Private banking has been broadly defined as financial and related services provided to wealthy clients. It is difficult to measure precisely how extensive private banking is in the United States, partly because the area has not been clearly defined and partly because financial institutions do not consistently capture or publicly report information on their private banking activities. We do know, however, that domestic and foreign banks operating in the United States have been increasing their private banking activities and their reliance on income from private banking. The target market for private banking—individuals with high net worth—is also growing and becoming more sophisticated with regard to their product preferences and risk appetites. of the largest monetary penalty ever imposed on a bank in a money laundering-related case. More recent investigations of private bankers at Citibank and BankBoston continue to keep private banking in the forefront of public attention. Such cases, which can involve the illicit transfer of millions of dollars, underscore the crucial importance of private banking and its potential vulnerability to money laundering. Federal banking regulators may review banks’ efforts to prevent or detect money laundering in their private banking activities during examinations,including recent examinations focused on their private banking activities. During these examinations, regulators focus on a bank’s compliance program; internal controls; and, in particular, on its KYC policies. Regulators instruct their examiners to determine whether banks have implemented sound KYC policies in general and to ensure that these policies extend to their private banking activities. Until recently, U.S. regulators were attempting to incorporate KYC requirements as uniform regulations. However, the proposed KYC regulation, which was published for comment in December 1998, was met with an overwhelming public response that raised concerns about the government’s scrutiny of personal banking accounts. In the face of these concerns, U.S. regulators have since withdrawn the proposed regulations. Nevertheless, regulators we interviewed for this statement told us that, during the course of examinations, they continue to verify that banks have prudent banking policies, including KYC policies, that ensure compliance with the Bank Secrecy Act. Although regulatory efforts to establish uniform KYC requirements have stopped, Congress continues to look for ways to reinforce current anti- money-laundering laws and, more specifically, to promote due diligence in customer banking relationships. For example, the Chairman of the House Committee on Banking and Financial Services recently introduced legislation that would, among other things, require financial institutions that open or maintain a U.S. account for a non-publicly-traded foreign entity to maintain a record of identity for each beneficial owner of the account. The legislation would also prohibit U.S. depository institutions from maintaining banking relationships with banks that are not licensed to provide services in their home countries. The growing importance of private banking over the last several years led the Federal Reserve Bank of New York (FRBNY) to undertake a special initiative focusing on private banking that disclosed a number of key weaknesses in selected institutions’ internal controls for detecting or preventing money laundering. In 1996 and 1997, FRBNY attempted to review private banking activities at about 40 domestic and foreign banking institutions in the New York district. During the course of these reviews, examiners focused on assessing each bank’s ability to recognize and manage money laundering risks associated with inadequate knowledge of its clients’ personal and business backgrounds, their sources of wealth, and their use of their private banking accounts. FRBNY officials explained to us that most of the banks reviewed had adequate anti-money-laundering programs for their private banking activities, although a few were antiquated and vulnerable to money laundering. Deficiencies identified in the private banking area primarily involved poor internal controls, such as insufficient documentation and inadequate due diligence standards. In a systemwide study conducted during 1998, the Federal Reserve assessed the risk management practices at seven banks with private banking activities. The study found that internal controls and oversight practices over private banking activities were generally strong at banks that focused on high-end domestic clients, while similar controls and oversight practices were seriously weak at banks that focused on higher risk Latin American and Caribbean clients. In the latter part of 1997, the Office of the Comptroller of the Currency began targeting national banks’ private banking activities based on law enforcement leads or on the bank activities meeting OCC’s high-risk criteria. A primary focus of these reviews has been the banks’ implementation of sound KYC policies and procedures. In these reviews, OCC targeted 10 high risk national banks for expanded Bank Secrecy Act examinations, three of which focused on the banks’ private banking activities. OCC found that only one bank had diligently developed processes to manage the risks associated with anti-money-laundering and KYC issues, while the anti-money-laundering processes of the remaining two banks were classified as weak or needing improvement. A second major area for our work was regulatory efforts to oversee offshore private banking activities, including the types of procedures regulators use and the deficiencies they have identified during