FATF Plenary Meeting, Valencia, 2017
FATF plenary meeting in Valencia, Spain, on February 24, 2017. Photo credit: OECD Organisation for Economic Co-operation and Development / Flickr (CC BY-NC 2.0)

How does the sprawling global banking system keep ”bad money” out? Amid the trillions of dollars flowing across borders that lubricate a global system of trade and investment, there is a little-known organization, based in Paris, which sets the rules that banks, nations, and customers like us have to live by.

This organization, an international standard-setting body known as the Financial Action Task Force (FATF),  is tasked with reining in global money laundering and stopping money being syphoned off for terrorism. In doing so it creates what is called the Bankers’ Blacklist. Our guest on this week’s WhoWhatWhy podcast, Julia Morse, worked in counterrorism at the FBI, is currently a political science professor at the University of California, Santa Barbara, and just published The Bankers’ Blacklist: Unofficial Market Enforcement and the Global Fight Against Illicit Financing. 

She argues that the FATF is the most important international body that people have never heard of. She explains how it sets the international banking standard that banks and nations must adhere to. If they don’t, she explains, they are not only shamed, but cut out of the global economy.

Morse reveals how the organization has encouraged banks and nations to actually care about the dangers of dark money, even more than caring about the few extra dollars of profit they would retain by turning a blind eye.

Because the US banking system is so central and so globalized, she says, the US wields undue influence over how other nations and their banks operate. Yet, surprisingly, there is tight cooperation among the banks and the 39 countries that make up the FATF system.

Morse talks about the role of the FATF in international sanctions and in creating an ongoing blacklist of bad actors. She explains how criminals try to game the system, and how one of the FATF’s most important missions is to combat terrorist financing.

Even though some small nations have complained about all the operational rules and regulations that they say they can’t afford, Morse notes that, at the end of the day, everyone has to go along: It’s the price of participation in today’s international monetary system.

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Full Text Transcript:

(As a service to our readers, we provide transcripts with our podcasts. We try to ensure that these transcripts do not include errors. However, due to a constraint of resources, we are not always able to proofread them as closely as we would like and hope that you will excuse any errors that slipped through.)

Jeff Schechtman: Welcome to the WhoWhatWhy podcast. I’m your host, Jeff Schechtman. Back in the mid-1970s, as the Bretton Woods system of finance came to an end, we began to see the early signs of the modern era of the globalization of money. Bankers like Walter Wriston at Citibank in the mid-’70s talked of the free flow of capital around the world. Barriers to financial exchange and trade began to melt away. And of course, like any such change, it laid the groundwork for bad actors. The predicate for dark money and money laundering was set, and sometimes, those bad actors included both individuals and nations.

Over time, the number of bad guys shoveling cash around the world would grow. And no surprise, global terrorists would also become part of the action. Enter the Financial Action Task Force, a quasi-governmental organization designed to keep bad money out of the financial system, protect depositors, and in so doing, reinforce fundamental protections in our domestic and global banking systems. Up until now, this has been a little-known organization.

Now, it’s the subject of a new book by my guest Julia Morse. Julia Morse is an assistant professor of political science at the University of California, Santa Barbara. She has long worked in the world of counterterrorism, including for the FBI, and now she’s the author of The BankersBlacklist: Unofficial Market Enforcement and the Global Fight against Illicit Financing. Julia Morse, thanks so much for joining us here on the WhoWhatWhy podcast.

Julia Morse: Thank you for having me. I’m excited to be here.

Jeff: It’s great to have you here. How did you first hear about the Financial Action Task Force?

Julia: So that’s actually a really interesting story. So after I got my master’s degree, I was working at the State Department, and I was on a rotation up at the US mission to the United Nations on the sanctions team. And so I was really excited to be there negotiating security council resolutions, working on counterterrorism and sanctions targeting terrorists. And I kept hearing about this organization that I had never heard about before, which was the Financial Action Task Force or FATF, as the US government likes to call it.

And I was really surprised because I, as someone who was interested in international organizations, thought the center of global counterterrorism and countering terrorist financing would’ve been the Security Council. And actually, everyone said, “No. If you want to know where the action really happens, the body that’s really making a difference is this body, FATF.” And so, when I went back to get my PhD, I decided, “Well, let’s see. Is this institution really mattering? How is it shaping global banking?” I was surprised really with what I found.

Jeff: And talk a little bit about what you found, which was not just about looking for bad actors, but it really at the same time was reshaping the whole business of global banking.

