High-Risk Customers: Who Are They and How to Identify Them?

Getting more customers online might seem great, but is it always good for your business? Our guide is here to help you understand and recognize customers who could cause problems in the long run, also known as high-risk customers.

Financial institutions, like banks, have rules to follow. They need to be careful and check customers to stop fraud and money laundering. We'll explore high-risk customers' examples customers examples and common types, and how to identify them. But first, let's understand what we mean by 'high-risk customers.'

Who are High-Risk Customers?

High-risk customers are individuals or entities that pose a greater risk to a business or financial institution due to different factors. These factors may include a higher likelihood of involvement in illegal activities, financial instability, or a history of behavior that could lead to financial losses for the institution.

Financial institutions are required to identify high-risk customers for several reasons. One of the most important reasons is compliance with AML requirements and regulations. But what is AML compliance?

What is AML Compliance?

AML stands for Anti-Money Laundering, and AML compliance refers to the set of regulations, policies, and procedures that financial institutions and other regulated entities implement to detect and prevent money laundering and other financial crimes. The primary goal of AML compliance is to ensure that financial systems are not used for illegal activities, such as money laundering, terrorist financing, and fraud.

10 Types of High-Risk Customers

High-risk customers can fall into various categories based on their characteristics, activities, or backgrounds. Financial institutions and businesses often categorize customers as high risk due to factors that may pose a greater threat of financial loss, regulatory non-compliance, or association with illegal activities. Here are 10 common types of high-risk customers examples:

1. Money Service Businesses (MSBs): This category includes entities such as money transmitters, currency exchanges, and check cashing services, which may be at a higher risk of being used for money laundering or illicit financial activities. High-risk accounts are financial accounts that carry a higher chance of being involved in fraud or illegal activities. High-risk accounts often show unusual transactions or have connections to risky individuals.

2. Politically Exposed Persons (PEPs): PEPs are individuals who hold prominent public positions, such as government officials or politicians. These individuals are considered high-risk due to their potential susceptibility to corruption or bribery.

3. Non-Profit Organizations (NPOs): Some non-profit organizations may be considered high risk. This is true especially, if they operate in high-risk regions, ones that are known for financial irregularities, lack of transparency, or if there are concerns about funds being diverted for illicit purposes.

4. Correspondent Banking Relationships: Correspondent banking involves one financial institution providing services to another. These relationships can be high risk, especially when dealing with banks in jurisdictions with weak AML controls or inadequate regulatory oversight.

5. High-Volume Cash Businesses: High-risk businesses deal predominantly in cash transactions, such as casinos, jewelers, and luxury goods dealers.

6. Cryptocurrency and Virtual Asset Service Providers (VASPs): With the rise of cryptocurrencies, businesses involved in the exchange, transfer, or storage of virtual assets are considered high risk due to the potential for anonymity and the use of digital currencies in illicit activities. Learn more about Cryptocurrency Transaction Monitoring: Regulations and Best Practices.

7. Customers with Poor Credit History: Individuals or businesses with a history of financial difficulties, late payments, or defaults on loans may be considered high risk when assessing creditworthiness.

8. Shell Companies: Entities with no significant business operations, often created for the purpose of financial maneuvering or concealing the beneficial ownership of assets, are considered high risk. Shell companies are typically used in the third stage of money laundering, which is the integration stage.

9. Foreign Correspondents and Transactions: Customers involved in international transactions, especially in regions with a higher prevalence of financial crime or weaker regulatory controls, may be classified as high risk.

10. Sanctioned Individuals or Entities: Individuals or organizations subject to economic or trade sanctions imposed by governments or international bodies are high-risk customers due to legal and compliance concerns. The sanctions screening process is of utmost importance to identify sanctions individuals.

