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The case of anti-money laundering regulation

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University of Zurich
Swiss Banking Institute
Hans Geiger
Impact of Regulation on the Costs of Banks
The Case of Anti - Money Laundering Regulation
University of Zurich
Swiss Banking Institute
Impact of Regulation on the Costs of Banks
Hans Geiger
Brussels, February 2007
Slide 1
The Regulatory Burden in the Swiss Wealth Management Industry 2002
Regulatory Burden 2002
Inc. Banks -
[CHF per capita]
large
Inc. Banks
small
-
Securities
Private Bankers
Dealer - Wealth
Management
Securities
Dealer Securities
Trading
Regulatory Burden
12'154
28'734
6'938
18'580
14'161
Compliance Costs
10'935
24'270
6'412
15'255
11'568
Prevention of Money Laundering
5'059
8'374
2'746
4'936
145
Risk Management
2'472
3'458
1'002
2'372
4'825
Equity/ Liquidity/ Accounting
1'561
5'400
829
2'107
4'508
Others
1'843
7'038
1'835
5'840
2'090
1'157
4'327
440
3'039
1'979
External Auditing Costs
357
1'600
145
2'174
1'057
Internal Auditing Costs
800
2'727
295
865
922
62
137
86
286
614
Incremental Auditing Costs
Direct Costs
Sources: Hubli 2004, Marti 2004.
University of Zurich
Swiss Banking Institute
Impact of Regulation on the Costs of Banks
Hans Geiger
Brussels, February 2007
Slide 2
Swiss Banking Institute – Survey on Anti-Money Laundering
Burden of Regulation
• Analysis on Regulatory Burden (not only AML) in Swiss Private Banking:
– 5% of a private bank�s in Switzerland total cost is attributed to
compliance
– 45% of the total compliance costs are spent for AML
– In contrast to other regulatory areas, AML measures have significant
impact on the front divisions of a bank.
– Bigger banks face advantageous economies of scale, smaller
participants are penalised.
• Regulators have taken up the bank�s concerns about „overregulation“.
– Today: Cost Benefit Analysis performed for many regulatory projects
– UK�s FSA as precursor of this development
University of Zurich
Swiss Banking Institute
Impact of Regulation on the Costs of Banks
Hans Geiger
Brussels, February 2007
Slide 3
The Paradox of AML – Policies
Results of a comparative study on the impact of the Anti-Money Laundering
regulations on the competitive position of the banking sector
in Germany, Singapore and Switzerland
• Regulation and implementation of Money Laundering prevention measures in
comparable financial centers do not result in a considerable distortion of competition on
an international basis.
• The goal of Anti-Money Laundering efforts, namely the prevention or reduction of
drug trafficking and organised crime, has not been achieved.
• The banks consider the compliance with AML rules as essential and important. AML
activities have become a necessary requirement to conduct successful business locally
and abroad.
• The AML activities generate considerable direct and indirect costs.
University of Zurich
Swiss Banking Institute
Impact of Regulation on the Costs of Banks
Hans Geiger
Brussels, February 2007
Slide 4
bad
Modelling the World of AML Measures
good
Clean World
Criminal World
Financial
Institutions
Designated
Institutions
Non designated
Institutions
Natural
Persons
The official strategy: „More of everything“
University of Zurich
Swiss Banking Institute
Impact of Regulation on the Costs of Banks
Hans Geiger
Brussels, February 2007
Slide 5
3 Theses
1.
Cost / benefit analysis should be undertaken for AML measures
2.
Benefits should be defined and measured in
terms of predicate crime
3.
Costs to be considered are
• Indirect costs / collateral damage
• Direct costs
University of Zurich
Swiss Banking Institute
Impact of Regulation on the Costs of Banks
Hans Geiger
Brussels, February 2007
Slide 6
MANDATE FOR THE
FUTURE OF THE FATF
(September 2004 – December 2012)
The need for continued action against money laundering and terrorist financing
1. The current remit of the FATF expires at the end of August 2004. Considerable progress has
been made in the fight against money laundering since the inception of the FATF in 1989. However,
the FATF still has a major task to perform in continuing to set standards in the context of an ever more
sophisticated international financial system. This key role should be completed by carrying out
typologies and compliance work in order to ensure global action against money laundering. Following
the expansion of its mandate in 2001 to include the fight against terrorist financing and the
introduction of the Eight Special Recommendations, the FATF opened up an entirely new area of
work. Although much has been done, there is an obvious need for continuing mobilisation at the
international level to deepen and broaden anti-money laundering action and the fight against terrorist
financing. This document, therefore, sets out the main tasks of the future mandate of the FATF.