Julia: I like to think of FATF as this organization that has transformed the way everyday people do banking, do business, and yet people have never heard of it. So it’s probably one of the most important international bodies that people have never heard of. Because the Financial Action Task Force, beginning in early 1990, set these standards related to how banks should try and keep dark money, money laundering, criminal money out of the financial system. There’s a lot of regulation today that exists around banking that has just evolved as a result of this effort.

And after 9/11, this really picked up, and banks today, they have all of these complex procedures where they have to do things like verify who customers are, assess customer risk profiles, subject them to basically greater scrutiny. These are called, in the AML anti-money laundering space, Know Your Customer requirements.

And these are pretty cumbersome requirements for banks, actually, if you think about the number of transactions that are going globally. But as a result, they’re a way of adding an additional layer of security to make sure that criminals and terrorists aren’t sending the same amount of money through the financial system.

Jeff: Talk about the reasons why the financial system was so concerned about these bad actors engaged in money laundering and sending this money through the financial system because, on the surface, it might seem to some as if “Well, if the banks weren’t getting hurt in the process, why should they care?”

Julia: So I do think that’s an argument, and I think that probably is true. Banks are profit-driven actors, and so that’s what they’re concerned about. I think a couple of things shifted in the early 2000s. The first is that there are pretty significant reputational consequences for being the bank that allows a major terrorist attack to go forward. If your bank is being used for the next 9/11, you can imagine how that might really hurt your share price. It might make people less likely to want to use the bank.

And then we also actually saw in that period a number of public scandals related to banks that had not conducted adequate due diligence and were allowing people like Pinochet, the former dictator of Chile, to use their banking system and suffered major reputational loss. In the case of Riggs Bank, which was a very well-known, prestigious bank in the D.C. area, it actually led to the complete collapse. So there are some reputational concerns at play for banks, which is part of why they care about this issue.

But the other thing that began to happen in the 2000s and especially after the financial crisis was that US regulators started to evaluate these bank compliance systems. And when banks were not actually implementing these rules, were not conducting effective due diligence on these transactions, they started getting really massive fines. So we see this with HSBC, which in 2012 was fined more than $1 billion dollars, we see. And then that trend has just continued till today.

If you google it, there’s billions of dollars that have been enacted in terms of bank fines, and now it’s not just in the United States; it’s in a lot of other countries too. So banks all over the world now have these incentives to try and really keep track of who is using their banking system and to make sure they can show to regulators that they’re actually doing what they’re supposed to do.

Jeff: Talk about the globalization of the US banking system and how that was such a critical part of this: The fact that US banks became not just domestic banks really, but they became either individually or part of global banking institutions.

Julia: So it’s very interesting because part of what makes the banking system such a powerful tool in driving countries to change their policy is that it’s incredibly interconnected, and many different kinds of financial flows go through the banking system. So trade flows, remittances, everyday transfers, investments, a lot of different kinds of money are moving through the banking system.

And the United States, as the most centrally located largest banking system, and the fact that a lot of transactions are done in dollars, it gives the US banking system a lot of clout, and so when the US banking system starts to care about something, it means that banks in other countries have to care too. So if the US says, “We don’t want to do business with other banks that are not actually screening customers because we think they’re going to open us up to the possibility of criminals or terrorists,” then what happens is those banks say, “OK. Well, we need to create systems, so we can show US banks that we’re trustworthy.”

Jeff: One of the remarkable aspects that you point out in the book in The Bankers’ Blacklist is how much cooperation there has been in the global banking system.

Julia: So it’s very interesting because I think my research as a general political scientist, I study international organizations and how countries work together to solve problems, and one of the things that makes the Financial Action Task Force so interesting to study is that it’s really this example of really effective cooperation where it’s a small group of countries — there’s 39 members — but they were able to come together and formulate standards and then evaluate compliance with those standards and incentivize other countries that weren’t following the standards to follow them in a way that has drastically transformed banking.

And banks, basically, part of the reason they’ve been able to do that when we look about all the other co-operation issues and climate change, and there’s many other types like trade, there’s many other areas where we don’t get quite as effective cooperation. And I think part of the reason it’s worked in this area is because banks have really stepped in to reinforce the standards so that banks basically, through their own incentives, not because they have been tasked with this job, but through their own incentive structures, punish countries that don’t actually follow the rules. Those countries are more risky. And so it creates a really strong incentive for those governments to try and change their policy.

Jeff: In many ways, as you alluded to before, shame becomes a big issue with this.

