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

2021

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.