Perverse Impacts of Anti-Money-Laundering and Financial Crimes

In September 2020, Buzzfeed News and a coalition of other investigators dropped a bombshell on the world of international finance and law enforcement. A leaked set of documents from the U.S. Treasury’s Financial Crimes Enforcement Network, or FinCEN, showed a disturbing pattern of lax enforcement. When banks reported suspected money laundering to the very agency tasked with monitoring ill-gotten criminal funds, quite often, the authorities did nothing about it at all.

This was at least a threefold failure. First and most obviously, transactions flagged by banks in Suspicious Activity Reports (SARs) to FinCEN weren’t actually being stopped. Second, filing the reports shielded the banks themselves from legal liability, allowing them to continue facilitating criminal transactions (and collecting fees on them).

This op-ed is part of CoinDesk’s Sin Week.

This buck-passing two-step led to absurdities like HSBC (HSBC) moving money for the already-sanctioned WCM777 Ponzi scheme, and Standard Chartered (SCBFF) and Deutsche Bank (DB) indirectly facilitating transactions for the Taliban, all while reporting the transactions as clearly suspicious. As Buzzfeed concluded at the time, it seemed that “laws that were meant to stop financial crime have instead allowed it to flourish.”

Less attention was given to the third failing of FinCEN’s SAR system: It compromised the privacy and security of banking customers who had done nothing wrong. Former FBI special agent Michael German at the time described FinCEN’s trove of SARs to Buzzfeed as similar to the huge “data hoards” created by other forms of mass surveillance. They create a rich target for exactly the sort of exfiltration that wound up happening.

Much of the data that became the FinCEN files was initially requested by Congress as part of its investigation of potential Russian interference in the 2016 presidential election. It included troves of data about entirely innocent customers, which Buzzfeed and other news organizations carefully redacted. But had the same data fallen into less responsible hands the fallout might have been catastrophic.

The FinCEN files, taken as a whole, revealed the SAR system to be substantially a kind of theatrical performance – one with a steep production budget.

“A pretty sound estimate is that the financial surveillance regime we’ve got costs tens of billions of dollars annually globally. And it might be in the high tens of billions,” says Jim Harper, a privacy advocate and senior fellow at the American Enterprise Institute, a libertarian-leaning think tank.

With that budget, banks were pretending to monitor suspicious financial transactions, and enforcement agencies were pretending to control them. This bit of Kabuki invaded the privacy of innocent customers and threatened the banking relationships of legitimate businesses, while drug lords and oligarchs continued doing business.

The entire system may be less a tool for crime prevention than a means of bureaucratic ass covering, with a rich dollop of authoritarian surveillance on top.




The big risks of ‘de-risking’

In theory, anti-money laundering (AML) measures are meant to identify and stop the global movement of funds either earned through criminal activity or intended to fund bad actors. The big-picture goal is to increase human happiness by strangling the bad guys’ finances. Those efforts extend into the realm of cryptocurrency – anti-money laundering measures are why you probably had to provide personal identification, or “know your customer” information, when you signed up to use the Coinbase (COIN) or Binance crypto exchanges.

That requirement illustrates one of the big trade-offs of the current surveillance-heavy AML model. Like FinCEN’s trove of SARs but on an even larger scale, KYC data imposes security risks on law-abiding citizens. In early 2021, for example, a trove of KYC data was hacked from Indian payment app MobiKwik.

But there are deeper, more systemic costs to the current status quo in anti-money laundering efforts. And they fall most heavily on some of the most marginalized and powerless people on Earth.

The entire system may be less a tool for crime prevention, than a means of bureaucratic ass covering.

“It drives up the price of banking across the board,” Jim Harper says. “So the person who feels they can no longer afford a banking account, that’s because of the surveillance that makes it much more expensive.” While AML requirements may not be the only factor, there’s no denying the rising costs and declining services of conventional banking in recent years, which Lisa Servon documented in her excellent 2017 book “The Unbanking of America.”

Another major concern has been the threat of tighter regulation to global trade and developing countries. Stricter sanction regimes and higher fines for violations after the Sept. 11, 2001, attacks and the 2008 financial crisis appear to have contributed to American banks severing international relationships, a process broadly referred to as “de-risking.” The main culprit here is the set of national blacklists maintained by the global Financial Action Task Force (FATF). Those lists have grown more rapidly in recent years, with noticeable impacts.

“You saw a massive contraction in [international] correspondent banking relationships,” says Matt Collins, a global development specialist who works with the Brookings Institution and the World Bank. For banks in the developing world, losing banking connections to major economies can seriously hamper a local economy’s ability to, for instance, keep stable import/export relationships.

“These [rules] are in general likely to be regressive,” says Collins. In other words, they fall heavily on countries, banks and other entities with fewer resources and less influence over the system itself. “Even if everyone involved is clean, the due diligence is a struggle.”

More to the point, much like the flood of SARs to FinCEN, the de-risking process is more about meeting particular processes and controls than it is about targeting the actual problem of illicit finance.

“Regulators think we need to make sure every country has a similar set of standards,” says Collins. “As an economist, I think you want to go after countries that are hosting a lot of illicit finance. And if you look at where the money ends up, it’s countries that actually have good standards.” Specifically, Collins is referring to the United States – now the top global destination for laundered funds.

“But those countries don’t end up on the [FATF] blacklist,” Collins laments. “ Small African countries end up on the list.”

Does AML actually work?

These risks and barriers could be considered trade-offs for a financial system that restricts criminal activity. But the shocking truth is that we have almost no insight into what exactly we’re getting in return.

