Applying the rating agency model to financial crime

Learning from the past to change the future of Correspondent Banking

Elucidate
Elucidate
Feb 26 · 5 min read

Today, the global FinCrime risk management industry finds itself at a pivotal moment. As it stands, the global economy is more integrated than ever before. With this interconnectedness has come a marked increase in the financial crime risk borne by financial institutions operating in the global market where risk managers are now left to oversee complex international networks. In looking towards the future of the financial industry, it may be useful to look to the past, and the evolution of the credit risk industry; in its history lies a model for the future of the financial crime risk industry. It would be wise to take note.

The Lending Market of Yesteryear

In its early years, the lending market found itself at a similarly critical juncture to that at which global trade now finds itself. In its earliest stages, credit risk management was based on handshake agreements, and bilateral conversations. The industry lacked meaningful standardisation. The eventual standardisation of the industry was largely borne out of the pressures of the early 20th century American economy, where standards developed in response to an evolving secondary market for railroad industry bonds and securities. Industrialisation and a growing Western American market drove the need for financiers to connect with corporates in need of capital. As the secondary debt market grew, it led to a concurrent need for consistent and transparent pricing down the chain. In addition, as long as credit decisions were almost entirely subjectively made, some were left excluded from the credit market, limiting opportunities and economic growth.

At the present moment, the globalised trade and payments industry inhabits a space all too similar to that of the lending market firms at the time of industrialisation. It seems that the industry on the whole is awaiting that next crucial, evolutionary step. While the marketplace is different, and over a century has passed, the context and pressures are the same.

The Pressures of the Past are Alive and Well in 2020

Parallels can easily be drawn between the global Correspondent Banking space, and the lending industry of the late 18th century and early 19th century. In a sense, the situation faced by many risk managers at correspondent banks is very similar to that faced by early speculators in the newly industrialised American economy: in a rapidly expanding market, traditional methods of counterparty relationship management were and are still unfit for the task at hand. Global correspondent banking relationships are typically still managed bilaterally, with assessments being made according to subjective and variable definitions of financial crime risk, all of which result from that familiar absence of rigid standardisation. While steps have been taken to bring a common language to the industry through the work of entities like the Wolfsberg Group, the actual assessment of counterparty risk at the correspondent level lacks uniformity across the industry. From a relationship management perspective, the industry is still operating on the same terms as the debt financiers of the 1880s.

Further, trade globalisation has brought about a pressing need for the development of an effective global payment network. This need is made only more clear in light of recent trends towards regional aggregation of cross-border payments and the resulting development of a secondary payment market of sorts. This led to an increasing need for the multiple institutions involved in a single cross-border payment to share a common understanding of the financial crime risk associated with any given transfer. As previously noted, similar trends were seen as well in the later years of American industrialisation, trends which drove the standardisation of credit risk and the rise of the credit ratings industry.

With current financial crime risk management practices operating on vague and largely subjective definitions of risk, many have been left excluded from the growing global market due to the unchecked biases and unfounded assumptions inherent to a subjective decision making process. De-risking has indeed limited the access of developing and emerging economies to the global market. As in the early 20th century, these problems undoubtedly have the same cause: ineffective and ill-defined conceptions of risk, overlaid onto an archaic method of managing that risk across a complex network of business relationships. As such, many of the same pressures and drivers of change faced by early credit assessors exist as well for today’s financial crime risk managers.

The need for a shift in current practices could not be clearer, and the necessity of standardisation could not be less glaring.

Potential for Change

Exploring the change brought by the credit risk industry, enables one to understand the great potential for change financial crime risk agencies bring.

Clear standardisation of financial crime risk would provide the financial industry on the whole with far greater accuracy in risk decision making, more fairness in counterparty interactions, a more extensive and inclusive financial network, and greater transparency for all parties involved.

Further, the advent of new technologies in the machine learning and computing space present an as-of-yet unexploited resource for development within the risk management field. The capabilities of such technologies remove subjectivity and bias from the equation, providing consistent and objective reporting capabilities from day one.

Elucidate is Here to Help

This is precisely what Elucidate brings to the table. With the Elucidate FinCrime Index, Elucidate has developed the world’s first fully capable platform for financial crime risk assessment. Built using revolutionary machine technology, the EFI provides accurate, standardised, and objective assessments of financial crime risk. Built with transparency in mind, the EFI allows institutions from all over the world to easily assess their counterparty risks in a simple, yet robust manner, allowing otherwise isolated banks to stand on equal footing in the global financial market. Of course, as an algorithmically-driven and automated product the EFI is free from concerns of subjectivity and bias — your score is your score. It’s time for the industry to evolve, and the first step in the process starts with the EFI.

Elucidate

Written by

Elucidate

Elucidate is an independent ratings agency for FinCrime risk, making it simple to score, manage and price FinCrime risk through the Elucidate FinCrime Index.

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