Trade-based money laundering (TBML) activity is widely recognised as one of the most common manifestations of international money laundering, which has emerged as an issue of growing interest amongst the policymakers in both developed and developing countries.
It involves exploitation of the international trade system for the purpose of transferring value and obscuring the origins of illicit wealth, which may vary in complexity but typically involve misrepresentation of price, quantity or quality of imports or exports.
Banks may willingly or unwillingly be implicated in TBML (trade-based money laundering) schemes when such institutions are used to settle, facilitate, or finance international trade transactions.
TBML is a critical area of malpractice that can be done through misrepresentation of price, quantity or quality of imports or exports, and the techniques involved include over- and under-invoicing of goods and services; multiple invoicing of goods and services; over- and under-shipments of goods and services; and falsely described goods and services.
In many cases, this can involve abuse of the financial system through fraudulent transactions involving a range of money transmission instruments, such as wire transfers.
Growing risks and challenges in global trade services are relevant for risks of TBML as well. Key challenges are trade finance gap, information gap, document rejection, court injunction, disruption in correspondent banking relationship, sanction, financial crimes especially trade-based money laundering etc.
The challenges and concerns are impacting trade services offered by banks. In nearly 30 per cent instances, the requests of trade finance were rejected as a result of money laundering or terrorist financing-related concerns, according to the most recent survey by the International Chamber of Commerce (ICC).
Almost 80 per cent of respondents agree (or strongly agree) that money laundering-related requirement is a barrier to servicing trade-financing needs.
Regulatory and policy concerns on TBML have brought notable changes in terms of greater know-your customer (KYC) requirements; increased efforts on price verification of tradable; struggling correspondent banking relationship; and increased compliance and reporting requirement and costs.
With the increased regulatory requirements on banking services, the less regulated portion of banking i.e. the shadow banking, has come under scanner of the policymakers and the regulatory authorities, in both developed and developing countries.
Increased KYC due diligence requirements have resulted in significant impediments to trade financing activities. And as a result of the regulatory burden and uncertainty, the banks often avoid entering into some transactions altogether.
The KYC tactics, required to properly vet against TBML, practically need more extensive analysis, including more precisely knowing the business of clients. Broadly speaking, it is also about third party policies, screening and processes of also 'know customer's customer\ (KYCC) to mitigate risks.
In regards to pricing of the tradable, it is suggested that information about the product range and pricing should be collected from a bank's business clients during the due diligence process. One can also research online to check the accuracy of the data. Upon completion of the research, one can check transactions against that data to ensure that they are in line with the expectations.
Banks in general are not in a position to make meaningful determination of legitimate unit pricing due to lack of relevant business information, such as terms of a business relationship, volume discounting or specific quality of the goods involved.
Furthermore, many products are not traded in public markets and there are no publicly available market prices. Even where goods are publicly traded, the existing prices may not reflect the agreed price used in any contract of sales or purchases and these details are usually not available to the banks involved due to competitive sensitivity of such information.
Correspondent banking is mainly being threatened by an overenthusiastic interpretation and enforcement of rules aimed at preventing money laundering and terrorist financing. The number of linkages between banks has been declining in recent years, largely because the industry has been trying to avoid risk-prone services, especially when business opportunities are low.
The impact of the de-risking has now been rebounded to some extent, as development institutions such as the Word Bank and IMF. are now working in tandem to redefine correspondent banking business with an expectation to bridge the gap between uncertainty in regulator expectation and compliance programme of global correspondent banks.
As a whole, the changes have brought in greater compliance and reporting requirements for banks. Increasing compliance requirement and reporting in trade services has been pulling the overall costs of offering trade services in all global economies.
The ICC survey observed that capital adequacy requirements have made trade finance business more expensive and have translated directly into balance sheet constraints on the business. Regulatory requirements designed to mitigate the risk of financial crimes and money laundering have brought unintended consequences particularly in emerging markets.
One critical concern is that detection of TBML is a relatively difficult task since volumes of trade flows are massive and because TBML can take complicated forms. Monitoring trade transaction is the key to handling TBML, and probably the KYC is the most critical component of any anti-money laundering programme, especially the one looking to control TBML.
A comprehensive KYC arrangement offers foundational understanding of activity and partnerships the customer should be reasonably expected to engage in; and for TBML especially, expanding beyond just KYC to understand trading partners, vessels, products being shipped is necessary to effectively identify TBML.
The responsibilities of banks in setting up right control mechanisms and monitoring arrangements are particularly crucial where reliance on documentary trade is very high.
Greater capacity building and more effective cooperation on information sharing are especially necessary for the prevention of TBML.
Financial Action Task Force (FATF) has published two separate guidance papers to address concerns related to TBML. Several other international organisations are working to support emerging economies to address TBML.
As a global trade platform working to link emerging market banks with international banks, the International Finance Corporation (IFC) recently prepared a guideline for the emerging market banks that are involved with trade finance. Certain red flags are identified and used as dangers or warning signs for the banks and other stakeholders as part of the process of identifying TBML.
Certain other relevant documents include consolidated sets of red flag from three key documents titled Trade-based Money Laundering by FATF published in 2006; Best Practices on Trade-Based Money Laundering by FATF published in 2008; and APG (Asia Pacific Group on Money Laundering) Typology Report on Trade-Based Money Laundering published in 2012.
These documents might be particularly helpful to the policymakers, regulatory agencies and banks that are attempting to address TBML.
Dr Shah Md Ahsan Habib is Professor and Director (Training) at BIBM.
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