Money Laundering Typologies Neobanks Should Know to Prevent Fraud

July 11, 2022
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As the digital world continues to expand, the financial sector has opened up to new business opportunities and some significant risks.

The introduction of neobanks has offered customers digital options for banking that are convenient and accessible; however, they’ve also become a target for fraudsters looking for ways to make their money laundering schemes undetectable. 

As a result, Neobanks are susceptible to many of the same threats that traditional banks have faced for years, as well as new challenges that require anti-money laundering (AML) teams to prioritize fraud prevention and compliance with AML regulations.

To fully understand the AML challenges your neobank is facing, we’ve created a list of the types of money laundering found in neobanking, along with necessary AML regulations that you need to know about, sorted into the following sections:

By the end of this guide, you’ll have a better understanding of the types of money laundering and the importance of establishing strong AML practices. Let’s dive right into the forms of neobank money laundering you’re likely to encounter.

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10 Types of Money Laundering that Neobanks Should Be Able to Recognize & Combat

Many money laundering methods exist, and the neobanking space is no exception.

For your neobank to be able to fight back against financial crimes like money laundering and terrorist financing, your compliance team has to be aware of the ways bad actors will try to commit these offenses and establish a detection workflow based on all the possibilities. 

Below ten money laundering typologies you need to know so you can better support your neobank’s AML efforts.

1. Smurfing

Smurfing, also called structuring, is the act of moving large sums of illegal funds by making smaller transactions that avoid thresholds that would trigger AML investigations

This ensures that these smaller transactions are not treated as suspicious activity and remain undetected and unreported - allowing much more significant sums to be laundered without raising the attention of regulatory bodies.

Signs this type of fraud is occurring: 

  • Several small transactions amount to a large sum of money within one account.
  • Transactions are always just below the threshold for regulatory triggers.
  • Multiple accounts involved with many smaller transactions coinciding.
  • Numerous small deposits are paid to an overseas account, totaling a large sum.

Solution: Finely tune your transaction monitoring and suspicious activity thresholds to ensure that even the most adept attempts at laundering are detected. Watch for accounts that consistently transfer values just below the standard thresholds to catch these bad actors attempting to fly under the radar.

2. Money Mules

Money mules are individuals that move funds as part of a money laundering operation, whether they are aware of it or not. While in traditional banking, mules physically move illegal funds, in neobanking, mules can do this by virtually transferring funds via user accounts and digital wallets.

Signs this type of fraud is occurring:

  • Multiple small transactions are happening in a single account.
  • Activity is suspicious when compared to the account’s previous transactions.
  • The account holder is trying to transfer money from a deposit that hasn’t been cleared.
  • A dormant account is suddenly processing a lot of transactions.

Solution: Identity verification will play a crucial role in rooting out muling in neobanking, as you’ll be able to determine suspicious accounts and users and shut them down. Effective muling requires multiple people across jurisdictions, so monitoring networks to correctly identify the source of funds will allow you to catch virtual money mules.

3. Fraudulent Accounts

Fraudulent accounts are created using partially or entirely false information and are commonly used in money laundering so that individuals can avoid prosecution. Since neobanking is a digital service, fraudulent accounts are widely used in neobanking for laundering illegal funds. 

Fraudulent accounts themselves can also be used to launder money directly, with criminals taking advantage of free incentives - even if just to convert illicit funds to legitimate funds.

Signs this type of fraud is occurring:

  • An applicant’s name and SSN aren’t a match.
  • An applicant’s SSN is the same as another account holder with an established financial history.
  • The name attached to an account change once it has successfully been opened.
  • Only one transaction occurs before the account holder disappears.
  • The account holder appears to be unconcerned when their account is flagged.
  • A deposit occurs on the Friday or Saturday before a bank holiday, which gives the account holder time to use or transfer funds before the deposit is fully vetted.
  • A deposit is made with a stolen, forged, or counterfeit check before quickly being withdrawn.
  • An applicant is over 25 but has a newly issued SSN.
  • An applicant is over 25 with no previous financial history.
  • An unestablished business opens an account without supporting documents.

