The fight against money
laundering
An economic analysis of a cost-benefit
paradoxon
Hans Geiger and Oliver Wuensch
Abstract
Purpose – To provide an economic view on the costs and benefits of anti-money laundering (AML)
efforts.
Design/methodology/approach – Based on a international, comparative study conducted in
Switzerland, Singapore and Germany, the authors outline the impact of AML measures on banks and
the financial services industry. The paper discusses possible reasons for the failure of AML to fight the
predicated crimes. It also discusses the collateral damage caused by AML.
Findings – Compared with the monetary and non-monetary costs of money laundering prevention
for the society and the economy, the benefits are small. Instead of broadening and deepening the
current AML framework, a thorough review of the current approach should take place.
Research limitation/implications – Costs and benefits of AML measures are hardly quantifiable.
The authors resort to a qualitative approach, stylising possible outcomes and side effects of money
laundering prevention.
Practical implications – Useful set of arguments for discussing the benefits and shortcomings of
the current and upcoming AML measures.
Originality/value – Money laundering measures and their impact are examined using basic laws of
economy and financial intermediation.
Keywords Money laundering, Economic value analysis, Cost benefit analysis
Paper type Conceptual paper
Prologue
The Swiss Banking Institute of the University of Zurich has, in co-operation with
universities in Germany and Singapore, conducted an international survey on the
anti-money laundering (AML) measures among banks in Switzerland, Germany and
Singapore[1]. The conclusions of the survey are puzzling:
.
Banks consider the compliance with AML rules as essential and important.
.
The AML rules’ implementation is highly burdensome and causes significant
costs and efforts throughout the banks.
.
There seems to be a broad consensus amongst practitioners and scientists that
the impact of money laundering prevention on the predicate offences is small.
It is the objective of this paper to analyze the puzzle of these three findings and
formulate some theses for the future development of AML measures.
Introduction
Banks and other participants in the economy have become used to ever increasing
regulation, but constantly complain about the burden they face in fulfilling the
requirements. According to the “Banana Skin Report” in 2005[2], “the remorseless rise
in regulation has become the greatest risk facing the banking sector”. Regulators have
taken up these concerns and consider the balance between costs and benefits of
existing and upcoming regulatory requirements today[3]. This is, however, not true for
all regulatory aspects. One notable exception is the area of money laundering and
terrorism financing. Various provisions have been enacted which engage the financial
services industry in the fight against the use of the financial sector by criminals. In
contrast to other regulatory areas such as capital adequacy or risk management,
benefits and costs of AML ventures are not considered. The AML pipeline is full of
upcoming provisions, especially as the relevance of organised crime, drug trafficking
and other illegitimate ventures did not decrease in spite of the massive measures taken
during the last two decades.
When discussing with banks and other financial services providers about AML,
they mainly emphasize on the implementation costs, which place a significant burden
on the industry, especially on smaller market participants. A recent study[4] showed,
that money laundering prevention measures account for 45 per cent of the total
regulatory burden and 2 per cent of the total costs in Swiss private banking. The cost
of regulation exhibits strong economies of scale. The burden for small banks[5] is more
than twice as high than for bigger banks. Small banks are therefore heavily penalised
against larger institutions. This applies for the implementation of banking regulation
in general, and for money laundering prevention in particular. However, private banks
also regard money laundering prevention as the most important regulatory area[6].
According to the official view, the money laundering prevention measures work
along the following principle[7]: first, by depriving the criminals of their illicit assets,
the expected revenue of a predicate criminal venture declines. Second, by imposing the
necessity of laundering the assets, the transaction costs increase. Finally, the money
laundering prevention efforts increase the probability of being detected and
convicted[8].
Whilst this deterrence mechanism sounds logically reasonable, its effectiveness and
efficiency for fighting predicate crime is doubtful. Direct costs and collateral damages
are high, the benefits for reducing predicate crimes small. This paper focuses on the
“collateral damage”. We show that money laundering prevention measures leads to
undesired side effects both for the economy and for the society as a whole. They may
even counteract one of the most important objectives of the endeavor, to fight
organized crime.
The next section introduces basic economic principles and outlines their
applicability in the area of money laundering and money laundering prevention.
