Last month, U.S. Treasury Secretary Janet Yellen said central banks should explore creating and issuing sovereign digital currencies. The hypothesis is that such currencies — digital dollars among them — could create “faster, safer and cheaper payments,” she said at a virtual conference.
“There’s a lot of things to consider here,” Yellen said. “But it’s worth looking at.”
Yellen noted that among those “things to consider” is how regulators would “manage money laundering and illicit finance issues.” When it comes to those issues, there’s at least one person in Washington, D.C. that has had a front row seat to financial regulation for more than four decades. Ed Wilson is a partner at Venable LLP, a firm that specializes in financial regulations, including providing legal advice to senior Department of the Treasury officials, interacting with other cabinet and sub-cabinet offices. He also serves as a Lucinity Advisory Board member, an advanced artificial intelligence (AI) systems company that helps banks detect money laundering.
As deputy and acting general counsel for the Treasury department during the Reagan administration (1986-1988), he participated in the formation of the Financial Crimes Enforcement Network (FinCEN), U.S./Canada Free Trade Agreement negotiations (CAFTA), international debt and tax matters, and other Treasury policy and operational matters. He is no stranger to risky and volatile financial environments, such as the one the industry finds itself in now.
Wilson said he believes the rise of cryptocurrencies demands advanced technologies to close the gap with financial criminals. But playing defense isn’t necessarily the sharp tip of Wilson’s spear. The opportunity to have money on an undisputable and never-forgotten ledger would increase transparency and fairness. With ethical companies and cutting-edge technology, crypto could be the way to a new world order in anti-money laundering (AML), represented by fairness, efficiency and accountability.
Wilson told PYMNTS’ CEO Karen Webster that the current environment will involve advanced technologies to help financial institutions (FIs) close the gap with financial criminals out to exploit the digital movement of money at faster and faster speeds. With effective high tech in place, critical human capital will be freed up to focus on intuition and context, which often can be additional weapons against the fraudsters.
“Banks put too much emphasis on reducing reputational risks [caused by] regulatory failure,” he said. “They could reduce that if they would instead change how they run their account opening and anti-money laundering procedures.”
Digital Dollars
Wilson, like other people in the regulatory community, said he believes digital dollars can address the need for a central bank digital currency (CBDC) as well as more security around the general area of cryptocurrency. While existing electronic payment mechanisms work on an account-based model, the digital dollar differentiates itself as a token, combining cash-like properties with many of the benefits of the existing account-based payment mechanisms.
According to Wilson, the digital dollar could potentially solve the vexing problem of financial inclusion by making account openings ubiquitous and streamlined. And along the way, the Federal Reserve, with those digital dollars in place (and the means of distributing that money), would be adept at addressing quick settlement and compliance.
“It’s a twofer,” he said.
But the digital dollar also brings up some existential questions about the role of the Fed, the role of Treasury and the role of the banks. Yellen and Fed Chair Jerome Powell have, in Wilson’s estimation, done a good job in laying out who winds up being the depository institution (that’s the role of the banks). The Fed, he noted, does not have a lot of experience in lending money — at least not on a retail level.
“My personal bias is that the Fed has got to do it at the wholesale level,” he said. “But if it does that, then that’s using a digital currency at the bank level and concentrates a lot of power in those treasury banks.”
For those banks comes the dilemma of real-time payment themselves.
As he put it: Banks must consider how they can monetize real time payments and examine their basic business models in the process. They’ve got to shift from a model that makes significant money from issuing credit cards, from fee income, and move to direct, account-to-account (A2A) relationships. With careful planning along the way.
“You’d better have a business model before you start blowing everything up,” cautioned Wilson.
Move Away From Rules Based Systems
The farther money travels, in a way, the more potential there is for fraud, particularly when money crosses borders. Wilson reflected back to the late 1970s, when, during a stint in government, this question came up: How does one send money home via remittances to “grandma in Guatemala” — at less cost?
“And every way we came up with, the DEA [Drug Enforcement Agency] hated,” said Wilson.
That’s because the know your customer (KYC) and AML efforts, quite simply, would prove ineffective.
Fast forward to today and the narrative has become even more urgent. As real-time payments take root, compliance teams have an ever-shrinking window in which to prove that the parties on either side of the transaction are legitimate, that accounts can be validated in time.
Move away from rules-based systems, and things will start to improve, he stated. The rules-based systems and the fraud prevention teams in place simply are inefficient uses of resources.
“We hire bright young people to sit and look at a screen and say ‘yes, no, yes, no, yes, no,’” he told Webster. “For eight hours a day, could you do that? You’d go nuts.”
And probably make “bad” fraud detection decisions, too, as fatigue and monotony set in.
But according to Wilson, the combination of artificial intelligence (AI) and machine learning (ML) will reduce the number of people needed to combat fraud. Context matters, and AI and ML can help give context.
“We can conduct due diligence on customers and cut down the number of false SARS [suspicious activity reports],” he said. “Right now, if a bank sees anything out of line, they file a SAR just to protect themselves.”
The financial services system has a vested interest in creating a new ecosystem for delivering money directly to individuals. The trillions of dollars in stimulus checks and the Paycheck Protection Program (PPP) did not get to recipients without some hiccups, done through paper checks and prepaid cards (which in some cases were inadvertently thrown out).
A large subset of the population, said Wilson — those without accounts — find it cheaper to stand in line at Walmart on a Friday, pay a utility bill, send money home to relatives across borders, and then get a prepaid card and go grocery shopping.
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