Solution: Since fraudulent accounts are frequently used for laundering money anonymously, the prevalence of these accounts will be intrinsically linked to - and an indicator of - the fraud occurring against neobanks. 

To eliminate the problem at the source, perform diligent user onboarding that complies with KYC/KYB procedural best practices, ensuring that only legitimate accounts are set up in the first place.

4. Identity Theft and Account Takeover Fraud

Identity theft (briefly mentioned above) and account takeover fraud (ATO) are both forms of financial fraud that involve using a victim’s identity. 

While identity theft involves using stolen information to open a new banking account, ATO occurs when a fraudster takes over an existing account. These are widespread methods of fraud in neobanking, as it provides an avenue to disguise illegal funds as legitimate by laundering money through previously legitimate accounts.

Signs this type of fraud is occurring:

  • An account is opened using a reported identity theft victim’s name, social security number (SSN), and/or date of birth.
  • An account holder flags the presence of unfamiliar transactions.
  • Transactions occurring within an account are uncharacteristic when compared to previous history.
  • An account has a spike in activity that coincides with a known data breach or other major event involving stolen data.
  • A sudden influx of requests for a password change.
  • Several accounts encounter multiple unsuccessful login attempts.
  • Multiple accounts contain the same information, such as SSN or email address.
  • An account is accessed from a different device or IP address.

Solution: Since digital banking is never done face-to-face, it can often be harder to determine who is operating an account. You must have a strict identity verification process to combat identity theft and ATO fraud. 

Beyond this, you need to monitor transactions for irregular and suspicious activity. By monitoring for suspicious activity, you can ensure that legitimate accounts are not compromised and used for money laundering and fraud.

Integrating software that connects your team to identity data while tracking every account’s historical data will allow for automatic detection of these types of money laundering, giving your team the power to better protect consumers and your neobanking platform. 

Learn how automating transaction monitoring and case management enabled Lili to reduce fraud loss by 50% and cut investigation times by 75%!

5. Tax Evasion

Tax evasion is the act of illegally attempting to avoid paying one’s taxes or paying less than what is owed. This is done by either making a false declaration (or no declaration at all) to tax authorities while attempting to hide the true financial data. 

Neobanks are often sought after by tax evaders who believe the speed at which these digital banking platforms can deposit and transfer funds out of the account (without having to do so in person) can help them better hide these funds and avoid detection.

Signs this type of fraud is occurring:

  • Deposits are transferred overseas quickly.
  • Account holder’s address doesn’t align with the location of various in-store transactions.
  • Larger deposits are unaccounted for on the account holder’s tax return.
  • Account holder’s SSN appears to be falsified or belongs to someone else.
  • Deposits are transferred to a different account, presumably held by a business partner.

Solution: Identifying attempts at tax evasion comes down to being able to thoroughly verify an individual’s actions, especially those done to conceal the truth. Your neobank’s compliance team needs to develop an AML model equipped with effective tracking and management tools to establish a framework for preventing and detecting tax evasion.

There are various ways bad actors can attempt tax evasion, so it’s crucial that the workflow you develop looks for issues with identification during the onboarding process, automates transaction monitoring to identify suspicious activity, and supports partnerships with government agencies and overseas financial institutions. 

This will help you to paint a complete picture of a customer’s finances and give you the ability to pinpoint these attempts at fraud better.

6. Social Engineering

Social engineering also referred to as an authorized push payment (APP) scam, is when a fraudster can manipulate an individual to either reveal sensitive information or take a desired action for their financial gain. These attempts at fraud often occur over the phone or online through emails and social media. 

Neobanking is a prime target for this type of fraud due to the anonymity associated with digital operations. Fraudsters can either trick innocent people into laundering money using their own accounts or exploit them to gain sensitive financial data that they can use.

Signs this type of fraud is occurring:

  • Transactions occur that don’t align with the account’s transaction history.
  • Large transfers are made overseas or to an uncharacteristic location of the account holder.
  • Transactions occur from an IP address that doesn’t match the one(s) typically used by the account holder.
  • A digital banking session lasts longer than 30 minutes.

