Inherent -vs- Residual Risk in AML/CTF

"Inherent" and "residual" are terms often used in the context of risk management, particularly in fields like finance and compliance, including Anti-Money Laundering (AML) compliance.

1. Inherent Risk: This refers to the level of risk associated with a particular activity or process before any controls or mitigating measures are put in place. In the context of AML, inherent risk would represent the susceptibility of a business or financial institution to being used for money laundering or terrorist financing, considering factors like the nature of the products or services offered, the types of customers served, the geographic locations of operations, etc. Inherent risk is inherent to the nature of the business or activity itself.
   

2. Residual Risk: Residual risk, on the other hand, is the level of risk that remains after controls and mitigating measures have been implemented to manage the inherent risk. In the AML context, residual risk reflects the risk that remains even after compliance measures such as customer due diligence, transaction monitoring, and reporting suspicious activities have been implemented. It's essentially the risk that the institution or business still faces despite its efforts to reduce it.

Managing residual AML risk involves implementing strategies and measures to further mitigate the risk that remains after initial controls have been applied. Here are some key steps:

1. Enhanced Due Diligence (EDD): Conduct thorough due diligence on high-risk customers, such as politically exposed persons (PEPs), complex corporate structures or shareholders multilayering companies, and customers from high-risk jurisdictions. This may involve gathering additional information beyond simplified customer due diligence procedures.
   

2. Ongoing Monitoring: Implement robust systems for ongoing monitoring of customer transactions and behavior. This includes real-time transaction monitoring for incoming or outcomings' wire transfers and periodic reviews to detect the quality and quantity of suspicious activity reports (STR's) and ensure compliance with AML regulations.
   

3. Risk-Based Approach: Adopt a risk-based approach to AML compliance, where resources are allocated based on the level of risk posed by customers, products, services, intermediaries (channels) and geographic locations. This ensures that higher-risk areas receive greater attention and scrutiny.
   

4. Internal Controls and Governance: Establish robust internal controls and governance structures to ensure compliance with AML regulations and mitigate the risk of financial crime. This includes clear policies and procedures, segregation of duties, and oversight by senior management and the board of directors.