examinations. Federal banking regulators and law enforcement officials have raised concerns about offshore private banking activities and their potential to be the private banking “soft spot” for money laundering. Although banking regulators believe that customers generally use offshore entities to establish or maintain private banking accounts for legitimate reasons, they are concerned that this practice may also serve to camouflage money laundering and other illegal acts. Offshore entities, including private investment companies and offshore trusts, provide customers with a high degree of confidentiality and anonymity while offering such other benefits as tax advantages, limited legal liability, and ease of transfer. Detecting or preventing money laundering by offshore entities can pose special difficulties because documentation identifying the individual or group that controls these offshore entities and their U.S. private banking accounts (referred to as their “beneficial owners”) is frequently maintained in the offshore jurisdiction rather than in the United States. Regulators recognize that the use of offshore entities to establish or maintain U.S. private banking accounts tends to obscure the account holders’ true identities. Consequently, they instruct their examiners to look for specific KYC procedures that enable banks to identify and profile the beneficial owners of these offshore entities. In the course of examinations, examiners may test the adequacy of beneficial-owner documentation maintained in the United States. At the time of our earlier review in 1998, with the exception of FRBNY, we found no evidence that examiners had attempted to examine the documentation that banks maintain in offshore secrecy jurisdictions. also a way to induce banks to develop or improve their systems for maintaining appropriately detailed information on the beneficial owners of offshore entities that maintain U.S. accounts. Other Federal Reserve and OCC examiners we contacted in 1998 expressed different views about accessing such documentation during examinations. Some examiners, for example, said that they do not see a need to examine offshore documents if they are confident about the bank’s commitment to combating money laundering. Since that time, according to a Federal Reserve official, its examiners have routinely attempted to examine documents maintained in offshore jurisdictions. Offshore branches are extensions of U.S. banks and are subject to supervision by U.S. regulators, primarily the Federal Reserve or OCC, as well as host countries. However, such branches are generally not subject to this country’s Bank Secrecy Act. For this reason, U.S. banking regulators do not attempt to determine whether offshore branches are in compliance with specific anti-money-laundering provisions contained in the Bank Secrecy Act, such as the one requiring that suspicious transactions be reported to U.S. authorities. Instead of monitoring formal compliance, U.S. banking regulators try to identify what efforts the branches are making to combat money laundering and to determine whether the banks’ corporate KYC policies are being applied to activities, such as private banking activities, that the offshore branches may engage in. Although examiners are able to review the written policies and procedures being used in these branches, they must rely primarily on the banks’ internal audit functions to verify that the procedures are actually being implemented in offshore branches where U.S. regulators may be precluded from conducting on-site examinations. They may also rely on external audits, but are less prone to do so because external audits tend to focus on financial, rather than anti-money-laundering, issues. beneficial owners of these offshore entities, maintaining such information in clients’ U.S. files, or having the ability to bring it on-shore in a reasonable amount of time, promotes sound private banking practices, according to the Federal Reserve. Our review in 1998 of FRBNY and OCC examinations found that examiners identified a number of general private banking deficiencies that also pertained to the banks’ offshore private banking activities. Two such deficiencies were inadequate client profiles and weak management information systems. For example, examiners found that some banks’ client profiles contained little or no documentation on the client’s background, source of wealth, or expected account activity, or on client contacts and visits by bank representatives. Examiners also found that some banks’ management information systems did not track client activity or did not allow bankers to systematically examine all accounts related to a given client. Both of these deficiencies make it difficult for banks to monitor clients’ accounts for unusual or suspicious activity, according to the banking regulators. At the time of our review in 1998, we noted that most banks with deficiencies identified during FRBNY’s private banking initiative had started to take corrective actions to address these deficiencies. For example, during follow-up examinations, examiners found that banks had started to make progress on improving client profiles. Some bank officials we interviewed during this assignment expressed concerns that securities brokers and dealers are not subject to the same regulations covering suspicious activity reports or to the same regulatory reviews of KYC policies that banks are subject to. They indicated that this inconsistency creates an “uneven playing field” that they felt was unfair, particularly since brokers and dealers are engaged in private banking activities similar to those of the banks themselves.