Significant changes in worldwide banking regulatory practices are being brought about by organized crime, money laundering, and the movement away from military intervention.
To force banks to help monitor and confiscate illegal funds, governments worldwide are adopting powerful banking regulations that are creating "synthetic risk" banks must now manage. These rules require financial institutions to track, detect, and report deviant financial transactions or face penalties or fines.
Banks that choose to manage this synthetic risk manually will significantly complicate their operations, but those that invest in automation sensitive to these new regulatory pressures stand to gain.
Events that are causing regulatory change in the banking world include the skyrocketing drug trade and the movement away from military intervention to stop that trade.
The total annual value of the world drug trade is greater than the economies of many countries. In the United States, estimates for the amount of money changing hands each year in the cocaine business exceed $50 billion.
The size of the drug trade has reached a point at which most of the developed world is now concerned not only with the human loss that addictive substances cause but also with the political power that drug- generated wealth can provide. Drug money already has significant influence in many South American and Asian countries.
In years past, if a nation, entity, or group of individuals breached what was considered reasonable behavior, military muscle was called on.
However, as the cost of military intervention grows, the developed world is moving further away from military confrontation as a means for reining in deviant activities. And if nations like North Korea, Iraq, Libya, or Iran gain access to nuclear weapons, military intervention will become even less feasible.
Under these circumstances, financial regulatory measures are gaining popularity as a part of the solution to the drug money problem.
Consequently, banks around the world are being forced to use more powerful technology to track, detect, and report deviant financial activities.
To create a sense of urgency for banks to help manage these problems, governments worldwide are creating the synthetic risk with which banks must now cope.
In the United States, for example, the Treasury Department formed the Office of Foreign Asset Control, or OFAC, in 1993 to monitor and confiscate funds from nations, entities, or individuals that the government deems undesirable.
Banks' synthetic risk consists in potentially substantial fines for violations of these government regulations.
The mechanism for this in the United States is a list of "blocked entities" compiled by the Treasury office and distributed to banks. This list triggers the capturing of funds from transactions involving the listed parties. The office expects names to be recognized even if they are misspelled, abbreviated, or transposed.
If a bank fails to detect, detain, and report such a payment, it faces civil actions in amounts up to $10,000 per violation and criminal fines up to $500,000.
In addition, the rules of the Treasury office allow for fines of up to $250,000 against individuals involved in the criminal act of allowing such payments to be processed.
As an added incentive to bank officers, the Treasury office also has the right to request prison sentences of up to 12 years if it feels that a bank has knowingly helped make a payment to a blocked entity. Thus, by establishing the office, the U.S. government has created a new form of risk for banks to manage.
Similar demands on European bankers are being considered, but their participation is more voluntary, and the current risk is less significant.
If past trends hold true, however, their regulators will continue to increase the risk for European banks in order to align more closely with U.S. practices.
In recent years, the Europeans have led the regulatory trend toward detecting money laundering, because oftheir fear of the rising Eastern European mafia and its potential effects on Western economies.
European regulators want to keep a close eye on developments in Eastern Europe and will not hesitate to force domestic banks to manage this area of major concern.
The United States is in the process of adopting a new wave of money laundering rules that may even surpass those of the Europeans.
In the past year, the U.S. Congress passed legislation governing the control of laundered funds. Rules were adopted Jan. 3 and will take effect next Jan. 1. They require banks to make available to examiners upon request, within three to five business days, the preceding five years' transaction history by account, named individual, or intermediaries. These rules also give new policing powers to the bank examiners who insure the procedures are in place.
The current rules are soon to be followed by an even more stringent set - what have been called "know your customer" regulations. These will require pattern tracking, reporting of transaction anomalies, and more.
The impact of this new form of risk on the banking industry is enormous. Banks must manage it or face significant financial loss.
The volume of transactions to be inspected, housed, and audited numbers in the millions, making it unrealistic for most institutions to try manual compliance.
The only means for a bank of any size to manage this form of risk is to make additional technology investments. Those that choose not to invest in automation technology that is resilient to these new regulatory pressures will be unable to manage this risk effectively.
If banks do not use some kind of automated operator to check all transactions, their operations will be significantly complicated by the new anti-laundering rules.
Considering the costs associated with manually reviewing transactions, automation in the regulatory area is mandatory for banks that wish to survive.
Mr. Izzo is a senior vice president of Logica Inc. and general manager of its international funds transfer products group.