Governments now use financial institutions as foreign policy tools to combat terrorismALEX DOMANSKI/Reuters
When a government uses sanctions to keep rogue nations in check, or law enforcement agencies bust criminal cartels, they can usually thank a bank. Financial institutions may seem like an unlikely partner in crimefighting—but they actually play a crucial role in maintaining global security.
But banks are growing more wary of their role in helping freeze or investigate suspicious channels in the global flow of money, and their caution could create fertile soil for even more crime—and more economic instability.
Governments now see banks as "foreign policy tools on the front lines of the war against terrorism and organized crime," says Randall Mikkelsen, North American managing editor for Thomson Reuters Compliance and Regulatory Risk.
"They're counting on banks to enforce sanctions," he says. "It places a big burden on them to screen their customers and identify suspect payments."
That burden can translate into billions of dollars in fines for doing business with clients that are engaged in illicit activity. With the stakes so high, banks have resorted to the wholesale dumping of entire customer bases to neutralize any chance of flouting anti-money-laundering or terrorist-financing rules. But the trickle-down effect of this de-risking, especially in poorer countries, is increasingly being viewed as a risky move itself.
Former U.S. Department of Treasury Under Secretary for Terrorism and Financial Intelligence David Cohen told the American Bankers Association in a speech last November that this type of de-risking behavior "can undermine financial inclusion, financial transparency and financial activity, with associated political, regulatory, economic and social consequences."
De-risking is a practice that Brett Wolf, a senior money-laundering correspondent with Thomson Reuters, calls "possibly the most significant anti-money-laundering issue at present."
"There's only so much the banks can do, and I think there's a perception out there [that governments are] perhaps asking too much of banks in terms of detecting every illicit transaction," Wolf says.
Enforcement of sanctions and anti-money-laundering laws by banks has been used in the Western fight to stem nuclear proliferation in Iran and North Korea, pressure Russia over its intervention in Ukraine and cut off terrorist financing around the world.
But this system also takes a heavy toll on non-complying banks. Wolf notes that the U.S. government entered into a $1.9-billion settlement with HSBC in 2012 over failures to stop drug-money-laundering by Mexican cartels. The following year, Credit Suisse paid out a $2.6-billion settlement over a tax-evasion scheme involving U.S. citizens.
Regulators in 2014 also fined BNP Paribas $9 billion for breaching U.S. sanctions on Iran, Sudan and Cuba.
And in March, the stakes got even higher for one bank in Spain.
"The Banco Madrid case shows that money-laundering problems can bring down a whole bank through enforcement and damage to its reputation," said Mikklelsen.
"There absolutely is a compliance challenge," Wolf says, adding that the U.S. government, in limited partnership with the private sector, has been reviewing the "patchwork" of regulations put in place during the past four decades "to see if there are places where the burden on financial institutions could be minimized."
'Collateral Damage:' People and Banks
If de-risking is not curbed, Brookings Institution fellow John Villasenor says, "collateral damage" might include "millions" of legitimate customers in countries considered high risk, any of whom would be unintended victims cut off from the financial system: "Many of these people depend on remittances to pay for basic necessities like food and housing."
Without access to the global finance system, critics say, disenfranchised populations could be drawn to criminal activity or even terrorism.
"If you have a large segment of the population frozen out of the banking system, that's really bad for them, and I think for banks as well," says Leland Chan, general counsel for the California Bankers Association.
Also, areas that lack banking institutions tend to gravitate toward a cash economy, stunting the global reach and growth of banking institutions. For example, denying banking access to legitimate U.S. marijuana dispensaries or payday lenders shuts them off from transparent financial outlets.
"What are they left with? They're stuck doing everything with cash," Chan says. "We know from experience what that leads to. Temptation to cover your transactions, temptation to rob people. If you force transactions to go outside the traditional banking system, it lends more opportunities for illicit activities."
Paul Hickman, president of the Arizona Bankers Association, warns that "unforgiving" regulation also casts a chilling effect on banks with regard to who they are willing to do business with, even in the cases of one-off lapses.
"They're not saying: We understand that was an honest mistake," he says.
A nervous lender might reason that closing a swath of accounts is worthwhile, Mikkelsen says, if it means avoiding big financial repercussions for letting something slip through the cracks.
"Banks have paid billions of dollars in fines for failures in the anti-money-laundering system," he says. "It's hitting them in their pocketbooks significantly."
Even so, Hickman says motivations to de-risk aren't driven purely by economics.
"Bankers aren't just concerned about reputational and regulatory risk," he says. "They often just flat-out don't want to bank bad guys."
Canada's Challenge
When compliance with regulations works, it can have a life-saving impact at home.
Canada's Royal Canadian Mounted Police credited the Financial Transactions and Reports Analysis Centre of Canada (FinTRAC) with flagging suspicious banking activity that led to 2013's Project Smooth.
The operation resulted in two arrests for conspiring to carry out a terrorist attack against a Via train traveling from New York to Toronto.
"It's a fallacy to think that Canada's financial system is free of criminal activity," says Daniel Seleanu, the Canadian regulatory intelligence reporter for Thomson Reuters.
A 2014 Kroll report found that while Canada had a consistently rosy image for its ability to stem financial foul play, it faltered in the areas of cybersecurity and management of conflicts of interest.
Senior executives surveyed for the report said Canada "often reported overall fraud incidence well below the global average."
That misperception of Canada as generally immune to fraud may have been due to a low number of reported money-laundering convictions, Seleanu says.
"Canada's got a big illegal drug business. Bikers, meth, weed in [British Columbia]. All that money needs to be laundered and reinserted into the legitimate financial system," he says. "That's big crime, and it's happening in Canada."
FinTRAC, which also administers fines to noncompliant banks, doesn't identify illicit activity, says spokesman Darren Gibb: "We provide the transaction reports to help law-enforcement partners identify that."
The agency receives about 20 million transaction reports a year from financial institutions. Last year, analysts forwarded 1,143 "disclosures" to the RCMP and Canadian Security Intelligence Service for money laundering and terrorist financing investigations.