Variations in suspicious activity reports : an exploration into the factors that may explain why reporting levels

Abstract

The risk-based approach (RBA) was initially introduced in 2013 by the Financial Action Task Force (FATF) as a solution to the increasing volumes of suspicious activity reports (SARs) filed by regulated entities and the subsequent workload on enforcement authorities. However, since then, suspicious reports have not shown a dramatic decrease in volume but has in fact been increasing, suggesting a potential relationship between the two. One of the main reasons surround the uncertainty and ambiguity that both regulators and regulated entities face when interpreting what constitutes low, medium or high risk when it comes to assessing risk in their own context. This is highlighted from AML activities such as identification of politically exposed persons and beneficial owners as well as the risk categorization of countries. To investigate this potential relationship, a regression analysis is performed using SAR data on compliance scores from the 4th round of Mutual Evaluation Reports (MERs). Mutual evaluations are a process for FATF to understand how well a country is performing on each of their 40 recommendations (FATF, 2021) thus the scores from these reports act as an indicator for how closely a country follows the RBA recommendation from FATF. The results indicate that there is a significant and positive relationship between the two variables. Countries that achieve higher scores, which indicate that they follow the RBA closely (in large part due to potential fines and exclusion from the global financial system), file more SARs. Because some institutions may choose not to follow this approach so closely, variations across countries occur. This suggests that the description of the RBA is too broad and ambiguous, leaving each country’s regulators and regulated entities uncertain as to what constitutes low or high-risk activity. To hedge against this uncertainty and err on the side of caution, regulated entities rather choose to report transactions on the border of being suspicious, contributing to a problem known as defensive reporting, leading to a further increase in SAR volumes. When SAR volumes are too high, each subsequent report loses credibility thus diminishing the value that the SAR regime can provide, what is termed the phenomenon of the ‘Crying Wolf’. The outcome of this analysis provides a starting point towards the conversation that indeed, the risk-based approach does contribute to increased SAR levels and variation across countries. Consequently, the risk-based approach can be further refined to reduce uncertainty that governments, regulators and regulated entities face. Hopefully, by doing so, the value of reporting suspicious activity is preserved and allows SAR levels to be used as a meaningful indicator of the effectiveness of AML regimes.