Source: http://www.fatf-gafi.org/dataoecd/14/60/36309648.pdf
University of Zurich
Swiss Banking Institute
Impact of Regulation on the Costs of Banks
Hans Geiger
Brussels, February 2007
Slide 7
Swiss Banking Institute – Survey on Anti-Money Laundering
Results: Burden of AML Regulation
• Answer more depending on a bank’s size than on its domicile.
• Own regulator/rules are mostly regarded as strongest.
• The more a bank is engaged in international business with branches or
subsidiaries abroad, the less it sees differences between the AML rules.
• Many banks regard their own internal rules framework as more
burdensome than the regulatory requirements.
– Especially big banks share this view, regard it as advantage against
smaller competitors.
– Motivation
• Uniform regulatory framework for all business activities;
• Influenced by many regulators;
• High sensitivity for reputational and operational risks.
University of Zurich
Swiss Banking Institute
Impact of Regulation on the Costs of Banks
Hans Geiger
Brussels, February 2007
Slide 8
Swiss Banking Institute – Survey on Anti-Money Laundering
Results: Reputation matters
• Most banks see their AML efforts as important to protect and strengthen
their reputation.
• Reputation is important on three levels:
– Clients
• Clients may not like to have business relationships with doubtful
banks.
– Correspondent banks
• Business relationships with doubtful banks are seen as an
operational and reputation risk, may even be forbidden by own
regulator.
– Regulators
• (Alleged) money laundering cases and lax procedures are
sanctioned by own and foreign regulators.
• Good AML reputation is necessary for successful business!!!
University of Zurich
Swiss Banking Institute
Impact of Regulation on the Costs of Banks
Hans Geiger
Brussels, February 2007
Slide 9
Swiss Banking Institute – Survey on Anti-Money Laundering
Results: AML measures within a bank
•
•
Ranking by effectiveness (banks’ judgement)
1. Due Diligence on Client
2. Due Diligence on Beneficiary
3. Transaction Monitoring
Ranking by effort
1. Due Diligence on Client
2. Due Diligence on Beneficiary
– Assessment of Transaction Monitoring varies between most and least
costly.
University of Zurich
Swiss Banking Institute
Impact of Regulation on the Costs of Banks
Hans Geiger
Brussels, February 2007
Slide 10
Anti-Money Laundering – Effective?
Statements, Facts and Goals
•
•
•
•
Statements:
– “AML keeps money laundering cases out of our bank, but does not
contribute to a prevention of money laundering on aggregated level.”
– “99.9% of all laundered money is still somewhere in the economy.”
Further facts:
– During the last 20 years, organised crime did not decrease.
– Drug business is still prospering.
Goals
– Original goal: Combat drug business.
– United Nations: “[…] crucial contribution to the fight against
organised crime[…]
– FATF: “counter the use of the financial system by criminals”
AML regulation will continue to be extended
– FATF: “need […] to deepen and broaden AML action”
University of Zurich
Swiss Banking Institute
Impact of Regulation on the Costs of Banks
Hans Geiger
Brussels, February 2007
Slide 11
Anti-Money Laundering – Effective
What is the desired effect?
•
•
•
•
•
Def. “Effectiveness”
– Effectiveness means the capability of producing an effect.
The desired effect is the goal of the venture.
What is the goal of AML measures?
– Is it the fight against the predicate crime?
• Really achieved?
– Is it the fight against the use of the financial system by predicate
offenders?
• This is not the same as the “fight against predicate crime”, as
criminals may choose alternatives.
– Is it just keeping the own bank and financial centre out of the news?
We think, it should be the fight against the predicate crime.
If it is, then any cost-benefit consideration has to take the effect on
predicate crime as measure for effectiveness and benefit.
University of Zurich
Swiss Banking Institute
Impact of Regulation on the Costs of Banks
Hans Geiger
Brussels, February 2007
Slide 12
Anti-Money Laundering – Effect on predicate crime
Circumvent AML provisions
•
The use of the financial system is not the only way for criminals (and
legitimate ventures) to conduct transactions
– Usage of cash or other anonymous means of transfer
– Keeping money in the criminal world
– Bilateral or multilateral netting
– Use of “Non-designated institutions”
– Trade-based money laundering
•
All alternatives are not very well handled by the current AML framework.
