Current Developments in Monetary and Financial Law, Vol. 5
Chapter

Chapter 14 The Impact of Weak AML/CFT Frameworks on Financial Stability

Author(s):
International Monetary Fund
Published Date:
November 2008
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Author(s)
ZENÓN ALBERTO BIAGOSCH

Strong frameworks for anti-money laundering (AML) and combating financing of terrorism (CFT) can have a powerful influence on preserving a nation’s financial stability. On the other hand, countries with weak AML/CFT regimes are subject to the negative effects that large international criminal organizations can have on their economic growth and financial stability. Thus the strengthening of AML/CFT systems is a subject of vital importance to individual nations and the international community.

This chapter first describes the breadth of the problem caused by criminal and terrorist organizations. It then discusses steps that have been taken to strengthen AML/CFT, with a particular focus on the experience of Argentina. Finally, the chapter offers a proposal for regional and international standards to strengthen AML/CFT frameworks.

The Problem

All nations pursue sustained economic growth. Their success, however, is strongly linked to how effectively their governments ensure stability of the financial system. One of the challenges faced today by individual countries, as well as by the international community, is that financial stability can be undermined by the activities of criminal organizations.

In Argentina the directors of the Central Bank are responsible, under the bank’s charter, for “supervising the good performance of the financial market.” To achieve this objective and to ensure the sustained stability of the country’s financial system, the Central Bank’s regulatory and supervisory powers in regard to liquidity and solvency have been supplemented with policies to prevent and control money laundering and terrorist financing. (These policies are described later in the chapter.)

To understand the relationship between AML/CFT and financial stability, three factors must be taken into account:

  • Criminal organizations can exert great economic power in the absence of a proper AML/CFT system. In fact, they can undermine the economic and political stability of a country—and, consequently, its financial stability.
  • States are devoting an increasing amount of funds to control money laundering and terrorist financing.
  • There is a growing need for international standards on banking supervision related to AML/CFT in order to protect and reinforce financial stability.

Individual nations and the international community are facing criminal organizations that carry out transactions involving huge amounts of money. The breadth of the problem is illustrated by data from several sources:

  • Relying on IMF data, the USA PATRIOT Act stated that money laundering ranges from 2 to 5 percent of the world’s gross domestic product, approximately US$ 600 billion.1
  • In its annual report on drugs and crime, the United Nations reported in 2006 that 5 percent of the world’s population 15–64 years of age uses drugs. In addition, drug trafficking amounted to US$ 320 billion in 2003, exceeding 90 percent of the worldwide gross domestic product.2
  • The Financial Action Task Force in June 2005 declared that trafficking in people and illegal immigration amounts to approximately US$ 10 billion.3
  • The Basel Committee’s 2002 research on fraud related to the banking sector analyzed 89 international banks and showed that their losses reached around €1.4 billion millions euros due to internal and external fraud.4
  • Research by the Association of Certified Fraud Examiners estimated that U.S. losses for fraud could reach more than US$ 600 billion.5
  • The World Bank estimated that bribes paid worldwide were over US$ 1 billion in a single year.6

These data demonstrate that national governments and the international community are facing the equivalent of supra-states, in the form of criminal organizations, that generate more wealth than many countries. Their economic power not only affects the stability of worldwide financial systems; it is also used to fund their activities. The conduct and transactions of cross-border criminal organizations harms economic growth, undermines the peace of society, and, in many cases, evades the most sophisticated security structures in the world.

The activities of criminal organizations affect different aspects of society. The most relevant aspects are related to economy and finance, policy, and society. The economic-financial aspect is basically affected in three ways: (1) a reduction in the resources of the formal economy; (2) investments contrary to economic expectations; and (3) disregard for achieving normal profit. In other words, illegal funds are, in general, invested for speculation, accumulation, or concealment. This causes a drop in the rate of international economic growth and may even damage the regular functioning of financing and capital markets.

The inflow or outflow of funds of criminal origin may adversely affect a country’s market stability, with three major consequences:

  • A change in variables such as interest rate, exchange rate, the price of properties, liquidity, and quotation of shares and debt instruments;
  • A decreasing level of transparency, soundness, confidence, and reliance on financial markets;
  • Transfer of a domestic problem to the worldwide economic and financial systems.

Criminal organizations can affect the political-institutional aspect of states because they can afford any costs to obtain their objectives, particularly because they do not intend to obtain profits. In general, they are willing to corrupt the executive, legislative, and judicial powers and law enforcement functions through bribery. Such corruption is one of the heaviest prices the international community has to pay for having to live with transnational criminal organizations.

Additionally, governments are forced to invest growing resources to implement compliance controls. In this regard, it would be advisable to estimate through research how much governments spend in that respect; in other words, how much societies must pay to fight criminal organizations.

Since the attacks of September 11, 2001, in the United States, there has been a worldwide trend toward preventing such crimes and punishing the perpetrators. In many cases, states have been forced to increase their budgets to enforce these measures. Further, it has been necessary to adopt stronger legislation and even to interfere with the private sector, in many cases disrupting the normal operation of private business. Because the population is aging in the more developed countries, a smaller working population must pay higher contributions for the security measures.

