Money laundering & Terrorist financing. Risks for financial institutions

Money laundering and terrorist financing make harm to financial systems and weaken and even endanger financial institutions. The destructive impact of money laundering and terrorist financing on overall economic development is obvious. As to consequences to financial institutions like banks, insurance companies and investment management firms in more particular terms, they can be generally described as 4 types of risks.

The risks to financial institutions caused by money laundering and terrorist financing can be classified as reputational, operational, legal and concentration. However, it is often quite difficult to exemplify and distinguish them, as these risks are largely interrelated.

Reputational risk is the potential to adverse publicity as regards financial institution’s practices and result in a loss of confidence in the integrity of the institution. If institution’s reputation has been damaged by suspicions, rumours or allegations of money laundering or terrorist financing, borrowers, depositors and investors quit doing business with it. This, in its turn, increases the risk of the overall loan portfolio.

Operational risk is the potential for loss, which is a result of inadequate or failed internal processes or external events. Such losses take place when financial institutions incur reduced, terminated or increased costs for inter-bank or correspondent banking services. Increased borrowing or funding costs also belong to this type of losses.

Legal risk is the potential for law suits, adverse judgments, fines and penalties generating losses, unenforceable contracts, increased expenses for an institution or even closure of it. As a result, legitimate customers may become victims of a financial crime and sue the institution for losing money. It goes without saying that investigations also cost money and they may involve penalties and fines.

Concentration risk is the potential for loss, which is a result of too much credit or loan exposure to a single borrower. lacking knowledge about a customer and his/her business can expose a financial institution to risk.

To conclude, due diligence procedure is what helps financial institutions to understand and identify customers and to protect themselves.

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