Solution: The best way to combat social engineering and the myriad of fraud schemes that come with it is to offer a safe, secure user experience for your users that they can trust. Communicate clearly to your users how you will contact them and what type of information you will (and won’t) ask of them so they can identify an attempt at social engineering when it occurs.

This type of traditional banking and neobank fraud can be stressful for the victims involved, which is why neobanks should do their part to stop social engineering in its tracks. 

Along with using the right transaction monitoring software, your compliance team needs to have a solid risk management solution that can keep track of evolving phishing scams and other forms of social engineering.

7. Terrorist Financing

Terrorist financing is a form of reverse money laundering that occurs when seemingly “clean” money is used to fund terrorism. The money used to fund these illegal activities often comes from sources that wouldn’t raise any suspicions, such as charities or legitimate businesses.

These funds will sometimes undergo multiple transfers to avoid being tracked, which is why neobanks are increasingly at risk of seeing this type of fraud. In addition, the ability to transfer money quickly while also hiding the identities of everyone involved makes neobanking an attractive option for bad actors.

Signs this type of fraud is occurring:

  • Transactions that are atypical of the client’s financial history.
  • An unusually large sum of money is transferred from an account.
  • A client appears to have multiple accounts with different financial institutions for no apparent reason.
  • An atypical transfer is made to a foreign account.
  • A series of transfers are created between various accounts.
  • A client appears to be using smurfing to transfer a large sum of money.
  • Money is transferred to an account in a high-risk jurisdiction.
  • A business account transfers money to a source inconsistent with the company’s purpose.

Solution: Many cases of terrorist financing involve fraudsters with one or more high-risk factors, such as geographic location. Risks and compliance teams should work within your neobank’s organization to establish an AML risk assessment to improve their transaction monitoring to crack down on bad actors who fit the criteria for potential attempts at terrorist financing.

8. Shell Companies and Trusts

Shell companies and trusts are false entities established to hide the true identity of the owner(s). Shells will not have any actual business activity but will exist as a way of raising, storing, and moving money. 

Since neobanks don’t have the long-established regulatory operations of traditional banks, they are an ideal target for shell companies and trusts - as the operators can use them to hide and move funds to avoid regulation. In addition, because of their anonymity, shell companies and trusts are ideal choices for tax evasion and money laundering.

Signs this type of fraud is occurring:

  • The account holder’s address is located in a tax haven jurisdiction.
  • The account holder’s address is located in a jurisdiction that doesn’t match the locations the financial institution typically serves.
  • The address on file appears to be shared by multiple companies.
  • The company name attached to a business account is bland and/or meaningless.
  • Large, unexplainable transactions are made.
  • Transactions are made between a high number of recipients.
  • Unable to confirm the identity of the originator or recipient of a transfer.
  • Transactions don’t appear to match the company’s intended purpose.
  • Transfers are made to account in high-risk jurisdictions.

Solution: Critically assess new users during onboarding to ensure that you perform all pertinent KYC/KYB checks and verify their identity, reducing the amount of fraud that can occur in the first place. Don’t stop there, though, monitor regularly for suspicious activity and strange transaction patterns so that you can identify attempts to launder money when they occur.

9. Transaction Laundering

Transaction laundering, also called undisclosed aggregation or factoring, is when a legitimate business merchant processes a financial transaction on behalf of another party to conceal illicit funds and activity. 

Like money mules, the business merchant involved can be fully aware or unaware that they’re engaged in money laundering. Since many neobanks offer personal and business accounts, those involved in transaction laundering might target them as a way of quickly transferring funds and concealing the true identities of those involved in these transactions.

Signs this type of fraud is occurring:

  • Transactions occur that seem atypical for the account holder.
  • A business account transfers/receives money to/from a source that doesn’t seem to align with the company’s purpose.
  • An account holder transfers money shortly after receiving it from a third party.

