AML Customer Risk Assessment: Identifying the ML/FT risk

In accordance with the Prevention of Money Laundering Act, 2002 (PMLA) and the IFSCA (AML, CFT, and KYC) Guidelines, 2022, the reporting entities (regulated entities) are required to develop and implement robust anti-money laundering programs to combat money laundering and terrorism financing crimes. This AML program must be comprehensive and targeted to identify the financial crime risks and adopt adequate controls to manage the same. One of the critical AML measures is customer risk assessment, a crucial component of the Customer Due Diligence (CDD) process.

In this article, we shall discuss customer risk assessment or customer risk profiling, its significance, and the best practices to determine the customer risk profile effectively.

Understanding Customer Risk Assessment under the AML Program

AML customer risk assessment is a systematic process adopted to assess the financial crime risk a particular customer or business relationship poses to the business. This process shall help the entity develop a risk profile for each customer and determine the nature and degree of the customer due diligence measures to be applied to manage the assessed customer risk.

The customer risk assessment is carried out considering the various factors like:

  • Customer’s identification information, including the residential and occupational location
  • Legal structure and ownership/control structure (in case of legal person or legal arrangement)
  • Nature of the associated business activities
  • Connection with Politically Exposed Person (PEP)
  • Purpose of the given transaction or nature of the business relationship
  • Expected value and volume of the transaction
  • Person’s financial position
  • Involvement of any intermediaries or third parties

All these parameters about the customer and the proposed transaction offer great insights into the person’s risk classification, allowing the entity to reasonably categorise the customers as high risk, low risk or medium risk. When the risk assessed seems to exceed the entity’s ML/FT risk appetite, such customer must be identified as “unacceptable” unless necessary risk mitigation measures ensure the net risk is within tolerable limits.

Customer risk assessment is not limited to one-time activity while onboarding the customers. The customer’s profile is dynamic, as would be the customer’s risk rating. Hence, the regulated entities must continuously monitor the customer’s activities, identification details, transaction patterns, etc., to check if the initially developed customer risk profile is appropriate or needs re-assessment to incorporate the changes in nature of risk radiated and the control measures required.

Exploring the significance of Customer Risk Assessment under AML compliance

Customer risk assessment is a significant aspect of the Customer Due Diligence process and the overall AML compliance program that enables regulated entities to adopt a proactive approach to safeguard the business against budding threats and maintain the integrity of the business and the national economy as a whole.

Identifying the ML/FT risks

The thesis around which the AML framework revolves is the timely identification of potential ML/FT vulnerabilities and the application of necessary measures to prevent them.

By thorough analyses, if the customer risks, the regulated entities may identify the red flags associated with the given business relationship. This also empowers the entity to pinpoint the high-risk customers, exposing increased financial crime exposure.

Further, while monitoring the adequacy of the risk classification allotted to a customer, the entities monitor the customer’s conduct and transactions, resulting in the identification of suspicious activity or unusual patterns, if any.

Application of Risk-Based Approach and staying AML compliant

PMLA and the IFSCA AML Guidelines provide for adopting a risk-based approach while implementing the AML program, ensuring effective risk mitigation while optimally utilising the resources.

With the customer risk score, the regulated entities can determine the nature of risk mitigation measures to be deployed, ensuring efficient allocation of the AML resources to manage the assessed customer risk. For example, the entities must deploy Enhanced Due Diligence (EDD) measures when the customer is graded as high-risk. In contrast, in other cases, a standard customer due diligence would be sufficient.

This shall also ensure that the entities comply with the regulatory requirements for assessing the customer risk and deploying adequate measures adopting a risk-based approach, including enhanced customer due diligence and ongoing monitoring of business relationships.

Maintaining Business Reputation

The efforts around customer risk assessment demonstrate the entity’s commitment toward AML measures while ensuring a smooth and hassle-free customer onboarding process. When medium or low-risk customers are not burdened with excessive inquiries (which are otherwise necessary for high-risk customers), it boosts the customer’s confidence in the client’s business and compliance approach. It builds a maintainable reputation for the business in the eyes of the customers and other stakeholders.

