The Clock Is Ticking: Complying with New Global Financial Regulation; Financial Institutions Are Facing Growing Pressure to Meet International Standards on Anti-Money Laundering and Other Regulatory Challenges. but Technology Can Help Ease the Burden. (Technology Supplement)
Wells, Stephen, Journal of Banking and Financial Services
World terrorism, corporate collapses and the advent of internet banking have all contributed to financial institutions being subject to increasing regulation. Pressure is also growing on international banks and institutions to monitor and control their transactional activity to prevent fraud and money laundering.
The US Patriot Act, passed after September 11 2001, introduced legislation allowing the American government to scrutinise funds suspected of links to terrorism and drug crime.
The US Office of Foreign Assets, which administers the Patriot Act, is also increasingly focused on suspicious funds arriving from abroad. Banks and institutions around the world are being asked to provide financial information regarding cross-border settlement to international regulators on a daily basis.
This growing concern with international regulation has placed considerable focus on global financial standards. In June 1999, the Basel Committee on Banking Supervision issued the first of three consultation papers on revisions to the 1988 Basel Capital Adequacy Accord. The proposed new provisions are designed to increase global regulatory compliance by financial institutions.
Although there is currently no legal obligation for Australian institutions to comply with the Basel Accord, the Australian Prudential Regulation Authority (APRA) is keen for Australian banks and institutions to meet these new standards, due to be ratified by the end of the year. International circumstances demand that financial institutions meet exacting global standards that eventually will become legally enforceable.
Financial institutions in the US are already subject to strict reporting requirements under the Proceeds of Crime (Money Laundering) and Terrorist Financing Act and Regulations. Institutions failing to report transactions as prescribed by the Act are liable to severe penalties.
Broadway National Bank in New York, for example, was fined $US4 million in November 2002 for failing to file suspicious activity reports. Western Union First Data Corporation was also fined $US8 million for similar non-compliance. The US Office of Foreign Assets would like this situation to apply to all internationally operating banks, including those in Australia.
Basel and operational risk
APRA describes the Basel Committee on Banking Supervision as the "de facto global standards maker for internationally operating banks". It is urging Australian banks to consider what they are going to do to meet the new operational and technical requirements of the new Accord.
Known as Basel II, these provisions set tighter operational regulations aimed at reducing institutional risk and controlling fraud and money laundering, while refining the original provisions to facilitate compliance.
Essentially, the 1988 Accord determines the amount of capital a bank or financial institution must have available to limit its insolvency risk and the potential cost of this for depositors. Under the existing guidelines, banks notionally set aside capital amounting to eight per cent of the value of each loan they make. In practice, the amount of capital set aside is determined by risk weightings.
Basel II outlines the minimum capital adequacy required of banks and financial institutions to cover their financial exposure. It includes guidelines to managing the process of determining risk in investments and loans and emphasises operational risk as a primary consideration in risk weighting.
It also attaches greater importance to institutional risk management strategies, internal control systems, regulatory reporting and market discipline.
The Bank for International Settlements Committee has recommended that internationally active institutions should formally make a capital provision against operational risk. Under the Basel II provisions, an institution's level of compliance determines capital adequacy. …