the closure of several regional branches
- Its customers are rapidly withdrawing their money
- It’s not exercising adequate due diligence during customer onboarding
A bank run, or run on a bank, is when several of a bank’s customers withdraw a significant amount of money from the bank all at the same time. Bank runs can cause bank failures—or at least make them more likely—because they rapidly reduce the number of liquid assets a bank has available to meet its short-term obligations.
Unfortunately, bank runs are becoming more common with the advent of fast, widespread communication over the internet. Rumors on social media of a bank being in danger of failing can spark panic among its customers, causing them to try to withdraw their money while the bank still has money to give. And electronic funds transfers allow customers to make near-instantaneous withdrawals without ever setting foot in a bank branch. Both of these factors were prominent in the March 2023 collapse of Silicon Valley Bank.
Some potential indicators of a bank run include:
- News reports or rumors of the bank’s financial troubles
- Social media posts indicating a loss of consumer confidence in a bank
- A sudden spike in withdrawals from a bank
- Customers withdrawing large amounts of money at once from a bank
- Broader economic problems, such as recessions or stock market crashes
Bank runs and bank failures can be made less likely to occur by banks having tighter compliance frameworks. This includes conducting internal audits with the necessary tools and data so that compliance teams can properly evaluate risk. In turn, they can develop and enforce the necessary internal controls to minimize risk, such as the bank maintaining an adequate percentage of its assets as liquidity.
Some of the main benefits of compliance in banking are as follows:
- Protecting against financial crime and conflicts of interest: Compliance helps protect a bank against illegal or unethical activity—either external or internal—that impacts its operations, and thus its ability to meet its obligations to creditors and depositors.
- Avoiding regulatory fines: Compliance also helps a bank avoid losing money to fines from governments and regulatory agencies.
- Preserving customer and public trust: Complying with regulations helps to protect a bank’s reputation so people will want to continue doing business with the bank (or the financial system in general).
- Fighting other types of crime: Financial crime, such as money laundering, is often linked to more widespread problems. These include illegal arms trading, human or drug trafficking, terrorism, and criminal groups that benefit from these activities. AML banking compliance helps cut off the flow of resources that makes these other forms of crime possible.
- Having better risk management: Compliance is sometimes seen as an onerous obligation, but the rules and regulations exist for a reason. They are meant to help banks avoid preventable mistakes that needlessly jeopardize operations and consumer trust.
In contrast, non-compliance can cost a bank in many different ways – as we’ll illustrate below.
Part of the importance of regulatory compliance in banking is recognizing what can happen if regulations aren’t followed. Not following required rules and laws can have the following consequences for a bank:
- Compromised operations: A bank without proper controls is more likely to have money or sensitive information stolen, disrupting its functioning. This can result from an attack by an external party, or an employee inside the bank abusing their position.
- Regulatory fines: Governments and regulatory agencies can impose fines on banks that don’t comply with required AML/CTF regulations to deter them (and other banks) from non-compliance.
- Civil liability: Non-compliance can leave a bank vulnerable to civil litigation for failing to adequately protect consumers’ assets.
- Criminal liability: If a bank is found to be complicit in financial crime because of non-compliance, the bank’s leadership group could face jail time. The bank itself may also be subject to even stricter regulatory monitoring, or may even lose its industry-required licensing.
- Sanctioning: Banks that are complicit in dangerous activities because of non-compliance may be added to sanctions lists. This can make it very difficult for them to maintain customer bases, especially if they have international clientele.
- Loss of consumer confidence: In general, non-compliance can damage the trust a bank’s customers have in its ability to manage their money. This can cause customers to switch to a competing bank, or—in a worst-case scenario—panic and go on a bank run to reclaim money they fear they won’t have access to in the near future. This can have a ripple effect that decreases consumer confidence in other banks as well, or even the entire financial system.
So if all of these bad things can happen to a bank that doesn’t comply with applicable laws and regulations, then why does non-compliance happen in the first place? Part of the reason why is how much compliance operations can cost.
The Costs of Compliance
Financial crises, like the one from 2008, have resulted in stricter and more complex regulations for banks. Accordingly, the costs of complying with these regulations continue to increase. This is why some banks, in the past, have tried to cut corners with compliance and hope that it wouldn’t end up costing them.
However, the regulatory penalties for being caught being non-compliant have gone up dramatically as well. Add in the other potential downsides of non-compliance, and compliance in banking should be seen as a way to save revenue instead of as an inconvenient expense.
To that end, regulatory technology (Regtech) solutions—like Unit21’s—make the costs of compliance much easier to bear. They allow banks to automate compliance tasks while keeping up with changes in national and international regulations. In doing so, they allow banks to have smoother onboarding processes, as well as more transparent internal and external monitoring. All of this saves banks time and money by speeding up manual processes while avoiding redundancies and human error.
Money laundering is a cornerstone of financial crime that seeks to illegally legitimize the proceeds of many other unlawful activities. These include human trafficking, drug smuggling, arms proliferation, corruption, and even terrorism. So governments and regulatory agencies around the world have stepped up their efforts to combat it over the past several decades.