Approach and Best Practices to effectively carry out AML Customer Risk Assessment

As mentioned above, customer risk assessment is a systematic process involving analysis of the customer’s details to evaluate the type and extent of risk associated with a business relationship or transaction.

The following are the best practices the regulated entity must keep in mind for AML customer risk assessment:

Developing a robust Customer Risk Assessment Program

To ensure consistency and effectiveness in customer risk assessment, it is important to document a sophisticated methodology to carry out the customer risk assessment, defining the factors to be considered for such assessment and the circumstances when the customer would be classified under high, medium or low-risk baskets. The risk assessment process must be developed considering the applicable AML regulations, the risk indicators generally observed in the business sector, and the outcome of the entity’s Enterprise-Wide Risk Assessment to make it more personalized and practicable.

This should also include the reference to the ongoing monitoring of the risk classification, its validity and the scenarios warranting change in the customer risk category.

A written set of procedures would serve as a foundation of the AML Program, guiding the compliance team to analyse the customer risk and document it appropriately and thoroughly.

360-degree review of the Customer Profile

An ideal process of customer risk assessment begins with a diligent review of the customer’s information collected during the “Know Your Customer” stage. The information to be considered for risk assessment includes personal details like:

  • date and place of birth
  • nationality
  • addresses
  • details about the beneficial owners and senior management
  • nature of business activities the customer is engaged in
  • financial profile of the customer (source of funds and source of wealth)
  • other identification details such as PEP, connection with high-risk jurisdictions mentioned on sanctions lists

This must be clubbed with transactional parameters like the nature of products and services requested, etc. For an existing business relationship, the customer’s transaction patterns and frequency, the complexity of the transaction, payment modes used, etc., must also be considered.

Only a holistic understanding of the customer can ensure that the assessed risk is appropriate, helping the entity to deploy accurate risk mitigation controls.

Continuous Monitoring of Customer Risk Profile

The regulated entity must regularly review and update the customer risk profile, considering the nexus between the original risk profile and the transactions and activities carried out during the ongoing business relationship. For this, the regulated entity must deploy robust ongoing monitoring systems that review the transactions and customer behaviour, including the relevance and accuracy of the customer’s identification details.

With ongoing monitoring, the entity can immediately identify the change in customer details or behaviour that warrants a relook at the appropriateness of the customer’s risk rating and the due diligence measures deployed.

For example, if the customer happens to be a PEP after 2 months of onboarding, the entity must quickly get a notification for the same, triggering the application of enhanced due diligence measures.

Adequate Employee Training

It is essential to create familiarity around the importance of customer risk assessment and the methodology to carry out the same. The entity must invest in regular employee training, imparting necessary education on factors to be considered for assessing customer risk, their roles and responsibilities, actionable when any anomalies are examined, etc.

Implementing the right tools and solutions for AML Customer Risk Assessment

The entity may consider deploying advanced AML solutions and software that automatically evaluates customer information and puts them into appropriate risk categories based on the evaluated information and the configured assessment rules. Further, technologies like AI and data analytics can keep track of customer transactions and activities and continuously map them with the customer risk profile to determine any inconsistencies between the two, highlighting the actional insights around the reassessment of the customer risk.

Let AML India be your partner in implementing a solid Customer Risk Assessment process!

The regulated entities must design and implement a robust customer risk assessment to assess the level of ML/FT threats the customer poses to the business, enabling the entities to deploy the required due diligence measures. In this business and compliance essential process, appoint a professional team to design and implement the customer risk assessment program for you.

With our understanding of the legislatures (PMLA, IFSCA AML Guidelines, and relevant regulations issued thereunder) and the business, we help you fine-tune your customer risk assessment template, which provides a risk score and offers insights to make an informed business and AML decision.

About the Author

Pathik Shah

FCA, CAMS, CISA, CS, DISA (ICAI), FAFP (ICAI)

Pathik is a Chartered Accountant with more than 25 years of experience in compliance management, Anti-Money Laundering, tax consultancy, risk management, accounting, system audits, IT consultancy, and digital marketing.

He has extensive knowledge of local and international Anti-Money Laundering rules and regulations. He helps companies with end-to-end AML compliance services, from understanding the AML business-specific risk to implementing the robust AML Compliance framework.