International Regimes

Over the last few years, several international bodies, both public and private, have proposed or implemented a number of recommendations to prevent and reduce risks arising from different kinds of criminal conduct, to combat increasingly complex and sophisticated crimes, and to protect the stability of states and their markets. The proposed guidelines include the following:

  • Recommendations of the Financial Action Task Force and its new methodology of evaluation;
  • Resolutions of the United Nations Security Council;
  • Basel II statement on operating risks, and a revision of the Basel Core Principles;
  • The Sarbanes-Oxley Act of 2002 in the United States, and the implementation of the resulting regulations by the Public Company Accounting Oversight Board;
  • New principles of corporate governance promulgated by the Organisation for Economic Co-operation and Development;
  • New accounting rules such as the International Financial Reporting Standards;
  • Updated International Standards on Auditing of the International Federation of Accountants;
  • Revision of the methodology of the Committee of Sponsoring Organizations of the Treadway Commission.

The Case of Argentina

Central bankers and banking supervisors should continue doing their best to implement international standards and, particularly, regional AML/CFT regulations. In the case of Argentina, the Central Bank and the Superintendence of Financial and Exchange Institutions have adopted new AML rules over the last two years and enforced a new regulation on prevention and control of terrorist financing. This new AML/CFT regulatory framework is in line with international standards.

In addition, the Central Bank of Argentina has established a specific mechanism to monitor and prevent money laundering and terrorist financing, which includes the following elements:

  • Implementation of a banking supervisory regime that focuses on AML/CFT;
  • Implementation of a qualified and trained group of inspectors in AML/CFT;
  • Planning of supervisory activities over the financial system according to a risk-based approach;
  • Arrangement of an examination schedule on the basis of a risk matrix of the financial system itself;
  • Rating financial entities’ in-house monitoring structures.

Regional Standards: Latin America

Most international observers view banking supervision as the axis of prevention. However, international organizations have produced few specific documents in regard to a methodology for specialized AML/CFT banking supervision. The need for international standards in banking supervision that focus on AML/CFT is to protect and strengthen the financial stability that is a primary goal of all countries. For that reason, the Central Bank of Argentina is making efforts to reach a regional agreement on standards and best practices on specialized banking supervision intended to fight money laundering and terrorist financing.

The implementation of the rules applicable to financial systems differs greatly among Latin American countries. However, they all comply with regulatory standards issued by international organizations such as the Financial Action Task Force (FATF), Financial Action Task Force on Money Laundering in South America (GAFISUD), and the Inter-American Drug Abuse Control Commission (CICAD) of the Organization of American States (OAS). For that reason, there should be supplementation and emphasis on effective regional surveillance mechanisms, such as:

  • The FATF and GAFISUD New Methodologies of Mutual Evaluation;
  • The CICAD/OAS Mechanisms of Multilateral Evaluation;
  • Article 4 of the IMF Articles of Agreement and the Financial Sector Assessment Program (FSAP) of the IMF and World Bank;
  • Due diligence principles for business and correspondent activities with Latin American banks provided by the U.S. financial system in line with the USA PATRIOT Act.

In short, the Central Bank of Argentina proposes that a mechanism for AML/CFT supervision be implemented both on a regional and international basis. This does not mean that the regulatory standards in effect, such as those provided by the Financial Action Task Force, should be replaced. On the contrary, they could be supplemented with a banking supervisory mechanism. This initiative is based on four pillars:

  • Regulation. The regulatory framework should be homogeneous and supported by the existing standards such as those provided by the Financial Action Task Force.
  • Specialized supervision. An AML/CFT-oriented supervisory scheme should be designed, based on a risk matrix to be implemented by qualified and trained inspectors.
  • Rating. Specific rating mechanisms should be implemented, focusing on the components to be rated and rating systems applicable to financial entities. (Argentina has traditionally rated financial entities in terms of their liquidity and solvency position to protect its financial system’s stability. These entities should now be rated in terms of their compliance with regulations on the prevention and control of money laundering and terrorist financing.)
  • Use of information. There should be clear guidelines on the use of information and to what extent it may be shared—for instance, channels for sharing information within public and private sectors, and between them, and the ratings assigned. Special attention should be paid to the legal frameworks of different jurisdictions.

Adopting the standards with the above-mentioned characteristics would allow governments to:

  • Reinforce AML/CFT regulations and make financial entities aware of this concern;
  • Provide financial systems with the necessary tools to do business on a more reliable basis, particularly in countries accepting the proposed standards;
  • Generate information that can be shared among the private sector and among regulatory bodies;
  • Identify those countries or entities that do not endorse the standards proposed;
  • Reduce the level of uncertainty in relationships, considering that the new guidelines could help to distinguish the particular characteristics of countries in each region and at the same time generate specific procedures to take into account the reality existing in each country.

The International Monetary Fund and the World Bank have been providing technical support for the supervisory methodology currently being implemented in Argentina. Indeed, this is a priority item on the agendas of both the Central Bank of Argentina and the Superintendence of Financial and Exchange Institutions, which are in charge of supervising the financial services community and warning them against criminal operations.

Note: The views expressed in this paper are those of the author and should not be attributed either to the Central Bank of Argentina or to the Superintendence of Financial and Exchange Entities.
1USA PATRIOT Act (Public Law 107-56), Sec. 302.
2United Nations Office on Drugs and Crime, World Drug Report 2005.
3FATF, Money Laundering & Terrorist Financing Typologies 2004-2005, at 67.
4Basel Committee on Banking Supervision. The 2002 Loss Data Collection Exercise for Operational Risk: Summary of the Data Collected, p.12, Table 8.
5Association of Certified Fraud Examiners, 2006 ACFE Report to the Nation on Occupational Fraud & Abuse, (p. 4):
6United Nations Office on Drugs and Crime, “Datos sobre la Corrupción.” Available at www.unodc.org.

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