Adverse Consequences of Money Laundering: The Risk Tetralogy

The adverse consequences of money laundering are generally described as reputational, operational, legal and concentration risks. They are interrelated, and each has financial consequences.

  • Reputational Risk

Reputational risk is described as the potential that adverse publicity regarding an organisation’s business practices and associations, whether accurate or not, will cause a loss of public confidence in the integrity of the organisation.

As an example, for a bank, reputational risk represents the potential that borrowers, depositors and investors might stop doing business with the bank because of a money laundering scandal involving the bank. The loss of high-quality borrowers reduces profitable loans and increases the risk of the overall loan portfolio. Depositors may withdraw their funds.

Moreover, funds placed on deposit with a bank may not be able to be relied upon as a source of funding once depositors learn that a bank may not be stable. Depositors may be more willing to incur large penalties rather than leaving their funds in a questionable bank, resulting in unanticipated withdrawals, causing potential liquidity problems.

  • Operational Risk

Operational risk is described as the potential for loss resulting from inadequate internal processes, personnel or systems or from external events. Such losses occur when institutions incur reduced or terminated inter-bank or correspondent banking services or an increased cost for these services.

Increased borrowing or funding costs are also a component of operational risk.

  • Legal Risk

Legal risk is the potential for lawsuits, adverse judgments, unenforceable contracts, fines and penalties generating losses, increased expenses for an organisation, or even the closure of the organisation.

For instance, legitimate customers may become victims of a financial crime, lose money and sue the organisation for reimbursement. There may be investigations conducted by regulators and/or law enforcement authorities, resulting in increased costs, as well as fines and other penalties.

Also, certain contracts may be unenforceable due to fraud on the part of the criminal customer.

  • Concentration Risk

Concentration risk is the potential for loss resulting from too much credit or loan exposure to one borrower or group of borrowers.

Regulations usually restrict a bank’s exposure to a single borrower or group of related borrowers. Lack of knowledge about a particular customer or who is behind the customer, or what the customer’s relationship is to other borrowers, can place a bank at risk in this regard.

This is particularly a concern where there are related counter-parties, connected borrowers, and a common source of income or assets for repayment. Loan losses can also result, of course, from unenforceable contracts and contracts made with fictitious persons.

Source: ACAMS.

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