What is Transaction Monitoring?

Transaction monitoring refers to the practice of reviewing financial transactions in order to identify suspicious behavior. Financial institutions use software (either purchased from a vendor or built by the company itself) to do this. This software uses a complex set of rules to determine if a transaction should be considered “unusual.” Any usual transactions are then passed along to the compliance team for further investigation.

Introduction

In financial compliance, transaction monitoring is best thought of as the canary in the coal mine – an early warning system designed to help keep bad things from happening. Who’s the financial canary, you ask? (No, it’s not an actual bird.) In fact, unless you’re a fledgling fintech with just a handful of customers, it’s likely not a human either. 

The amount of traffic flowing through even small- to mid-size financial institutions is enough to make human review of individual transactions an impractical affair. Instead, computer software sifts through the transactions, passing along anything suspicious to the compliance team. 

Understanding Transaction Monitoring Systems

But that begs the question: how do you teach a computer what a suspicious financial transaction looks like? In short, you give it rules to follow. At its most basic, a transaction monitoring system looks at transaction data through an algorithmic filter that says “this combination of factors is okay,” and “this combination of factors is not.” 

The algorithm itself has to be fine-tuned, however. If your net is too broad, the more sophisticated criminal will slip through. Too fine, however, and your compliance team will find themselves overwhelmed by false positives – flagged transactions that are, in fact, perfectly innocent. ‍

How does risk assessment correspond to effective transaction monitoring?

The more your transaction monitoring setup aligns with your company’s risk profile, the more refined your filters will be, resulting in effective AML detection as well as reduced false positives. A great transaction monitoring program will take into account a company’s unique operational structure, its geography and KYC data (as well as other factors) to create an optimal set of rules. It’s for this reason that smaller companies – while often choosing an out-of-the-box transaction monitoring solution – almost always find they need to upgrade. Most find that an out-of-the-box solution isn’t able to meet their needs, and that instead they’re looking for something with greater customization options. This might be a completely custom-built program, or a system that combines vendor tools with in-house engineering. Either way, it’s clear that, as a regulated company, you can’t afford to have sub-par transaction monitoring.

Transaction Monitoring: AML vs. Fraud

The process of transaction monitoring is used to detect suspicious activity related to both money laundering and fraud. Because these are often separate departments within an organization, however, the rules governing what triggers an alert will be different for each. It’s common for these groups to work in siloed environments, making meaningful collaboration difficult. Recently, however, many companies have begun to invest in stronger collaboration tools, bringing these two groups closer together. An effective transaction monitoring setup, when coupled with a strong case management platform, can serve as an effective communications channel for cross-disciplinary analysis.

Wrap Up

Transaction monitoring is an absolutely essential part of any compliance program. An effectively optimized transaction monitoring setup will reduce false-positives and increase overall efficiency, but – like the wheels on your car – an absent or non-functional system is the fastest way to go nowhere.