The Importance of Managing Money Laundering and Terrorist Financing Risk

Correspondent banking relationships have a vital role in our economy, facilitating global trade and economic activity. In recent years, these relationships have come under pressure as increasingly more global banks have exited from business relationships with entire classes of customers.  There are a variety of reasons behind these decisions to exit a business relationship.  They include commercial reasons such as profitability and market consolidation, but also the perceived money laundering or terrorist financing risks.

This de-risking practice is therefore often more about de-marketing and has serious consequences. Vulnerable customers, charities, and money or value transfer businesses in particular, have felt the negative impact of de-risking. They rely on these business relationships to support their community and to operate essential services. Migrant workers, for example, often rely on remittances or money or value transfer services to send a large percentage of their earnings back to their families in their country of origin. The economic stability of many communities depends on these remittances.

If they are excluded from the financial system, customers will need to resort to cash or alternative, non-regulated financial services for their financial transactions. Transactions that take place outside the regulated financial system are much harder to trace, and significantly increase the risk that proceeds of crime or funds in support of terrorism remain undetected. So de-risking not only exacerbates financial exclusion by depriving vulnerable and underserved communities from access to financial services, it also has a negative impact on the transparency of financial transactions and increases the risk of money laundering and terrorist financing. 

Preventing harmful de-risking has been a priority for the Financial Action Task Force (FATF) since 2014. The FATF contributes to people's safety and security and also helps protect the integrity of the global financial system from money laundering and the financing of terrorism and proliferation. 

The FATF Recommendations provide countries with strong tools to protect the integrity of the financial system by keeping out any funds that are linked with crime or terrorism.  Each member country has committed to implementing these measures in their national legal, operational and law enforcement framework. The FATF’s robust peer review process assesses how effectively all countries have implemented these standards and whether they deliver the right results.

The cornerstone of the FATF Recommendations is the risk-based approach. This approach requires that risks are managed on a case-by-case basis – by countries and by financial institutions.  The first step is to identify, understand and assess money laundering and terrorist financing risks. Each country is unique, and so are the risks that it must mitigate. Many factors come into play, for example a country’s geographic location, the size of its economy, or the importance of its financial sector in the international financial system. Once a country has fully understood its particular risk context, it can take steps to mitigate this in accordance with the risk level it has identified. There is no one-size fits all approach to effectively managing money laundering and terrorist financing risk. 

It must work closely with its regulated sectors to share its assessment of the risks and to ensure that they too have understood the national risk context and their own risks, and are taking a risk-based approach in their own implementation of anti-money laundering and counter-terrorist financing measures. Only when money laundering and terrorist financing risks cannot be mitigated should they take the decision to terminate a business relationship.  The wholescale de-risking that we have witnessed in recent years is not in line with the FATF’s requirements, because it is applied to entire classes of customers or even to whole countries or regions.  

De-risking has a significant impact on certain sectors and regions that have been categorised in their entirety as high-risk and consequently found themselves excluded from the financial system.  The FATF has therefore taken several important steps to clarify the requirements of the FATF Recommendations, including by issuing public statements and guidance to discourage wholesale de-risking and to explain what the risk-based approach is.

The FATF has issued guidance for the money or value transfer services (MVTS) that specifically states that “while certain MVTS providers may act as a conduit for such illegal funds transfers, this should not necessarily result in the categorisation of all MVTS providers as inherently high money laundering / terrorist financing risk”.

The FATF has additionally published guidance on correspondent banking services to clarify regulatory expectations about what due diligence is and is not required in a correspondent banking relationship. This makes clear that there are different degrees of risk involved in different correspondent banking relationships and that financial institutions are not responsible for conducting due diligence on their correspondent partner's customers – or as commonly termed ‘knowing your customer’s customer’.

The non-profit sector has also felt the negative impact of de-risking which hampered its ability to provide the services that are so urgently needed in certain communities. In June 2016, and with significant input from non-profit organisations themselves, the FATF revised its Recommendations to confirm that not all non-profit organisations are high risk. The FATF refined the methodology used for its peer reviews. Assessments of countries’ efforts to tackle money laundering and terrorist financing will look at whether measures applied to the non-profit sector are focused and proportionate to protect them from terrorist financing abuse without disrupting or discouraging legitimate charitable activities. 

Tackling inappropriate de-risking remains a priority for the FATF.  As standard setter, the FATF has clarified that, from an anti-money laundering and counter terrorist financing perspective, account closures should only occur if the risks, once identified, assessed and understood, cannot be adequately mitigated. The FATF will monitor the use of its guidance. But ultimately it is up to jurisdictions, their regulators and financial institutions to put the risk-based approach into practice.

FATF’s peer reviews look at how well a country has identified and understood its risk environment, and whether an understanding of these risks is also present in its financial sector and designated non-financial business and professions. The assessment teams look at how effectively these particular risks are being mitigated. The focus on effectiveness is the strength of the FATF’s assessment methodology.  Each peer review looks at whether the country has met the technical requirements of the 40 FATF Recommendations. In addition, it looks at whether a country’s efforts are delivering the right results. The effectiveness assessment focuses on 11 key areas of an effective framework to tackle money laundering and terrorist financing that include; supervision, financial intelligence, international cooperation and legal persons and arrangements.  

The importance of effective implementation and the challenge of doing this well was highlighted when the Panama Papers drew attention to the large scale abuse of legal persons and arrangements.

The FATF standards set out comprehensive measures to ensure transparency to prevent the misuse of corporate vehicles.  These standards are globally recognised and are also used in the peer review process of the Global Forum on Transparency and Exchange of Information for Tax Purposes (Global Forum).  However, the Panama papers confirmed what the FATF’s current cycle of assessments had already started to reveal – many countries have not yet fully and effectively implemented the FATF’s Recommendations on beneficial ownership and transparency. 

Following a call by the G20, the FATF is working with the Global Forum to improve countries’ implementation of its standards to improve transparency of financial transactions.

The challenge today is not the lack of measures to help countries tackle money laundering and terrorist financing.  The challenge lies in the effective implementation of these measures.  The FATF’s assessments look at the effectiveness of a country’s actions to prevent, detect and punish money laundering and terrorist financing.  Each assessment results in a set of targeted recommendations to the countries to help it strengthen its measures and their effectiveness in the context of the risks it faces.

In today’s increasingly interconnected financial system, criminals and terrorists do not stop at national borders.  It is up to each country to take effective action to protect the integrity of the financial system so that they do not become the go-to place for criminals and terrorists to use, raise and move their funds.  They can do this by effectively managing risks and re-risking, rather than de-risking, and by ensuring that financial services are available to as much of the population as possible. 

For more information: www.fatf-gafi.org

Santiago Otamendi
President