Source of Funds (2024)

Source of Funds (1)

What Is a Source of Funds?

Source of funds refers to the origin of funds used in a transaction. It relates to the account that was used to make a payment and the source of the money in that account.

Businesses must put checks in place relating to the source of funds (SOF) to ensure that their customers are not using transactions to launder money gained through illegal activities. This is one of many steps that organizations must take to ensure that they comply with anti-money laundering legislation such as the 6th Anti Money Laundering Directive (6AMLD).

Establishing the source of funds can be complicated, particularly where transactions are made through companies. In such cases, businesses must dive deep in order to comply with anti-money laundering (AML) legislation, establishing facts ranging from how the company makes its money to who is the ultimate beneficial owner of a business – that is, the person who will ultimately gain financially.

Despite the difficulties, businesses must put processes in place to ensure that their verification of sources of funds is sufficient to meet the requirements of AML legislation. Failure to do so could result in legal proceedings, heavy fines, and extensive reputational damage due to the resulting association with criminals.

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How Does the Source of Funds Verification Work?

Source of funds verification works by asking customers to provide evidence of where their funds have come from. Employment contracts and documents that show proof of investments, for example, can demonstrate that funds have been obtained through legitimate channels.

Having to identify the source of funds behind every single transaction places an enormous administrative burden on businesses. Thankfully, risk-based, machine learning-driven Know Your Customer (KYC) solutions are available to help organizations identify their most risky customers and take steps to ensure they act accordingly.

Different elements of a transaction can trigger a business to initiate a source of funds verification. For example, a new customer who spends $100,000 or more in their first purchase (or first few purchases) certainly warrants further attention. Likewise, any customer deemed as being particularly high-risk, such as a politically exposed person (PEP), will need to go through additional checks.

Tips to Make the Process Easier

Any reliable source of funds verification starts with ensuring that robust processes are in place for gathering and verifying customers’ personally identifiable information (PII) as part of the onboarding process. Doing so manually is far too onerous and time-consuming; opting for a fully featured, customizable KYC and fraud-fighting solution is essential in order to simplify the process.

Examples of Source of Funds

Sources of funds can be both legitimate and illegitimate. A legitimate example of a source of funds can include anything where the money was obtained through legal means, such as:

  • wages, bonuses, dividends, and other income from employment
  • pension payments
  • interest from personal savings
  • returns on investments
  • money from property sales
  • legitimately won money, such as that received from betting or winning the lottery
  • inheritance and gifts

Illegitimate sources of funds, on the other hand, include money gained through terrorism, fraud, bribery, laundered money, and so on.

Why Is SOF Important?

Businesses have a legal and moral responsibility to establish the source of funds used by their customers. SOF is important because establishing where money came from can ensure that businesses aren’t inadvertently laundering money and/or funding terrorism through their daily operations.

Let’s put this in context. The United Nations Office on Drugs and Crime estimates that between 2% and 5% of global GDP is laundered. That’s somewhere between $800 billion and $2 trillion.

Businesses are doing all they can to fight back, with the result that the global anti-money laundering software market has grown from a value of $868 million in 2017 to an estimated $1,770.2 million in 2023, according to BIS Research.

The sheer scale of the money laundering that is taking place highlights why measures such as SOF verification checks are vital. Fraud-fighting and crime-fighting agencies have a huge task on their hands and so need businesses to play their part and do all they can to prevent money laundering from taking place, thus reducing criminals’ opportunities to use the proceeds of their crimes.

Businesses also have a financial incentive to put robust anti-money laundering verification processes in place. The minimum fine under 6AMLD for those guilty of non-compliance is €5 million (equating to $5.4 million at the time of writing), as well as four years’ imprisonment, with harsher penalties in place for repeat offenders. Reputational damage can also impact businesses found guilty of non-compliance with anti-money laundering legislation, leading to the loss of customers and revenue.

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Differences Between Source of Funds and Source of Wealth

It’s important to note that source of funds and source of wealth (SOW) are not the same thing. As we’ve discussed above, establishing the source of funds relates to identifying where the money used in a transaction has come from. A source of wealth, on the other hand, refers to the origins of a person’s overall wealth, rather than the funds relating to a single transaction.

This means that businesses looking into the source of an individual’s wealth must undertake additional work to that required for the verification of the source of funds.

Businesses weighing up whether they need to undertake source of funds versus source of wealth verification checks are largely guided by regulatory requirements. Those working in the banking, insurance, property, and financial services sectors, for example, are likely to look far more closely at the source of wealth, due to the nature of the work they undertake and the amount of money that they process.

While businesses can establish the source of funds used in a transaction by checking financial documents, the source of wealth verification must look deeper. An individual who has accumulated their wealth through employment, for example, could show their contract, pay stubs, tax returns, and other salary-related documents as evidence. One who has inherited wealth could provide evidence of the transfer of funds from the estate of the deceased, including documentation of any tax paid in relation to the inheritance. Wealthy business owners, meanwhile, could show their income statements, contracts, sales documents, and so forth.

The evidence requirements involved in SOF versus SOW checks will vary from case to case. As such, businesses need to be flexible in their approach and ensure that the checks they undertake are always suited to the customer in question.

Best Solutions for Source of Funds Verification

Meeting AML source of funds requirements can feel overwhelming at times, but using the right software solutions can reduce it to a manageable task. Know Your Customer (KYC) verification can become a routine part of customer onboarding, with businesses tweaking their solutions to ensure that they don’t introduce an offputting amount of friction.

The top anti-money laundering software solutions boast a wide range of features, with different approaches suited to different markets. As such, businesses need to research the ideal solution for their sector, geographic location, and general customer risk profile. Doing so will help companies home in on the perfect AML software to meet their needs, including a robust approach to source of funds verification.

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