FCA issued warning to challenger banks about financial crime controls

According to the findings of a recent study performed by the Financial Conduct Authority (FCA), a number of challenger banks have major deficiencies in their financial crime controls and need to enhance how they assess financial crime risk.

In other cases, challenger banks did not have financial crime risk assessments in place for their customers, according to the examination, which took place in 2021.

“Our three year strategy highlights our commitment to reducing and preventing financial crime,” comments Sarah Pritchard, executive director, markets at the FCA. “This is important in creating that confidence for consumers and market participants in financial services and in demonstrating that the UK is a safe place to do business.

“Challenger banks are an important part of the UK’s retail banking offering. However, there cannot be a trade-off between quick and easy account opening and robust financial crime controls. Challenger banks should consider the findings of this review and continue enhancing their own financial crime systems to prevent harm.”

The FCA concentrated its investigation on challenger banks, which were relatively new to the market and offered a simple application process.

This comprised six challenger retail banks, the majority of which are digital banks with a combined customer base of over eight million.

The assessment found an increase in the number of suspicious activity reports filed by challenger banks, raising questions about the quality of these banks’ due diligence when taking on new customers.

The examination did uncover several examples of exemplary behaviour, such as the creative use of technology to quickly identify and authenticate clients.

The acts of challenger banks raised the eyes of both their consumers and regulators last year in a number of instances.

The FCA, for example, launched an investigation into Monzo in July after it was discovered that the challenger bank had broken significant financial crime legislation.

Prior to the event, the same bank experienced a significant service outage when hundreds of its own clients reported being locked out of their accounts in 2020.

The FCA’s current concerns about the safety, security, and validity of its services, as well as its function as a bank, are not without merit.

It’s not unexpected that Monzo announced £114 million in losses around the same period. The company’s losses then continued to rise throughout last year, peaking at £130 million.

The security failures of challenger banks have swiftly become the talk of the industry, even outside the reach of the FCA. When the German neobank N26’s anti-money laundering (AML) failures were revealed, the Bank of Italy prevented it from engaging with its customers.

This isn’t to say that the challengers are the only ones that face this problem. The FCA fined HSBC £64 million in 2021 after discovering ‘serious weaknesses’ in the bank’s procedures for detecting fraudulent activities among the millions of transactions it performs each month.

Around the same time, the FCA fined banking behemoth NatWest £265 million after the regulator discovered that the bank had failed to identify £400 million in questionable transactions.

While the report is correct in pointing out the challengers’ flaws, it is important to realise that financial crime affects all parts of the financial industry, and that not all players are ideal.

However, it may be claimed that if banks continue to be incapable of preventing, or at least reporting, crime and securing sensitive financial data, they should be stripped of their licence to operate.

What is the opinion of the industry?

Dr. Henry Balani, Encompass Corporation’s global head of industry and regulatory affairs, says: “Challenger and digital banks have experienced tremendous growth in their customer bases in recent years, however, this rapid scaling has meant that compliance programmes have not always kept pace. Dealing with increased volumes of customers and transactions while expanding into new markets has added complexity to anti-financial crime initiatives.

“Adopting best-of-breed KYC automation is the only way for banks, specifically, to effectively address the problem. Using innovative technology ensures continued high standards of compliance at scale, while improving the customer journey and experience.

“Challenger banks have a reputation for being digitally advanced, but the need to maintain high levels of customer growth, while managing increasing financial crime risks, requires continued innovation.”

Colum Lyons, CEO of the identity verification company ID-Pal says: “The challenges highlighted in the FCA’s review are not unique to challenger banks, and all financial services companies should have rigorous processes in place to protect their business and their customers from financial crime.

“The regulator is being very vocal that scrutiny across financial services is going to increase in the coming months and years, so it’s vital that companies get their controls in place to avoid serious monetary and reputational damage.

“The only way to do that is to adopt proper identity checks, so it’s promising that the FCA is recognising the benefits of digital ID&V services as good practice for businesses to identify and verify customers quickly. Customers want speed and efficiency, and these tools help financial services meet the demands without cutting corners or letting compliance slip.”

Stephen Baker, CEO of Baker & Partners, said: “Is it too obvious to say that challenger banks present a challenge? The original challenge was intended to be against the established high streeters, but the challenge has developed from a commercial one to a regulatory one. And a big one at that.

“While it is true that challengers are out of their infancy, it is probably fair to say that they are still in very early adolescence. The analogy is decent. Challengers are fresh, exciting and agile, but there are growing pains, most notably associated with risk-taking which is often unconscious.

“Challengers depend on technology, notably mobile tech, which, with the ideas behind it, grows at an almost unfathomable pace. It seems inevitable that existing methods of regulatory compliance have not kept pace internally with the challengers.

“The risks are patent: loss of customer funds, data loss and money laundering are high among them. How is all of this to be viewed? History helps. Any innovation of worth has suffered early setbacks but has survived and the worst dangers designed out by refinements. They have survived because their utility has been irreplaceable.

“We predict the same journey for the challengers and it is of comfort to note that the FCA is abreast of the problems so that lessons will be learnt and incorporated into what remains a highly valuable offering.”

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