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The Critical Failures in KYC/AML Control Testing - What Banks Need to Know
The Critical Failures in KYC/AML Control Testing - What Banks Need to Know

May 9, 2025

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In recent years, financial institutions worldwide have faced unprecedented regulatory scrutiny regarding their Know Your Customer (KYC) and Anti-Money Laundering (AML) controls. The consequences of compliance failures have been severe and far-reaching: billions in fines, downgraded regulatory ratings, restricted business operations, and significant reputational damage that erodes customer trust and shareholder value.

For banks and financial institutions operating in this high-stakes environment, robust internal control testing has emerged as the critical first line of defense against compliance failures. Yet despite massive investments in compliance technology and personnel, many institutions continue to struggle with fundamental control weaknesses that expose them to regulatory action.

Based on an analysis of recent global regulatory enforcement actions and audit findings, this article explores three of the most pervasive failures observed in internal control testing of KYC and AML processes—and what these failures mean for risk management, governance frameworks, and compliance sustainability in today's complex financial landscape.

1. Deficient Customer Due Diligence (CDD)

The foundation of any effective AML program begins with knowing who your customers are and understanding the risks they present. However, banks are increasingly failing to update or maintain comprehensive customer profiles after initial onboarding. This "set-it-and-forget-it" approach to CDD has proven particularly problematic as customer risk profiles naturally evolve over time.

In many documented cases, politically exposed persons (PEPs), high-risk clients, or beneficial owners go unidentified or are misclassified for extended periods, exposing banks to substantial financial crime risk. These failures in CDD frequently result in misaligned risk ratings, late or missed suspicious activity reports (SARs), and serious audit deficiencies that often cascade into broader compliance breakdowns.

Today's regulators expect dynamic, risk-based profiling—not a one-time setup. Failure to implement ongoing due diligence can trigger not only substantial fines but also remediation orders requiring costly system overhauls and reputational damage that can impact customer acquisition and retention.

Real-World Example

More recently in 2024, DBS Bank in Hong Kong was fined HK$10 million by the Hong Kong Monetary Authority (HKMA) for failing to regularly update customer risk profiles and not performing enhanced due diligence on high-risk accounts as required by local regulations. The regulator noted that these deficiencies had persisted despite previous warnings, demonstrating a pattern of inadequate remediation that ultimately led to escalated enforcement action.

2. Ineffective Transaction Monitoring

Even with proper customer identification, many financial institutions continue to struggle with detecting suspicious transaction patterns. Banks frequently rely on outdated monitoring rules or poorly calibrated alert scenarios, resulting in millions of potentially suspicious transactions going unflagged or creating excessive false positives that overwhelm compliance resources.

In July 2023, the U.S. Federal Reserve imposed a $186 million civil penalty on Deutsche Bank AG and its U.S. affiliates for failing to adequately address long-standing deficiencies in their anti-money laundering (AML) and sanctions compliance programs. These deficiencies were initially cited in consent orders issued in 2015 and 2017, yet the bank failed to make sufficient progress.

In several other high-profile cases, institutions failed to revisit monitoring parameters for high-risk jurisdictions or activity patterns even after significant changes in geopolitical risk landscapes. This static approach to transaction monitoring creates dangerous blind spots in an institution's financial crime detection capabilities.

Gaps in transaction monitoring systems often lead to delays or outright failures in Suspicious Activity Report (SAR) filings—omissions that regulators view as systemic issues rather than isolated incidents. These failures frequently lead to severe penalties and consent orders requiring comprehensive system overhauls under regulatory supervision.

Poor tuning, outdated risk typologies, and ineffective alert management processes consistently reflect poorly during both internal control testing and external regulatory audits. Financial institutions must move beyond simple rule-based monitoring toward more sophisticated, behavior-based anomaly detection that adapts to evolving criminal methodologies.

3. Inadequate Sanctions Screening and High-Risk Controls

As global sanctions regimes shift rapidly in response to geopolitical events, financial institutions face mounting challenges in maintaining effective sanctions compliance programs. Failure to update sanctions lists or implement real-time screening mechanisms can have devastating consequences, including direct facilitation of transactions that violate international sanctions laws.

For instance, in October 2024, the UK Financial Conduct Authority (FCA) fined Starling Bank £28.9 million after discovering serious flaws in its financial crime controls. The bank had onboarded over 49,000 high-risk customers between 2021 and 2023, despite a prior commitment to suspend such activities. Furthermore, its sanctions screening tool failed to check customers against the complete UK sanctions list since 2017, leaving the door open for sanctioned individuals to access the UK financial system.

These lapses in control may expose institutions not only to substantial regulatory penalties but also to financial crime and severe reputational damage. Auditors and regulators alike consider sanctions screening a critical control; weaknesses in this area often trigger immediate regulatory escalations and demands for corrective action plans with tight implementation timelines.

Best Practices and Implementation Strategies

For financial institutions looking to strengthen their control testing frameworks, here are some comprehensive resources sharing the industry best practices and implementation strategies. .

  • Internal Control Testing: 10 Best Practices for Banks - This guide outlines essential strategies for effective risk management and compliance through systematic control testing.

  • How to Implement Control Testing Programs to Mitigate Risks - Learn how banks can identify risks and co-create effective internal controls and enterprise risk management frameworks with a structured approach.

  • Key Benefits of Control Testing to Mitigate Enterprise Risk - Discover how financial institutions developing and implementing effective internal controls and frameworks for control testing programs through a systematic methodology.

By learning from the failures of others and implementing robust testing frameworks, financial institutions can transform compliance from a cost center into a competitive advantage that protects both their reputation and their bottom line.

Conclusion

In today's environment of heightened regulatory expectations and increasingly sophisticated financial crime, robust internal control testing is no longer optional—it's essential for institutional survival. Financial institutions must proactively assess their KYC/AML programs across three critical dimensions: risk-based design, operational effectiveness, and timely remediation of identified gaps.

Leading institutions are now moving beyond traditional compliance approaches to implement more advanced testing methodologies, including continuous monitoring, advanced analytics, and integrated assurance frameworks that provide real-time visibility into control effectiveness.


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Anaptyss is a digital solutions and business services company based in Alpharetta, GA. The organization delivers digitally enabled, value-led managed services to a diverse clientele in the financial services industry. Anaptyss co-creates innovative solutions to help clients evolve their standalone tasks and processes to fully integrated and versatile functions/CoEs, transforming their business and technology operations. Anaptyss' globally scalable managed services ecosystem, driven by the proprietary Digital Knowledge Operations™ approach, offers clients access to new-age intelligent digital technologies, deep-domain expertise, and top-tier talent.

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