Money Laundering Poses a Risk to Financial Sector Stability

Cross-border financial crime is here to stay. While people everywhere enjoy
the convenience of a globally connected financial system, criminals exploit
this intricate network to move illicit funds across borders and evade
capture. As these criminals protect their ill-gotten wealth derived from
tax evasion, corruption, and drug trafficking, among others, financial
crimes thrive. No financial institution or country is immune. Money
laundering scandals caused bank collapses and shocked countries.
Ultimately, society pays the cost through an erosion of trust in the
integrity of the financial system, often leading taxpayers to subsidize
failing banks and limiting customer access to credit.

Banks, as gatekeepers to the financial system, battle unceasingly against
money laundering and terrorist financing. But national anti-money
laundering efforts focus primarily on domestic risks, and as a result they
often lag. Bank regulators also play a crucial role, but often don’t make
the best use of limited resources, and divergent approaches hamper
effective global collaboration.

IMF staff partnered with eight Nordic and Baltic countries—Denmark,
Estonia, Finland, Iceland, Latvia, Lithuania, Norway, and Sweden—in a
first-of-its-kind anti-money laundering technical assistance project. Our findings reveal that combatting money
laundering is beyond the capacity of any single nation—and that countries
must innovate together to find a solution.

Tracking criminal proceeds

IMF staff is constantly expanding the toolkit to help Fund members focus
on

cross-border illicit flows. Using machine learning technologies and data analysis, we scrutinize
financial movements, gaining insights into the global landscape and
identifying indicators of potential macro-critical money laundering
scenarios. Our analysis features in the annual health checks of IMF member
economies (e.g., Singapore 2022 Article IV

consultation) and under the

Financial Sector Assessment Program (e.g., UK
2022 FSAP).

Collaborating with the Nordic-Baltic countries, we used these tools to
improve countries’ understanding of unusual financial flows warranting
scrutiny. These tools enhance countries’ ability to screen potential
illicit financial flows and focus on emerging threats. Collaboration also
allows countries to identify and connect seemingly disconnected
cross-border money laundering and terrorism financing threats.

Following the money also involves considering countries chosen by criminals
for cleaning illicit gains. This allows key anti-money laundering agencies
to develop measures to enhance scrutiny of unusual transactions passing
through their financial systems that originate in high-risk jurisdictions.

Knowing the breaking point

While the Fund’s focus on macroeconomics and the link between financial
stability and financial integrity risks is

well established across our work our project with the Nordic-Baltic countries further expands our efforts
to better quantify the financial stability impact of money laundering
shocks.

Examining data related to regional money laundering cases reveals a telling
pattern: banks grappling with financial integrity concerns suffered sharp
stock price drops, elevated perceived credit risks, and declines in
deposits affecting their liquidity. Moreover, the money laundering shocks
triggered equity price declines and heightened the cost of insuring against
a corporate default, as shown by credit default swap prices. And that’s
only what happened at an individual bank level. Looking at the regional
impact, substantial spillover effects affected other key regional banks,
indicating a contagion dynamic between the affected banks and their
counterparts.

Helping the gatekeeper

Taking a broader perspective, our study of the supervisory frameworks
within the Nordic-Baltic region led to recommendations at both country and
regional levels.

As main gatekeepers of the financial system, banks must prevent and detect
money laundering. Criminals find banks alluring due to their extensive
cross-border networks, interbank ties, and products and services that open
themselves up to the risk of money laundering. A parallel borderless trend
is the rise of crypto assets, offering speedy global transfers attractive
to criminals.

That is why it’s imperative that national regulators who supervise banks’
anti-money laundering efforts are able to look at the bigger picture when
overseeing them. With a global supervisory mechanism lacking, supervisors
need to broaden their perspective, scrutinizing non-resident risks and
inter-border laundering countermeasures. This calls for stronger
international collaboration, a point emphasized by IMF staff (e.g., Euro Area Article IV consultation).

Going forward, while good practices are emerging in cross-border
transaction data collection and analysis, the integrated banking system
calls for greater cross-border data collection to better understand and mitigate these
risks. Technological solutions can aid in analyzing this information to
create a regional picture for targeted supervisory efforts, including
multi-country initiatives. Countries should also exchange data on money
laundering incidents, while also delving deeper into the need for banks to
bolster capital reserves against associated losses.

Regulators should also vigilantly monitor newer entrants to international
finance, such as crypto asset service providers, with risk-adjusted
scrutiny. Given the global nature of these providers, cross-border
cooperation remains key here as well.

The bottom line is that continued analysis of financial integrity’s impact
on stability can fortify the global financial system against money
laundering shocks.

Returning to the Nordic-Baltic project, the region’s narrative serves as a
cautionary tale: “Invest in preventive and mitigating measures before the scandal is at your doorstep.”
Presently, the commitment to prevent money laundering in the region is a
priority at the highest levels of the different governments concerned.

—This blog and the Nordic-Baltic project were overseen by Chady
El-Khoury, and reflect contributions from Alexander Malden, Santiago
Texidor Mora, and Indulekha Thomas, with assistance from Grant
Riekenberg.