Applying these economic laws, the following section describes the impact AML
provisions have on the legitimate and illegitimate sphere of the economy. The strategy
of banks and states in implementing current and developing upcoming AML provision
is then discussed. The final section gives basic rules the authors deem important for
assessing and improving the AML efforts.
Economic aspects of the anti-money laundering measures
In this paper, we present a stylised view on AML prevention and its positive and
negative effects by applying basic laws of economics. We assume that the same
economic laws apply both to the legitimate and the criminal spheres of the society.
Basic principles of economics
In classical economic theory two basic forces determine the behavior of an individual.
First, every individual acts rationally and aims to maximise his personal utility. This
principle is taken into account for most decisions an individual takes. For criminal
ventures which are committed to acquire personal wealth in particular, the decisions
are governed by this principle. Second, the personal utility of an economic venture is
mainly determined by its expected costs and revenues, which in turn are governed by
the fundamental laws of demand and supply.
In this classical world of Adam Smith, it is not the individual person or company
who looks after the wellbeing of the nation:
He [the individual] generally, indeed, neither intends to promote the public interest, nor
knows how much he is promoting it. [. . .] he intends only his own security; [. . .] he intends
only his own gain, and he is in this, as in other cases, led by an invisible hand to promote an
end which was no part of his intention[9].
The state should protect its citizens from “violence” and “injustice”[10]. Adam Smith
proposed the “obvious and simple system of natural liberty”[10], where:
. . . every man, as long as he does not violate the laws of justice, is left perfectly free to pursue
his own interest his own way, and to bring both his industry and capital into competition
with those of any other man, or order of men.
But these principles only work, if the legal framework, e.g. AML rules, does not lead to
distortion of competition. Given the differences in economic law and implementation
worldwide, and also the different impact of AML rules and other regulation on the
participants of the economy, this assumption is questionable. State regulation often
actively sets competitive incentives and therefore promotes certain institutional
structures. This is dangerous, as could it retard, “instead of accelerating, the progress
of the society towards real wealth and greatness; and diminishes, instead of increasing,
the real value of the annual produce of its land and labour”[10].
Supply and demand. In an open and competitive market the invisible hand
determines the volume and the price of goods and services through the law of demand
and supply. Any good or service is available and traded on the market if there is
enough demand, if producers are willing to supply the product or service in principle,
and producer as well as customer can agree on a price.
For the supplier, the predominant objective is to create value out of his activities. In
that case, the price has to cover the production costs (raw materials, salaries, etc.),
transaction costs, and a premium for the risk and the profit of the producer.
Besides production costs, transaction costs play a decisive role for a market
economy. They represent the price for using the market mechanism and thus for the
exchange of goods and services between producers and consumers. The lower the
transaction costs are, the better the invisible hand can work to raise the wealth of
nations. Examples for transaction costs are transportation costs for a good produced,
but also fees for using the financial system to arrange the payment for the good or
service obtained. Money laundering costs are also transaction costs.
Criminals as rational beings. The modern economic theory of crime is based on the
essay “Crime and Punishment” published by Gary Becker[11]. The main purpose of the
article was “to answer [. . .] [the] questions [. . .], how many resources and how much
punishment should be used to enforce different kinds of legislation”[12]. Becker
assumes that a person commits an offense if the expected utility to him exceeds the
utility he could get by using his time and other resources at other activities:
This approach implies that there is a function relating the number of offences by any person
to the probability of detection and conviction, to his punishment if convicted, and to other
variables, such as the income available to him in legal and other illegal activities [. . .][13].
Fighting the cause by fighting the result. When applying Becker’s model to the AML
world, a peculiarity has to be considered: the prevention and punishment measures are
not taken against the predicate offence or offender, but against a consequential act of a
money launderer, who is not necessarily the same person as the predicate offender[14].
Consequently, a possible conviction of the money launderer does not automatically
imply a conviction of the predicate offender.
Ceteris paribus, tighter AML provisions lead to higher production and transaction
costs of the predicate crime. They should therefore influence predicate offender. He
may loose the assets to be laundered due to confiscation. In addition, detecting money
laundering raises the possibility of detection and conviction for the predicate offender.
Empirical evidence suggests that this relationship is only weak if verifiable at all[15].
