Why banks should transform trade finance controls

By digitizing trade finance controls, banks can better address money laundering and help SMEs seize exciting international business opportunities.

In brief

• Rising trade with developing countries offers SMEs growth prospects but increases banks’ operational burden in assessing trade-based money laundering risks.
• Manual trade processes and escalating regulatory demands hinder banks’ ability to safely grow their trade finance business.
• By digitizing trade finance controls, banks improve credit and financial crime risk management, and unlock revenue opportunities for SMEs and themselves.  

Trade-based money laundering (TBML) is the process of legitimizing illicit proceeds through the use of trade transactions. With the growth of world trade, TBML techniques have become more attractive. Despite the United Nations predicting contracting economic output, Europol expects organized criminals to thrive by exploiting struggling businesses with candid offers to support them through the economic instability.

The pool of vulnerable enterprises has grown dramatically over the COVID-19 period.  EY’s 2021 global survey of more than 5,600 SMEs reveals that 74% suffered declining revenues, profit margins, and sales volumes as a result of the pandemic. Of companies that received credit during the crisis, 29% are very or extremely concerned about repayment. 

Manual trade processes hinder anti-money laundering efforts

The perfect storm of increased trade and cumbersome trade finance processes makes it easier for illicit transactions to go undetected.

Getting to know a client’s business, and monitoring it for material changes, is especially challenging. This is even more difficult when facilitating trade transactions for SMEs doing business in developing countries with limited know-your-customer (KYC) controls. The anti-money laundering think tank Global Financial Integrity estimates that 87% of illicit financial flows from developing countries are classified as TBML– that’s as much as $970b per year.

At the same time, trade with these regions forms an important part of many western countries’ economic recovery plans. The UK’s Department for International Trade (DIT), for example, recently announced a Developing Countries Trading Scheme (DCTS) that would grow commerce with up to 70 countries. Although this is good news for hard-hit SMEs, it increases the operational burden for banks trying to assess such trades for money laundering risks. 

EY data shows that as much as 30% of banks’ trade operations capacity is consumed by manual reviews for compliance. Trade transactions go through a compliance review process 2 to 4 times during a typical lifecycle.  For example, an Export Letter of Credit must be reviewed on receipt, reviewed again when associated documents are collected and amended, and reviewed once more when payments are requested or received. When you add the challenge of sourcing accurate customer information, it’s easy to see why banks struggle to safely grow their trade finance business while complying with escalating regulatory demands.

Recent focus and attention have been brought to this topic in the UK and globally by government and regulatory reviews into TBML. Recently, Her Majesty's Treasury in the UK has signaled its intention to increase monitoring of criminal infiltration of legitimate supply chains. Further, the Financial Conduct Authority (FCA) and Prudential Regulation Authority (PRA) jointly issued a “Dear CEO“ letter (pdf) in September 2021 cautioning financial institutions to mind their trade finance risk control gaps. Similarly, inter-governmental body the Financial Action Task Force, in collaboration with the Egmont Group of Financial Intelligence Units, has released detailed TBML risk indicators (pdf) that they expect banks to look for when financing trades; many cannot be spotted with manual processes alone.

Digitalization can boost the fight against trade-based money laundering 

SMEs are rapidly digitizing their businesses, turning to e-commerce and platforms to drive sales, with particularly high growth in developing regions. According to EY’s global SME survey, over the past year, use of online and mobile banking rose by 43% and 40% respectively, while visits to branches and offices declined significantly.

By tapping into the vast amounts of data created by digital customer touch points, banks have a great opportunity to deepen their understanding of SME clients, and to better monitor suspicious activities. Fintech innovations present an additional source of customer data, including accounting information, optical character recognition (OCR) of paper documents, and various specialized databases providing company information, complex legal entity relationships and ownership structures.

In addition to boosting the fight against financial crime, access to richer data enables more precise customer segmentation and enhanced knowledge of risk concentration. A large majority (82%) of SMEs taking part in EY’s global survey say they’re interested in sharing necessary intelligence with their primary financial services provider to facilitate a more profitable relationship. 

By gradually transforming their trade finance controls, banks could better support SMEs through difficult economic conditions, as well as protecting them from potential criminal abuse or sanctions violations from new trading partners.

Transforming trade finance controls through technology

In the initial transformation phase, banks should focus on digitizing their trade finance processes, and move away from burdensome paper-based operations. Once they have established a strong foundational data platform to handle both structured and unstructured data, they can then seek to drive efficiencies through the adoption of advanced analytics and artificial intelligence (AI) capabilities. Applying AI technologies can help to automate repeatable compliance processes. Beyond providing TBML “red flags”, AI could extend to export or import controls, identifying dual-use and embargoed goods, checking sanctions and detecting fraud. Customer activity monitoring can help profile entities, prioritize which alerts to investigate, and further automate the alert triage process.

Technology has great potential to improve documentation, testing, and risk governance models, meet regulatory risk-based demands, improve anti-money laundering policies, and tighten up change control procedures.

Information available via Fintech solutions can be expanded to include clients’ accounting data or digitalized paper submissions, and up-to-date company information such as global ID, business name, address, telephone number, credit risk score, records on complex legal entity relationships, and ownership structures. And, through automated analysis and monitoring, banks not only enrich their TBML detection, but can also make faster and more informed lending decisions.

If banks fail to digitally transform trade finance controls, they risk losing market share to emerging financial services providers that can offer SME clients a superior experience. EY’s survey found that 55% of SMEs are dissatisfied with banks for taking too long to assess their credit risk, and 36% are considering switching to alternative financial providers.

All the more reason to seize the opportunity presented by the shift to digital trade and harness the subsequent growth in data to deliver improved TBML prevention.

Special thanks to David Cooperman, Executive Director, Business Consulting, Financial Services, Ernst & Young LLP United States and Abhay Chauhan, APAC Director, Corporate, Commercial and SME Banking, Ernst & Young Advisory Pte. Ltd. for their contributions to this article..