The Financial Conduct Authority’s Challenge to Challenger Banks

In the past decade, one of the most noteworthy trends in the United Kingdom banking sector has been the growth of so-called ‘challenger banks’.  Challenger banks can be defined as small- to mid-size banks that seek to compete with traditional High Street banks by using modern financial practices, including operating solely online or through an app and allowing customers to take advantage of additional services (eg budgeting and instant spending notifications) that some High Street banks do not yet offer.

Whatever the technological benefits that challenger banks may have over certain traditional banks, they are no less subject to legal and regulatory oversight by United Kingdom authorities.  A recent development that underscores this point is an April 22 report by the United Kingdom Financial Conduct Authority (FCA) on its review of United Kingdom challenger banks’ financial crime controls.

That review, which the FCA conducted in 2021, ‘focused on challenger banks that were relatively new to the market and offered a quick and easy application process’, including six challenger retail banks with more than eight million customers.  The scope of that review included six categories: governance and management information, policies and procedures, risk assessments, identification of high-risk/sanctioned individuals or entities, due diligence and ongoing monitoring, and communication, training, and awareness.

At the outset, the FCA noted that it ‘found some evidence of good practice, for example innovative use of technology to identify and verify customers at speed’, but also that ‘more needs to be done by the challenger banks sector as a whole in light of the areas of improvement we identified’.  With regard to the six review categories, the FCA made a number of findings that identified a variety of deficiencies:

• Customer Due Diligence (CDD): The FCA found weaknesses in CDD, such as most challenger banks’ failure to obtain details about customer income and occupation.
• Enhanced Due Diligence: The FCA found that ‘[s]ome challenger banks were not consistently applying enhanced due diligence (EDD) and were not documenting it as a formal procedure to apply in higher risk circumstances, for example when managing politically exposed persons (PEPs)’.
• Risk Assessment: In one of the more telling observations, the review stated that some challenger banks ‘had customer risk assessment frameworks that were not well developed and lacked sufficient detail. Some did not even have a customer risk assessment in place’.
• Transaction Monitoring: The FCA ‘found ineffective management of transaction monitoring alerts. For example, inconsistent or inadequate rationale used for discounting alerts’.
• Suspicious Activity Reports: The FCA stated that the National Crime Agency’s Financial Intelligence Unit ‘noted a substantial increase in the volume of Suspicious Activity Reports (SARs) reported by challenger banks as banks exit customer relationships for financial crime reasons’. That increased volume ‘raises concerns about the adequacy of these banks’ CDD and EDD checks when onboarding these customers. We also had concerns about the quality of SARs reported to the NCA’.
• Financial Crime Programmes: The FCA ‘found weaknesses in the effective management of financial crime change programmes’, including inadequate oversight and a lack of pace of implementation.

In its conclusions, the FCA did not sanction or criticize any challenger bank by name.  It advised that challenger banks ‘should keep evaluating their approach to identifying and assessing the financial crime risks they are exposed to’. It also stated that it ‘will continue to monitor firms’ compliance with their anti-money laundering obligations’.

Challenger banks should take some comfort from the FCA’s comment that ‘there are limited differences in the inherent financial crime risks faced by challenger banks, compared with traditional retail banks’. Nonetheless, the FCA announcement strongly signaled that the FCA plans, as part of its continuing monitoring and oversight of compliance with the Money Laundering Regulations (MLRs), to seek updates from challenger banks regarding their financial crime frameworks.  It would therefore be prudent for challenger banks to conduct a prompt and thorough review of all of their financial crime compliance programs, particularly CDD and risk-assessment processes, to avoid running afoul of the MLRs in the future.

Jonathan J Rusch is an Adjunct Professor of Law at the American University Washington College of Law