The time has come to reset our anti-money laundering laws. Let’s re-examine the pros and cons of our approach to combatting money laundering. What works and what doesn’t work? We have four decades of experience with anti-money laundering laws in the Unites States starting with the misnamed Bank Secrecy Act of 1970 (not counting the state AMLs before that). Any objective analysis would question the effectiveness of our approach.
As the 2001 National Money Laundering Strategy explained, “If anti-money laundering initiatives are not making a significant difference in disrupting money laundering activity, principles of good government mandate that law enforcement discontinue those efforts.” I would be hard pressed to find anyone who would set up our current system if we were starting from scratch.
In the United States, the two main forms financial institutions send to Treasury’s Financial Crimes Enforcement Network are the Currency Transaction Report and the Suspicious Activity Report. According to FinCEN’s last annual report, FinCEN received nearly 15 million CTRs in fiscal year 2011 and about 1.4 million SARs. In reality, the tripling in the number of SAR forms over the past decade probably has more to do with defensive filing than a doubling in real financial crimes. Defensive filing happens when institutions over-filing to protect themselves from regulators with diminishing utility to law enforcement.
As I testified before the International Commission of Jurists Eminent Jurists Panel on Terrorism, Counter-Terrorism and Human Rights in 2006, “It is my belief that we need to scrap our current AML policies and start over. Instead of policies attempting to vacuum up as much data as possible to look for ‘profiles’ based on incomplete, outdated and often inaccurate data, we should aim to reduce greatly the amount of reports filed.”
According to FinCEN’s May 2013 SAR Activity Review, very few SARs were filed for suspected terrorism financing. Instead, as FinCEN Director Jennifer Shasky Calvery told the Florida International Bankers Association in February of this year, “more than 90 percent of those counter-terrorism BSA records are CTRs.” Time to scrap the CTRs with reports of information law enforcement wants.
For example, marketing companies use aggregated consumer information without Personally Identifiable Information (PII) to better target advertising. Similarly, FinCEN was able to make use of changes in aggregate legal money flows reported in CTRs from different institutions in the Colombian Black Market Peso Exchange money laundering system. Working with law enforcement to identify what their needs are and how they use the data, we could substitute aggregated data from each institution without PII for the CTRs. This approach better addresses law enforcement needs, reduces regulatory burden and protects consumer financial privacy. The information targeted in these reports could be updated as law enforcement needs change.
The years following have only re-confirmed my belief in that approach. Our anti-money laundering laws have not gotten drugs off of our streets, stopped people from cheating on their taxes or prevented financial fraud. The other original purpose was to prevent Americans from owning monetary gold through Swiss bank accounts, but the U.S. re-legalized gold a few years after the Bank Secrecy Act (BSA) was passed.
The last extensive survey of the regulatory burden of our AMLs was the 1993 Grant Thornton study for the Independent Bankers Association of America, which said, “smaller banks face the highest compliance cost in relation to total assets, equity capital and net income before taxes.” The most important take-away of that study was that the AMLs impose a hugely disproportionate cost on smaller institutions, raise barriers to entry for new competitors, and marginally increase the incentive for a consolidation of assets in the financial system, which contributes to the too big to fail problem.
These results are confirmed in other studies. “The basic conclusion is similar for all of the studies of economies of scale: Average compliance costs for regulations are substantially greater for banks at low levels of output than for banks at moderate or high levels of output,” according to the Federal Reserve Staff Study 171.
William Grant, on behalf of the American Bankers Association, has testified, “Instead of investing precious capital into new products to meet the ever-changing demands of our customers, banks are paying for changes to software to ensure compliance with all the new rules.” He added, “Even a small reduction in the cost of compliance would free up billions of dollars that could facilitate loans and other banking services.”
The government keeps ratcheting up the regulatory burden on the private sector to make law enforcement’s job easier after the fact. This approach does nothing to make us safer. However, I do support the USA PATRIOT Act’s Section 314(b). This approach facilitates SAR information sharing system between financial institutions when wrongdoing is suspected in attempted customer transactions between them. This deference to local knowledge is exactly the way our policies should evolve. Coupled with an expanded safe harbor to report any suspected wrongdoing, this approach would be more effective.