As described below, the predicate offender has other alternatives to choose than
laundering all the criminal proceeds. He can thereby significantly reduce the money
laundering costs and risks of his venture.
Economy of money laundering prevention
For most parts of the economy, AML rules act as a cost component and influence the
profitability of illegitimate and legitimate ventures. Hence, they set incentives against
engaging in legitimate and illegitimate activities. Contrary to most other state
determined exogenous variables, AML rules are not static, but subject to constant
change and development. This section deals with the rules steering the regulation
process, i.e. the economy of money laundering prevention. The “market” participants,
i.e. states, international organisations, banks and other members economy, are
supposed to be rational decision makers.
More of everything. The world of money laundering prevention, AML regulation
and rules can be depicted along three dimensions.
(1) Criminal vs clean. There is a “clean world” (defined by the absence of predicate
offences) and a “criminal world”. Money laundering is moving money from the
criminal into the clean world or – what is essentially the same – hiding the
criminal origin.
(2) Sectors of the economy. Seen from the standpoint of the Financial Action Task
Force (FATF), there exist four different sectors of the economy:
.
Financial institutions are subject to special rules and AML supervision as
well as to criminal law.
.
Designated non-financial businesses and professions are subject to the same
special rules and supervision, and are also subject to criminal law.
.
Non-designated businesses and professions are subject only to criminal law.
No special rules and no AML supervision apply.
.
Private individuals, natural persons outside sector (a) and (b) are only
subject to criminal law.
(3) Country-specific differences. There are different countries with different
domestic laws, rules and institutions. They can be broadly categorized into:
.
Black-listed countries[16];
.
Complying countries, which can be rated further by the extent of compliance
with the FATF recommendations[17].
Over recent years, the strategy of FATF has been “more of everything”: to move the
fences in a way that the clean world shrinks and the criminal world grows (extending
the definition of “predicate offence”); to enlarge the “financial” and “designated” sectors
which are subject to special AML rules and supervision, and thus to reduce the
non-supervised part of the economy; to sharpen the rules to which the supervised
sectors are subjected; to sharpen the requirements for the countries in the AML rating
process.
Incentives for and against regulation. If state intervention into the market, such as
AML rules, affects all market participants in the same way, the relative competitive
position of a single participant is not influenced. In that case, regulation fosters or
hampers the wellbeing of the economy without changing the relative wellbeing of the
single members.
If intervention affects different market participants in different ways, certain
competitors may face an advantage or disadvantage, the relative distribution of wealth
between the members of the economy is affected. In the end, the structure of a
particular market and industry is changed. The same is valid if regulatory provisions
differ between countries or industries. Such differences lead to “regulatory arbitrage”
by rational actors, so that activities are performed in the country or by the industry
which faces least regulatory constraints and costs.
Only in the latter case, market participants have an economic incentive to try to
influence the state interventions in order to improve their position. In the area of money
laundering prevention, the following situation applies:
.
Banks and other financial service providers are against stronger regulation for
themselves or promote heavier regulation for others, as long as there are
competitors which have a better position. They are indifferent if a
level-playing-field exists. They intend “only their own security”; [. . .] they
intend “only their own gain,” [9] they do not promote the interest of the economy
as a whole. In certain cases, banks may even lobby for stronger regulation, if this
could lead to a competitive advantage.
.
Clients of banks have no or low influence on state intervention, even if their own
economic position (compliance costs are in the end paid by the client) and their
rights (e.g. privacy and other basic rights) are concerned. The client has no better
choice[18], is not thoroughly informed[19] or simply not interested[20].
What is criminal – what is not?
A pivotal issue in money laundering prevention is the decision, whether an activity, a
person or funds are legitimate or not. This is difficult to judge. The criterion of
legitimacy divides the whole economic sphere into two parts, the legitimate and
illegitimate (or “criminal”). It seems to be feasible to locate a particular good, service or
an economic entity within one of the two spheres. In reality, this is not possible. The
classification is even more difficult if several jurisdictions are involved, each with most
of the time slightly, sometimes even vastly different views on the legitimacy. The same
applies to the offences qualifying as predicate crime for money laundering[21].
Therefore, the legitimacy of a good or service cannot be judged upon the subject itself.
One has always to know the background.
