Combating financial crimes in digital fast payment systems

Financial crimes exert enormous direct costs on society by supporting a wide range of criminal predicate offences, including fraud, trafficking, illegal trade in arms and terrorism.

Such crimes encompass corrupt activities that contribute to significant direct and indirect economic costs on society by diverting funds earmarked for public investment or social programmes away from their intended purpose. In addition to illegal activities, legal and illicit activities, such as tax avoidance, transfer pricing and profit shifting, undermine the delivery of public services.

These activities are supported by money laundering, which is critical to mask the source and intended recipient of the funds, to hide the amount transferred to the recipient, and to legitimise the use of the remitted funds by the final recipient.

By their nature, illicit activities are covert and therefore difficult to track.

However, the United Nations estimates that up to $2 trillion (Sh260 trillion) in funds is laundered annually. Recent innovations in digital payment systems that improve the efficiency of payments have also increased the susceptibility of payment infrastructure to financial crime. In particular, digital fast payments, which have increased in popularity in recent years, pose a major risk.

These systems are characterised by several traits, among them the execution of payments in real-time or near real-time, continuous and uninterrupted round-the-clock service availability and use in relatively low-value retail payments.

Banking payment systems

Systems that share these properties include fast payment systems within banking payment systems infrastructure, mobile money systems, which are frequently led by mobile network operators and cryptocurrencies, which are implemented as distributed systems. Fast payment systems, in particular, are new innovations in advanced economies that have been scaling up rapidly over the last decade.

According to the World Bank, about 100 jurisdictions globally have fast payment systems, and many other countries are scaling up implementation plans.

Financial crime in this ecosystem is enabled by environments that facilitate the anonymity of transmitting and receiving parties; that limit the window during which checks on transacted amounts can be performed; and that facilitate immediate and irrevocable withdrawal or further transfer of funds by the recipient party. Thus, real-time settlement and immediate availability of funds to the payee significantly increase the level of difficulty for regulatory and law enforcement authorities to react to incidences of financial crime, as any transferred proceeds can be moved immediately beyond the reach of authorities upon receipt.

In addition, the use of fast payments for retail transactions creates massive incentives for digital identity theft and fraud to perpetuate financial crime.

This is given the transparency of digital transactions and their widespread availability across a large number of individuals.

Critically, these incentives and the retail nature of fast payments put large segments of the population at risk of having their identities used to commit illegal activity, and also expose their income and savings to digital fraud. Additionally, cross-border transactions increase the burden of coordination across law enforcement agencies in investigating and prosecuting offences.

Cryptocurrencies, which also allow real-time payments and are available, have received significant attention as channels that facilitate financial crime.

Cryptocurrencies have proven attractive for financial crime due to the ability to mask a transacting party’s true identity, even when the blockchain of transactions is publicly available.However, cryptocurrencies are also highly volatile due to speculative activity on asset values, and levels of liquidity may also be lower across some cryptocurrencies relative to legal tender.

While innovations in digital fast payments have had a revolutionary impact in facilitating trade both domestically and across borders, they have also increased the range of options available to undertake illicit activity and up the level of difficulty for law enforcement and regulatory authorities to track and prevent the occurrence of illicit actions.

These activities are enabled by sophisticated techniques that mask the identity of the responsible parties, and the availability of funds to the recipient severely restricts the ability of authorities to block or reverse illegitimate transactions.

Thus, authorities require robust infrastructure to avoid falling far behind criminal activity. Mobile money systems, which share core properties with fast payment systems, offer key lessons that can inform the regulation of fast payments. One key lesson from the mobile money system is that it requires a holistic approach that addresses vulnerabilities across individuals and systems.

Illicit activity

It is important to note that a trade-off exists between the efficiency of fast payment systems and combating financial crime. Efficient, fast payment systems are more attractive for masking illicit activity.

Conversely, implementing effective controls to limit illicit activity, such as daily transfer limits, is also likely to lower the efficiency of fast payment systems.

Therefore, every jurisdiction must account for this tradeoff in the implementation of regulatory guidelines. Decreasing money laundering and fraud in digital payments is dependent on the implementation of a strong legal and regulatory infrastructure, in addition to close coordination across stakeholders and law enforcement.

The regulatory framework can be bolstered by implementing a sandbox environment that allows testing of new innovations that in turn may uncover vulnerabilities and thereby lower the risk of introducing new products. Further, the use of security certification of payments is key to ensuring that a minimum level of security standards is upheld by all institutions.

Real-time transmission of transaction messages is also central to maintaining the integrity of a payments system, but transmission messages should be secure and verifiable. More broadly, it is important to leverage data analytics and artificial intelligence to predict fraudulent trends.

The writer is the Author of “Combating Financial Crime in Digital Fast Payments: Insights from Mobile Money Systems”, commissioned by the Friedrich Naumann Foundation for Freedom