AML for Neobanks: Compliance Challenges and Solutions

Find out which qualities make up a neobank, how this new form of a bank differs from traditional financial institutions, if neobanks are obliged to stay in line with the same AML requirements and learn how they overcome their compliance challenges.

For quite some time, neobanks have been building a bridge between traditional banks and putting a twist on it — making it better, more efficient and even more customer-friendly. Unlike traditional banks, neobanks don’t have physical branches. So, with their innovative digital solutions and customer-first approach, they have disrupted the traditional banking scenery. 

The total amount of transactions in neobanking is predicted to grow by 13.15% every year from 2024. According to Statista’s research, this means it’s expected to reach a total of $10.44 trillion by 2028. However, despite the great success that neobanking brought to the financial sector, the issue of staying compliant with anti-money laundering (AML) regulations remains. 

Neobanks must meet AML compliance requirements and implement Know Your Customer (KYC) measures as part of the customer account opening process. AML compliance is one of the key elements paving the way for neobanking’s success, necessitating innovative solutions and robust software to detect and prevent financial crimes. 

Despite that, neobanks face regulatory challenges because unified AML frameworks are primarily designed for traditional banks. The digital evolution of companies, including neobanks, has led to a struggle for both these entities and regulators to establish effective regulations that address the unique aspects of digital onboarding and overall digital, only-remote services. 

We explore these issues and provide solutions for neobanks to implement AML compliance measures more effectively.

What is Anti-Money Laundering (AML)?

AML, or anti-money laundering, involves regulations, laws, and procedures designed to identify and prevent criminals from masking illegal funds as legitimate income. These policies aid banks and financial institutions in the fight against financial crimes. 

For example, in the USA, the necessity for regulated entities to implement an AML compliance program, as described in the Bank Secrecy Act (BSA). This Act outlines requirements for AML compliance programs, mandating that financial institutions establish policies and procedures to detect suspicious activity. They are also required to notify the government by submitting Suspicious Activity Reports (SARs). 

However, it’s not just traditional banks that must have a robust AML compliance program. These sets of measures are crucial for various businesses, including traditional financial institutions and entities like neobanks, money services businesses (MSBs), or insurance firms. 

The Five Key Pillars of AML Compliance

The BSA’s latest version outlines five essential AML compliance pillars that are guidelines for companies to implement into their AML program. 

The AML pillars mandate companies to follow these steps:

  1. Designating a compliance officer.
  2. Conducting thorough risk assessments.
  3. Developing AML procedures and policies.
  4. Continuously monitor and upkeep the AML program.
  5. Enforce Customer Due Diligence (CDD) measures and follow a risk-based approach.

In practice, this isn’t a one-and-done deal because it takes more than five steps for companies to stay compliant with AML. For example, a robust AML program should enable the company to gather up-to-date customer information, monitor their transactions, as well as screen for suspicious activity, and report suspicious incidents to regulatory authorities. 

Which Companies are Considered Neobanks?

Neobanks are considered to be a fairly new category of banks that operate entirely online, which means they don’t have physical branches. They typically offer various financial services, such as checking and savings accounts, through mobile apps or websites. Depending on location, these “financial technology” companies are known by various names like virtual, digital, internet-only, or simply online banks.

A graphic representation of the main qualities and features regarding neobanks

Some popular examples of neobanks include:

  • Revolut
  • Monzo
  • N26
  • Chime
  • Varo Bank
  • Bunq

A common approach among today’s neobanks is to break down typically high-margin products and offer them at a much lower cost. That’s why neobanks are known to have lower fees compared to traditional banks. In contrast, they may offer higher interest rates on deposits. Additionally, they specifically use technology to offer a personal feel to their customers who are looking for the best user experience when it comes to financial products.

The Principles of Neobanks and How they Operate

Neobanks operate through technology, utilizing algorithms and artificial intelligence to automate processes, cut costs, and enhance the customer experience. They also employ data analytics to understand customer behavior and provide personalized financial services. These banks might provide a free basic product, like an account, while generating revenue through supplementary services, including transaction and trading fees. 

For example, Chime, the one mentioned in our list, isn’t a traditional bank, so it has so many users because of it being a go-to choice due to low fees and a similar, fully digital banking experience. Chime does not assess its clients’ credit, making it a suitable option for those who have faced difficulties in obtaining an account in a traditional banking space. 

To open an account with a neobank, customers usually download the bank’s mobile app and follow straightforward steps to create their account. Some neobanks may require customers to provide personal information and undergo identity verification before gaining access to the bank’s services.

The Key Difference of Neobanks vs Traditional Banks

Neobanks, while resembling traditional banks, are smaller enterprises holding banking licenses. Their focus is on delivering enhanced customer service, transparency, and an overall superior customer experience when compared to larger, traditional banks. 

A concise chart illustrating the main differences between neobanks and traditional banks

That means the key difference between a neobank and a traditional bank lies in their physical presence:

  • Neobanks are entirely digital, lacking physical branches. They often offer a user-friendly, cost-efficient, and modern digital interface. 
  • Traditional banks are known for their brick-and-mortar locations that require customers to conduct their banking activities. Banks are reputable financial institutions due to their extensive range of services, compliance, and solid reputation.

Neobanks automate the onboarding process to be seamless and intuitive, which they are praised for today. Neobanks compete based on the minimal number of customer clicks and minutes required to access their financial services. 