The classification as (il)legitimate gets even more complicated, if not impossible at
all, when we introduce money to the model. By definition, money is a medium of
exchange and a store of value. It is, by definition, abstract, i.e. the value or function of
money, e.g. a bank note, is independent of the current, prospect or former owner and
also independent of the transaction due to which the current owner is in possession of
the money. By looking at a bank note or a gold coin, it is impossible to judge if it has
been acquired by legitimate means or not. The same applies to account entries in a
bank. In most countries bank notes and coins are the only legal tender, and they are
anonymous and abstract by definition.
The distinction between criminal and legitimate world is only feasible if an activity,
a deal, a person or a legal entity can clearly be associated with one of the two spheres.
What looks like a simple decision, is a complicated venture, which is traditionally
performed by state institutions such as prosecutors and courts. In the context of the
fight against money laundering, the judgment about the legitimacy is increasingly
transferred to private sector institutions such as banks. These, however, are not well
equipped and qualified for this task. If they have to take on police and judicial
functions, their primary function as financial intermediaries suffers. In addition,
different conditions apply to banks and the state, and the two behave differently.
Impact of anti-money laundering measures on the economy
Money laundering prevention influences both the illegitimate and the legitimate world.
Influence on the criminal world
Like any businessman, criminals are interested in keeping costs down and earnings up.
In view of rising costs for money laundering, the first and simple solution could be
backing out of predicate criminal activities which create a need for money laundering.
The current anti-money laundering framework seems to be built on this concept.
Reality shows that it does not work, though. Since, the beginning of the fight against
money laundering about 20 years ago, the targeted predicate crimes (drug trafficking
and organized crime) have grown and prospered. Empirical evidence shows that the
shadow economy gained importance during the last decades[22]. Even in developed
countries, the shadow economy has the size of 10-30 per cent of the countries’ GDP[23].
The decision to undertake a predicate crime is determined by demand and expected
gains. In the case of drug trafficking, the demand is still there, even though drug
trafficking is illegal. This means that customers exist which are willing to pay for the
good, no matter whether it is illegal or not. Consequently, there also are suppliers on
the market. While these have to bear the costs for doing illegitimate, covert activities,
they are able to cover these burdens by raising the price of the good. Certain aspects
enable them to set their prices nearly without constraints.
In legitimate markets, there (mostly) is competition, which is carried out over
product quality and price. Competition requires transparent markets, where suppliers
and demanders can acquaint themselves with the market condition. Monopolies and
other market structures hampering competition and market transparency are actively
fought against by the state. In the illegitimate world, the invisible hand of competition
does not work well. This world is dominated by other forces. Relying on the
addictiveness of the clients, suppliers are able to set the price at their discretion.
Competitors are forcefully put out of business and cartel-like arrangements are usual,
certainly in the world of organized crime.
This enables the suppliers to effectively control the revenue variable of the
profitability calculation. Even if money laundering contributes significantly to the
overall costs, suppliers are able to get significant excess profits, which in turn makes
the business financially very attractive.
Reaction of the criminal world
The AML measures have made moving money from the criminal world into the clean
world more costly. However, criminals are not forced to launder all the criminal
proceeds on a gross basis. They can choose amongst several alternatives:
.
Criminals can keep the money in anonymous form: the most important medium
where the distinction between criminal and clean is impossible are bank notes
(and coins). In most countries cash is the only legal tender, and it is perfectly
legal to store and move any amounts of cash. Although cash may have several
disadvantages compared with bank deposits, the difference may not be too
severe, especially in the case of currencies that are also accepted outside the
respective country. In addition, there are alternative and perfectly legitimate
systems for anonymous payments, such as the century old and efficient
Hawala[24] system.
.
Criminals could avoid money laundering altogether by keeping the dirty money
in the criminal world. The bigger the criminal world relative to the clean world is,
the easier and more valuable this alternative becomes. In the extreme case where
the whole world is criminal, money laundering becomes unnecessary and even
impossible.
.
