Why Is Customer Risk Assessment Essential for Financial Security?

Customer risk assessment has become a crucial process for financial organizations, including banks, neobanks, payment service providers, and digital lending companies. The goal is to filter out and recognize cyber crime before it is committed or to at least be prepared. By evaluating the risk posed by each customer, these institutions can better protect themselves from financial crimes such as money laundering, fraud, and identity theft. The rise of advanced technologies and the availability of alternative data sources have significantly enhanced the ability to assess customer risk accurately and efficiently.

This article delves into the various aspects of customer risk assessment, providing an educational overview without resorting to sales language or overtly promoting any specific platform. We will explore the key components of risk assessment, the role of alternative data and digital footprints, and the technological advancements that are shaping the future of this critical process.

What is customer risk assessment?

Customer risk assessment is a systematic process used by financial organizations to evaluate the potential risks associated with their customers. This process is essential for identifying individuals or entities that may pose a threat to the organization, whether through financial crime, fraud, or non-compliance with regulations.

The primary goal of customer risk assessment is to protect the organization and its stakeholders from potential losses and legal repercussions. By thoroughly evaluating the risk profile of each customer, financial institutions can make informed decisions about onboarding, transaction monitoring, and ongoing customer relationships.

Why customer risk assessment is important

Technology progresses at an incredible pace, creating countless ways to carry out fraud, especially in fincrime. This is where customer risk assessment steps in. As a process, it is vital for several reasons:

• Prevention of financial crimes: by identifying high-risk customers, organizations can take proactive measures to prevent financial crimes such as money laundering, fraud, and identity theft.
• Regulatory compliance: financial institutions are required to comply with various regulations, including Anti-Money Laundering (AML) laws and Know Your Customer (KYC) requirements. Effective risk assessment helps ensure compliance with these regulations.
• Protection of reputation: associating with high-risk customers can damage an organization's reputation. risk assessment helps safeguard the institution's reputation by minimizing exposure to potentially harmful activities.
• Enhanced decision-making: accurate risk assessment enables organizations to make better-informed decisions regarding customer onboarding, transactions, and ongoing relationships.

Fraud Statistics

To further prove just how powerful the impact of fraud can be, we need to examine the latest statistics. Synthetic identity fraud, for example, is projected to cost businesses approximately $5 billion in 2024 (source: Forbes).

Another huge problem is identity theft. The Federal Trade Commission (FTC) recently reported that it has received around 1.1 million reports of identity theft complaints, while in 2023, there 1 million were filed.

There are other numerous types of fraud and more statistics, all of which indicate fintech organizations and banks should be prepared to combat fraud. You can discover the latest information on similar topics, by reading Fraud Trends and Statistics in 2024. 

Other elements of risk assessment

In addition to traditional risk factors, financial institutions must consider various other elements that can influence a customer's risk profile. These factors, such as geographic risk and the types of services required, provide deeper insights into potential vulnerabilities and help enhance the overall effectiveness of risk assessment.

Geographic risk: geographic location is a critical factor in assessing customer risk. Individuals who lack permanent ties to a specific country may present higher risks compared to residents or citizens. It's important to investigate individuals conducting financial transactions away from their home or work locations. Money mules, for instance, often open accounts in various places to avoid detection and reporting of large cash transactions.

Financial institutions must carefully analyze the geographic patterns of transactions. Transactions occurring in regions known for financial crimes or those that deviate significantly from a customer's usual behavior should trigger additional scrutiny. Understanding the geographic context helps institutions identify and mitigate risks more effectively.

Service types required: the types of services a customer seeks can also indicate potential risks. Certain inquiries may signal money laundering activities. For example, questions about regular cash deposit processes or international wire transfers warrant closer scrutiny. These service-related inquiries can reveal underlying illicit intentions, requiring financial institutions to maintain vigilant observation.

By closely monitoring the types of services requested by customers, financial institutions can identify unusual patterns that may suggest fraudulent activities. Regularly updating risk assessment protocols to reflect the latest trends in financial crime ensures that institutions remain one step ahead of fraudsters.

How banks categorize risk

Banks employ customer risk scoring to evaluate the risk level associated with an individual or entity. This involves analyzing various risk factors to assign a risk score. Customer risk scoring helps financial institutions identify clients who may pose a higher risk of engaging in money laundering activities. In several countries, such as the United States, this scoring system is a legal requirement.

Risk scoring involves collecting and analyzing data on customer behavior, transaction history, and other relevant factors. By applying a consistent scoring methodology, banks can ensure that all customers are assessed fairly and accurately.