The Key Significance of Identifying High-Risk Customers

You might be wondering why financial institutions need to identify high-risk customers. Here are 10 key reasons why this identification is essential:

1. Preventing Money Laundering and Financial Crimes

• High-risk customers are more likely to be involved in money laundering, fraud, or other illicit financial activities.
• Identification helps financial institutions implement measures to prevent these activities, protecting the integrity of the financial system.
  

2. Compliance with Anti-Money Laundering (AML) Regulations

• Regulatory authorities mandate financial institutions to have strong AML programs.
• Identifying high-risk customers ensures compliance with AML regulations, preventing legal consequences and regulatory penalties.
  

3. Avoiding Terrorist Financing

• Some high-risk customers may be involved in providing financial support to terrorist organizations.
• Identification helps prevent the flow of funds to these entities, contributing to national and international security efforts.
  

4. Protecting Against Fraud

• High-risk customers may engage in fraudulent activities, posing a threat to the financial institution and its clients.
• Identification allows institutions to implement measures to detect and prevent fraud, safeguarding assets.
  

5. Preserving Reputation

• Associating with high-risk customers can damage the reputation of a financial institution or business.
• Proactive identification and management of such customers help maintain trust among clients, stakeholders, and the public.
  

6. Enhancing Due Diligence

• High-risk customers trigger enhanced due diligence processes.
• This involves a more thorough investigation of the customer's activities, transactions, and background, providing a deeper understanding of associated risks.
  

7. Risk Management

• High-risk customers pose a greater threat to the financial health and stability of the institution.
• Identification allows institutions to implement risk assessment strategies, mitigating potential losses.
  

8. Fulfilling Know Your Customer (KYC) Requirements

• KYC is an essential component of AML compliance.
• Identifying high-risk customers ensures that institutions have a comprehensive understanding of their customers, reducing the risk of unauthorized or illegal activities.
  

9. Meeting Regulatory Expectations

• Regulatory bodies expect financial institutions to have effective measures in place to identify and manage high-risk customers.
• Failure to meet these expectations can result in regulatory scrutiny and penalties.
  

10. Effective Allocation of Resources

• Resources and efforts can be allocated more efficiently based on the level of risk associated with different customers.
• Institutions can prioritize and focus on high-risk customers to ensure a targeted and effective risk management approach.

Red Flags and Indicators of High-Risk Customers

Recognizing warning signs and red flags helps in implementing effective risk management strategies and complying with anti-money laundering (AML) and know your customer (KYC) regulations. Here are the 12 most common red flags and potential risk indicators associated with high-risk customers:

1. Unusual Transaction Patterns

Rapid, frequent, or unusually large transactions that deviate from a customer's normal behavior may indicate potential money laundering or illicit financial activities.

2. Inconsistent Customer Information

Discrepancies in customer-provided information, such as varying addresses, inconsistent identification details, or discrepancies in business documentation, can be red flags.

3. High Cash Transaction Volume

Excessive use of cash, especially in industries where digital transactions are more common, can signal a higher risk of money laundering or fraudulent activities.

4. Relatives of the Politically Exposed Persons (PEPs)

Customers with connections to prominent political figures may pose higher corruption or bribery risks. PEP status should trigger enhanced due diligence.

5. Geographic Risk

Transactions or customers from regions known for higher levels of financial crime, corruption, or weak regulatory oversight may be considered higher risk.

6. Unexplained Wealth or Income

Significant increases in wealth or income without a clear explanation may suggest potential involvement in illicit activities. There should be an explanation of the source of wealth and source of funds. 

7. Lack of Transparent Business Activities

Customers with complex business structures, high-risk businesses, unclear ownership, or a lack of transparency in their operations may raise suspicions.

8. Frequent Changes in Beneficial Ownership

Rapid changes in the ownership structure of a business or entity can be indicative of attempts to conceal the true beneficiaries and their activities.

9. Use of Shell Companies

High-risk customers may employ shell companies with limited substance, often created to obscure the origin or destination of funds.

10. Negative Media Coverage or Legal Issues

Adverse media coverage, legal disputes, or involvement in past financial crimes are red flags that require careful scrutiny.

