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Fiat currency definition and meaning | AML glossary

What is a fiat currency? Definition and AML compliance meaning.

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Fiat currency definition.

Fiat currency refers to money that a government has declared as legal tender, but which has no intrinsic value of its own. Unlike commodities such as gold or silver, fiat money isn’t backed by a physical asset. Instead, its value is derived from the trust people place in the issuing government and its central bank. In the UK, for example, the pound sterling is a fiat currency, regulated by the Bank of England.

In the context of financial crime, fiat currencies can be a tool or a medium for illicit activity. Criminals may use cash to avoid detection in money laundering schemes, bribery, and tax evasion, taking advantage of the fact that physical currency can be easily transferred without leaving a trace. The anonymity that comes with cash transactions often attracts illicit actors seeking to evade detection by law enforcement agencies or regulatory bodies. Because of its widespread acceptance and ease of transfer, fiat money becomes a central point in many financial crimes, often serving as the preferred method of payment in illegal transactions.

Further, money laundering involving fiat currencies can occur through a variety of means, including structured transactions (also known as smurfing), where large sums of money are broken into smaller, less suspicious amounts. These smaller amounts are then deposited across multiple accounts to obscure their origin. The lack of traceable electronic records for cash transactions presents a significant challenge for compliance teams, making it harder to detect illegal activity.

What fiat currencies mean for AML compliance.

For AML compliance managers in UK-regulated businesses, dealing with fiat currencies is a delicate balance between facilitating legitimate transactions and preventing illegal activity. Financial institutions are legally required to have robust systems and processes in place to detect and report suspicious activity related to the use of fiat currencies. The complexity lies in understanding how fiat money moves through the financial system and identifying red flags that indicate potential financial crime.

As an AML professional, you should be acutely aware of the risks posed by cash transactions, which remain an attractive tool for criminals due to their relative anonymity. Businesses are tasked with implementing rigorous Know Your Customer (KYC) procedures, not only for clients engaging in digital transactions but also for those transacting in cash. This means closely monitoring the sources and destinations of funds, especially when dealing with unusually large or frequent cash deposits.

While digital transactions can often be traced and tracked through banking channels, cash transactions are harder to monitor, making them a common method for laundering money. For businesses, this could mean the need to enhance surveillance on high-volume cash depositors and implement stricter thresholds for reporting large cash withdrawals or deposits.

AML compliance teams must be familiar with how cash is being used within their institution and set clear guidelines for what constitutes unusual or suspicious activity.

Effective AML compliance also involves the use of advanced systems to track the movement of fiat currency through various channels. This could involve monitoring transactions across both physical and electronic platforms, ensuring that a comprehensive picture of a customer’s financial activities is maintained. Automated monitoring systems should be fine-tuned to flag red flags such as structured transactions or sudden, unexplained increases in cash activity.

Another challenge with fiat currencies is the potential for businesses to become unwittingly complicit in money laundering schemes. It’s critical that you remain proactive in your due diligence efforts. Conducting periodic audits, ongoing training, and ensuring that all employees are equipped to spot suspicious behaviour are essential steps in minimising exposure to financial crime.

Lastly, staying updated with the latest regulations and best practices is an ongoing requirement. Compliance with AML laws concerning fiat currencies is not static, and keeping up with legislative changes, case law, and emerging crime tactics will enable you to better safeguard your institution from becoming a target for financial criminals. 

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