In this article, we will explain finance lingo and dive into the basics of Source of Funds (SOF) and Source of Wealth (SOW). We will also explore Source of Wealth and Source of Funds examples.
The question that might have probably brought you here is: Where do my customers’ money come from?
First, let’s establish that the answer to this question is at the core of understanding Know Your Customer (KYC) compliance. In a world where money launderers keep changing and improving their methods, any firm must deploy KYC measures like customer due diligence (CDD) and transaction monitoring to protect assets and join the global fight against financial crime.
It might sound that Anti-Money Laundering (AML) and KYC compliance are complex, but the fact is, if they’re done correctly, efficiently, and with the right technology, you will be safeguarding your business in an effortless and time-efficient way.
It's as simple as that: Source of Funds and Source of Wealth checks ensure that your customers' funding sources are legitimate, guarding against high-risk activities. Now, let’s dive into the details of these two procedures.
What is the Source of Funds?
The Source of Funds goes beyond finding out where the money comes from; it looks into how customers earn it. Whether through work, selling property, or unexpected gains like surprise inheritances. In other words, knowing the 'how' is as important as the 'where.'
Source of Funds and AML Compliance
When companies want to know who their customers are and what they're all about, they use the Know Your Customer (KYC) procedure. It's like checking IDs to make sure everything is okay. So, to understand their customers and the kind of business they're doing, they set up some rules and checks. It's like keeping things organized and ensuring everyone is on the same page.
The KYC process involves the following:
- Customer Due Diligence:
Customer Due Diligence ensures financial institutions know their customers well, checking their backgrounds to prevent misuse.
- Transaction Monitoring:
Transaction monitoring keeps an eye on transactions, flagging unusual activities to prevent fraud or illegal actions.
- Sanctions Screening:
Sanctions screening involves checking if customers are on any watchlists or sanctions lists, ensuring compliance with regulations.
- Politically Exposed Persons (PEP):
PEPs check if customers hold influential positions, warranting extra scrutiny due to potential risks.
- Adverse Media:
Adverse Media involves scrutinizing public information to identify any negative news or associations related to customers, ensuring a thorough risk assessment.
Read more: What are AML Checks? & AML vs KYC
What is the Importance of Source of Funds?
Between 2% and 5% of all the money flowing around the world is considered suspicious. (Based on estimates from The United Nations Office on Drugs and Crime). That's almost $800 billion to $2 trillion! Businesses are fighting back, and according to BIS Research, the anti-money laundering software market has doubled from $868 million in 2017 to about $1,770.2 million in 2023. It's a serious game.
You might wonder why businesses care! If companies don't keep a tight watch, there are serious fines and even jail time, let alone losing customers and money because their reputation takes a hit.
So, businesses are doing this for more than just the rulebook. It's about bypassing trouble, keeping the cash clean, and making sure they don't end up unintentionally involved in some illegal businesses. Therefore, they should know about the sources of funds for business.
What is the Source of Wealth?
Let's zoom out a little bit. The Source of Wealth is not just about where the customer got that chunk of money. Instead, it's the whole story of how they built their wealth.
In other words, firms must ascertain why the client or customer has the assets they do and how they came to accumulate them.
In other words, both Source of Funds and Source of Wealth are important to check for potential criminal activity. When a firm sees a customer as 'high risk' and looks into where their money comes from, Source of Wealth backs up the decision on Source of Funds.
Further, below are examples of documents for verification:
- For Inheritance: Deceased details, legal documents of fund transfer.
- Business Ownership: Business description, income statements.
- Employment: Job details, pay stubs, tax information.
What are the Common Sources of Wealth?
These could be from various sources, for instance:
- Business ownership interests
- Employment income
What is the Importance of Source of Wealth?
The importance of Source of Wealth lies in understanding the complete picture of how an individual has accumulated their assets over time.
It helps understand if someone's money is real, varied, and secure. Banks can check where the money comes from to see if there are any risks. They then decide on transactions and relationships based on this information.
This process helps in:
- Fulfilling regulatory requirements
- Ensuring transparency
- Safeguarding against financial crime by identifying any irregularities or suspicious activities in the accumulation of wealth
The Source of Wealth is vital for comprehensive due diligence and risk management in the financial sector.
What are the Best Practices of Source of Funds & Source of Wealth?
While both Source of Funds and Source of Wealth involve verifying the legitimacy of financial sources, they address different aspects of a person's financial profile.
- Source of Funds best practices typically focus on the specific transactions and the origin of the money used for a particular activity. It involves:
- Assessing the risk associated with the funds (For instance, conducting a detailed bank statements analysis)
- Ensuring that the funds come from legitimate sources
- Verifying adherence to evolving regulations
- On the other hand, the Source of Wealth best practices take a broader view. It looks at the entirety of an individual's accumulated wealth and the various sources that contributed to it over time. Best practices in this context might involve:
- Assessing the overall risk associated with an individual's wealth
- Fortifying evidence through documents like audited accounts
- Leveraging technological solutions for efficient verification
Source of Funds Vs. Source of Wealth
It is worth noting that Source of Funds is specific to a transaction, whereas Source of Wealth analyzes lifetime wealth. However, overlaps can exist, like both originating from employment income.
Below are key differences between the Source of Funds and the Source of Wealth along with source of wealth and source of funds examples:
Challenges in Source of Funds and SOW Compliance
Navigating Source of Funds and Source of Wealth compliance poses significant challenges for businesses (sources of funds for business), including but not limited to:
- Complex Verification Process: The intricate nature of financial transactions makes it challenging to authenticate the sources of funds or wealth accurately.
- Concealment of Financial Origins: People can hide the origins of their finances, adding difficulty to verifying the Source of Funds and the Source of Wealth effectively.
Read more: How Does Money Laundering Work?
In conclusion, Source of Funds and Source of Wealth are fundamental in the Know Your Customer (KYC) and Anti-Money Laundering (AML) processes.
Therefore, overcoming challenges in proof of funds and Source of Wealth compliance requires diligence and adherence to best practices. Thorough client profiling, advanced analytics, technological solutions, regulatory compliance, and continuous education are vital in maintaining effective verification processes. Incorporating these strategies strengthens your ability to combat financial crimes and ensures regulatory compliance in an ever-evolving financial landscape.