UK Challenger Banks Face Increased Responsibility to Manage Financial Crime

Maturing UK Challenger Banks Have Now Got a Seat at the Regulatory Table

The FCA published the outcomes of its 2021 review of the financial crime controls at six challenger banks (Challengers)¹. The regulator’s focus on this segment of the financial industry reinforces the important place financial technology companies (FinTechs), and digitally enabled financial institutions in particular, have come to occupy in the UK’s banking ecosystem as a whole.

While the new entrants, the UK Challengers, directly compete with and share many commonalities with the traditional high street banks, their business model is more heavily focused on new customer acquisition, which dictates distinct priorities across their customer onboarding and lifecycle management.

As the FCA’s review identified, those priorities are not always aligned with customer due diligence (CDD) obligations as set out in the Money Laundering, Terrorist Financing and Transfer of Funds (Information on the Payer) Regulations 2017 (MLRs)².

Whilst the number of UK Challengers has grown steadily in recent years³, there is evidence that some investors’ confidence is beginning to fade⁴, given banks’ struggles to turn a profit - it appears that whilst the Challengers have been successful in quickly growing their customer base, moving these clients onto more profitable premium offerings has not been as easy. This may potentially create more pressure on Challenger banks to both retain customers and further grow their customer base by offering speedy onboarding and ready access to financial products such as current and savings accounts, debit cards, etc.

The Challengers have now been warned and need to re-evaluate their business models for financial crime risks and, where required, strengthen their financial crime controls frameworks in line with the following priorities emerging from the FCA’s note:

To meet their regulatory requirements in the first instance by:

strengthening CDD to include a Purpose and Nature of relationship assessment – i.e., asking fundamental questions around SoF (Source of Funds) and expected activity thus allowing for risk-profiling
using the improved CDD processes to conduct customer risk assessments enabling quantification of risks, customer segmentation and more relevant monitoring systems
building enhanced due diligence (EDD) protocols to control risks associated with higher-risk customers, e.g. PEPs (politically exposed persons), high-net-worth-individuals with links to high-risk countries, etc

To build financial crime risk management into the firm’s DNA and its long-term strategy by coordinating the development of the banks’ anti-financial crime frameworks in tandem with their market expansion.

Whilst on the face of it, it may seem like this greater onus on financial crime compliance does not easily fit with the Challengers’ business model and objective to disrupt the banking landscape, we believe that most players in this space should not fear being bound in red tape and bogged down with multi-layered governance and processes as they already have a strong infrastructure in place that can be leveraged relatively quickly to bring their ways of working in line with the FCA’s regulatory requirements. This can be achieved by prioritising the following:

Taking advantage of the existing intuitive interface to collect the CDD-level data
In contrast to, for example, global markets and corporate banking, the retail banking business is relatively uncomplicated when it comes to building a strong financial crime framework. Obtaining information and asking specific questions at onboarding is typically much easier to do over a mobile app than through letters requesting customers to provide pages of additional documentation. These questions can be formulated succinctly, with drop-down menus to choose from. They can be structured as decision trees to create a seamless digital customer journey, e.g., if the customer declares they work in a certain profession, the next question asking for their level of income or account funding amount would be specific to the level of salary expected in a given region. Any inconsistencies identified would generate a flag internally or initiate a focused customer outreach. Nowadays it is relatively common to be able to create an automated CDD journey without compromising the customer experience or customer retention rates.

Making the most of scalable IT infrastructure & data management capabilities to monitor customers’ activity more effectively
One of the strongest advantages of the Challengers, is their common model built on a single IT infrastructure with one data management solution. Such a centralised solution allows for all relevant data to be accessed almost instantly in a unified format – making it easier to holistically analyse triggers to identify and mitigate financial crime risks more easily. For example, getting an overview of a customer’s CDD information and their transactional behaviour over time as well as any pre-existing internal referrals and alerts raised, can be done at once rather than by manually consolidating data from various systems through a complicated net of spreadsheets – something that is not uncommon in traditional banks’ control environments. The fact that they do not necessarily need to embark on extensive transformation and harmonisation programmes positions Challenger banks well for creating more efficient operating models that avoid silos between various frontline and second line of defence teams.

Exploring innovative ways to fully digitise KYC and financial crime compliance more broadly
The Challengers are already extensively using advanced machine learning techniques and artificial intelligence. Coupled with a superior, more flexible IT infrastructure, this should form a strong foundation for enabling rapid change across various financial crime processes including KYC (Know Your Customer), Enhanced Due Diligence and Customer Risk Assessment. For example, machine learning can be used to predict changing risk profiles based on trigger-events and other circumstances picked up throughout the ongoing due diligence process. Challengers are already well positioned to explore smarter ways of building effective financial crime compliance. In this way AML controls can continue to evolve in line with changes to firms’ business model and growth trajectory.

How FTI Consulting can help

At FTI Consulting we work with a broad range of financial institutions and understand that financial crime typologies are rapidly evolving, with criminals becoming increasingly more digitally sophisticated. We are genuine leaders in the field of automating customer onboarding and KYC – members of our team played a lead role in the writing of the FATF guidelines on automating KYC and similar work for local regulators, and we have delivered live solutions for 15+ financial services organisation in the past 18 months.

We are the trusted advisor for financial crime for many of the world’s regulatory bodies, across multiple sectors and are sought out by businesses to provide our independent expert opinion and validation on all aspects of their financial crime prevention activities.

To find out more about our financial crime capabilities please download our service brochure or get in touch to find out how we could help your firm respond to your individual business needs.

Footnotes:

1: https://www.fca.org.uk/news/press-releases/review-weaknesses-challenger-banks-financial-crime-controls

2: https://www.handbook.fca.org.uk/handbook/EG/19/14.html

3: https://www.statista.com/topics/6290/challenger-banks-in-the-uk/#dossierKeyfigures

4: https://technologyquotient.freshfields.com/post/102gwjj/the-outlook-for-uk-challenger-banks