11. Engagement in High-Risk Industries

Businesses operating in sectors prone to money laundering or fraud, such as casinos, virtual currency exchanges, or precious metals trading, may carry higher risk.

12. Failure to Provide Adequate Documentation

Customers unwilling or unable to provide comprehensive documentation, including identification papers, business licenses, or financial statements, may be considered high risk.

How to Detect High-Risk Customers with FOCAL?

In this section, we give you three examples of how FOCAL AML Compliance Suite enables financial institutions to identify high-risk customers. 

1. Presence on the PEPs List

In the customer onboarding process, FOCAL enables you to screen customers and identify high-risk entities seamlessly. Through continuous screening and monitoring, FOCAL taps into a vast database of over 1300 real-time global sanctions, Politically Exposed Persons (PEP) lists, and adverse media. 

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2. Transaction Monitoring for Deposits Exceeding AML Threshold

FOCAL helps businesses and financial institutions monitor transactions. FOCAL ensures that organizations can effectively track and manage high-value transactions, maintaining compliance with AML regulations. Particularly in transaction monitoring, FOCAL actively examines and logs deposits surpassing a predefined threshold to meet AML compliance.

In the FOCAL platform, the threshold can be easily adjusted. Although such transactions should not be automatically blocked, having the data readily available for manual review proves beneficial, especially when preparing a Suspicious Activity Report (SAR).

3. Customizable Risk Rules

FOCAL empowers businesses by enabling them to define and implement custom rules tailored to their specific risk criteria. This flexibility allows organizations to align their rules with industry standards, compliance requirements, and risk tolerance, ensuring a personalized approach to risk assessment.

The innovative Rule Builder, a customizable, algorithm-driven tool, plays a central role in accurately evaluating potential risks associated with new customers. By fine-tuning assessment criteria, businesses can ensure alignment with both industry standards and their unique needs, thereby amplifying regulatory compliance and enabling informed decision-making.

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Conclusion

In conclusion, the importance of identifying high-risk clients cannot be overstated, as it forms the bedrock of an effective risk management strategy. Financial institutions must take proactive measures in recognizing potential risks and understanding the specific behaviors that may indicate a high-risk client.

The strategies discussed, along with the integration of advanced tools like FOCAL, highlight the industry's commitment to staying ahead in the fight against illicit activities.

FAQs

Q1. What characterizes a high-risk customer in the banking sector?

High-risk customers in banking are those with factors such as unusual transaction patterns, questionable financial history, or involvement in industries prone to illicit activities.

Q2. Identifying high-risk customers in banking: What steps can be taken?

To detect high-risk customers in banking, banks implement measures like thorough customer due diligence, transaction monitoring for anomalies, and screening against global sanction lists and politically exposed persons (PEP) databases.

Q3. What is user risk in the context of banking?

User risk in banking refers to the potential threat or likelihood of a customer engaging in activities that could lead to financial loss, fraud, or non-compliance with regulatory standards.

Q4. What industries are more prone to high-risk customers?

Certain industries, such as financial services, gambling, cryptocurrency, and international trade, are often associated with higher risk due to the potential for illicit activities.

Q5. How can technology help in identifying and managing high-risk customers?

Technologies, such as artificial intelligence and machine learning, can be employed to analyze large datasets and detect patterns indicative of high-risk behavior. Automated systems can also streamline compliance processes.

Discover how the FOCAL AI-powered AML compliance suite significantly reduced Aseel's onboarding time by over 87%.

Q6. Can I refuse to do business with a high-risk customer?

In some cases, businesses may choose to refuse or terminate relationships with high-risk customers to mitigate potential risks. However, this decision should be made in accordance with applicable laws and regulations.

Q7. How often should I reassess the risk level of customers?

Regular reviews, especially when there are significant changes in a customer's profile or behavior, are important. Continuous monitoring and periodic risk assessments help ensure ongoing compliance and risk mitigation.