Risk Based Approach: strengths and weaknesses
In today’s financial challenging environment, institutions are exposed to numerous economic abuses making it necessary...

Risk Based Approach: strengths and weaknesses

In today’s financial challenging environment, institutions are exposed to numerous economic abuses making it necessary to activate preventive measures to decrease the risks. Among these, money laundering (ML), terrorist financing (TF), corruption, insider dealing, embargoes, and international sanctions.

The British Financial Services Authority (FSA) was one of the first regulators to promote the Risk-Based Approach (RBA), together with the Canadian and Australian financial authorities. The motivation for developing a risk-oriented framework was coming from the need of the authority to adapt to the new developments in the financial sector, a domain very advanced in the UK. Moreover, economic collapse created a need to put risk approach in the first place. In 2000 under the Financial Services and Markets Act 2000, the FSA developed 4 basic principles: the maintenance of market confidence, the provision of the appropriate degree of protection for consumers, the reduction in the scope for
financial crime, and promoting public understanding of the financial system. The way to promote these principles was for FSA to commit to a "risk-based approach". In this sense, the FSA developed the ARROW risk assessment framework ("Advanced Risk Response Operating frameWork").

Shortly followed by the Financial Action Task Force (FATF) and other international organizations that adopted and worked on the principle, publishing recommendations and guidelines. The 2012 FATF Recommendations (updated in 2018) and the relevant Guidelines published by FATF are still considered as a reference by many industry professionals. The application of an RBA is not optional, but an operational requirement for the proper implementation of the FATF Standards.

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Risk Based Approach

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RBA: an efficient risk prevention mechanism

RBA is a methodology that helps financial institutions to deal with the risks they identify. The RBA is dependent on the assessment of risks that the financial institutions have to conduct in order to apply in a later stage the RBA. Hence, it is manifest that the risk assessment forms the basis of an institution's RBA. The professionals have to look at the global picture of their business in order to use RBA appropriately. Moreover, it is important for the right implementation of RBA, that the professionals involved have followed the appropriate training and have grounded experience to evaluate the risk assessment. The applicable legal framework and the guidance as provided from the relevant authorities have to be taken into account. A common understanding of the RBA mechanisms is essential for the supervisors and financial institutions.

RBA helps financial institutions to allocate their resources in the most efficient way, meaning that the institution is able to prioritize and focus on essential risks and apply preventive measures that are commensurate to the nature of risks. Domains of risks with less importance could apply lighter measures. This approach can save the productivity and long-term gains of the institution.
The same risks can be assessed differently depending on the different industries and the business model. RBA is suitable for small companies because it provides them with flexibility, depending on the assessment of the specific risks.

Risk and Rule-Based Approach: a critical view on the new and old regime

  • 1

    The Risk-Based Approach is more flexible than the rule approach, as it leaves the possibility to the financial institutions to consider the risks in their total. The rule-based approach requires compliance with rules irrespective of the underlying risk.

  • 2

    Prioritisation is also another advantage of the RBA. The rule approach do not promote the prioritisation and all the advantages that this can bring to the business. RBA helps to the allocation of sources and this can mean more gains, less costs and less personnel.

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