Section 314(b) is a model of how bureaucratic institutions should assist and facilitate a more decentralized peer-to-peer, rather than top-down, approach. In fact, financial institutions on their own and working with each other already stop nearly all of the financial fraud in the system.
Such a change to real-time action from those suspecting actual wrong-doing rather than the gratuitous reporting of law-abiding customers going about their legal transactions helps banks protect themselves from fraud and other financial crimes as well as helping law enforcement actually prevent crimes in the first place unlike the rest of its approach.
According to a 2011 KPMG study, AML costs were expected to rise 40 percent from 2007, but in fact they have risen 45 percent since then. “The extent of cost rises is underestimated by many.” It added that “many wanted more guidance and a collaborative approach” similar to what I have suggested here and elsewhere. The KPMG studies show that AML professionals consistently underestimate the future costs of AML compliance. PWC has a similar study on the costs of AML compliance.
Bankers routinely complain among themselves and to their trade associations that the AML compliance has long been one of their most burdensome regulations and that the examiners are extremely tough in their BSA exams and investigations – and so are the auditors.
In addition to the US Treasury’s FinCEN, other regulations and advice by the Financial Action Task Force, International Monetary Fund, Egmont Group and other national regulators complicates AML compliance, increases costs and limits consumer choice.
As I wrote for US Rep. Ron Paul as his legislative staffer in a dissenting view on proposed AMLs in 1998, “This increased burden must ultimately be passed on to the consumer. The increased costs on financial institutions these bills impose will lead to a reduction of access to financial institutions, higher fees and higher rates. These provisions are anti-consumer. The marginal consumers are the ones who will suffer most under these bills.”
There are political costs to consider. The increased scrutiny of politically exposed persons and sanctions greatly complicate AML compliance, increase costs and can cause unintended political by-products. In addition, to the extent the AML programs are successful, they can divert funds away from monitored channels to places with no financial intelligence. Iran trades with gold marginally reducing demand for the U.S. dollar in international trade. Individual Iranians use bitcoins as an alternative to their currency instead of the U.S. dollar. Just recently, the Cuban interest section in Washington, D.C. is closing for lack of legitimate banking options because of AML and FATCA compliance concerns.
Even when the authorities shut down the Liberty Reserve operation (an alternative electronic currency operation allegedly set up for money laundering), they admitted that most people using the site were there for the low 1 percent transaction fees for remittances or get around forex restrictions. The plight of the Kenyan, Guatemalan and Somali people and others around the world who depend on low-cost money transfers to survive or rise out of poverty or recover quickly from disasters should not be ignored.
AMLs stifle needed new payment systems such as bitcoin. Less regulated industries such as technology are adapting much faster than the financial system. Actors in the financial industry are often late adopters to quickly changing technologies. On the other hand, new electronic monies have been less regulated (though this is changing).
It is bitcoin, Liberty Reserve and others that are allowing faster and cheaper mobile payments to more of the world’s population, including the unbanked, than has ever been possible. These changes mean more money is reaching the people who need it most ─ and faster including situations when lives depend on it. Grafting a failed AML approach from the polyester-wearing disco music era onto the fast changing 21st Century technologies can’t end well.
In conclusion, as I cited in my 2001 Congressional testimony on what became the USA PATRIOT Act, money launderers do not have a statistically significant chance of being caught so the deterrent effect of our AML approach is negligible. Only a minuscule fraction one percent of CTRs and SARs result in criminal convictions. I know of no examples where AML reports prevented any terrorist events.
Our AMLs are a failure: the drug trade continues unabated, financial fraud is more prevalent now than ever, and terrorist groups continue to finance their operations. The greatest tragedy is what everyone knows and policymakers don’t seem to care: it is the unbanked, the poor, and the racially and ethnic minorities in rich countries (and the populations of poorer countries) that suffer these costs for such elusive benefits.
Time to reboot our AML policies to aid law enforcement, encourage innovation, cut costs and protect privacy and other human rights.