Unintended Consequences of Anti–Money Laundering Policies for Poor Countries

Read the executive summary below or download the full report (PDF).

Executive Summary

Money laundering, terrorism financing and sanctions violations by individuals, banks and other financial entities are serious offenses with significant negative consequences for rich and poor countries alike. Governments have taken important steps to address these offenses. Efforts by international organizations, the US, UK and others to combat money laundering and curb illicit financial flows are a necessary step to increase the safety of the financial system and improve security, both domestically and around the world. But the policies that have been put in place to counter financial crimes may also have unintentional and costly consequences, in particular for people in poor countries. [1] Those most affected are likely to include the families of migrant workers, small businesses that need to access working capital or trade finance, and recipients of life-saving aid in active-conflict, post-conflict or post-disaster situations. And sometimes, current policies may be self-defeating to the extent that they reduce the transparency of financial flows.

The policies that have been put in place to counter financial crimes may have unintentional and costly consequences.

Under the current approach, banks are asked to prevent sanctions violations and assess and mitigate money laundering (ML) and terrorist financing (TF) risks, or face penalties. However, regulators sometimes send mixed signals about whether and how banks and other entities should manage their ML/TF risk, which sometimes results in simplistic risk assessment methodologies being applied by these entities. There may also be a chilling effect resulting from the imposition of legitimate fines on some large banks for egregious contraventions of anti-money laundering, counter the financing of terror and, particularly, sanctions laws (commonly referred to collectively as AML/CFT). These factors, along with others, have led banks to adopt an understandably conservative position. This includes exiting from providing services to firms, market segments and countries that are seen as higher risk, lower profitability and could become the source of costly future fines, monitorships or even prosecutions. Banks are engaging in “de-risking” by ceasing to engage in types of activities that are seen to be higher risk in a wholesale fashion, rather than judging the risks of clients on a case-by-case basis. [2]

Individual banks may be acting rationally in not serving certain types of clients, due to a variety of factors. However, the implementation of AML/CFT appears to have created categories of clients whose business cannot justify the associated compliance costs. The financial exclusion of such clients creates yet another obstacle for poverty alleviation and economic growth, especially in poor countries. While the consequences seem manifold, the data are too weak to make systemic judgments. That said, we do observe some correlations between AML/CFT policies and debanking of money transfer organizations, correspondent banking, and non-profits trying to access banking services in difficult environments:

• Migrants who want to send money home and the families who rely on that money need a healthy money transfer organization (MTO) sector. These MTOs are seeing banking services denied, downgraded, or made more expensive. In other words, MTOs are pushed out of one bank and have to find another that may be more expensive, or based in a less transparent jurisdiction. In 2013, more than 140 UK-based remittance companies were told by Barclays Bank that their accounts would be closed. Following this, and similar de-banking episodes in the US and Australia, only larger money transfer organizations have access to bank accounts. Industry bodies report that many smaller players have been forced to close, become agents of larger businesses, or even disguise the true nature of their operations in order to remain banked. Given that remittances from migrant workers total $440bn a year (more than three times foreign aid), a vital source of finance for poor countries might be affected.
• Vulnerable people in post-disaster or conflict situations rely on non-profit organizations (NPOs) to deliver humanitarian assistance. Citizens of all countries rely on NPOs to assist in sustainably reducing the incidence of terrorism. But these same (NPOs) report difficulties carrying out operations. For instance, HSBC closed the bank account of several NPOs including the Cordoba Foundation, a think tank that receives money from the UK government for work to prevent terrorism, saying only that continuing to bank the organization ‘fell outside the bank’s risk appetite’.
• Small to medium-sized firms in poor countries lack the credit they need to create jobs. To get access to this credit, they need local banks to have easy connections to large international banks. Unfortunately, rich country banks increasingly report withdrawing correspondent banking services from banks in high risk jurisdictions, including many poor countries, reducing their access to the global financial system.
• Regulators may also be losing out. They find it more difficult to track transactions as MTOs who cannot send funds electronically begin to use potentially less transparent mechanisms including bulk currency exchanges, and as banks and businesses in poor countries have to send funds via banks with less robust compliance programs and operating in less transparent jurisdictions instead of directly to rich countries. In the long term, this threatens public safety and economic stability across the globe.

So serious is the problem of de-risking that Mark Carney, Governor of the Bank of England and Chairman of the Financial Stability Board, has termed it ‘financial abandonment’, while Janet Yellen, Chair of the US Federal Reserve, acknowledged before Congress that rich countries’ AML/CFT rules were ‘causing a great deal of hardship’. In 2015, the G20 Finance Ministers and Central Bank Governors welcomed work by the FSB that addresses the withdrawal of correspondent banking.

In this report we catalogue extensive suggestive evidence of some of the unintended consequences of AML/CFT and sanctions enforcement. We recognize that FATF and others are already taking steps to address these problems and we welcome their efforts. In this report, we recommend five key actions that should be taken by public officials — particularly in the Financial Action Task Force (FATF, the global standard setting body for AML/CFT) and the Financial Stability Board (FSB, which coordinates and reviews the work of the international standard setting bodies) — as well as by national regulators, banks, MTOs and NPOs. The support of the United States, the United Kingdom and other rich countries for these efforts are critical, as is that of the G20.