Solution: Without the proper AML knowledge, it can be reasonably easy for transaction laundering to go unnoticed. This, like all the other money laundering typologies, makes it crucial for your risk and compliance team to understand the three stages of money laundering

In addition, knowing how these fraudsters navigate placement, layering, and integration with the help of a business front will help establish a focus for spotting suspicious transactions. With this information, your team can establish an AML monitoring system to detect and flag the signs that these types of transactions might occur.

10. Cyber-Laundering

Cyber-laundering is when online transactions are used to launder illicit funds. Cyber-laundering can occur in numerous ways, such as creating false e-commerce sites or crowdfunding campaigns. 

Online games, social media, and digital currencies also offer opportunities for delinquents to access or transfer funds while remaining undetected. As a digital alternative to traditional banking, neobanking is a prime target for cyber-laundering.

Signs this type of fraud is occurring:

  • An account receives funds from an e-commerce store that appears suspicious.
  • An online purchase is made from an e-commerce store that seems suspicious.
  • Funds are sent or received through online gaming, especially if atypical for the account holder.
  • Transactions occur that are out of the ordinary for the account holder.
  • A deposit is used to purchase digital currency.
  • An account holder receives various deposits from selling digital currencies.

Solution: As the digital world grows, so do cyber-laundering opportunities. To avoid these sneaky transactions, equip your AML team with a monitoring solution that will give them access to monetary and non-monetary data. Being able to paint a complete picture of a financial trail will help your team confidently determine which transactions require further investigation and confirmed instances of fraud.

Anti-Money Laundering Regulations Neobanks Should Be Aware Of (and Adhere To)

The most significant way that neobanks can fight against money laundering is by adhering to all the AML regulations in their jurisdiction. Countries like the US have introduced numerous regulations that financial institutions must follow, and neobanks are no exception to these rules. 

Failure to adhere to any of them would likely result in your neobank being fined or penalized and could significantly harm your reputation as a trustworthy service provider.

To ensure you do your part, here are some vital AML regulations that neobanks need to know in the United States (remember to check for region-specific regulations wherever you operate):

  • Bank Secrecy Act (BSA): US legislation established in 1970 that requires financial institutions to assist FinCEN with AML through record-keeping and suspicious activity reporting best practices.
  • FINRA Rule 3310: Developed in support of the BSA, this rule requires financial institutions to develop and implement a written AML program in accordance with FINRA’s guidelines to maintain compliance.
  • USA PATRIOT Act: Created in 2001 as a direct response to 9/11, this act enables the prevention, detection, and prosecution of international money laundering and terrorist financing. It also outlines financial institutions' responsibilities for preventing and reporting suspicious activity.
  • Anti-Money Laundering Act (AMLA): Part of the National Defense Authorization Act (NDAA), the AMLA details data collection and SAR sharing regulations to help financial institutions better assist the government with money laundering prevention.
  • Corporate Transparency Act (CTA) - Also part of the NDAA, the CTA allows FinCEN to maintain a database of beneficial owners. This helps financial institutions collaborate with FinCEN to prevent the use of shell companies for financial fraud.
  • MOBILE Act: A 2019 law that allows financial institutions to digitally onboard new customers by scanning identification, such as their driver’s license. It requires all neobanks and other digital banks to verify the account holder’s identity before they can use any financial services.

Neobanks are subject to many many of the regulations traditional banks must follow, and - by nature - they operate closely with traditional banks. The fact is, neobank users need to transfer funds to a neobank from where their money currently is, which is often a traditional bank. 

Since these transactions are all subject to the regulations of traditional banks, neobanks are quasi-regulated by the traditional banking system.

Beyond that, as financial institutions themselves, they are subject to many of the same regulations that apply to traditional banks. New laws are also being imposed specifically on neobanks to ensure they are properly regulated - as they function differently from traditional banks in many ways.

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Those are all the money laundering typologies that neobanks should know about. If you’re ready to scale your fraud and AML strategy, Unit21 offers a best-in-class platform for AML monitoring and compliance management. It's important to have a compliance solution that can be seamlessly integrated into your tech steck for immediate performance.

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