Julia: Yes, it’s naming and shaming with peace, I would say. What happened then, since 2010, the Financial Action Task Force has published this public list of countries that are struggling to comply with the standards. It’s actually a pretty nice-sounding announcement: “These are countries that have problems, but they’re working together.” Then there’s a separate announcement, a separate list, where countries are a little bit more finger-pointed: “OK. They need to be doing more.”

And then there’s a final, a third countermeasures list that’s just targeted to North Korea and Iran. And what’s happened is when countries end up on this list, they really work to get off of it because, even though the list is not officially coercive, even though the list is saying, “Oh, they’re making progress,” banks use this list and they say, “Oh.” They put it in their risk models and their compliance models, and they say, “This country is now riskier. We need to update how we do transactions with them.”

And a country might find it’s more expensive for them to send money abroad, or it’s taking a little longer for them to do business. Or when I was doing interviews on this, Thailand was one of the countries that was listed, and the banks in Thailand found they were having trouble opening new branches in the European Union because the European Union saw them as higher risk.

So there’s all these different ways in which the banking system starts to penalize these countries that have been on this list. And so what happens is the governments of those countries say, “OK, we don’t want these penalties. We need to change our policies so that we meet these standards so that we’re not on this list.”

Jeff: How much has this organization been involved in sanctions when they’re brought against countries?

Julia: So it actually doesn’t really sanction. The only exception to that, well, I would say there’s two exceptions. One, in the early 2000s, there was an earlier listing process where they were trying to get countries to follow the standards. And countries that were not changing standards fast enough that were on this — an early version of a blacklist — were subject to calls for countermeasures. They’re not officially sanctions, but they’re calls for banks and financial systems to take countermeasures.

And in the case of the US, the US did take that call and then sanctioned some of these countries or actors in those countries. And then, what now there is a countermeasures list that they’ve had for two decades now. Right now, I believe the only country on it is North Korea. And so that reinforces what the North Korea sanctions that are at the Security Council or individual sanctions that you might have going on in the United States or in some of these other countries.

So it’s a parallel process, but it works a little bit differently than sanctions. And I think, probably because it targets the banking system as a whole because it’s not official sanctions, it’s actually able to be used against a much broader set of countries. But if you think about it from a political standpoint, it’s pretty costly for the United States or European countries or Western countries to sanction countries that are their allies. That’s not something that they’re generally going to do.

But to put them on this list, which is technically not coercive, which is banks stepping in, is much more politically palatable. And so we have seen countries like the Philippines or Turkey end up on this list, even though they are important allies, because it has a lower political cost, whereas the US would, of course, never sanction those countries.

Jeff: Who runs this organization? Where is it based? What does the operations of it look like?

Julia: That’s another thing that’s fascinating about it. So it’s based in Paris. It is housed within the OECD, but it is really a maybe 15–to–20 person secretariat. And most of those people are not independently employed by FATF. They’re actually seconded from the Mexican ministry, the American ministry, German ministry. They’re actually bureaucrats from those countries who come to work in FATF for a couple of years on rotation.

And then the meetings are attended by Treasury finance officials and then maybe some State Department officials. So it’s really a bureaucratic organization. And I think that’s one of the things that has made it more effective is that it’s viewed as a little bit more removed from politics versus the Security Council gets a ton of news coverage. So when the Security Council takes action, if they pass a resolution, those kinds of policies are going to be coordinated at a pretty high level for most governments, particularly on important issues.

For FATF, these are fairly technical issues related to money laundering and terrorist financing related to banking. And so the people who are working on it are less engaged in international transnational politics and more engaged in “OK, how do we make these policies work? How do we get the banking system to do what we want it to do?” And that’s part of what I think gives it some of the authority in this issue area.

Jeff: How effective has its enforcement mechanism been beyond these issues of shame that we talked about before?

Julia: So I will answer that in two ways. So in terms of getting countries to change their policies and actually getting countries to adopt FATF standards, FATF has been extremely effective, probably one of the most effective international organizations there is. We’ve seen rapid, dramatic policy change. Remember, even US laws against money laundering didn’t develop till the 1980s; FATF didn’t start till 1989, 1990. And then criminalizing terrorist financing, that was really late 1990s, where it even started to be talked about. And then after 9/11, it picked up steam.

So, if you track this, this is only maybe 30 years, which is a short time in the policy space, and yet we’ve seen almost every country today has laws criminalizing money laundering, criminalizing terrorist financing. They’ve created financial intelligence units to comply with these rules. They have regulated their banking systems. We’ve just seen really dramatic policy change in this area.