Criminals may use one of the oldest and most efficient payment mechanisms:
bilateral or multilateral netting, with or without counterparty substitution. The
clearing system[25] is the most important institution for diminishing the demand
for money in the broader sense. The system was already described and
recommended by Adam Smith for the case that “gold and silver should at any
time fall short in a country”[26]. “Buying and selling upon credit, and the
different dealers compensating their credits with one another once a month or
once a year, will supply it [money] with less inconvenience”[26]. To make use of
this mechanism, criminals will “buy and sell upon credit” within the criminal
world and balance the remaining net amount by transferring it to the clean
world. They can thus reduce the amount and the total cost of money laundering
substantially.
.
Criminals may use the international financial system, thus exploiting legal,
regulatory and other differences between different countries.
.
Criminals may use “non-designated institutions” (in the FATF terminology) and
private individuals for transferring criminal money into the clean world.
Examples are the legendary pizzeria for smaller amounts, international trade[27],
real estate or corporate finance for big transactions. From the criminal’s point of
view it could be advantageous to not only use the clean institutions for
laundering criminal money, but to merge the predicate criminal activity into the
non-criminal activity of a non-designated institution. The routes through the
non-designated sectors are less liquid and thus more expensive and need
substantial resources.
All alternatives require professional resources and long-term investments. Such a
environment is typically provided by organized crime. It is conceivable that AML
measures promote large, sophisticated organized crime structures rather than fight
them.
Influence on the legitimate world
By definition, crime prevention deals with criminal actions which have not been
committed[28]. So, from a criminal law point of view, persons and legal entities are not
criminal yet, if at all. This raises the bar for acceptable costs and collateral damages.
In contrast to prosecution, which affects only alleged criminals, everyone is subject
to crime prevention and AML measures. Current money laundering law exactly
requires that, as every financial transaction could involve illicit funds.
Besides these direct cost of AML measures, there are also indirect costs in the form
of collateral damage:
(1) Damage for the society:
.
A loss of civil liberties[29], especially privacy. The AML provisions are a
threat to the privacy of the individual;
.
It is the goal of the official AML policy “to counter the use of the financial
system by criminals”. Society seems to accept that criminals use other parts
of its systems jointly with non-criminals: examples are the transportation
system, the education system, the legal system, or the health care system.
(2) Economic damage:
.
The AML mechanism increases the direct costs of legitimate market
transactions in the same way as illegitimate ones. By increasing the
transaction costs of the economy, the AML measures hinder the working of
the invisible hand and reduce the wealth of the nations. The whole economy
faces increased transaction costs for using the financial system and the
payment mechanism in particular. The effect is not limited to transactions of
the “financial sector” but it impacts also the “designated non-financial
businesses and professions” in the same way. It also increases the
production costs of most services provided by the “financial sector” and the
“designated non-financial businesses and professions”;
.
Economic sectors, actors and countries with a low sophistication of AML
systems and probably a low reputation[30] face heavy discrimination,
severely impacting chances of participating in the benefits of international
trade and co-operation;
.
The risk exists of making the “complying institutions” and “complying
countries” an exclusive club. This leads to regulation driven promotion of
monopolistic or oligopolistic structures and results in high economic costs.
Interaction between criminal and legitimate sphere
Applying the AML framework described above, the attributes “criminal” and
“legitimate” are not only given by law and courts, but actually by the private sector as
well. Because the latter applies a risk-based approach, it may judge a person or an
action as “doubtful” which is not “criminal” but “not legitimate enough” or “not
profitable enough”. Emphasis has to be put on the fact that “doubtful” for a bank does
not need to mean “criminal” in any way. The actual “criminality” of clients and their
funds is hardly recognizable. Hence, banks and other financial services providers rely
on criteria such as nationality, religious affiliation, industry and domicile of a client to
create a risk profile. Depending on the risk affinity the bank has and its regulator
allows, prospect clients may be refused because they exhibit high-risk criteria, without
any hints on the actual doubtfulness of a client.
By treating actually legitimate clients and transactions as “doubtful” they are
moved from the legitimate world to the grey one, with many consequences:
.
Many services and provisions of the legitimate world are not available any more
to all economic subjects or only available at prohibitively high costs.
.
The illegitimate world will be happy to offer these services, but to their
conditions.
.
This will firstly lead to an extension of the criminal world, and secondly to the
secluding criminalisation of persons originally acting in the legitimate world.
.
The extension of the criminal world provides new liquidity and members to
it, thus enabling the criminal world to acquire more services and products
without leaving the criminal sphere.
