Since September 11, the finance sector has come under the spotlight for its role as a conduit for terrorist funds. Politicians are making great speeches and blaming the banks. But to stop the abuses would require no less than a politically unacceptable clampdown on minorities, the curtailing of civil liberties and the halting of world trade.
On September 10, the Institute for International Research kicked off its 11th annual forum on anti-money laundering at the Warwick Hotel in mid-Manhattan, New York. The great and the good were all in attendance - lawyers, treasury staff and bankers from blue-chip firms. For a day, they presented the standard conference fare of worthy talks on such topics as "minimising money laundering risks in correspondent banks" and "ensuring compliance with the latest Office of Foreign Assets Control (OFAC) regulations".
Calm before the storm
Delegate bankers listened to the speeches politely and attentively but over coffee breaks and lunch, they let slip their true feelings about anti-money laundering procedures. "My boss just wants me to come up with the cheapest solution so we can say we have complied," said one. Said another: "Our aim is just to focus on high net worth individuals and not to bother with the rest." His answer? "Shut the IMF and World Bank down." This is extreme talk, yet it is rhetoric that is being embraced by a growing number of people. Before the annual meeting was postponed this month, an estimated 100,000 people were due to converge on the Washington DC headquarters of the IMF. Many will have to wait. But it is safe to assume that they will not be giving up.
For many people who have assumed the complicated job of addressing such problems, even the word globalisation is fraught with difficulties. Take Jeffrey Sachs, global economist and director of the Center for International Development at Harvard University. He looks strained when asked to produce an assessment of globalisation. "It is so much more complicated than thinking it is a scorecard. I keep telling people that a pathology textbook doesn't have one page - there are many diseases that afflict societies," he says.
Another banker in conversation with a salesman of anti-money laundering technology, capable of tracking a bank's entire transactions, said without a hint of humour or irony: "Why can't we just track the money laundering transactions? Wouldn't it be cheaper?"
The next day, the worst act of terrorism the world has ever seen occurred a mile or so away from the conference, and every banker's mindset about monitoring financial transactions - as well as about most other things they took for granted, such as peace and security - has been radically altered.
Technology suppliers and consultants are inundated with inquiries, more even than after previous wake-up calls such as the discovery that leading international banks were involved in handling funds looted from Nigeria by the late General Sani Abacha, or the revelations of Citibank's involvement with the wealth of Raul Salinas, the disgraced brother of a former Mexican president.
Politicians and legislators are also focusing on the financial sector. The US Congress is fast-tracking laws that would force US banks to scrutinise correspondent accounts and give the treasury secretary increased powers to compel foreign banks holding such accounts to comply with the investigations. Added impetus has been given to a European Union directive on anti-money laundering rules, previously stalled because MEPs were arguing the case of German and Austrian lawyers not to be included within its reach. The Financial Action Task Force (FATF), set up by the G7 more than a decade ago but whose attempts to crack down on offshore centres were originally rejected by the Bush administration, is suddenly back in the limelight with renewed missionary zeal. The UK is setting up an anti-terrorist finance unit and clamping down on bureaux de change.
Hurried measures
The problem with initiatives taken in the shocked aftermath of a crisis, however, is that while they contain a necessary sense of urgency, they lack the cool detachment needed for good policy making. Interviews with experts in anti-money laundering reveal that almost everything proposed to tackle the issue of terrorist funds will either fail to achieve what is intended or, conversely, unleash such a radical shake-up that global commerce will come grinding to a halt. For example, the US-proposed crackdown on correspondent banking, if enforced rigorously, would make world trade on its current scale impossible. Ironically, Britain's prime minister Tony Blair, in a highly charged speech post-September 11, highlighted easier and fairer world trade as a route out of poverty for nations such as Afghanistan where degraded conditions act as a breeding ground for terrorism. The US stance on correspondent banking runs counter to this aim.
A new approach
Tracking down funds being channelled to terrorists requires a completely different approach from that used for anti-money laundering purposes. The latter involves dirty money (the profits of drug dealing and crime) being cleansed through the financial system and is much easier to spot than the often legitimately sourced funds used to finance terrorism only after they move out of the system. Simply tightening up anti-money laundering rules will have no impact on the flow of terrorist funds except where they arise from criminal conduct.
To really put the screws on terrorist funding would require banks to profile their customers on the basis of race, religion and origin, which would be politically unacceptable and runs counter to Mr Blair's efforts to convince Islamic communities that the so-called war is not against them. In the US, efforts to curb the traditional hawala system of money transfer may run into the same problems.