That being said, the caveat I will give is that I have studied this issue from the perspective of someone who’s interested in co-operation. How do you get countries to change their laws? How do you get them to change their policy? It is harder to answer what the effect of these laws has been on criminal flows and terrorist flows because we don’t have really good data on those things. It’s an ongoing challenge for researchers. And, of course, criminals are always thinking of new ways. They’re always trying to evolve their techniques.

And as we’ve had new technologies, things like cryptocurrencies come into the sphere, it becomes more challenging because there’s always one step ahead. So there’s two separate parts to that.

Jeff: How is the SWIFT system involved in this?

Julia: So SWIFT is the secure messaging system that allows banks to trade, to exchange messages. And it is important because it’s centrally located. And we saw its importance in what happened with Russia, actually. Recently, in the spring, people might recall that SWIFT took the unprecedented step of saying they were going to cut off access of certain Russian banks to the SWIFT messaging system, which basically meant it would be extremely difficult for those actors to participate in the global financial system.

So the fact that finance is connected through this entity, it really allows banks to play this role of being a little bit more coercive. And there has been an argument by Henry Farrell and Abe Newman for the spin-out from nearly four years now about weaponized interdependence. So the fact that countries are so interdependent through things like SWIFT gives potential leverage, basically, to countries that can control or influence these actors.

SWIFT is ostensibly an independent actor, but the US and European countries were able in the spring to convince SWIFT to try and essentially step in to punish Russia. And so that kind of ability of the banking system to use its interconnectedness to cut off access to people and to punish certain countries for their actions, I think, is part of what makes global finance so powerful: such a powerful policy tool.

Jeff: You mentioned crypto before, and in many ways that has always been seen as a way around this system. Talk a little bit about that and how organizations like the Financial Action Task Force are dealing with crypto today.

Julia: Yes, so that’s a great question. I think crypto is this area that FATF has started to go into. They recognize that it’s a problem. It is, on the one hand, the blockchain technology of tracking, if it was used in the right way, potentially, could allow you to know exactly where money came from and where it was going. On the other hand, because of the way blockchain is used, it’s often completely anonymous. And so it’s very hard to know when we’re talking about crypto who’s getting the money and how it’s transferring. And that offers a potential pathway for criminals or terrorists to circumvent the financial system.

I will say on this that I saw a presentation maybe six months ago where someone was talking about this issue and at least as of a couple of years ago, there wasn’t a lot of evidence yet of criminals trying to use cryptocurrencies. There probably are the more advanced tech-savvy criminals that larger networks may be, but a lot of criminal networks and organizations and the same with terrorists, are not necessarily so tech-savvy that they’re moving through these forms of currency. But of course, as they become more popular, there’s the risk that there does seem to be transference, and we get a little bit more movement on that side.

And so I think FATF has been doing some reviews and thinking about what would it look like for governments to try and regulate this sector, or what would it look like to have standards. And they have been trying to push more transparency in terms of cryptocurrencies and crypto exchanges, trying to figure out who is getting the money, and where is it going. But this issue, because countries deal with it differently, and it’s still emerging, there’s really been a lot less action on that space. And so it is a space that’s a little bit more vulnerable than, or at least more developing, I would say, than some of the other areas where they’re more used to regulating the banking sector, and there’s existing treasuries or finance industries that have a lot of expertise in that area.

Jeff: Where, if anywhere, has there been pushback to this? We’ve talked about the great cooperation between financial institutions, cross border co-operation between countries. Has there been any pushback to this over the years, and if so, from where?

Julia: So yes, there definitely has been pushback. And I think, part of the co-operation challenge, it would not be such a success story, if all countries were happy to change their laws on this. And so some of the pushback has come from smaller countries, say small island countries in the Pacific or smaller economies where you can imagine that these countries are poor countries where they just have limited resources, and the FATF rules are fairly cumbersome. They require them to set up bureaucracies and these new financial intelligence units and to regulate their banking sector and to take all these steps. And for a country that has pretty limited resources and maybe no problems with terrorist financing or money laundering, those countries often don’t understand: “Well, why do we need to do this?”

And of course, the argument is, well, if there’s a hole in the bucket, the water can go through. So anywhere that you have a gap in laws, eventually criminals or terrorists will learn that. But it is a understandable argument from these country’s perspectives that they say, “This is costing us and we have limited resources spending it on this particular issue.” I think there’s also pushback that’s unique to different countries. So terrorist laws are controversial in some countries.

