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Fighting dirty money

Author(s):
International Monetary Fund. External Relations Dept.
Published Date:
August 2004
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No one quite knows how much money is laundered every year, but informed guesses estimate that the illicit economy could amount to as much as 2–5 percent of world GDP. National law enforcement agencies have been fighting financial crime for many years, and the terrorist attacks of September 11, 2001, made the fight against money laundering and the financing of terrorism a top priority also for the international community. The IMF has emerged as a key player because of its expertise in financial systems and near-universal membership of 184 countries. Camilla Andersen of the IMF Survey asked Barry Johnston, Assistant Director in the Monetary and Financial Systems Department, who leads the IMF’s financial sector work on anti-money laundering, and Jean-François Thony, Assistant General Counsel in the Legal Department, who is in charge of the legal aspects, about the progress made to date.

According to Johnston, September 11 brought home clearly that “money laundering and terrorism financing are a global problem, and you need to develop global systems to combat them. If one country has a weakness in its system, then there is a risk that the money laundering and terrorism financing will gravitate to that country.”

The social and political costs of money laundering are serious. Organized crime can infiltrate financial institutions, gain control over large sectors of the economy, and corrupt the political system. Dirty money can also destabilize a country’s financial systems, and lead to serious financial crisis.“Money laundering may be symptomatic of broader problems of governance within financial institutions and that can have significant implications for a country’s economic development,” Johnston said. Money laundering has, for instance, been a factor in some recent banking crises in Latin American and elsewhere.

How money is laundered

Illicit transfers of money are carried out for two main purposes: to hide the criminal origin of the funds and to protect them from confiscation. According to Thony, criminal proceeds are usually in cash, so the first—and usually the most difficult—thing the launderer has to do is to integrate the cash into the financial system. Once this has been done, the money undergoes a series of transactions, all of which are aimed at having it appear as if it has a legitimate origin.

In the third phase, the funds—now almost clean—are spent or reinvested in the licit economy. According to Thony, this is usually done in one of three ways. “First, through consumption—criminals like big boats, cars, and houses. Second, through normal investment. It is not unusual to see criminals investing as ‘bon père de famille’ in nonrisky instruments such as bonds or annuities. Third, the almost clean money is invested in businesses such as casinos, restaurants, cinemas, and hotels that typically involve a lot of cash payments. In fact, such businesses can themselves serve as money laundering machines.”

The IMF’s role

Because of its expertise in financial matters and global reach, the IMF has become a key player in fighting money laundering and the financing of terrorism. In March, following the successful completion of a 12-month pilot program during which the IMF and its partners assessed the anti-money laundering regimes of more than 50 countries, the institution’s shareholders decided to make such assessments a standard feature of the institution’s work. They involve the following elements:

• assessing member countries’ compliance with an international standard—in this case, the 48 recommendations developed by the Financial Action Task Force (FATF) against money laundering and the financing of terrorism (see box);

• providing technical assistance to member countries to help them meet the FATF’s recommendations;

• providing training to other organizations to help them develop the capacity to conduct assessments and deliver their own technical assistance;

• conducting outreach through organizations such as the Global Organization of Parliamentarians Against Corruption to build political consensus for the need to take action against money laundering and terrorist financing; and

• conducting research, often in collaboration with other organizations.

The 48 recommendations of the Financial Action Task Force

The Financial Action Task Force (FATF) has spearheaded efforts to counter the use of the financial system by criminals. In 1990, it established 40 recommendations that set out a basic framework for combating money laundering. The recommendations were last revised in 2003 with input from the IMF and the World Bank. Following the terrorist attacks in the United States, the FATF expanded its mission beyond money laundering to also cover terrorist financing, and issued eight special recommendations that aim at denying terrorists and their supporters access to the international financial system.

In August 2002, the IMF and the World Bank endorsed the 48 FATF recommendations as the standard for their operational work.

This work is carried out in close cooperation with other organizations, including the World Bank, whose staff conduct assessments and provide technical assistance alongside that of the IMF as part of the joint Financial Sector Assessment Program (FSAP). The IMF also works closely with FATF in developing methodology, with the seven FATF-style regional bodies, which conduct their own assessments, and with the United Nations—including the counter-terrorist committees in New York and the global program against money laundering in Vienna. According to Thony, “The efforts of the international organizations can be summarized as, first, making sure that countries have the capacity to fight crime and, second, helping them harmonize their legal frameworks so that criminals or terrorists cannot take advantage of differences in legislation from one country to another.”

Countries, not the IMF, fight the crime

But is it really possible to fight crime with standards? According to Johnston, this is not how the IMF’s work should be understood. “Countries fight crime. Standards simply help us benchmark their capacity so that we can determine whether they have the requisite laws and institutional arrangements in place to carry out that fight effectively.” In this respect, “the assessments are primarily a diagnostic tool for us to help identify strengths and weaknesses in countries’ anti-money laundering regimes. We would then—if the authorities request it—follow up with technical assistance to help them build up capacity.”

