Unveiling the Threat: How Criminals Exploit Fintech's Weak Links

In the fast-evolving landscape of digital finance, a recent joint report by FATF and Egmont raises a red flag, emphasizing the need for heightened vigilance and regulatory measures to combat potential vulnerabilities in the burgeoning realm of digital banking. The report points out that criminal organizations are increasingly channeling funds into emerging digital financial institutions, such as payment service providers (PSPs) and e-money issuers, citing potential shortcomings in their control mechanisms compared to traditional financial institutions (FIs).

Unlike their more established counterparts, digital entities may lack robust controls, creating a potential opening for criminal exploitation. The report highlights a concerning trend known as the "displacement effect," where criminals pivot toward these newer digital financial providers to sidestep the comparatively stringent controls imposed on traditional FIs. As these digital institutions become integral players in the financial ecosystem, addressing potential regulatory gaps becomes imperative.

One major concern outlined in the report is the complex web of financial relationships within the payment network of this digital era. The existence of nested financial relationships among various institutions, with payment institutions engaging in transactions with each other and providing accounts to smaller providers, intensifies the challenges associated with tracing transactions. This fragmentation hinders the prompt availability of crucial information on the originator and beneficiary of transfers.

To counteract these risks, the report advocates for resilient regulatory supervision over these newer financial institutions, emphasizing stringent licensing or registration requirements. The focus is on preventing criminals or their associates from exerting control over these entities. Regulatory authorities are urged to ensure that transacting institutions maintain thorough oversight over their perimeters, highlighting the need for proper customer due diligence (CDD) and transaction monitoring on both ordering and beneficiary nodes.

A particularly alarming trend highlighted in the report involves the exploitation of financial innovation for criminal enterprise financing (CEF) purposes, specifically through the use of virtual International Bank Account Numbers (vIBANs). While legitimate uses for vIBANs exist, criminals capitalize on the "optically identical" IBANs and vIBANs to deceive victims into believing they are transferring funds into a conventional bank account when, in reality, it could be a vIBAN directed at crediting an e-wallet.

Complicating matters, vIBANs can be reissued by a financial institution's client, making it challenging to ascertain the country of origin and the location of the master account. This exploitation of vIBANs allows criminals to "mask" beneficial ownership information and obscure the movement of illicit funds, posing significant challenges for authorities attempting to identify the true master account and issuing financial institution.

In response to these challenges, some jurisdictions have taken a crucial step by collaborating with banks issuing vIBANs to swiftly identify the payment institution linked to master accounts once CEF has been identified. As the digital financial landscape continues to evolve, the report underscores the necessity for ongoing vigilance and adaptive regulatory measures to safeguard the integrity of the financial system.

By fLEXI tEAM