The importance of indicators in combatting illicit financial flows

The importance of indicators in combatting illicit financial flows

28 October, 2019    

The problem of illicit financial flows is recognised in the SDGs yet little progress has been made in combatting them

Illicit financial flows (IFFs) are typically understood as “dirty money” crossing borders. The term covers a number of different cross-jurisdictional crimes including money laundering (ML), bribery, corruption, resource smuggling, human trafficking, terrorist financing (TF) and trade mispricing. We define IFFs as

“Capital, financial and resource flows that are earned, transferred, intermediated and/or used illegally.”

Apart from representing some of the most deplorable crimes, IFFs also have long-term impacts on the growth prospects and trajectories of countries. They entrench corruption and reduce the public resources available to governments that could have been used for social spending[1].

Given their importance, IFFs are recognised as a key target under SDG 16.4:

“By 2030, significantly reduce illicit financial and arms flows, strengthen the recovery and return of stolen assets and combat all forms of organised crime.”

Despite such recognition, progress in combatting IFFs has been slow.

Why is it so difficult to deal with IFFs?
  • IFFs is a confusing term. IFFs are complicated and there is a lack of understanding of what they actually constitute. Internationally, there are many different definitions for IFFs, and these variations can have significant implications on the way IFFs are understood.
  • No one is really being held accountable. There is limited incentive to deal with IFFs as they are not properly incorporated into the mandates of government bodies and the private sector. Some types of IFFs, such as ML, may be dealt with by separate bodies but there is no holistic view, mandate or accountability framework for IFFs.
  • Working in silos. IFFs cut across multiple mandates, bodies and jurisdictions, thus they require a coordinated approach to track and counter. However, many government departments and private sector firms work in silos and do not have access to the data and information from other units or companies. Cenfri’s work in Africa highlighted that there are significant mandate, regulatory and operational challenges that limit coordination between departments.
  • Capacity constraints. There are also capacity constraints in the public and private sectors that limit the ability to detect, mitigate and prosecute IFF-related offenses.
  • The data challenge. Data is unstructured, held in inaccessible pockets between silos and isn’t linked or compared to global data sets. The data systems countries use are often also nascent and geared to ad-hoc queries as opposed to being AI-driven with the ability to compare structured and unstructured data geared to real-time detection.
What are the solutions?

The establishment and adoption of indicators or indicator frameworks that measure a country’s risk of IFFs can help countries understand how well they are combatting IFFs and what needs to be done to improve the combatting of IFFs.

IFF indicators track a country or institution’s risk of IFFs by assessing the vulnerability and threat of IFFs. Indicators can also be used to track the status quo, highlight weak areas, and incentivise actions that improve the ability of a country or industry to counter IFFs.

Countries do currently track industry and country-wide AML-CFT risk and make efforts to combat ML-TF. However, we argue that the focus of current AML-CFT frameworks is centred on traditional ML, which is typically done at a retail level and not necessarily that significant when compared to other types of IFFs[2]. A Cenfri study on Inclusive Compliance Models indicates that up to 80% of banks’ mitigation resources and efforts are directed at very low risk accounts, responsible for almost no ML, while only 20% is directed at most of the ML risk. In fact, the focus on ML and TF as part of global AML-CFT initiatives has necessitated a move by criminals towards other, less policed modalities, such as trade-based money laundering (TBML). In its 2006[3] paper on TBML, the FATF notes that

“…as the standards applied to other money laundering techniques become increasingly effective, the use of trade-based money laundering can be expected to become increasingly attractive.”

TBML, along with other IFFs like corporate tax evasion, are avenues for wholesale financial crime and require significant resources to combat. Yet in 2019, 13 years after this statement by the FATF, AML-CFT efforts are still more focused on checking whether the bank’s customer brought their proof of address than on complicated financial and trade transfers involving wholesale ML. In order to change this, we need to incorporate IFFs into risk assessments and develop indicators that track and monitor progress so that the public and private sectors are able to turn their attention to where it matters most.