The results of such a shift can be severe. The more services and products can be
supplied out of the criminal world, the higher is the relative value of non-laundered
money. This reduces the need for money laundering, strengthens the illegitimate
economy and removes funds and resources from the legitimate sphere of the economy,
which is subsequently weakened. Here, the fence is not shifted by the regulators and
supervisors. Instead it moves by itself into the wrong direction.
This is especially the case when the list of predicate offences is extended. When the
predicate offence was drug dealing only, the chance to meet this criteria was very
small. Today, given the extensive list of predicate offences, it is likely that there is at
least a chance that a prospect client is engaged in such activities. Therefore, the
investigation effort rises as does the risk and cost for all client relationships.
Anti-money laundering and effectiveness: a paradoxon?
After over 20 years of money laundering prevention, the results are disappointing:
organised crime and drug trafficking still prosper. Banks face a high burden because of
their active involvement in money laundering prevention. The various prevention
schemes have weakened the basic rights of the bank clients, who have to pay for the
prevention measures. Of course, there has been some success. Compared to the direct
and indirect costs as well as to the estimated volume of organised crime, the victories
are minor and the costs are high.
However, AML regulation is going to be extended instead of being thought over.
Why does a review not take place? Who is in charge?
Role of banks and the financial services industry
Banks and the financial services industry are applying the laws and regulations they
are required to. Complying with the requirements is mandatory, as the market players
risk their license or at least the comity of regulators and supervisors. Even complaining
about the rules too loudly could be conceived as doubtful conduct.
In addition, they sometimes react with even stricter and more detailed rules defined
by themselves or industry associations. They do so mainly to foster their reputation,
prevent further regulation by state and international entities and to minimise risk.
Applying a risk-based approach. The risk aspect is arguable. Regulators, especially
in Europe, begin to apply a risk-based approach to their money laundering regulation.
The reason is that innovation on the criminal side makes it difficult for regulators and
prosecutors to keep pace and to formulate detailed money laundering criteria ex-ante.
In addition, the banks are allowed to adapt their money laundering effort along their
risk assessment of a particular client. A retail customer with few and standardised
transactions such as the salary reception and rent payment requires less caution than a
cash-intensive business or a private banking client with assets distributed
internationally.
The risk-based approach, however, places a high responsibility on the banks, as
they have to develop their own assessment framework, take sound decisions and
defend their work when problems arise. In that case, they may have to prove the ability
of their assessment framework to courts and regulators and cannot just show a filled
form with predefined check boxes, which was supplied by the regulator.
Avoiding the risk of wrong decisions. Banks are not always willing to take this
responsibility. Big banks with an extensive client base and significant assets under
management may be able to apply a very low risk affinity and to refuse clients which
raise the slightest suspicion[31]. Smaller banks, in a competitive position not so
favorable, may be inclined to accept such clients, at least if checks about the
background of the clients do not reveal problematic aspects. These checks, however,
are expensive and decrease the profitability of such a client relationship. Another
strategy of the bank may be to let the supervisor take the decision. They can achieve
that by filing suspicious activity reports (SAR), which will result in a supervisor’s
decision about the alleged legitimacy or illegitimacy of a client or transaction. If such a
decision is available, the bank minimises its risk to perform any wrongdoing ex-post.
Differences in the type of business and attitude of banks and countries regarding
SAR reports can be seen by looking at the statistics of Financial Intelligence Units
(FIUs). In Switzerland, 863 SARs were sent to the Swiss FIU in 2003. About 80 per cent
of these cases were forwarded to the prosecutors after a first investigation. In the same
year, 100,000 reports were sent to the FIU in the UK. In 2005, 195,000 reports were
filed[32]. The resource requirement to deal with this vast volume of reports on the
banks’ and the state’s side is enormous. The relationship between reports and crime is
questionable. There is a weak correlation in the area of drugs[33], but no significant
dependency to other areas of crime[34]. Furthermore, with each report, the privacy of
the client is compromised.
