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Weapons of mass obstruction
Banks struggle to comply with sanctions intended to block assets or transactions of state foes
Piotr Zembrowski 19 Mar 2015
 
Jones  

Business news headlines throughout 2014 were dominated by announcements of record bank fines levied by US regulators. Fines and settlements during the year reached more than US$100 billion. It is estimated that half of that amount was for taking unfair advantage of customers while the other half was for non-compliance with financial sanctions.


Financial sanctions target individuals, organizations, firms or countries deemed to be involved in criminal or terrorist activities. Notably, 2014 saw new financial sanctions imposed by the US, Japan and several European countries on Russian individuals and companies in the wake of the country’s annexation of Crimea and its military operations in eastern Ukraine.


This only added to the already long list of individuals and organizations whose assets are blocked and with whom doing business is prohibited. While the US dominates the regulatory space – extending its reach to any institution that does business in the US (and most global corporates do) – other countries, many in the emerging markets, follow in its steps with their own lists of sanctions.


To be able to do business around the world, a bank must be compliant with four major sanction regimes. One list is issued by the US Office of Foreign Asset Control. The European Union has its own sanctions list reflecting the objectives of the Common Foreign and Security Policy, while HM Treasury (UK) issues its own consolidated list of targets. On top of that, the United Nations Security Council publishes its own such list.
The objectives and targets of the four lists differ as they reflect the individual policies of the different regulators, and global financial institutions find it necessary to monitor and implement all four. The complexity of compliance with the four lists can tax the resources of even large financial institutions. When changes are made, they need to be disseminated and implemented in a matter of hours to prevent targets of the sanctions from transferring their money out of the system or into more lenient jurisdictions.


In a way, it’s a game of cat and mouse. Even in the digital age, when financial information can travel across the globe in a fraction of a second, “if you’re put on the list, you have about 48 hours to try to move your money out, before your assets are frozen”, says Hugh Jones, president and CEO of Accuity, a global provider of payment and compliance solutions.


Accuity distributes comprehensive sanctions information daily to its 21,000 customers in 150 countries. Having worked in the financial information business for 18 years, seven of which have been at Accuity, Jones has a unique insight into the level of implementation of financial sanctions around the world.


And the sight isn’t pretty. Without naming countries or institutions, Jones lists several common problems he has been routinely encountering in the realm of compliance with international financial regulations, be it anti-money laundering (AML) or politically motivated sanctions.

 

Inadequate processes, systems
A common perception among some local bankers is that they know their customers well enough, having done business with most of them for many years. The attitude is: “There’s no-one laundering money here, it can’t happen at my bank,” says Jones. This false sense of security translates into inadequate spending on compliance programmes.


This leads to inadequacy of processes and systems. Even if transaction processing is no longer paper-based (although sometimes it still is), screening systems are frequently inadequate. Old technologies rely on exact matching of names from the sanctions lists. This approach is now considered vastly insufficient as the sanctioned parties can use different spelling of names to avoid detection, even though the published lists make an effort to include all known alternative spellings. Newer systems implement fuzzy logic to account for alternative spelling of names.


Another common result of inadequate compliance processes is that only certain customers or transactions are vetted. Even if there are “hits”, in-depth checking proves too onerous and is often neglected.


Still another problem is that some banks screen only new customers. “A good person can turn bad, or be co-opted by a bad person,” says Jones. “I can call my aunt and have her do my banking.”


While progress is being made, the overall level of compliance is far from adequate. “In the non-Western world, certainly in emerging or non-industrial economies, probably one in five banks is grossly negligent,” says Jones, “Embarrassingly so; chillingly negligent.”


He blames chiefly human nature. “Humans do poor job assessing risk,” he says. “They feel they’ve been doing something – they’re screening – but you could drive a truck through that bank.”


Such loopholes make the whole system porous and less secure. Jones likes to use the analogy of airport security screening. “If there are airports in the world where you don’t have to go through metal detectors before you get on a plane to fly to New York or London or Singapore, then the whole system of air transportation is very dangerous.”

 

There’s always an opportunity
The situation is even further complicated by systemic weakness of regulatory bodies in certain Asian countries. Again, without naming the countries, Jones points out that where banks are in part state-owned, they often feel immune to fines and other repercussions from the government. The thinking goes: “The government owns 60% of us, so why would they fine us?” he comments. In such countries, “compliance is more of an afterthought”.
Some local banks, however, see the lax regulatory and compliance regime as an opportunity. “If you’re in an emerging market, you can use the compliance adherence as a competitive advantage,” says Jones. If a bank bites the bullet and implements a full compliance process as the only one in its country or region, it will become the darling of the financial institutions in the developed world and a channel for all their business there.
“If one emerges as the compliant bank in Angola or Ghana or Vietnam, it will all of a sudden break out and become the go-to bank for the region,” he adds.


Even those visionary bankers may be stymied by cultural factors, though. In some countries, playing fair brings more than just additional cost – it can cost business. “In Myanmar, for example, it is difficult to get a customer to share the source of funds when they make a deposit,” he says. “It’s difficult even to get an address because culturally it isn’t something they are used to doing. People are wary.” A new client might go to a competitor who doesn’t ask hard questions.


Large financial and commercial centres like Hong Kong and Singapore aren’t immune to money laundering or illegal transactions, despite the high level of compliance with AML regulations and sanctions regime. One of the loopholes lies in trade finance, in particular in mis-invoicing. It involves deliberately invoicing a higher amount than the cost of acquired goods, with the excess payment being diverted to other, illegal uses. Whether used for money laundering, tax avoidance or dodging capital controls, it is a relatively low-risk endeavour for criminals, especially if it involves offshore banking entities and if customs controls are lax.


The record level of banking fines levelled by US and other countries’ regulators and their persistence in pursuing the large players are “meant to send a clear signal to the entire financial system that non-compliance is not an option”, says Jones, even for “too-big-to-fail” global institutions or domestic US banks. “The fines will continue to increase until people take notice,” he adds. The pain has to be felt for the fines to do their job. That will happen when banks have to disclose their costs to their shareholders and fire people responsible for them.


While the behind-close-doors process leading to levying of fines and settlements has been criticized for its opaque nature, “this is the only way to do it”, says Jones. If penalty amounts were determined based on a formula, in a crystal-clear way, banks would do cost-benefit analysis, making compliance purely a business decision. This would, in a way, legitimize the illegal activity in question. “An opaque threat is better,” he adds.


And while fines for major banks range wildly, with BNP Paribas paying the largest to date at about US$9 billion in 2014 for violating US sanctions, there are rules behind that apparent arbitrariness. Four factors play a role: the volume of transactions, the period of time, whether they continued after they were discovered, and whether the bank attempted to cover them up. “If you found it, stopped it and self-reported, it’s a different paradigm,” he points out.


As to political sanctions, Jones likes comparing them to missiles. Thirty years ago, when the banking system was far less integrated, exerting political pressure hinged on military means. Now, financial sanctions constitute another tool in the arsenal. While the hardship they cause is still painful and questions can be raised about its arbitrariness, targeting and effectiveness, it is still preferable to weapons.

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