Curbing money laundering

Updated 01 Jun, 2020

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Banks remain reluctant to perform as agents for regulators to curb money laundering. — AFP/File
Banks remain reluctant to perform as agents for regulators to curb money laundering. — AFP/File

RECENT regulatory penalties by the Office of Financial Asset Control (OFAC) of the United States, Financial Conduct Authority (FCA) of the United Kingdom and the State Bank of Pakistan (SBP) are reflective of the failure of banks to comply with anti-money laundering (AML) regulatory requirements.

These challenges relate to the banks’ adoption and implementation of AML regulations.

In the United States, the Department of Financial Services (DFS) imposed a fine of $225 million against Habib Bank Ltd’s New York branch. Its licence to operate in New York was suspended in 2017. DFS made HBL liable for misconduct, which included dealing with Al-Rajhi Bank with a reported link to Al Qaida. Besides, it permitted around $250m worth of transaction to sanctioned persons and entities while 13,000 transactions were permitted without information about their nature and the identity of the parties involved.

More recently, OFAC found Standard Chartered Bank (SCB) in violation of numerous sanctions the US government had imposed on various countries, including Iran, Syria, Sudan, Burma and Cuba. SCB’s London, Dubai and New York branches were involved in facilitating transactions that violated the US economic sanctions. SCB agreed to settle OFAC’s claim for $132m regarding 911 transactions worth around $133m to or through the United States in violation of Iranian Transactions and Sanctions Regulations (ITSR).

A United Arab Emirates–incorporated petrochemical company was engaged in the sale and transportation of petroleum products to and from Iran. In 2007, SCB Dubai performed customer due diligence (CDD), whereby the petrochemical company’s owner was identified as the “resident in a high-risk jurisdiction”. From 2009 to 2012, SCB Dubai maintained an account for the petrochemical company despite various indications about the Iranian connections of the company. By 2011, SCB Dubai could decide to end its account relationship with the petrochemical company.

SCB undertook global remediation of its sanction and effectively co-operated with OFAC to ensure compliance with US economic sanctions. SCB has agreed to avoid the recurrence of the breach in the future through measures improving management commitment, risk assessment, internal controls, audit, training and annual certification to the satisfaction of OFAC requirements.

In the United Kingdom, the FCA imposed a fine of £102m against the failure of SCB UAE to comply with AML standards under the ML regulations in 2019. Employees of SCB UAE conducted sanction evasion transactions to maintain client relationships. Eventually, the bank staff preferred client relationships to compliance with financial crime policies.

The FCA penalty concerned two areas of monitoring: CDD and ongoing monitoring. Moreover, firms in the United Kingdom are under an obligation to ensure their non–European Economic Area (EEA) branches apply the CDD and ongoing monitoring requirements equivalent to the UK ML regulations. A correspondent bank is required to conduct CDD and enhanced ongoing monitoring of non-EEA respondents under the UK ML regulations.

In Pakistan, the SBP imposed a fine of Rs35.62m on HBL’s UAE branch for non-compliance with the screening requirements under FATF AML guidelines. The SBP imposed the fine for ineffective customer screening procedures. The bank’s employees were involved in assisting transactions conducted by sanctioned persons. The bank was also involved in dealing with politically exposed people.

In another case, the Supreme Court took a suo motu notice of a case in which 32 fake bank accounts were being held in Summit Bank Ltd, Sindh Bank Ltd and United Bank Ltd. Two prominent politicians were suspects of laundering the money earned through bribery, kickback and corruption. The court held that there is a clear lack of professionals with the expertise to detect money laundering.

The court, therefore, constituted a joint investigation team (JIT) comprising of financial regulators and law enforcement agencies. The JIT was given the task to investigate the matter thoroughly to convict the suspects.

There are two observations with regard to the penalties imposed by regulators in the three jurisdictions.

One, banks prefer to make profits by facilitating clients’ requests instead of being compliant with the regulatory requirements. Their unwillingness to comply with regulations is a regulatory failure, which brings into question the effectiveness of AML regulations in the three jurisdictions.

An economic theory of offence suggests that if the cost is higher than the benefit of offence for a potential perpetrator, it will deter criminal behaviour. Therefore, policymakers emphasise heavy regulations and strict scrutiny, including both personal and criminal liability, for bank employees and even top management.

Nonetheless, banks remain reluctant to perform as agents for regulators to curb money laundering. An effective AML framework should be based on the cost-benefit analysis of regulations for financial institutions. Proponents of the cost-benefit analysis of regulations criticise the current approach of regulators who “believe that the most important thing is to stop bad things happening in finance”.

Secondly, the nature of regulation in all three jurisdictions reveals the approaches regulators have taken to mitigate money laundering. The Patriot Act of 2001 allows the extraterritorial regulatory jurisdiction to ensure foreign banks comply with US AML regulations, which serve the country’s political agenda. Quite contrary, the United Kingdom has imposed extensive regulations on its banking system. As a result, financial regulators are being overburdened with the scrutiny of almost every little banking transaction under the Suspicious Activity Report (SARs) requirement.

Pakistan has inadequate regulations to overcome the risk of financial crimes identified by the Asia Pacific Group. Tools to mitigate the risk are highly insufficient. For example, regulatory bodies do not have the resources to monitor the risk, the framework is ineffective, the prosecution and conviction rates are quite low and financial intelligence is almost non-existent to overcome the risk assessed by policymakers.

The writers work at Lahore University of Management Sciences

Published in Dawn, The Business and Finance Weekly, June 1st, 2020