U.S. Department of State
1996 International Narcotics Control Strategy Report, March 1997

United States Department of State

Bureau for International Narcotics and Law Enforcement Affairs

FINANCIAL CRIMES AND MONEY LAUNDERING

CHALLENGES POSED BY A CHANGING BANKING WORLD

Four aspects of modern-day banking are particularly challenging to governments seeking to stop money laundering: correspondent banking, offshore banking, private banking and cybercurrency.

Correspondent Banking. Regulators, money laundering investigators, and international policy making bodies like FATF are facing profound challenges from a banking world which not only knows no geographic horizons and is open 24 hours a day, but is increasingly inter-connected, as large multinational banks extend their reach not only through branch and subsidiary networks but through correspondent relationships that cross the globe.

The concern is not with the growth or dominance of the largest banks, or the extension of their networks, but, whether standards of prudential supervision are met at every juncture in this web of correspondent banking. The emergence of active financial service industries in every jurisdiction capable of becoming active players on the electronic highway of super-banking, places ever more emphasis on vetting transactions at the bank of origin. There is not the confidence today that the scope of current know-your-customer policies are sufficient to actually cover most financial transactions at origination.

The scope of international banking was made clear at the winter meeting in 1995 of the International Bank Security Association. The world's 12 major financial centers except Japan have one or more banks or financial institutions among IBSA's 52 voting members and six associate members, and these banks include many of the world's largest international banks.

An IBSA survey showed that 27 of these 58 banks have headquarters offices and or branches in 146 countries. A separate survey showed that 19 of the 58 members own percentages (and sometimes controlling interest) in 144 other banking institutions. The actual "reach" of these big banks, both in terms of branches and holdings, is far greater as only 27 of the 58 responded to the surveys on branches.

While FATF has conducted an extensive external relations program, which has engaged an estimated 65 governments outside its own 26-member roster, no single agency, not even the UNDCP, has accepted the responsibility for ensuring uniform standards of anti-money laundering enforcement, or bank regulation, among all nations and territories.

Offshore Banking. An agreement of potentially far-reaching consequences on offshore and cross-border banking was made by banking supervisors from 140 countries at the June 1996 International Conference of Banking Supervisors. Their agreement, incorporated into a report by the Basle Committee on Banking Supervision, issued in October, contains 29 recommendations designed to strengthen the effectiveness of supervision by both home and host-country authorities of banks which operate outside their national boundaries.

The report states that, as a starting point, home supervisors must be able to make an assessment of all significant aspects of their banks' operations, using whatever supervisory techniques are needed including on-site inspections. The paper proposes means by which home-country supervisors can obtain the information they need for effective consolidated supervision of an international banking group. The paper addresses impediments to effective consolidated supervision and suggest ways to overcome these barriers. The paper also contains guidelines for determining the effectiveness of home country supervision, for monitoring supervisory standards in host countries, and for dealing with corporate structures which create potential supervisory gaps. There are also guidelines for host country supervision.

The supervisors recognized that some of the recommendations are in conflict with bank secrecy or similar legislation in certain countries. Where there is conflict, the supervisors have agreed to use best efforts to have the conflicting legislation amended. It was agreed that the compliance of individual countries with these recommendations would be reviewed prior to the next international meeting which is scheduled for October 1998.

The Offshore Group of Banking Supervisors (OGBS) has reached agreement with FATF on a protocol for evaluating the effectiveness of the money laundering laws and policies of its members. This is a positive development but OGBS includes only about half of the known offshore banking centers among its members, and there is a continued belief that OGBS remains the best available vehicle for reaching out to these centers, hopefully with an expanded membership.

However, there is also a concern about different kinds of charters for financial facilities being issued in various parts of the world, facilities which are structurally different from the banking houses represented by OGBS. These International Business Corporations, or IBCs, are being chartered with much the same kind of operational latitude enjoyed by offshore banks, but, in many instances, with even less regulatory oversight. Nowhere is the concern about IBCs more prevalent than in the Caribbean. The US has urged governments around the Caribbean Rim and elsewhere to apply more rigorous oversight to these non-bank financial institutions.

Private Banking. Major national and international banks are engaged in fierce competition to attract wealthy individuals and companies as private banking clients. The very term implies that transactions will be confidential, and indeed that private banking customers will be treated differently. Private banking departments are also prepared to offer a seemingly wide range of personal services. The concern here is not that a major bank's officers might secure hard-to-get entertainment tickets, or facilitate high-ticket shopping; those kinds of services have long been traditional with advertising agencies, management consultant services, etc.

The concern is that bank officers, who rely on private banking commissions for their income, will suspend the rules on transactions -- not just failing to report transactions as required by various banking and anti-money laundering laws, but, disregarding basic tenets of sound banking and thus negating the transparency which is essential to a bank's prudential supervision of its business.

Cybercurrency. The use of microchip-based electronic money for financial transactions, via smart cards and the internet, has the potential to assume an important place in the future domestic and worldwide payments system. These chip-based electronic cyberpayments systems are emerging very rapidly.

Currency--paper notes and metal coins--has always been of particular importance in payments involving illicit activities. Currency attributes include ease of use, wide acceptability, and most importantly from the standpoint of law enforcement - anonymity. A significant feature of the new cyberpayments systems is that some systems are being engineered to be an electronic emulation of paper currency. Cybercurrency includes the attributes of conventional currency: a store of value, a medium of exchange, a numeraire, potential anonymity and convenience.

But there are added features: transfer velocity (almost instant electronic transfer from point to point) and substitution of electrons for paper currency and other physical means of payment. Obviously this is an innovative addition to the payments system, but it also requires close attention since the use of microchip and telecommunications technologies adds some significant new dimensions for law enforcement.

