Is this a correct measure or an exaggeration?

Money launderers are increasingly using cryptocurrencies to conceal the origin and flow of illicitly obtained funds, according to Chainalysis’ latest report on money laundering and cryptocurrencies., blockchain analytics company.

The growing number of money laundering cases, including those driven by the widespread use of cryptocurrencies, highlights the growing challenge of finding the right balance between the need to ensure fair and inclusive access to banking services and the implementation of effective fraud prevention measures.

The trend of debanking by major financial institutions can be attributed to a variety of factors, including both regulatory pressure to combat financial crimes and customer dissatisfaction with traditional banking services. Thus, the intersection of debanking and fraud prevention appears to be a complex and dynamic topic in the financial industry. If we refer to the most common understanding of the term, debanking is a practice in which financial institutions deny or withdraw services to certain customers or businesses, often citing compliance with anti-money laundering (AML) and counter-terrorist financing (CTF) regulations. While these actions are intended to protect the financial system, they can inadvertently affect legitimate customers, leading to a lack of access to basic banking services.

High Risk Sectors and Debanking

This issue is particularly relevant for high-risk sectors such as cryptocurrencies, where the risk of fraud and money laundering is perceived to be higher. As the Chainalysis report highlights, blockchain technology creates both challenges and opportunities here. Blockchain technology is the foundation for decentralized banking (DeFi) applications, which provide a variety of financial services without the need for traditional intermediaries such as banks, brokers, etc. Public blockchains, while transparent and traceable, are also used by illicit actors to launder money due to their cross-border, instantaneous, and inexpensive nature. Financial institutions are using advanced blockchain analysis tools that can track transactions and detect suspicious patterns suggesting money laundering to manage these complexities. These instruments are crucial for identifying illicit activities, including cybercriminals’ use of so-called cross-chain bridges, privacy coins, and mixers to conceal the source and flow of money (details can be found in the aforementioned report).

However, the reliance on these technologies and stringent compliance measures can result in an overly generalized “broad-minded” approach to risk management, leading to the debanking of entire sectors and groups perceived as high risk. This can have significant consequences for legitimate businesses and individuals, pushing them towards less regulated and riskier financial alternatives, including cryptocurrencies.

Blockchain technology offers enormous potential to support financial inclusion by providing financial services to unbanked and underbanked populations. However, concerns about its potential impact on illicit activities and the need for a robust framework for governing cryptocurrency transactions remain important topics of discussion.

Therefore, ensuring fair and equal access to essential banking services while balancing the need to introduce strong fraud prevention mechanisms is both a solution and a real challenge.

Improved Know Your Customer (KYC) and transaction monitoring protocols, combined with cross-border collaboration and public-private partnerships, can go some way to achieving this. By leveraging data-driven insights and maintaining a risk-based approach, financial institutions can better distinguish between legal and illegal activities, reducing the likelihood of unnecessary debanking while effectively combating financial crime.

Debanking: Does it help or hinder fraudsters?

Given the complex interplay between the need for robust fraud prevention mechanisms and ensuring equal access to banking services, it becomes necessary to explore different perspectives on this issue. A recent expert panel discussion entitled “Freedom and Debanking: Has It Helped or Hurt Fraudsters?”, organized by CFAAR (Crypto Fraud and Asset Recovery Network) and Pennington Manches Cooper in London, provided valuable insights into these challenges.

Experts’ observations

Sean Kiernan, Founder and CEO of Greengage emphasized the importance of a nuanced approach to risk management: “Financial institutions need to develop more sophisticated risk assessment models that accurately distinguish between legitimate and high-risk clients. Overreliance on ‘blanket’ rules can result in the exclusion of many legitimate businesses, especially in the emerging fintech and crypto sectors.”

Heather Buchanan, Director, Bankers for Net Zerohighlighted the challenges faced by small businesses and startups. “Debanking has had a disproportionate impact on smaller businesses that lack the resources to navigate complex regulatory environments. These businesses often turn to less regulated financial services, which, paradoxically, increases their risk of exposure to fraud,” she noted.

Frederic Buret, Associate Head of Digital Asset Investigations at Grant Thornton UKoffered his thoughts on how advanced blockchain analytics tools are being used to combat financial crime. “Cryptocurrency is much more attractive to customers because they remain in possession of their funds. However, from a financial crime-fighting perspective, blockchain transparency is a double-edged sword. While it enables effective tracking of illegal activities, it also requires constant adaptation to new techniques used by criminals. Financial institutions need to stay ahead of these trends to prevent abuses while ensuring they do not stifle innovation.”

The discussion also touched on the broader implications of debanking for financial inclusion. As noted
Charlotte Hill, Panel Moderator and Partner at Pennington Manches Cooper“Financial inclusion is a key goal that should not be sacrificed in the name of fraud prevention. The key is to find a balance that protects the financial system without unfairly penalizing legitimate customers. This requires cooperation between regulators, financial institutions and technology providers to develop more sophisticated and fair policies.”

Balancing security and access

The debate around debanking and fraud prevention is complex. While the need for rigorous measures to combat financial crime is clear, it is becoming increasingly sophisticated, with Francesca Carlesi, Revolut UK CEO, recently calling it “an emergency that needs to be fought like a crime”.

Financial institutions must take a more targeted approach to risk management, using advanced technologies and data-driven analytics to distinguish suspicious illegal activities from legitimate transactions.

In this effort, cross-border cooperation and public-private partnerships are essential. As the experts on the Panel mentioned, by sharing information and best practices, stakeholders can develop more effective strategies to combat money laundering and fraud without compromising access to financial services. Improved KYC and AML protocols combined with advanced transaction monitoring systems can help achieve this balance while ensuring that the financial ecosystem remains safe and inclusive.

The ultimate goal, of course, is to build a financial system that can withstand fraud and money laundering while providing everyone with fair access to banking services. However, to achieve this ideal picture, all parties involved must maintain ongoing and continuous communication, creativity, cooperation, and intelligence sharing.