“The idea that cracking down on money laundering and tax evasion should eliminate the incentive to commit the predicate crime is a fundamental pillar to this system,” says Matt Collins. “And it’s the most untested part of the theory of change behind the whole apparatus.”

In other words, we have very little solid evidence that harsher anti-money laundering rules reduce the volume of drug trafficking or other major crime. Collins says he is unaware of a single economic study clearly showing a reduction of crime following new AML rules (though he admits such a study might be difficult to design).

One specific example of unclear results is FinCEN’s Geographic Targeting Order for residential real estate. This rule requires sellers to identify the individual person behind all-cash real estate purchases, which are often leveraged for money laundering, tax evasion or capital flight.

“You expect to see a decline in those transactions after that increase of transparency,” says Collins. “And we’ve found no evidence that that changed.”

There is a silver lining, of a sort. While there may or may not be an impact on old-fashioned crime, Collins says recent pushes for more transparency for former tax havens has reduced the amount of tax evasion around the world. “There’s a pretty large decline in deposits in tax havens, so people are responding to it.”

Money laundering to the highest bidder?

Don’t spend too many tears for the wealthy, though. While tax evasion may be getting tougher, money still talks when it comes to AML oversight.

The influence of the wealthy and powerful over the system is sometimes subtle and indirect. For instance, Collins believes the weak results of some current AML efforts are not so much problems with the policies themselves as with their lax and underfunded implementation, both by governments and banks.

Various sorts of information provided to enforcement agencies by banks or real estate titling companies is frequently simply fraudulent and, according to Collins, “FinCEN [and other agencies] just don’t have the ability to verify that that information [in reports] is fully correct.” These deceptions aren’t even subtle: “Lots of companies [in reports] are owned by Jesus Christ and other stuff that seems to have been put in as a joke,” Collins says.

The underfunding of financial oversight bodies is chronic in the U.S., and that tends to benefit those with big money. Before the Biden administration’s recent injection of funding, the Internal Revenue Service had been warning for years that it was severely underfunded. Among other effects, this underfunding led to a decline in audits for the very wealthy, who often use complex maneuvers to reduce their tax burden. Similarly, a new real estate ownership registry that would expand FinCEN’s existing order has missed its deployment deadline because Congress did not fully fund the project.

A truly suspicious mind might wonder who benefits from choking off funding for financial crimes enforcement. U.S. legislators, after all, remain heavily dependent on financial support from large corporations and wealthy individuals. Some government officials, including former Trump administration Commerce Secretary Wilbur Ross, have been directly damaged by leaks of financial information.

Money has its privileges in other ways, too. Collins says recent research has shown that AML measures may have had less impact on correspondent banking relationships than the declining profitability of specific relationships – but again, the cost of AML compliance is itself contributing to rising costs.

Money plays an even bigger role in how much scrutiny banks subject individual customers do. “It’s easier to look the other way when it’s a Russian oligarch who’s going to bring you millions of dollars,” says Collins. “It’s harder to look the other way when it’s a small business who won’t bring that much.”

Can we fix it?

In some sense, this isn’t news. Financial privacy of any sort has long been much more accessible to the wealthy than to average people. But it’s particularly bitter that AML measures have made profitability and wealth a greater factor in who has access to global banking – including when there really is suspicious activity.

But fixing any of this presents a pernicious political double-bind. As noted, legislators’ wealthy financial backers might not particularly want the AML system to be entirely effective. But banks and legislators alike are highly motivated to create the appearance of strong enforcement, which winds up falling disproportionately on smaller fish.

At the same time, according to AEI’s Harper, any reforms that might decrease financial surveillance and control are nearly verboten among politicians. He points particularly to the current $10,000 threshold for reporting cash transactions to the IRS. In its current form, the requirement is incredibly broad, explicitly including any landlord who receives more than $10,000 in cash payments from a tenant in the course of a year, or a car dealer who sells a car for more than $10,000 in cash.

But the requirement has become so burdensome and absurd only after decades of legislative inaction. “It was set at $10,000 in 1972,” Harper notes. “The equivalent now is something like $70,000 or $80,000 dollars [due to inflation]. Maybe people moving that much cash a long time ago was inherently suspicious … I don’t agree, but I can at least see the argument.”

“But $10,000? Unfortunately, I have to give that to contractors all the time.”

Correcting this drift, Harper says, has been a political nonstarter because it threatens the entire premise of heightened financial surveillance. “If you open that discussion, you have to open the rest of the discussion.” And banks, despite shouldering added costs, have no leverage to push for cutting red tape because it would make them seem even softer on money launderers than they already (apparently) are.

There are efforts to study the real impact of AML measures, under the banner of “effective AML.” Technological innovation may also play a role in breaking the deadlock: A startup called Consilient is developing machine learning-based AML tools for banks similar to what credit card companies deploy to catch fraud. Crucially, their “federated” data model would reduce the sharing of customer information outside of banks, potentially making it both more private and more effective than the manual, outdated SAR system.

And, of course, there’s a final technological option: an exit from the traditional financial system through cryptocurrency or similar systems. As FinCEN’s recent move against mixer Tornado Cash showed, that opportunity is narrowing, and the practical necessity for real decentralization is growing.

It’s genuinely unclear whether crypto can get there before anti-money laundering efforts with unclear benefits devolve into a quest for complete repressive control. Harper fears that such a locked-down system would inflict serious social harms.

“Complete financial surveillance would create a truly controlled society that would be highly law abiding,” Harper says.

“But it would not be a virtuous society.”


August 31, 2022 Published by The CoinDesk News.

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