Why FinTech and Regulator Collaboration Is Vital to Fighting Financial Crime

Aston Carter

What Is FinTech?

FinTech — the universal term for “financial technology” — uses software, hardware and other technology solutions to revolutionize financial transactions. From online banking and mobile payment apps to cryptocurrency, nearly 90% of Americans use some form of FinTech to manage their money.

COVID-19’s Impact on FinTech and Financial Crime

While FinTech isn’t new, the COVID-19 pandemic accelerated industry growth and innovation as the demand for contactless payments surged. The rapid adoption and use of new technologies has made it difficult for regulators to keep pace with this disruptive industry. Regulatory controls have not matured to the level of the traditional banking system — making FinTech companies a prime target for financial crime.

Regulators have taken notice of the risks facing FinTechs — from money laundering and human trafficking to terrorist financing and other financial crimes. They are challenging FinTechs to add protections that safeguard the U.S. financial system. To strike a balance between regulation and innovation, FinTech companies must take strategic action to manage vulnerabilities and proactively shape the regulatory landscape.

Regulatory Compliance for FinTechs

Regulations and licensing vary based on a FinTech’s business model, types of products and services offered and operating jurisdiction. FinTechs that engage in financial transactions — moving money from one entity to another — are subject to similar financial crime regulations as traditional banks and financial institutions.

Evolving Financial Crime Regulations

On June 3, the Biden-Harris Administration established the fight against financial crime as a core economic and national security priority. The following month, the U.S. House of Representatives passed the ENABLERS Act — a sweeping anti-money-laundering reform in support of President Biden’s anti-corruption strategy.

The legislation would broaden the definition of a “financial institution” — closing a loophole that has enabled the exploitation of certain industries to hide money and assets within the U.S. financial system. In addition to art dealers, lawyers, investment advisors and other financial intermediaries, the bill would also include those who engage in the business of providing third-party payment services. If signed into law, FinTechs that conduct payment processing, cash vault services or wire money would be legally deemed “financial institutions.”

In addition to reporting requirements, the bill would compel certain FinTechs and other financial gatekeepers to comply with anti-money-laundering, customer due diligence, account identification and client verification requirements. The ENABLERS Act, which is attached to the annual defense bill for 2023, was considered by the U.S. Senate in early September.

Customer Legitimacy and Risk Management

In the FinTech industry, speed is key to growth. Striking a balance between customer convenience and regulatory compliance can pose significant challenges for FinTechs. One such example is federal Know Your Customer (KYC) requirements — guidelines used in the financial sector that help prevent financial crime.

KYC requires companies to collect enough personal information during the onboarding process to validate a customer’s identity, understand the nature of their activities and assess their risk for engaging in illicit activity. If a customer poses a high risk, their request to open an account may be denied.

FinTech’s Struggles With Customer Identification

The rapid pace at which customers open FinTech accounts makes it difficult to verify a customer’s identity during the onboarding process. A drawn-out approval may negatively impact a FinTech’s ability to capture new accounts as potential customers leave for a less cumbersome service. Additionally, limited credit histories for younger customers and the advancement and prevalence of fake IDs make compliance with KYC standards a significant challenge.

Alternative payment methods, such as cryptocurrencies, also create a counterparty risk for FinTech companies. Because they rely on anonymity and exist in a decentralized system, crypto payments make it nearly impossible to detect terrorist financing, sanctions violations and other financial crimes. Nevertheless, FinTechs that hold their customers’ digital wallets are inherently responsible for compliance with KYC requirements.

How Are FinTechs Impacted by Financial Crime?

The evolution of FinTech created new opportunities for financial crime. Anonymity and the ability to swiftly transfer money appeals to those seeking to exploit the financial system. FinTechs face many of the same threats as banks and credit unions, insurance companies and other businesses in the financial services sector. As a result, FinTechs must be on the lookout for:

• Economic Sanctions Violations

• Human Trafficking

• Terrorist Financing

• Money Laundering

• Bribery and Corruption

• Drug Trafficking

FinTech’s Transaction Monitoring Strategy

Monitoring customer transactions is key to managing FinTech risk and preventing financial crime. Through manual processes and the use of automated tools, companies flag unusual financial behavior or suspicious patterns for review and reporting.

One example of suspicious behavior is the rapid transfer of large amounts of money. These transfers may indicate “layering” — a money-laundering tactic that uses a series of transactions to conceal the origin of illegal funds. Strategically adding “layers” creates complexity for investigators attempting to track the funding source. This is among the methods used to evade economic sanctions.

When suspicious behavior is identified, FinTechs file a Suspicious Activity Report (SAR) with the Office of the Comptroller of Currency. Federal regulators are then responsible for investigation and enforcement.

How Can FinTechs Prevent Financial Crime?

Communication and collaboration among FinTechs and regulators are essential to fighting financial crime. Establishing partnerships between these stakeholder groups provides an opportunity to protect the U.S. financial system without jeopardizing industry growth.

FinTechs can help regulators better understand the rapidly evolving industry, including emerging products and services, trends in customer use and industry-specific challenges. Empowered with this knowledge, regulators would be better equipped to establish reasonable, forward-thinking regulations that are mutually beneficial.

By building upon established partnerships and fostering new ones, FinTechs and regulators can communicate regarding risks, crime trends and other key patterns of activity that may support faster identification of bad actors. Both stakeholders must come to the table ready and willing to identify and implement regulatory solutions that balance protection and compliance with innovation.

What Role Do Consulting Services Play in Supporting FinTechs?

A trusted consulting services partner like Aston Carter can help FinTechs navigate the complexities of an evolving regulatory landscape. In addition to understanding what federal regulations apply to your FinTech, knowledgeable professionals can support the development of strategies and risk management processes that support regulatory compliance.

To discuss how Aston Carter can partner with your organization, contact us today!

*Original article featured on Aston Carter's website.

*I provided content support for this piece.