Luxembourg’s banking sector, once heralded for its stability and strong governance, is now grappling with substantial hurdles in adhering to anti-money laundering (AML) regulations, a new consultancy report reveals. The industry is struggling to recruit qualified personnel and invest in advanced tools necessary to meet these stringent compliance standards.
The report, released on Friday by PwC Luxembourg, highlights the sector’s struggle to attract, retain, and upskill staff with the necessary AML expertise, leading to operational deficiencies that could result in severe penalties and reputational damage. The report also sees a risk of overreliance on artificial intelligence tools used for AML.
One of the primary issues plaguing Luxembourg’s banks - mostly affiliates of international banking groups - is the difficulty in maintaining a workforce adept in AML. The chief operating officer (COO) is crucial in addressing this shortfall, collaborating with the chief compliance officer (CCO) and chief risk officer (CRO) to identify and rectify operational weaknesses.
Reputational harm
“A failure in AML controls could rapidly lead to significant penalties and sanctions alongside reputational harm that can be hard to undo,” PwC said in its report, underlining the “ultimate responsibility” of the CEO and the board of directors.
Luxembourg’s financial supervisor CSSF in recent years has stepped up its supervision on financial institutions in particular in the field of AML. Increasingly, financial institutions - banks and AIFMs - are being fined for failing to meet the requirements. The ECB, which n Luxembourg directly supervises three banks; Spuerkess, BIL and Quintet Private Bank, has singled out tax and financial crime-related matters as supervisory priorities.
PwC said banks should see supervisors as a partner that is “attentive and open to structured dialogue.” It said the bank’s senior management should “proactively engage” with the CSSF and ECB.
‘Recipe for disaster’
“The CEO should not shy away from taking the necessary actions to remediate any shortcomings that may be identified,” said PwC. ”As for the board, the tone at the top is crucial, and the chairperson and the directors need to promote a strong culture of AML compliance.”
PwC underlined that, given that supervisors will conduct targeted reviews on the effectiveness of bank boards, directors “should harness the openness and constructive challenge” and demonstrate “openness, humbleness and humility” Doing the opposite and failing to acknowledge different perspectives “is a recipe for disaster”.
The integration of generative artificial intelligence in AML processes has been suggested as a potential solution. However, this technology requires highly skilled personnel to operate effectively. PwC said the absence of such expertise exacerbates the banks› compliance struggles, highlighting a glaring weakness in their operational frameworks.
“Luxembourg’s banking sector has demonstrated overall stability over the past decades, however recent market challenges present escalating difficulties to maintaining its resilience,” said Björn Ebert, PwC Luxembourg partner and financial services leader, in a statement. “Clearly, GenAI is poised to play a pivotal role in the sector’s future, elevating efficiency, accuracy, and customer service standards”.
Risk of overreliance on AI
The role of the CRO is pivotal in establishing robust governance frameworks to oversee AI solutions› development, testing, and deployment. However, relying solely on GenAI models poses significant risks. These models often function as black boxes, producing results that need rigorous quality checks to prevent errors.
Despite the sophisticated appearance of these tools, without experienced professionals to interpret and analyse the outputs, the risk of inadequate AML processes remains high. PwC said this reliance on technology without corresponding human expertise underscores a critical vulnerability in Luxembourg’s approach to financial crime prevention.
“Results provided by the GenAI tools which, despite looking very professional and sophisticated for the non-experienced user, can often turn out to be inadequate,” the report said.
The need for robust digital transformation strategies, including the adoption of GenAI solutions also adds to the financial burden that banks face. While these investments aim to improve operational efficiency and regulatory adherence, they significantly increase the overall cost of compliance for Luxembourg’s banks, the report said.
Substantial investments in new technologies, data management systems, and human resources are also required to deal with the complexity and expense associated with managing governance and Environmental, Social, and Governance (ESG) risks.
Tax credit
The introduction in Luxembourg of the digital and ecological transformation (DET) tax credit, which offers an 18 percent tax credit for investments related to these transformations, signals a push for banks to enhance their technological and environmental capabilities. However, this initiative also implies substantial upfront costs for compliance, as banks must invest in new systems, processes, and staff training to meet these evolving standards, PwC said.
The tax credit “should serve as an incentive for Luxembourg’s banks to modernise their front-to-back value chains and invest in digital native product and services,” PwC said, referring to the “need to remain competitive” in an industry with strong cost pressures.