Why CFT regulations fall short
Terrorism financing has received renewed media attention with the rise of Islamic State of Iraq and Syria (ISIS), the richest terrorist group in history. Current financial counterterrorism (CFT) approaches fail to combat existing terrorist financing threats largely because the Financial Action Task Force (FATF) lags behind the evolution of terrorist group business models.
Given the inadequacy of FATF recommendations, CFT regulation is due for a major overhaul.
Global CFT regulation originated in 1999 with the International Convention for the Suppression of the Financing of Terrorism in the U.N. General Assembly. Since then, the Financial Action Task Force has been mandated with the task of monitoring country compliance with CFT.
Despite 15 years of multilateral efforts to suppress terrorism financing, CFT compliance rates are unmistakably low. In a recent statistical study, I find that the rating “compliant” was awarded only 4 percent of the time for countries evaluated by the Financial Action Task Force (FATF) from 2004 to 2011. On all the recommendations, the most common rating is “not compliant” (39 percent) or “partially compliant” (38 percent), comprising over three-quarters of all ratings.1
My dissertation is the first study to quantify FATF compliance ratings and to test the determinants of country implementation of FATF standards. The study examines numerous variables to assess the determinants of compliance. It turns out that the intensity of terrorist attacks, their magnitude, the regime type of the target country, as well as its capability, all fail to predict whether it will comply with CFT recommendations.
Across all logit model specifications, the most robust and statistically significant determinant of compliance is the strength of the country’s bilateral trade relationship with the U.S. This finding, I would argue, suggests that compliance is largely a function of U.S. financial influence rather than commitment to counterterrorism norms.
A major weaknesses of FATF’s recommendations is that they have always been based on helping to combat the foremost terrorism threat from the U.S. vantage. The rules established by FATF have consistently mirrored the recommendations of the 9/11 Commission Report, which are naturally based on countering al-Qaeda circa 2001. The terrorist financing model is frequently changing, however, and different terrorist groups have different business models. Driven by its own inertia rather than the evolving nature of the terrorist enemy, CFT is thus out of step with reality.
The FATF did revise its original CFT recommendations in February 2012, to its credit. Rather than including nine separate recommendations on terrorist financing, the new recommendations on CFT are more integrated with anti-money laundering (AML). This is a marginal improvement because so much terrorist money is now raised through international crime.
Al-Qaeda has raised its money through donors, charities, mosques, and increasingly, kidnapping.2 Islamic State of Iraq and Syria raises most of its money through extracting payments via extortion, collecting ransoms for hostages, robbing banks, and selling oil on the black market.3 In general, it’s fair to say that the Islamic State is more financially self-reliant than al-Qaeda ever was, as it controls territory and nourishes itself through predation on the local population.
The United States, which has spearheaded the CFT campaign from its onset in 2001, is among the most compliant countries with FATF rules. In fact, the U.S. imposes even stricter regulations than the FATF requires. According to CFT expert Matthew Levitt, if the Islamic State is serious about targeting the U.S. at home, it will still be able to transfer smaller amounts of money through hawala, an informal value transfer system, or raise it locally. The Islamic State’s threat is compounded by its propaganda appeal. Small plots by self-starters, however, would be a far cry from a 9/11-scope attack.
And yet terrorism research shows that historically most attacks against U.S. interests happen outside U.S. soil. According to Sandler and Enders (2004), terrorists respond to counterterrorism policies by substituting from hard targets to soft ones.
When counterterrorist policies reduce the terrorist “war chest,” it simply causes them to shift into other types of fund-raising activities and perpetrate less expensive attacks.4 The current CFT regulations are ineffective in suppressing attacks against U.S. interests, as the recent beheading videos of U.S. journalists by the Islamic State seem to suggest.
Additionally, the counterterrorism benefits of CFT regulations need to be weighed against the costs to the financial system. According to KPMG International’s Global Anti-Money Laundering Survey 2014, the costs of implementing AML/CFT regulations continue to rise at an average rate of 53 percent for global banking institutions and regulatory fines are soaring into billions of dollars. According to the survey, the cost-saving benefits of outsourcing and offshoring once enjoyed by financial institutions are now reduced since the brunt of responsibility for AML/CFT compliance falls on the outsourcing or offshoring institutions.
Further, the increasingly elevated costs of AML/CFT regulatory compliance have reduced the scale and scope of transnational financial activity. For instance, the stricter regulations imposed by the U.S. are negatively affecting the global financial system as international banks are scaling back on bank-to-bank alternative remittance transactions to reduce costs.5 Strict regulations are particularly damaging to developing countries whose economies rely on remittances.
The current CFT regime is ineffective simply because it doesn’t matter. Assessors find few countries with high compliance levels on FATF’s recommendations and the U.S. employs stricter standards than FATF anyway. Getting rid of FATF financial counterterrorism regulations altogether would have little effect on security, because so few countries comply in the first place.
Placing the burden of enforcement on private actors is onerous on the financial system and countries with divergent terrorist threats have a weaker incentive to comply. If CFT’s role is indeed to suppress terrorism financing, the current regime is clearly in need of reform. The U.S. needs to devise a superior system for protecting the homeland in an age of ISIS without financially strangling the banking system, which ultimately transfers the costs to customers.
Indeed, the current FAFT regime may even be counterproductive from an international security perspective by incentivizing groups like the Islamic State to skip international banking altogether by raising money through predation of the local population, including hostage-taking and the sale of involuntary brides. In sum, it is hard to see the security or economic benefits of today’s terrorism financing regulations.
- 1 Lula, Karolina. “Terrorized Into Compliance: Why Countries Submit to Financial Counterterrorism.” PhD diss., Rutgers University-Graduate School-Newark, 2014.
- Roth, John, Douglas Greenburg, Serena Wille, and Alice Falk. Monograph on Terrorist Financing: Staff Report to the Commission. National Commission on Terrorist Attacks upon the United States, 2004.
- Malas, Nour, and Maria Abi-Habib. “Islamic State Economy Runs on Extortion, Oil Piracy in Syria, Iraq.” The Wall Street Journal. August 28, 2014. Accessed September 01, 2014. http://online.wsj.com/articles/islamic-state-fills-coffers-from-illicit-economy-in-syria-iraq-1409175458.
4 Enders, Walter, and Todd Sandler. “What do we know about the substitution effect in transnational terrorism.” Researching terrorism: Trends, achievements, failures 119 (2004): 137.
- “Poor Correspondents.” The Economist. June 14, 2014. Accessed September 01, 2014. http://www.economist.com/news/finance-and-economics/21604183-big-banks-are-cutting-customers-and-retreating-markets-fear.