Economic sanctions can be powerful tools to combat crime and rogue actors. They also imply that financial institutions must constantly monitor their customer base and their transactions. Doing so is time-consuming and expensive, while the many different lists that must be consulted make the task truly onerous. Yet not screening customers and transactions can lead to sanctions violations with large penalties. Automated sanction screening tools are really the only way forward. This article discusses how sanctions work, why sanctions matter, and what your financial institution can do to stay on the right side of the law.
For various reasons, a government, a group of countries, or local and international agencies may establish a financial ban or barrier against an individual or entire country. These barriers, also known as sanctions, can be seen to be a modern and non-violent form of warfare: blocking the ability of individuals, companies, or countries to transact financially can have severe implications on the affected parties. Sanctions can make it impossible to exchange money and buy goods and services. In turn, the affected parties may change their actions, views, or opinions to get the blocks and bans lifted. Sanctions do not always work, and their effectiveness depends on the repercussions and whether the affected parties are amiable to change.
How sanctions impact financial institutions
For sanctions to be effective, there must be a mechanism for enforcement. Governments and agencies may not be able to enforce rules in foreign jurisdictions. Still, they can create regulations around sanctions that affect domestic firms’ ability to do business with persons and organizations that are sanctioned. For example, the US cannot enforce sanctions in Russia against persons who work for Russian security services. But the US government can force US financial institutions and institutions working in partner countries worldwide to exclude sanctioned individuals and companies from the financial system.
The penalties for violating sanctions measures
Financial institutions stand to pay stiff penalties and suffer severe repercussions if they do not comply with sanction legislation. For example, Deutsche Bank was fined a collective $258m in 2015 by two US Federal agencies because the bank failed to place the required policies and procedures that would have prevented transactions with financial institutions in Iran, Libya, Syria, Burma, and Sudan. The stiff penalties were imposed on Deutsche Bank because its non-compliance meant that financial institutions in these countries could evade sanctions. There are countless examples of stiff fines, which is why financial institutions fear the implications of getting caught in a sanctions net.
Who are PEPs?
It is also worth knowing who politically exposed persons or PEPs are. While not necessarily directly targeted by sanctions, PEPs are closely related to targeted parties. Many financial institutions believe that dealing with PEPs is risky as there is a chance that sanctions may be inadvertently violated or that the PEP may behave in a way that contravenes sanctions without the financial institutions’ safeguards. At the very least, PEPs should be monitored throughout the day-to-day operations.
Avoiding the sanctions trap
Checks and balances must be implemented to alert compliance staff whenever a sanctioned party or PEP tries to enroll as a customer. These checks must also apply to existing, safe customers who try to transact with approved parties. The next step involves preventing circumvention. Merely matching against a list is not enough: institutions must adopt complex strategies to avoid letting through disguised transactions. This includes so-called “stripping” efforts where material information about a financial transaction is hidden or changed to prevent sanctions. Clearly, there’s a great deal of work involved in meeting obligations around sanctions, but what compounds the problem is the variety of different sanctions lists compiled by a range of agencies. The US Bank Secrecy Act and Patriot Act are just two US examples, while financial institutions also need to contend with the EU’s Fourth Money Laundering Directive even if they are not EU-based. It is an almost inhuman task.
Automated sanction screening is the only realistic option.
Automated systems, of course, are less encumbered by capacity issues. A sanction screening service can automatically match all transactions against a database of PEPs and sanctioned parties and flag any actions that exceed risk thresholds. Quality systems will provide additional capabilities, including detecting circumvention by, for example, intelligently matching names and addresses. While humans are often inconsistent in their day-to-day work, an automated system can offer consistent and traceable analysis. This reduces the opportunity for internal rogue actors to bypass an institution’s controls and minimize the chance of human error in terms of missed red flags and false positives. Financial institutions can essentially implement an automated system that offers sophisticated sanction screening, covering all jurisdictions and authorities. Computerized systems can do so at a lower cost and higher accuracy, greatly reducing the chances that your institution would fall foul of sanctions and be subject to extremely costly fines.