Outdated legislation and unclear government policies mean less developed countries are the ones to suffer as a result of anti-money laundering strategies.

What happens when global goals of financial inclusion run up against global rules designed to detect and prevent money laundering? Banks ‘derisk’. They exit relationships, or reduce exposure to customers, industries or countries perceived to pose heightened risk of facilitating criminal activity and money laundering. These relationships include money service businesses, currency dealers and charities, primarily in poorer or less-developed countries: the very regions that are the targets of global financial inclusion initiatives.

As a consequence, these clients are reluctantly forced to return to the shadow banking world from which they emerged. This trend can be blamed partly on well-intentioned anti-money laundering regulations introduced 50 years ago but not revisited to align them with contemporary realities. As an example, deployment of significant regulatory and law enforcement resources towards monitoring low-value transactions from, say, the street sale of drugs, has not resulted in a meaningful decline in money laundering. Instead, it has diverted precious resources away from focusing on high-value transactions, for example in real estate or the antiquities market. Iterative additions to the original regulations coupled with significant recent penalties for non-compliance imposed by global regulators have merely exacerbated the problem. The limited resources at our disposal now have to police a larger universe, errors and slippage are inevitable.

Back to basics

Even though banks and other financial institutions are in the business of taking risk, there is a logical tipping point on the cost-benefit continuum where a bank will simply exit the relationship, or the business, rather than spend increasing sums on compliance with regulations that need to be more clearly defined and consistently enforced.

Neither the banking sector nor regulators have access to unlimited resources to police this evolving universe, so there is an opportunity to revisit the scope and purpose of anti-money laundering regulations by focusing on the old question: what are the problems we would like to solve?

Although the earlier focus on the narcotics trade has not relaxed, criminal elements and state actors have developed more creative mechanisms for moving illicit funds in significant amounts into the formal banking system. Regulation and enforcement, however, have not been equally dynamic and continue to focus on all known threats instead of on those that should really matter. The creation of additional regulations to counter evolving threats has merely increased the burden on banks, governments and regulators across the globe.

The World Bank estimates that around two billion people globally do not use formal financial services and more than 50% of adults in the poorest households are unbanked. The World Bank believes that financial inclusion is a key enabler to reducing poverty and boosting prosperity, hence its president has called for universal financial access by 2020.

Ask the right questions

So how best do we better align the global objective of financial inclusion with our logical interest in countering the flow of illicit funds? A good place to start would be for governments, bankers and regulators to initiate a fresh dialogue that would assist in prioritising expectations. There are a number of questions that could help reorder our priorities and permit more effective allocation of scarce resources:

• Is the recording of $10,000 in currency transactions actually a good indicator of street crime, and is it as important as the detection of proceeds from the theft of state assets, or antiquities from conflict zones? Is the threshold of $3,000 for filing a currency transaction report still appropriate? How successful has the routine filing of suspicious activity reports been in detecting and prosecuting high-value financial crimes? Should artificial intelligence be used to replace outdated technologies for mining transactional data to detect patterns and trends of abnormal behaviour?

• Can the banking industry be provided with clearer definitions of governmental priorities in the fight against financial crime? In the absence of a global regulator, how best can we ensure that regulations are uniformly implemented, or enforced? Are banks and other financial institutions the right entities to entrust with the task of crime detection?

It is evident that a serious rethink is warranted if we wish to curtail the flow of illicit funds through the banking system while attempting to foster global financial inclusion. A pathway to success may lie in working smarter, not harder.

Ajay Badyal heads the Assurance & Advisory Services Unit of the Compliance Function at the Federal Reserve Bank of New York. The views expressed here are his own and do not necessarily reflect those of the Federal Reserve Bank of New York or the Board of Governors of the Federal Reserve System.

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