Often, neobanks offer mobile-first interfaces that guide customers through each step with clarity. Some neobanks verify their customers using features like facial recognition and selfie identity verification. So, instead of waiting for the account to be opened for days, like with traditional banks, neobanks give access to their users in a few minutes. 

Are Neobanks Risky?

Neobanks typically team up with larger, well-known traditional financial institutions. This link provides neobanks with access to specific deposit services and the protection of the larger bank’s support. Despite being online banking service providers and not traditional banks, neobanks are considered as safe as other, more traditional options. 

Despite that, banks and other businesses, especially those with huge amounts of money flowing, are considered to be high-risk sectors. This factor makes neobanks more susceptible to various types of fraud. 

Here are some common neobank fraud types:

  • Account takeover fraud. Also known as ATO fraud, an attack where criminals gain control of online accounts, ranging from emails and bank accounts to social media profiles. They exploit stolen credentials through phishing, data breaches, social engineering, and other illicit methods. For example, via purchasing credentials on the dark web for very low prices.
  • Chargeback fraud. A chargeback occurs when a cardholder disputes a transaction, seeking a refund from their bank or credit card company. While designed to protect customers from fraud, the chargeback process can be exploited by dishonest individuals.
  • Identity theft. Identity theft is a very popular type of identity fraud. It occurs when someone exploits the person’s data for fraudulent purposes. For instance, through stealing credit card details, obtaining medical services, or submitting a false tax return in your name.

Consequently, neobanks not only need to verify customer identities but also prevent fraud by adapting. This means implementing an anti-fraud strategy for the evolving cybersecurity landscape that targets all financial institutions.

How Does AML Work in Traditional Banking?

To stay compliant with AML regulations, traditional banks must integrate these processes into theri AML programs:

  • Know Your Customer (KYC). In the KYC process, or the ID verification procedure, banks gather and verify customer identification, ensuring the accuracy of digital identity compared to real-world identity.
  • Customer due diligence (CDD). Following KYC, banks conduct a risk assessment for new customers, which is part of the CDD process. 
  • Customer and transaction screening. In banking, customer information undergoes screening against various databases, including politically exposed persons (PEPs), government records, watchlists, and sanctions
  • Ongoing monitoring. Traditional banks are also obliged to monitor individuals involved in money transfers, preventing transactions with sanctioned or banned individuals. Since risk levels might change over time, this should be an ongoing compliance process.
  • Suspicious activity reporting. This process involves maintaining an accurate and up-to-date audit trail, which is crucial for regulators when submitting reports regarding detected suspicious activity.

Related: KYC and AML Compliance — Key Differences and Best Practices

Are Neobanks Subject to the Same AML Regulations?

Neobanks, as licensed financial institutions, are obligated to adhere to AML and KYC regulations. These are the same regulations that require traditional banks to verify customer identities and prevent transactions with sanctioned countries or individuals engaged in illegal activities. 

Neobanks, even though they aren’t directly regulated, have to follow the strict requirements set by their partner banks, acting like their own kind of unofficial regulator. When neobanks bring in new customers, they’re carefully watched and need to give a lot of paperwork to satisfy their partner bank’s checks.

Due to their virtual nature, neobanks often use AI-powered software to conduct KYC checks and identify fraudulent transactions, which makes it more difficult. That’s because this task can be intricate for neobanks due to potential limitations in accessing data compared to traditional banks, necessitating reliance on technology to automate AML processes.

Common AML Compliance Challenges that Neobanks Face

Navigating the AML compliance landscape can be complex for any financial institution. Neobanks aren’t any different when it comes to this task, especially when they need to navigate through different jurisdictions and various partners’ requirements. Nevertheless, it’s crucial for neobanks to proactively adhere to these regulations, safeguarding customers and protecting the whole financial system’s integrity. 

A display showcasing the most popular AML compliance challenges among neobanks
That said, here’s a short list of the most common AML challenges faced by neobanks:
  • High transaction volume. Processing numerous transactions can make it tough for neobanks to distinguish suspicious activities from legitimate ones.
  • Emerging complex fraudulent tactics. A notable example in this context is deepfakes or synthetic identities, where criminals combine stolen and genuine data to craft deceptive personas akin to “Frankenstein” creations. This rapid progress in AI has raised increasing concerns about its potential for misuse.
  • Constantly changing compliance requirements. Neobanks find it hard to keep up with AML compliance requirements because they were originally designed for traditional banking. As startups with limited resources for AML-related tasks, they struggle to keep up with AML program requirements.
  • Limited data resources. Neobanks may lack access to the extensive customer data available to traditional banks, making it challenging to verify identities and detect suspicious activity.
  • Cross-border transactions. Neobanks face challenges in complying with diverse and sometimes conflicting AML regulations across countries.
  • Lack of industry knowledge. Establishing a robust AML compliance program also requires skilled personnel and ongoing training, which results in increased costs.

So, navigating through the AML compliance landscape involves multiple steps, such as ongoing investment in robust RegTech solutions, employee training, or staying ahead of the ever-evolving regulations. 

At iDenfy, we can help you put all the pieces together with our complete AML toolkit, including AML screening and ongoing monitoring, transaction monitoring, KYC/KYB checks, and more. 

Book our free demo for a quick hands-on experience. 

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