Yet currency is not the only monetary instrument innovation. Cyberpayments also comprise other payment components. Already in use or design are cyberchecks, an emulation of paper checks, cybercredit, cyberdebit, etc. The common element is that these systems are designed to provide the transacting parties with immediate, convenient, secure and potentially anonymous means by which to transfer financial value. When fully implemented, this technology will impact users world-wide and provide readily apparent benefits to legitimate commerce; however, it may also have the potential to facilitate the international movement of illicit funds.

Many issues are raised by this new technology, including the issue of whether such payments constitute legal tender and are therefore subject to monetary reporting and supervision measures. There is a question whether reporting regulations must be completely redesigned to include the reporting of currency in electronic form moving to other countries via the Internet or across the border in a smart card or electronic purse. Law enforcement issues likely to arise in this area include fraud, counterfeiting and computer hacking. Moreover, high speed, worldwide transfers that are a facet of the cyberpayment technology add complexity to law enforcement's ability to trace criminal activity and recover illicit proceeds. And there are important international jurisdictional issues. Some cyberpayments systems are being designed to operate internationally and use multiple currencies. Thus, one of the challenges facing law enforcement and the international community will be determing jurisdictional authority in a global economy. The current regulatory/law enforcement framework relies on defined financial and geographic borders. The diminishing of such borders makes enhanced cooperation and coordination among nations critical to ensure that there are consistent policies.

All of these issues were the focus of a conference sponsored by the U.S. Department of the Treasury in September 1996. Addressing key public officials and representatives of the private sector, Secretary Robert Rubin announced the formation of a consumer electronic payments task force composed of the principal agencies in the federal government involved in payments.

Continued Examination by the International Community

The application of these new technologies is still in its infancy. How these systems develop and with what features will depend on the effectiveness and efficiency of these technologies, the market, and consumer acceptance. Therefore, while it may be premature to consider prescriptive solutions to theoretical problems, it is important and timely for governments and the private sector to continue to identify issues that need to be considered and perhaps implemented as markets and technologies mature. Many governments have come to recognize the need for greater and sustained cooperation to explore these issues.

At its June 1996 plenary, the FATF adopted a new recommendation (#13) stating that "countries should pay special attention to money laundering threats inherent in new or developing technologies that might favor anonymity, and take measures, if needed, to prevent their use in money laundering schemes." At its October 1996 plenary, the FATF agreed to call on SWIFT (the international messaging system for financial transactions) to provide additional information on the originator of financial messages between legitimate financial institutions.

In November 1996 in Paris, FATF, under the chairmanship of the United States, held its annual typologies exercise to identify recent trends in money laundering in FATF member countries as well as non-FATF regions. The meeting was attended by delegates from each of the 26 member nations as well as Interpol and the Organization of American States. This year, it was determined that a discussion of current technology developments in alternative payment methods would be beneficial and appropriate as many of the FATF 40 Recommendations could also apply to cyberpayment systems. This meeting served to continue a dialogue among FATF members and leading international developers and providers of electronic banking and cash payment systems. The meeting was an outgrowth of a FATF meeting held in January of 1996, called the Financial Services Forum, where representatives from governments and the private bank and nonbank sectors met to discuss anti-money laundering measures, in particular the issue of alternative payment systems.

Private sector experts invited by the FATF at the typologies meeting presented an overview of the current technology developments in these payment systems and discussed the issues raised by law enforcement with respect to money laundering. The goals were to increase the knowledge of the FATF about the operations of these systems, advise the industry of law enforcement's potential concerns, and ascertain what steps FATF and the industry could take together to ensure the development of these systems while protecting them from abuse by criminals.

Several other international organizations such as the Organization for Economic Cooperation and Development (OECD) which has recently issued Cryptography Guidelines, the Bank for International Settlements (BIS), the Basle Committee as well as others are involved in the study of cyberpayments.

In addition, at the G-7 Summit in Lyon last June, Heads of States and Governments called for a cooperative study to investigate the implications of recent technological advances that make possible the creation of sophisticated methods for making retail electronic payments. In response the Group of Ten (G-10) countries deputies formed a Working Party in Autumn of 1996 to develop a broad understanding of the international dimensions of policy issues resulting from the development of electronic payment systems.

Money Laundering Simulation Exercise

FinCen is using an automated exercise-based approach to assess the implications of emerging Cyberpayment technologies. It is developing a simulation exercise which will serve to: (1) educate exercise participants on the nature and key characteristics of these emerging technologies; (2) raise general awareness regarding the potential vulnerabilities emerging Cyberpayment technologies to financial crime; (3) explore various avenues for potential criminal applications of these technologies: (4) generate and identify a draft set of potential response strategies for dealing with these key vulnerabilities and (5) consider potential legal, regulatory, and educational action plans associated with selected strategies. The exercise, which is tentatively planned for April of 1997, is to include participants from government, academia, and industry both domestically and abroad.

Other Challenges. Other challenges include counterfeiting of currencies and other monetary instruments, especially bonds; the boom in contraband smuggling; the buying of banks and other financial institutions by suspected criminal groups; the resort by criminals to the use of smaller, less-monitored banks; and the sophisticated use of such new phenomena as direct access and pass-through banking, and electronic cash systems. There is continuing concern, given that financial crimes and money laundering are occurring with varying degrees of regularity in more than 125 jurisdictions, that some governments still have not criminalized all forms of money laundering. Some have not given sufficient regulatory authority to central banks and other institutions; many do not have adequate data systems to monitor trends and methods used in their territories; and many have not made adequate provision for mutual legal assistance.