Understanding Source of Funds and Wealth: An Overview for Financial Institutions

Mažvydas Miliauskas
Author
Mažvydas Miliauskas, CAMS
Published
January 17, 2024
Source of Funds (SOF) and Source of Wealth (SOW) in AML

In the ever-evolving landscape of financial crime prevention, the concepts of Source of Funds (SOF) and Source of Wealth (SOW) play a pivotal role.

These terms refer to the origins of a customer’s financial assets and the means through which they have accumulated their wealth, respectively. Understanding and verifying these sources are critical components of AML compliance for all financial institutions that are at the forefront of the battle against money laundering, terrorism financing, and other illicit activities.

Failure to comply with these requirements can have severe repercussions as it can expose institutions to significant financial penalties, reputational damage, and even criminal liability. 

In this article, we will look deeper into this topic in order to understand the key terms, problems that financial institutions face, what red flags to look for and share some practical examples on how to improve the best possible outcome for your organization.  

The importance of KYC program

SOF and/or SOW documents alone do not tell you anything without combining this information with the KYC program. For example, if the customer provided proof that their yearly income is USD 100,000, should we simply document this proof and move on? 

During the standard KYC process financial institutions gather a range of personal, financial, and professional information about their customers. Only by establishing robust KYC practices, financial institutions can identify and understand their customers and what is considered to be “normal” for them, assess the risks, and prevent the misuse of financial services for illegal activities.

If the institution considers that customer presents high risk patterns for money laundering and/or terrorism financing, they will be asked to verify their SOF/SOW. When the institution obtains the requested information, it serves as a baseline to establish a customer’s financial profile based on their income sources, occupation, and declared financial standing. Activity that significantly deviates from the established profile can trigger a red flag for further review during the ongoing due diligence process.

Source of Funds vs. Source of Wealth: key differences

While SOF and SOW are closely related, they serve distinct purposes and provide different insights into a customer’s financial background. Understanding the difference is critical for all financial institutions to effectively mitigate risks and comply with the existing AML regulations.

The source of funds refers to the origin of the money involved in a specific transactional activity. It addresses the short-term context and explains where the money used for a particular deposit, or a payment comes from. After the documents are obtained, it should be a good indication that the funds were earned in a legitimate way and do not derive from illicit activities. The obtained documents should also help to determine if such activity is expected to be a one-time event (e.g., sale of real estate, winning from a lottery, a gift), or a periodic event (e.g., salary, bonuses, dividends, income from rental activities etc.). 

Source of Funds (SOF)The source of wealth, on the other hand, refers to the overall accumulation of an individual’s financial resources over time (long-term context). It provides a broader view of how a person or entity acquired their wealth and reflects their financial standing from a holistic perspective that considers the cumulative origin of a customer’s wealth rather than focusing on specific transactions.

Source of Wealth (SOW)It is particularly important for high-net-worth individuals, politically exposed persons (PEPs), or customer’s that are regularly involved in large or complex transactions. There are many ways how the wealth can be obtained but the most common examples include the following:

  • Inherited wealth or family wealth
  • Profits from a business
  • Career earnings (e.g., salaries from long-term employment, high income career etc.)

In short, these are the key differences between the SOF and SOW:

AspectSource of Funds (SOF)Source of Wealth (SOW)
Purpose in AMLVerifies legitimacy of customer’s specific fundsVerifies legitimacy of customer’s obtained wealth and potential involvement of other parties
ScopeTransaction-specificOverall customer’s financial standing
Timeframe/ContextImmediate and short-termLong-term and cumulative
FocusOrigin of money for a transactionAccumulation of total customer’s wealth
ExamplesSalary, sale proceeds, dividendsInheritance, business profits, career earnings