Assessments under the FSAP are voluntary, but once a country has agreed to have its financial sector analyzed, assessment against the standard for anti-money laundering and countering the financing of terrorism will also be included. As Thony puts it, “the FSAPs are voluntary, but not à la carte!” To broaden the reach of the assessments, the IMF has also circulated questionnaires to countries undergoing Article IV consultations (the IMF’s regular assessments of its member countries’ economies). Johnston says he hopes that all the IMF’s 184 member countries will eventually undergo assessment, either by the IMF itself, or by the FATF and FATF-style regional bodies.

Unequal treatment?

The IMF also has a special Offshore Financial Center (OFC) Program for assessing nonmember jurisdictions such as Bermuda, the Cayman Islands, the Isle of Man, Guernsey, and Jersey (see IMF Survey, February 16). In fact, practically all offshore financial centers in the world have already undergone a first round of assessments.

Such thoroughness has led some observers to criticize the IMF and other institutions fighting money laundering for cracking down on small countries with thriving offshore centers, while turning a blind eye to illicit transactions in large industrial countries. According to Johnston, this criticism is misplaced: “The IMF’s approach has always been uniform, voluntary, and cooperative. While we have been assessing a number of small offshore financial centers such as the Bahamas, Bermuda, the Cayman Islands, and the Cook Islands under the OFC Program, we have also been assessing the major countries as part of the FSAP—including, for example, Canada, France, Germany, Singapore, Switzerland, and the United Kingdom.”

Thony says that the perception of unequal treatment may have sprung from the fact that many industrial countries legislated in this area early, and so have had a head start compared to smaller countries with less capacity.

While the industrial countries are ahead in terms of legislation, this has not prevented them from becoming magnets for money that has already been laundered. “Industrial countries become involved usually at the second phase of money laundering. Historically, cash has been introduced into the financial system in countries that have little or no anti-money laundering legislation, where a person could bring a suitcase of dollars to the bank and openly ask the cashier to deposit it into his or her bank account. The money is then transferred into the heart of the most solid financial systems, and at this stage it becomes very difficult to distinguish between a criminal and a legal transaction,” Thony says. However, he acknowledges that, while many loopholes have been closed, money launderers are also becoming more sophisticated.

Poor countries remain the most vulnerable to criminal exploitation of their financial systems. Indeed, recent findings suggest that there is a need to focus the international community’s efforts on fighting money laundering where the main risks are. For the IMF, this means spending more resources on technical assistance to help poor countries build capacity. Over the past 12–18 months, the institution has allocated some two-thirds of the resources devoted to this area to technical assistance, with over 80 countries benefiting from the IMF’s technical expertise.

Hawala dollars

The IMF is also studying informal transfer systems, such as hawala, which are especially common in the Middle East. These systems are particularly vulnerable because “hawala dollars” leave no paper trail. The challenge is to crack down on criminal uses of these systems without harming legitimate clients, which include foreign workers remitting pay to their home countries.

According to Johnston, there is a need for more research to identify an effective approach. “The private sector is not necessarily averse to regulation per se, because it acknowledges that it faces the risk of being associated with criminal or terrorist financing activities. We are seeking to build a consensus to establish regulation that would not significantly damage the legitimate purposes of informal fund transfer systems.”

Results so far

After little more than two years, the work of the IMF and other organizations involved in the fight against money laundering and the financing of terrorism is already seeing tangible results. For instance, before September 11, only four countries had ratified the UN Convention for the Suppression of the Financing of Terrorism. The following year, that number grew to 43. Today, 117 states are parties to the convention.

But the chief achievement may be somewhat less tangible. “The major part of our success is that we have created a global process,” Johnston says. “Before the IMF’s involvement, a number of other organizations were conducting their own assessments against the FATF standard, but there was no common approach. The IMF and the World Bank have created a global system using a common methodology. This has improved the utilization of scarce international resources by avoiding the duplication of efforts. In my view, this constitutes a major change in the way the world approaches the fight against money laundering and the financing of terrorism.”

Still, Thony acknowledges that he and his colleagues “have no pretension of stopping money laundering tomorrow.” One area where more needs to be done, he says, is helping countries establish financial intelligence units designed to centralize intelligence gathered by financial institutions on suspected criminal transactions. “Such units have proved to be a central element of anti-money laundering efforts, but half the countries in the world still need to develop such a capacity,” he says.

Critical to the entire effort, of course, is political commitment. “Even though we can get buy-in at the technical level for new laws or strengthening supervisory systems, unless we have the high-level political commitment, things don’t happen—the laws don’t get passed, resources don’t get assigned. We need to ensure that the political commitment is there, internationally, for this effort to be successful in the long run,” Johnston says.

The recent revisions to the FATF recommendations have expanded their coverage to a range of new sectors, including charities, accountants, lawyers, and real estate brokers. In this area also, “lower-income countries will face significant challenges in meeting the higher standards, and we will need to be sensitive to their development needs in our assessments and technical assistance,” Johnston says. The IMF expects to begin its assessments against the revised standards later this year and is already gearing up its technical assistance and training in preparation.

Laura Wallace

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Sheila Meehan

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