– Extend the framework?
– Capitulate?
University of Zurich
Swiss Banking Institute
Impact of Regulation on the Costs of Banks
Hans Geiger
Brussels, February 2007
Slide 13
Anti-Money Laundering -- Costs
Cost components
•
Costs of AML measures
– Direct costs
• Costs for the state (regulator, prosecution, investigation, …)
– Political decision, “self-funding”?
• Costs for the private sector (especially banks)
– Not decisive as long as an “level-playing-field” exist
– Indirect costs: collateral damage!
• Damage for the society
– Loss of civil rights, especially privacy
• Damage for the economy
– Increasing transaction costs for all participants of the
economy (primarily non-criminals)
– Discrimination of market members with low sophistication
– Promotion of monopolistic/oligopolistic structures
University of Zurich
Swiss Banking Institute
Impact of Regulation on the Costs of Banks
Hans Geiger
Brussels, February 2007
Slide 14
Anti-Money Laundering – Collateral Damage
What is privacy?
•
•
•
•
In contrast to prosecution of committed crimes, prevention affects all of us.
– Banks (and other service providers) must collect vast amounts of
information about their business relationships.
– They are obliged to hand them to state authorities or even allow
access without their knowledge.
– Only an extremely tiny part of the data available is related to crime.
Many constitutions and important court decisions hold up the right of
privacy.
– Swiss constitution, “census decision” of the German constitutional
court
Privacy is not only related to usage of available data, but also to data
collection.
In my personal opinion, the privacy of every citizen should be protected, as
long as he/she does not get in conflict with the law.
University of Zurich
Swiss Banking Institute
Impact of Regulation on the Costs of Banks
Hans Geiger
Brussels, February 2007
Slide 15
Anti-Money Laundering – Extension of framework …
… leads to more collateral damage
•
•
•
•
•
The bigger the list of predicate crimes, the list of industries involved in
AML, the harsher and broader the AML regulation, the higher the risk of
business relationships and the more “doubtful clients”.
“Doubtful clients” – if not very rich - will be excluded from the legitimate
club of the economy, no matter whether they are actually criminal or not.
The criminal world will be happy to satisfy the needs of this new group of
clients.
This will
– extent the criminal world;
– finally criminalise the “doubtful client”;
– provide liquidity to the criminal world and strengthen it;
– weaken the legitimate world.
The fence shifts, however, into the wrong direction.
University of Zurich
Swiss Banking Institute
Impact of Regulation on the Costs of Banks
Hans Geiger
Brussels, February 2007
Slide 16
AML – Cost-benefit analysis
Is there a case for CBA?
•
•
•
•
AML seems to be exempt from detailed cost-benefit analysis
– Official goal of AML measures
• Hampering organised crime;
• Reducing drug trafficking / corruption / etc.;
• Preventing acts of terrorism
are seen as so important, that they seem to be pursued at any price.
AML is a perfect example for ineffective and costly regulation.
– Costs and benefits are only loosely observed, as
• they are difficult to measure; and
• the result presumably does not fit into the political agenda.
AML is a perfect example for the process of international regulation
– Very few, forceful players set the regulatory agenda.
– Small players have no chance but to adopt.
– There is no chance to sit back, analyse and to make big strategic changes in
order to get it right.
AML is a perfect example for “political” regulation.
– Political goals override the economic and legal goals.
University of Zurich
Swiss Banking Institute
Impact of Regulation on the Costs of Banks
Hans Geiger
Brussels, February 2007
Slide 17
Swiss Banking Institute
Contact
Hans Geiger / Oliver WГјnsch
Swiss Banking Institute
University of Zurich
Plattenstr. 14
8032 Zurich
Switzerland
{geiger,wuensch}@isb.unizh.ch
www.isb.unizh.ch
AML Study (currently German only):
http://www.isb.unizh.ch/publikationen/amls/pdf/Aml2006-SbiVhv-pdf.pdf
Geiger/Wünsch: The fight against money laundering – An economic
anaylsis of a cost-benefit paradoxon, Journal of Money Laundering
Control, 10, 1, 2007.
http://www.isb.unizh.ch/publikationen/pdf/publ_1349.pdf
University of Zurich
Swiss Banking Institute
Impact of Regulation on the Costs of Banks
Hans Geiger
Brussels, February 2007
Slide 18
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