Compliance as quality criterion. Furthermore, bank specific compliance efforts
performed in addition to the required ones can be used to establish a quality criterion
(e.g. a certification) which in turn could result in a competitive advantage like
preferential treatment by the regulators or positive effects on reputation[35]. This could
result in a “closed shop” where some competitors form and promote a “regulatory
island”. Market participants not able to join this shop because of low sophistication,
size, upfront effort to meet the arbitrary criteria for joining or due to other factors, are
in turn penalised, although their services and products may be equally good or better
and there may be no tenable evidence that meeting the joining criteria leads to more
effective money laundering prevention. A “three-tiered” world arises:
(1) the “good” institutions;
(2) the “questionable” institutions and countries, which are not able or willing to
comply with the rules, but do not necessarily facilitate money laundering; and
(3) the “bad” institutions with a bad track record.
For a bank, the objective is to fulfil the regulatory requirements, to belong to the “good”
world and to take care that all its competitors face the same requirements and therefore
the same costs. In that case, they face no competitive disadvantage, because the rules
are the same for all of them[36]. They also have access to the global financial market,
because they comply with the international rules. Indeed, banks and financial centres
are very much preoccupied with the maintenance of “level-playing fields”. In addition,
they are able to pass the cost of compliance efforts to the client. In the end, the client
pays for the bank’s efforts to maintain its reputation.
Other goals of AML are not relevant for a bank’s decision. Banks do not take part in
discussions on the feasibility of AML, as this could hamper their reputation and
success. Banks therefore have only a weak incentive to engage in fundamental AML
discussions, as long as they are in the “good” tier of the world. If they do not, they may
put all efforts in joining the first level, rather than questioning the AML strategy.
Role of countries as regulators and policy setters
The creation, implementation and enforcement of rules in the area of criminal and civil
law as well as banking regulation and supervision is in the competence of sovereign
states, which therefore also should be the ones to address the issues of upcoming and
existing rules. The advancing globalisation of the economy in general and the financial
services business in particular lead to a different picture. In order to foster international
cooperation and prevent regulatory arbitrage, frameworks are coordinated on an
international level. Single member states of the FATF, although constituting and
taking part in the organisations, do not seem to have a significant influence on the rules
and “mandatory recommendations”. The classification outlined in the previous section
applies for states as well, as does the decision and incentive matrix. Therefore, even
most states will neither be able nor willing to question or influence the AML strategy in
a substantial way.
Challenges in the international space
Today, when crossing borders with a financial transaction (e.g. a simple payment), no
single state authority seems to be relevant anymore. This has been most impressively
proved in June 2006, when it became official that the US Government has tapped into
the S.W.I.F.T. database[37]. Many central banks, governments and industry members
have been informed. Also, the program should be seen as illegal in most of the G10
countries. However, none of the countries affected, except for the USA and Belgium,
saw itself as a responsible point of contact for the issue at all.
As long as there is no point of contact, there is no means to effectively complain
about a state’s or international organisation’s action. This is devastating, as the typical
client has no means to oppose the intrusion in his own basic rights [38].
Conclusion
The authors have performed a stylized analysis of the laws governing the cost and
benefit of anti-money laundering policies. Without recommending specific actions or
strategies, they think that the following theses should be considered:
.
Measures taken to prevent money laundering in the financial system, may it be
by state entities or the private sector, have to be judged upon their effectiveness
to achieve the stated goal.
.
Benefits should be defined in terms of predicate crime. To counter the use of the
financial system by criminals is not a viable objective.
.
There is a limit for the acceptable direct costs and collateral damage. Cost-benefit
analyses should be performed and alternatives have to be considered.
.
As a general rule, a measure should be deployed only, if the benefits achieved
exceed the costs. It is not feasible to place a high burden on the society and
economy without corresponding results.
As a common opinion, the current money laundering prevention framework fails to
reach its own original goal, which is to reduce predicate offences. It is wrong to
conclude that the current framework is not strong enough. The reason is, that the
attractiveness of criminal ventures is determined by many factors, and the cost of
money laundering is just one of them and can be compensated by others. AML
regulation has achieved a life of its own, where the objective to prevent predicate crime
has been replaced by other desires. This may not only hamper the achievement of the
original goal, but may also impose damage in the legitimate spheres of economy and
society.
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Corresponding author
Oliver Wuensch can be contacted at: wuensch@isb.unizh.ch
Credit:ivythesis.typepad.com
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