Targeting offshore centres, the speciality of FATF, largely misses the point since the major money laundering and terrorist funding centres are New York and London. The offshore centres themselves have long suspected that FATF's true motive for attacking them is to undermine the competitive advantage they enjoy through lower tax rates.
A lax system
While the US and the UK have extensive anti-money laundering rules, their failure to prevent it stems from either the loose nature of their know-your-customer rules or the lack of a secure identity card system, which means bank procedures for opening accounts can easily be flouted. Prior to September 11, the idea of a national ID card was a political non-starter in Britain but has since been discussed more seriously. In an Anglo-American civil liberties environment, however, it remains highly contentious, and could well be quietly shelved if the international situation calms down.
No wonder that a French parliamentary committee last month highlighted London as a major conduit for dirty money. The committee went on to criticise the authorities for their lack of co-operation with other European governments in the tracking of illicit funds. Arnaud Montebourg, the report's main author, complained that Tony Blair has "preached" all over the world about the terrorist problem but failed to clean up the City of London.
Drop in on the MLRO (the money laundering reporting officer) in any of the world's major banks based in London and you soon discover the challenges a financial institution faces in trying to keep illicit funds or funding at bay. While the bankers at the New York conference may have been too relaxed on the issue, the leading international banks have long taken the issue seriously. They fear - if for no other reason - the negative impact lapses could have on their reputation.
"Anti-money laundering was something very much being pushed by the regulators rather than the banks," says Andrew Clark, head of anti-money laundering services at PricewaterhouseCoopers. "But now there is the concept of reputation risk. If things go badly wrong, a lot of senior management time is wasted trying to undo the damage."
Says Ian Horobin, business development manager for software producer Searchspace: "Awareness of anti-money laundering is at the stage that environmental awareness was 10 years ago. It has become important but, in a few years, it will be considered fundamental."
Yet tackling the problem within the existing legal framework is extremely challenging for banks. For a start, there are too many sources of rules and guidance. In the UK, anti-money laundering rules are developed from all of the following: the first EU money laundering Directive, the Criminal Justice Act 1993, the joint money laundering steering group guidance notes, the Financial Services Authority's money laundering rules, the Terrorism Act 2000 and UN Security Council sanctions, soon to be joined by the Proceeds of Crime Bill, a second EU money laundering Directive and an emergency anti-terrorism Bill.
Says Nigel Morris-Cotterill, a lawyer specialising in this area who frequently contributes to The Banker: "There is no hope of any bank being able to understand its obligations under current anti-money laundering legislation. Add to this the requirement to comply on data protection and distance selling and it's a wonder anyone in finance stays in business.
"What we need in the UK is not more legislation. We need the existing law collected into one place so we can find it. It needs to be made plain who it relates to and how much trouble you are in if you don't comply with it."
Specific criteria needed
Many practitioners complain that the language used in anti-money laundering legislation is too vague. The laws and guidelines request that banks report unusual and suspicious transactions but fail to specify any criteria for picking them out. Or they say that banks should take reasonable steps to prevent illicit activity but do not spell out what is meant by this. The UK banks report 20,000-plus transactions a year to the National Criminal Intelligence Service but get little feedback on how useful is the information and whether it results in prosecutions.
In the US and Australia. every cash transaction above $10,000, or A$10,000 has to be reported, which means the authorities are overwhelmed with information to sort through. Says British Bankers Association chief executive Ian Mullen: "It is a matter of debate as to whether this stiff bureaucratic approach brings more convictions than the UK system where the onus is on the banks to identify suspicious transactions."
In both the US and the UK, know-your-customer rules are loosely defined and easy to break. In Britain, most banks require customers to present a utility bill as proof of address but, in some cases, a mobile phone bill or video club membership get substituted even though they are much easier to fake.
In the US, a social security card or driving licence are more secure ID than their equivalent in Britain, where there are so many fraudulent driving licenses and national insurance numbers around that accepting these as credentials would signal open season for the setting up of bogus accounts.
In the US, attempts to tighten know-your-customer rules, two years ago, fell foul of the American view of freedom, as members of the public deluged Congress with hundreds of thousands of protesting e-mails, and the new rules were consigned to the dustbin. Australia has a stricter points scoring system whereby different types of ID are added up and an account is opened only when a predetermined target is hit.
Douglas Hopton, head of group fraud and money laundering prevention at Barclays, says the difficulty he faces in preventing abuses is one of education: educating the internal staff, which he can control, as well as educating the public and the regulators, which is largely beyond the bank's sphere of influence. Retail customers often react negatively to ID-type questions and Mr Hopton's view is that a national ID card would solve this problem.
