AML/CFT Risk Management and Bank Profitability: A Covariance-Based Assessment Framework for Azerbaijan

Abstract

This paper develops a covariance-based framework for incorporating anti-money laundering and counter-terrorist financing (AML/CFT) risk into bank profitability assessment. AML/CFT obligations generate direct compliance expenditure, while inadequate controls may produce regulatory, operational, reputational and correspondent-banking losses. The framework treats credit, liquidity, operational and AML/CFT compliance risks as interdependent components of a bank-wide risk portfolio, represents their joint effect through a variance-covariance matrix, and links it to risk-adjusted profitability. The study is conceptual and scenario-based: it neither assigns unobservable AML/CFT risk scores to Azerbaijani banks nor claims causal estimates. It instead specifies measurable variables, equations and a future empirical protocol. The model indicates a potentially non-linear profitability effect: stronger controls raise current operating costs but may reduce expected losses from sanctions, remediation, reputational damage and de-risking. Azerbaijan is a relevant setting because institutional assessments identify banking as an important risk-bearing sector while comparable public bank-level AML/CFT outcome data remain limited.