National regulators should work to reduce regulatory uncertainty and provide clear signals to banks and other financial institutions. Banks should also play a role, especially by continuing to invest in portable identity verification and tracking. Money transfer organizations and non-profits should make greater efforts to implement and demonstrate effective compliance systems. Better cooperation among regulators, policy makers, and private actors would enable meeting the twin goals of stopping money going to bad actors and allowing finance to flow in an efficient and transparent way.

Where necessary, the actions we recommend need to be taken in conjunction with other specialist organizations such as the United Nations and the EU (sanctions), the Basel Committee on Banking Supervision (standard setter for bank supervision), the Committee on Payments and Market Infrastructures (standard setter for payment systems), the IMF and the World Bank. The Financial Action Task Force (FATF) is the global standard-setting body for AML/CFT. However, it has stated, in line with the evidence, that de-risking behavior has many drivers, a number of which lie outside its mandate. A process led by the FSB and supported by FATF is appropriate. [3]

We summarize five recommendations below. While some of the following recommendations are potentially ‘quick wins’ that could be enacted rapidly and at little cost, others would take several years to implement and will require significant financing, both from governments and from the private sector.

1. Rigorously assess the unintended consequences of AML/CFT and sanctions enforcement at the national and the global level

The strength of the suggestive evidence detailed in this report requires a rigorous causal investigation of the unintended consequences of AML/CFT enforcement.

• The FSB should conduct a rigorous assessment of the global AML/CFT and sanctions regulatory environment, including the guidance produced by FATF, with a view to reducing unintended consequences.
• FATF should continue to enhance its mutual evaluation methodology to include:
  • A. Displacement of transactions from more into less transparent channels, which are sometimes informal or processed through lower-tier, less compliant institutions
  • B. Risks in the whole economy, rather than just in the formal financial sector
  • C. Risks posed to the important drive toward financial inclusion
  • D. Over-compliance at the national level and in particular sectors

2. Generate better data and share data

In order to assess unintended consequences rigorously, more and better data should be generated through private and public sector efforts.

• The World Bank should make publicly available, both the results and if possible, the underlying anonymized data, from its de-risking survey of banks, MTOs and governments as soon as possible.
• The FSB should direct the World Bank to carry out representative, countrywide surveying of NPOs involved in the delivery of humanitarian assistance, banks and MTOs.
• Government agencies that keep detailed registries of regulated MTOs and NPOs should make available headline statistics about the numbers and nature of such organizations.
• National financial intelligence units, including but not limited to FinCEN, should query financial institutions for data regarding the volume, amounts and types of transactions associated with MTOs, NPOs and banking correspondents.
• On behalf of central banks and private financial institutions; SWIFT, CHIPS, CHAPS, BIS and other entities tasked with managing and collecting data on cross-border transactions and relationships should make available data on bilateral payment flows and the number of correspondent banking relationships between countries.
• National governments should make the data that they are using for risk analyses and regulatory impact assessments available to other jurisdictions and to parties conducting analyses that are demonstrably in the public interest.

3. Strengthen the risk-based approach

FATF should be congratulated for introducing and recently strengthening its risk-based approach. However, it needs to be applied more extensively and more consistently.

• FATF should provide a definition of money laundering and terrorist financing risk for its purposes that is consistent with a standardized definition (as provided by the International Organization for Standardization) and existing private sector definitions of ‘risk’.
• FATF should clarify its thinking regarding transparency and the tradeoff of risk in the formal versus informal sector.
• FATF should further encourage simplified due diligence where it is in the best interests of transparency.
• FATF should urgently revise Recommendation 8 to reflect the fact that NPOs may be vulnerable to terrorist abuse by virtue of their activities, rather than whether they happen to be an NPO or not.

4. Improve compliance and clarify indicators of lower risk

Compliance procedures at many NPOs and MTOs must be improved so as to be more effective. At the same time, more needs to be done to recognize those NPOs and MTOs that do have effective systems in place, including better supervision of MTO sectors at the country level.

• Many NPOs and MTOs, especially smaller ones, should improve their compliance procedures to ensure money laundering and terrorist financing risks are mitigated effectively and efficiently.
• FATF should provide greater clarity on the likely indicators of lower risk NPOs and MTOs, and national governments and industry participants should collaborate to reflect this guidance with best practice documents.

5. Facilitate identification and lower the costs of compliance

National governments, banks and the World Bank should accelerate the adoption of new and existing technology to facilitate lower cost customer identification, know your customer compliance, and due diligence.

• National governments should provide citizens with the means to identify themselves in order to make reliably identifying clients possible for financial institutions and other organizations.
• National governments should ensure that appropriate privacy frameworks and accountability measures support these identification efforts while ensuring the free flow of information related to identifying ML and TF.
• Banks and other financial institutions should redouble their efforts, with encouragement from the FSB and national regulators, to develop and adopt better messaging standards and implement KYC documentation repositories.
• Banks and other financial institutions should accelerate the global adoption of the Legal Entity Identifier scheme.
• The World Bank should convene all relevant entities to review the possibility of donor-subsidized third party verification for unprofitable clients.

Download the full report (PDF).