"Many regulators have not really grasped how banking has changed and that there are no longer branch managers who know all their customers. These days, customers do not often visit branches. The regulators also do not understand that corporate customers are multi-banked and that an individual bank is only seeing a small part of their activity," he says.
"We would much rather see prescriptive rules. We are concerned about vagaries that are subject to interpretation because you end up with an unlevel playing field as banks enforce them differently. You even have arguments within a single organisation about how to interpret them."
Mr Hopton also raises the issue about the impossibility of conforming to conflicting government aims. On the one hand, the UK government is keen for the socially excluded to have access to bank accounts, but that may well require less rigorous ID procedures than at present. "In which case, the terrorists would quickly become Big Issue sellers," he says referring to a magazine sold by the homeless on the streets of London and other UK cities.
Mr Morris-Cotterill believes any serious attempt to track terrorist funding will founder because of political unacceptability. "Knowing your customer doesn't help with tracking terrorist funding unless you already know or suspect that your customer is a terrorist. You have to fall back on profiling and, in the current case, you would have to profile on the basis of someone's name or origins, which is inherently racist. The banks cannot make that kind of presumption and the politicians do not want to talk about it."
It soon becomes clear that through a combination of political correctness and civil liberties concerns, banks in the UK and the US can never properly know their customers and are hard pressed to prevent the flow of illicit funds.
European strength
In Germany, France and other European countries where these issues matter less, controls can be stronger. It is also easier for some European governments to freeze assets without court authority as is required in Britain or without UN Security Council resolution as in the case of sovereign assets, although new legislation is attempting to tighten up in this area.
An Italian treasury spokesman says, for example, that the country has no banking secrecy and can easily observe and investigate most capital movements. According to MEP Chris Huhne, writing in a recent newspaper article: "France is one of the few EU members that appear to be able to freeze almost anything if the Tresor decides to do so."
Mr Huhne is critical of rushed moves by the European Commission to push through laws, making it easier to freeze assets. He thinks the new moves are Draconian and may hurt international banking in London. "Tough times make bad laws and the fallout from the attacks on Washington and New York on September 11 is no exception."
Practical measures
But the law is one thing, whereas the daily practical problems of banks can throw up something different. If, for example, retail banks are struggling to know their customers, how much more difficult is it to get effective controls established in the areas of private and correspondent banking?
The danger in private banking is that the customer relationship manager is both too close to his clients to notice anything suspicious and too powerful for the compliance officer to overrule. Funds may also come in through lawyers who are not subject to anti-money laundering guidelines. Leading private banks have laboured long and hard to try to correct these defects. "A private banker must never be allowed to become the powerful ogre," says one banker.
Correspondent banking is even more of a minefield as banks are basically trusting each other's anti-money laundering regimes and the system is only as good as the weakest link.
"If the US government pushes ahead with current proposals, US banks might have to stop correspondent banking, then how would international trade payments be made. It would stop legitimate trade going ahead," says Barclays' Mr Hopton.
The challenge for banks is to get systems in place that prevent illicit flows and funding, despite imperfect legislation, while at the same time not alienating their customers with over-zealous questioning. Ruud Nijs, a managing director with software developer HNC, says experience in tackling credit card fraud shows banks are prepared to write off a certain amount of fraud rather than embarrass legitimate customers with investigations.
"If you have 20 suspicious transactions and two turn out to be criminal, you had to investigate 18 genuine clients to reach that result. That could be too many for some banks," he says. Ironically, HNC released its latest anti-money laundering product on September 11.
Mr Nijs also points out that whatever rules are put in place, the criminals soon learn how to get round them. "If the rule says that transactions above $10,000 have to be reported, the criminals start sending out lots of $9,999 transactions," he says, referring to the technique known as smurfing.
For this reason, the latest anti-money laundering systems use artificial intelligence to detect any unusual transactions regardless of the standard rules. Accenture consultant Paul Cartwright points out that smart banks can use the data they pick up through anti-money laundering operations to understand better customer trends and so increase revenues.
The latest technology, however, costs millions of dollars to install and may be unaffordable for some smaller banks.
Says Andersen consultant Paul Doxey: "The knee-jerk reaction of banks can be to buy in expensive technology. But, sometimes, sophisticated technology is not the answer and it is never enough on its own.
If you have a manual system, strong internal cultures and good know-your-customer rules, you may be better off doing it yourself." Oh, and don't forget to write a letter to your MP on the vexed question of ID cards.