As the primary institutions that deal with money, banks are on the front lines in the fight against money laundering. So it’s very important for them to be compliant with any and all applicable AML regulations. Some basic requirements for doing so are the following:
- Designate a compliance officer to oversee an AML program’s creation and management
- Document AML policies on identification, reporting, data retention, communication, etc.
- Train all relevant employees on the legal/ethical requirements of the bank’s AML policies
- Independently review and update the AML system periodically
A bank should want a senior-level staffer with influence and authority to take charge of compliance matters—both instituting them and making sure they’re followed properly. The bank’s AML policies should contain protocols for KYC, transaction monitoring, and suspicious activity reporting; they should also be developed in a way that explains how they meet the required laws and regulations.
Any bank employees who deal with customers or transactions should be instructed on what laws and regulations the bank has to follow. From there, they should be given practical training on how to screen customers and transactions properly, how to spot indicators of money laundering, and how to notify the right people if they notice something suspicious.
Of course, bank staff and financial compliance requirements change over time. So it’s good to provide refresher training to ensure consistent compliance. It’s also essential to keep an eye on legislative or regulatory developments, in case an AML compliance program needs to be redesigned to teach something new.
The previous section covered some of the basics for building and maintaining a bank compliance program. Now, we’ll offer some advanced tips for optimizing compliance operations:
1. Get the right people (not just more people) involved in compliance
In response to an average increase in laws and regulations on banking, some banks will hire additional staff in an attempt to cover all their bases. But this isn’t always the best answer, as it can increase the chance of human error when compliance tasks need to be executed manually.
Consider hiring people with prior training or experience in key bank compliance issues like anti-fraud, AML, and CFT. Top candidates should be solution-oriented, and have growth mindsets for learning about and handling new regulations and risks.
Data scientists can also be helpful, as they are good at working with analytics tools to quantify and identify patterns in activities. This makes them useful for functions such as risk assessment, transaction monitoring, link analysis, and case management. Most other obligations can be taken care of by having the right tools, as we’ll explain next.
2. Assemble an effective compliance toolkit
Having the right bank compliance solutions can save a bank significant time and money. With the right toolkit, banks won’t have to worry so much about hiring additional staff, conducting compliance tasks manually, or cleaning up mistakes caused by human error.
An example is a consolidated KYC onboarding system that can automate not only identity verification, but also customer due diligence tasks such as sanctions lists checking and PEP screening. Another is a transaction monitoring solution that’s able to integrate non-financial activity data (such as phone calls, emails, and IP addresses) to predict financial crime before it’s carried out. One more is a case management platform that allows for visual link analysis to spot suspicious activity and quickly file reports to the appropriate departments and/or authorities.
3. Understand the types of threats a bank faces
A bank should understand the tactics, techniques, and procedures of actors and processes that pose risks to it. To use money laundering as an example, criminals could create deposit accounts using fake or synthetic IDs, hire legitimate customers to deposit money and then transfer it to them (“money mules”), or break up large deposits into smaller sequential transactions to avoid suspicion (“smurfing”).
This will help the bank more accurately evaluate and mitigate its operational risks.
4. Conduct a thorough and accurate risk assessment
Once a bank understands what risks it will possibly face, it can begin to judge what risks it will likely encounter. Comparing the bank’s existing controls against the areas where the compliance team expects the bank to face the greatest pressures will highlight residual risk to shore up. These pain points can be different depending on the bank’s routines, tech stack, management structure, auditing practices, client risk profiles, and product offerings.
5. Make compliance part of the culture
Risks related to regulatory compliance are often rooted in the same causes of other risks to a bank. So it makes sense to expand compliance beyond simply the bank’s compliance team. All employees, from senior management down, should be aware of the bank’s regulatory requirements—why they exist, how to follow them in day-to-day work, and how to report concerns of non-compliance. This lightens the burden on the compliance team by reducing the risk of internal compliance-related issues.
Also, remember that a big reason for the importance of compliance in banking is preserving the bank’s reputation and customer trust. So it can also be useful to craft a consumer-facing statement that summarizes the regulations the bank is required to follow, and the practical steps the bank is taking to comply. The goal is to help customers understand why the bank’s efforts to comply with regulatory requirements helps protect their interests.
Leverage Unit21 to Build an Effective Bank Compliance Program
The future of compliance in banking will likely involve new regulations surrounding emerging financial technologies. With cryptocurrencies, as a pertinent example, banks need to be prepared to deal with how they might be regulated as they’re integrated into existing financial systems. This is especially prevalent in light of how many cryptocurrencies are semi-anonymous and have decentralized control structures.
Unit21’s no-code compliance solutions are helping leading banks meet today’s compliance standards and keep up with tomorrow’s.
Now that we've covered everything related to banking compliance, head on over to our other article to learn all you need to know about bank fraud. Check out our comprehensive banking regulatory compliance checklist to ensure you're meeting all of your bank compliance responsibilities.
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