Challenges for financial institutions 

  • Requesting and verifying SOF and SOW documents come with significant challenges for the financial institutions, both operational and customer-facing. Criminals want to provide as little information and documents as possible, however there are also situations where legit customers do not want to share this documentation as well.  Below are some of the key hurdles the institutions face:
    • Customer Resistance – customers often perceive requests for SOF and SOW documents as intrusive, especially if they feel their financial history is private or irrelevant. Many customers do not fully understand why financial institutions require such detailed information, leading to frustration and resistance as they fear it can expose them to various breaches of privacy or misuse of their data.
    • Incomplete Documentation – verifying wealth accumulated over decades can be challenging if the customer does not have records, such as inheritance documents or old business contracts.
    • Informal Sectors and Cash-based Economies – customer’s income can be derived from informal sectors or cash-based economies, therefore customers may lack formal documentation to prove SOF or SOW. It is important to note when funds are coming from another financial institution, it cannot be automatically presumed they are clean and therefore, there is no further action is needed to verify their SOF/SOW.
    • Variances in Documentation – standards for financial documentation differ across jurisdictions or may require translation making it difficult to verify documents from certain countries or regions.
    • Politically Exposed Persons (PEPs) – PEPs may contain multiple sources of income, which can make their SOF/SOW verification a difficult process.
    • Data Integrity – ensuring that documents submitted by customers are authentic and not fraudulent requires sophisticated tools, expertise or even notary approvals/ Apostille.
    • Mismatching Regulatory Requirements – AML and KYC requirements vary across jurisdictions and are frequently updated, creating a moving target for compliance teams.
    • Regulatory Risks – regulators may impose penalties if institutions fail to collect adequate documentation or if due diligence procedures are deemed insufficient.
    • Customer Attrition – overly stringent or poorly communicated documentation requests may result in delays during onboarding and drive customers to switch to competitors with less burdensome processes.
    • Trust Issues – repeated or unclear requests for information can erode customer trust, particularly if the institution fails to explain the necessity of such requirements effectively.
    • Cybersecurity Risks – storing sensitive customer documents securely while ensuring compliance with data protection laws requires robust infrastructure and protocols.

Red flags in Source of funds and wealth documentation

  • When conducting KYC reviews and verifying Source of Funds (SOF) or Source of Wealth (SOW) documentation, financial institutions must remain vigilant for red flags that may indicate potential fraud, money laundering, or other illicit activities and could include one or more of the following patterns:
    • Inconsistencies/Mismatch Between Documents – discrepancies between customer-provided information (e.g., income, occupation) and the supporting documents, such as tax returns or employment contracts.
    • Conflicting Transaction Patterns – transactions that do not align with the customer’s declared source of funds or wealth (e.g., large deposits from unknown sources for a low-income individual).
    • Vague or Generic Descriptions – documents that fail to provide specific details about the origin of funds or sources of wealth, or claims of income from unverifiable or obscure sources, such as unregistered businesses or “gifts”.
    • Altered or Forged Documents – evidence of tampering, such as mismatched fonts, erasures, or inconsistencies in formatting.
    • Outdated or Incomplete Documents – submission of old or expired documents that do not reflect the customer’s current financial situation.
    • Third-Party Payments – SOF documentation showing funds coming from unrelated third parties with no clear connection to the customer, also transfers through multiple accounts or intermediaries that obscure the origin of funds.
    • Significant Wealth for Low-Income Individuals – a customer with limited income declaring significant assets or conducting large transactions without a plausible explanation.
    • Sudden Influx of Funds – large, unexplained deposits or rapid accumulation of wealth inconsistent with the customer’s profile or financial history.
    • Involvement of Politically Exposed Persons (PEPs) – PEPs with unclear or unverifiable sources of funds or wealth, should raise concerns about potential corruption or bribery.
    • Offshore Companies/Accounts – use of legal entities/accounts in jurisdictions known for secrecy or weak regulatory oversight and/or it appears to exist only on paper and have no legitimate business operations.
    • High-Risk Industries/Occupations – customers involved in industries with a higher risk of money laundering, such as real estate, gambling, or cryptocurrency trader.
    • Regular Cash Transactions – regular deposits or withdrawals of large amounts of cash, especially in amounts just below reporting thresholds.
    • Inconsistent Countries/Jurisdictions – transfers to/from countries or regions unrelated to the customer’s declared business or personal activities, especially if it presents high risk of corruption, weak AML regulations, or known financial secrecy.
    • Customer Behaviour – customers who are uncooperative or delay providing SOF or SOW documentation without a reasonable explanation or attempts to provide only the bare minimum required documentation, avoiding details that could raise scrutiny.
    • Unusual Cross-Border Activity – frequent international transactions with no clear business justification or connection to the customer’s declared activities. 
    • Absence of Documents – claims of income from employment without proper supporting documentation, such as pay slips, contracts, financial statements, tax filings etc.

    Special attention should be given to the following activities:

    • Structuring – deposits or withdrawals in amounts just below regulatory reporting thresholds.
    • Layering – transactions designed to obscure the trail of funds, such as multiple transfers between unrelated accounts, funds sent abroad and quickly returned to domestic accounts without a clear business purpose etc.