Low-risk customers
Low-risk customers are those whose identities and income sources can be easily verified by banks. Their transaction history aligns well with the profile they have provided, making them less likely to engage in fraudulent activities. These customers typically have a stable financial background and a history of compliant behavior. Financial institutions can afford to apply standard monitoring procedures for low-risk customers, allowing resources to be focused on higher-risk areas. However, continuous monitoring is still essential to detect any changes in behavior that might elevate their risk profile.

Medium-risk customers
Medium-risk customers are considered to have a higher-than-average risk. This group may include individuals or entities operating in regions known for illegal trade activities or those with less transparent financial backgrounds. These customers require more careful scrutiny and monitoring compared to low-risk customers. Banks need to apply enhanced due diligence measures for medium-risk customers. This includes more frequent reviews of their transactions and closer examination of any unusual activities. By maintaining a proactive approach, financial institutions can mitigate potential risks associated with this category.

High-risk customers
High-risk customers require extensive due diligence, particularly when their funding sources are unclear. This category often includes high net-worth individuals, nonresidents, or politically exposed persons. Banks must apply stringent measures to monitor and verify the transactions and backgrounds of these clients. Enhanced monitoring and due diligence procedures are critical for managing high-risk customers. This includes comprehensive background checks, ongoing transaction monitoring, and regular reassessment of their risk profile. By doing so, financial institutions can protect themselves from significant financial and reputational risks.

Onboarding protection with digital footprints

Digital footprints are the traces left by customers as they interact with various online platforms and services. These footprints provide a rich source of data that, when analyzed, can offer profound insights into customer behavior and potential risks. It must be said that traditional methods of assessing customer risk are simply sufficient. Financial institutions must turn to alternative data sources to gain a more comprehensive understanding of their customers. Alternative data refers to non-traditional information that can provide valuable insights into a customer's behavior, identity, and overall risk profile.

Customer risk assessment encompasses a wide range of activities, including:

• Identity verification: ensuring that customers aren’t using fake accounts or synthetic identities. Digital footprints assist in verifying the authenticity of customer identities. Cross-referencing digital footprints with other data sources ensures comprehensive identity checks.
• Behavioral analysis: analyzing customer behavior to detect anomalies and potential risks. By examining digital footprints, institutions can assess the consistency and authenticity of customer behaviors. Patterns such as transaction frequency, time of day, and interaction types help in building a reliable risk profile.
• Customer risk scoring and rating: assigning risk scores to customers based on various factors. It’s possible to utilize ready-to-use risk-scoring models to make more informed decisions based on digital signals.
• Predictive analytics: leveraging ML algorithms, digital footprints can be used to predict future behaviors and potential risks. Predictive models enhance the proactive identification of high-risk customers.

Pre-screening and alternative data analysis

Now, let’s elaborate on onboarding protection, the significance of pre-screening in preventing new account fraud, synthetic identity fraud, money muling and similar illicit activites. 

Identity pre-screening is a crucial step in the customer onboarding process for financial institutions. It involves evaluating potential customers before they are allowed to open accounts, ensuring that only legitimate individuals are granted access. This process is vital for preventing new account fraud, which can lead to significant financial losses and damage to an institution's reputation.

When conducting meticulous pre-screening, financial institutions can spot red flags early and prevent fraudulent activities before they occur. This proactive approach is essential in today's digital world, where fraudsters continuously develop sophisticated methods to exploit vulnerabilities.

In addition to pre-screening, organizations, and businesses need to conduct careful email analysis, offering valuable insights such as the email account's age, its domain provider, and any history of blacklisting. Similarly, phone number analysis is conducted to ascertain the type of line, verify geographic consistency, and confirm network authenticity.

By integrating these data points, our solution enables you to identify correlations and anomalies, transforming the collected information into actionable insights. This process leads to a more rapid and precise assessment of customer risk.

Customer risk assessment via Trustfull Identity Intelligence

Customer risk assessment is a critical component of financial security and regulatory compliance for institutions worldwide. Identity intelligence creates a safe environment for financial organizations so they can identify and mitigate potential risks. With the data and insights gathered from digital footprint analysis, it’s a lot easier to detect and prevent new account fraud, money laundering, and other financial crimes. Despite the challenges faced, advancements in technology and continuous monitoring offer promising solutions to improve the accuracy and efficiency of risk assessment.

The future of customer risk assessment will likely see increased adoption of AI, machine learning, and blockchain technology. These innovations will enable financial institutions to stay ahead of emerging threats and maintain robust security measures. 

In order to expand the fraud detection strategy of your organization, you can get in touch with our team of experts or visit our blog page to discover more news from the world of cybercrime and, of course, fraud prevention.