How to go about it?

The first step is for countries to recognise IFFs as a risk to financial integrity. This would ensure that they are spearheaded and incorporated into AML-CFT frameworks. Countries then need to modify their risk definitions in the National Risk Assessment (NRA)[4] in order to be vigilant of the movement within the different streams of ML risk while remaining cognisant of the broader IFFs phenomenon.

There are various different assessment criteria within national risk indicators. These can include IFFs considerations. A few examples are provided below.

Policy, strategy and regulation criteria

Illicit flows need to be present in policy to ensure that awareness of them filters down into various government departments and then into private sector. Indicators should track the extent to which IFFs are incorporated into government strategy and into government departmental mandates. In Cenfri’s country missions into East and West Africa in 2019, we found that government units do not recognise IFFs in policy, nor do they have IFF strategies in place. This means that ML and anti-corruption units did not have mandates and accountability frameworks related to IFFs, and therefore lack power and any incentive to intervene where necessary or hold the private sector accountable.

Investigation and prosecution of IFFs

Criteria that track the level of prosecution in relation to the level of tracked IFFs are important indicators of how effectively IFFs are being prosecuted. If data indicates a high level of IFFs, then countries can be expected to have significant prosecutions for such offenses. IFF data can also be compared to prosecutions for sub-types of IFFs, such as fraud, embezzlement, and forgery, particularly if there are no broader offenses for IFFs other than ML. Cenfri’s in-country visits in 2019 indicate that despite data to the contrary, in some countries there are zero prosecutions for IFFs per year, or zero ever.

Skills and capacity criteria

Part of the reason for the lack of significant prosecutions is because IFFs require specific skills and resources to prosecute and protect against. Indicators may measure the extent to which skills within key institutions are appropriate for the combatting of IFFs. There should be an ongoing gap analysis and capacity development strategy in place to ensure skills are brought in line with requirements. This can also be measured through assessment criteria.

Inter-agency coordination

Making progress in dealing with IFFs requires various bodies to coordinate, collect and share data that helps with understanding and prosecuting IFFs. This refers to coordination between public sector institutions, private sector institutions as well as between public and private sector institutions.

Such collaboration would normally require integral[5], structured data. Alternatively, regtech solutions that can compare non-structured, diverse sources of data are invaluable in correctly identifying, tracing, monitoring and assisting in prosecution. The public and private sector may leverage such data for real-time analysis. This same process can be leveraged for other processes like consumer due diligence (CDD), enhanced due diligence (EDD) and the effective analysis of risk on a near real-time basis. Having advanced technology and information can reduce the need for high levels of due diligence on low risk accounts. This can reduce IFFs but also improve financial inclusion because lower income individuals should not be subject to the same level of CDD requirements.

Cenfri is enhancing indicator tools in conjunction with global partners in order to incorporate more illicit flow activity into current areas of regulator focus. We envisage that this will turn the focus of AML-CFT efforts to where it matters most, so that IFFs can be countered without unnecessarily excluding people from financial services.

[1] Cooper et al (2018)

[2] For example, the monitoring of low-level accounts to try and detect incorporation of drug money into the formal financial system through smurfing.

[3] Financial Action Task Force: Trade based money laundering (2006)

[4] A National Risk Assessment (NRA) is an assessment of the vulnerabilities and threats of ML and terror financing at a country-level. Such assessments are used to understand where ML-TF risk resides in a country and to inform strategies to counter them.

[5] Integral means that the data are comparable as they are structured similarly and with comparable variables.

This work forms part of the Risk, Remittances and Integrity programme, a partnership between FSD Africa and Cenfri.

Similar Articles
Strengthening financial integrity through inclusion
How proof of address fell I...
The FATF standards and the unintended consequences
The Financial Action Task Force (...
An inclusive digital identity platform in the Pacific Islands
Digital identity is increasingly becoming the key enabler of digital inclusion across the globe. We conducted...
Africa: New toolkit may unlock access to financial services
Hundreds of millions of people globally remain excluded fro...