You can read more about the 3 stages of money laundering here.

Best practices for investigating Source of funds and wealth documents

In the end, we will review some best practices that can help financial institutions to ensure compliance and operational efficiency while maintaining customer trust: 

  1. Adopting a Risk-Based Approach  – segment customers and transactions into low, medium, and high-risk categories based on factors such as geography, industry, transaction patterns, and customer type (e.g., Politically Exposed Persons). This will ensure that resources are allocated accordingly by prioritizing the clients that present higher risk. This altogether will help to ease-up the communication flow with low risk clients, not triggering them without any necessity to provide additional documentation. 
  2. Standardize Document Requirements  – establishing a standardized list of acceptable SOF and SOW documents, such as pay slips, tax returns, property sale agreements, or inheritance papers.
  3. Understand Customer Profiles Holistically – cross-reference SOF and SOW documents with other aspects of the customer’s profile, including declared occupation, income, and transaction history. Use transaction monitoring systems to compare ongoing activities with expected behaviour based on the customer’s profile.
  4. Maintain Robust Communication – clearly explain why SOF and SOW documentation is required, how the company takes Data Security & Privacy topics seriously and offer step-by-step instructions on the types of documents required and acceptable formats to minimize delays or incomplete submissions. Use centralized communication platforms to handle queries and provide status updates on submitted documents.
  5. Utilize Existing Compliance Systems – implement digital solutions for seamless document submission to improve accuracy and reduce processing time. Also, deploy transaction monitoring tools that flag unusual patterns, such as large transactions, multiple small deposits, or cross-border transfers.
  6. Regular Trainings for the KYC department/teams – provide comprehensive training on identifying red flags, verifying documents, and applying AML regulations, evolving regulations, new document forgery techniques, emerging financial crime trends and real-world cases.
  7. Enhanced monitoring of high-risk accounts – execute enhanced monitoring for high-risk clients or high risk accounts with a purpose of additional layer of scrutiny  SOF and SOW verification.
  8. Adopt a Collaborative Approach – engage with regulatory bodies to stay ahead of compliance requirements and adopt best practices. Also, share insights and trends with other financial institutions to collectively address money laundering risks.
  9. Focus on Customer Experience – design processes to reduce the burden on customers while meeting compliance needs, such as enabling digital submissions and pre-filled forms.

Investigation in practice

Investigating KYC profiles and SOF/SOW documents requires a careful balance between regulatory compliance, operational efficiency, and customer satisfaction. By adopting these best practices, financial institutions can enhance their AML frameworks, mitigate risks, and foster long-term trust with their clients, ensuring a secure and compliant financial environment.

In the AMLYZE platform, it is made easier for compliance professionals to follow-up the processes, needed for accurate internal investigation:

1. Convenient customer profile, that helps to access critical information about the clients. A dedicated field is available where you can view essential details regarding the Source of income. This feature allows you to seamlessly integrate this type of information insights into your transaction analysis. By cross-referencing a client’s declared financial background with their transaction history, you can quickly identify inconsistencies, spot potential red flags, and ensure compliance with AML/CFT regulations.

Convenient customer profile

2. The Customer Due Diligence (CDD) Tab
is a highly valuable feature that streamlines the process of evaluating a client’s risk profile. It effectively highlights and organizes key criteria that should be considered during a thorough risk assessment. This allows for a more in-depth analysis by presenting essential data, such as transaction history, compliance checks, and potential red flags, in a clear and accessible format.

Customer Due Dillgence

By consolidating this information in one central location, the CDD Tab not only facilitates the efficient review of actions already performed within the customer’s case but also supports informed decision-making. It enables users to quickly identify areas of concern, making it easier to take necessary follow-up actions, such as requesting additional information or flagging the account for further scrutiny. In essence, this feature enhances the accuracy and effectiveness of customer file reviews, improving risk management and compliance processes while also saving valuable time.

With AMLYZE, you can gain a holistic view of your client’s financial profile, enabling more informed decisions and efficient risk management.

If you want to know how AMLYZE can solve the problems described below, please check Customer Risk Assessment or AML Investigations subpages.

About the author

Mažvydas Miliauskas
Author
Mažvydas Miliauskas, CAMS
Mažvydas is AMLYZE contributing author. CAMS certified high achiever who is passionate about financial crime compliance, ML/TF typologies and enterprise risk management.

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