For example, Brazil was one of the last countries to criminalize terrorist financing and to pass laws on terrorism. And that was because the term “terrorism” had a historical legacy in Brazil where it was used as a political tool to suppress political dissent. And we see that actually in a number of countries. And so passing a law on it was much more controversial because that’s what people thought about when they were thinking about these laws.

And then, of course, there’s also pushback from countries from some of the what were traditionally called tax haven countries where they say, “OK, we’re changing all of our laws and we’re doing all of these things to make it more difficult. But if you look at aggregate financial flows, the US has the biggest amount of financial flows. And so probably the biggest amount of money laundering, in particular, is moving through the US financial system because just as a percentage, the US financial system is so large, and that’s where it should be.”

And so sometimes it’s difficult because the US Treasury might be pushing certain standards about making sure we know who owns a trust or who is the beneficial owner of a company. But those particular laws, the people in charge of passing those laws in the United States are Congress and individual states, and they may not be on board with that particular issue. And so you can end up with a dichotomy where countries say, “Well, this is unfair. We’re changing our laws, but when we look at the United States, they don’t have a full law on the books.” And so there are some complicated factors that do make it a tricky political issue.

Jeff: And where are the weaknesses in the system as you’ve seen it? What are the things that keep all those bureaucrats in Paris up at night worrying about what might happen?

Julia: There’s a couple of things. I think there’s weaknesses that they worry about related to these things like trust, for example, that the laws on trust or laws on companies related to beneficial owners maybe aren’t doing what they are, and people can set up these anonymous trusts and therefore move money and bypass the system. So there’s gaps there.

There’s been some gaps on real estate. I will say that there is a need for more transparency to really prevent the ability of criminals to just buy real estate and anonymous names and launder money in that way. I think the other thing that does keep some people up are some of the consequences of this effort. So one of the things that has happened as a result of the anti-money laundering, countering terrorist-financing regimes is that we’ve seen the banking system really shift, and banks now have become a little bit more risk averse and have closed.

There’s been closes in the correspondent banking network, which are basically links between different banks in different countries. And so banks in some countries, in these countries that are maybe less profitable, less important financially, have found it increasingly harder to access the formal financial system. People who want to send remittances abroad have maybe found it more costly for places like Somalia where yes, there is a terrorist risk, but there’s also a lot of people there who rely on remittances from family. It costs a lot more money to send remittances now to Somalia than it used to because of these additional screens and banking lines drying up.

And I think there is a worry about that you don’t want to cut people off from the banking system completely both from an equity standpoint of “We want people to have opportunities for economic growth and development” but also from a standpoint of “If you cut people off, then they will go outside the financial system.” And so they will find these other informal ways of spending money which aren’t regulated. And so I think there’s this balancing act that countries have to play, have to figure out how to handle.

Jeff: And finally, Julia, how did they feel about being written about? This is an organization that generally flies below the radar.

Julia: So they’ve been pretty receptive to it, I will say. I’ve talked to some policy-makers and I know that the countries who have participated in FATF were delighted to have their work, I think, highlighted because I think they felt like they were doing something important and it often was not talked about. I think they’ve also appreciated to have — in my book, I have some more quantitative empirical evidence of their impact. And I think it’s always nice when you work in that space to see “OK, there is a real impact.”

And I will say there was a couple of people that there’s FATF central and then FATF has these nine regional bodies that work on different regions and their affiliates. And there were some people at the regional affiliates who were really helpful in the interviews and were very happy to help, to talk to me about the work, and very supportive of the book. So overall, I will say they’ve been pretty supportive of the work, so that’s great.

Jeff: Julia Morris, the book is The Bankers’ Blacklist: Unofficial Market Enforcement and the Global Fight Against Illicit Financing. Julia, I thank you so much for spending time with us today here on the WhoWhatWhy podcast.

Julia: Yes, thank you for having me.

Jeff: Thank you. And thank you for listening and joining us here on the WhoWhatWhy podcast. I hope you join us next week for another radio WhoWhatWhy podcast. I’m Jeff Schechtman. If you like this podcast, please feel free to share and help others find it by rating and reviewing it on iTunes. You can also support this podcast and all the work we do by going to whowhatwhy.org/donate.


Author

  • Jeff Schechtman

    Jeff Schechtman’s career spans movies, radio stations and podcasts. After spending twenty-five years in the motion picture industry as a producer and executive, he immersed himself in journalism, radio, and more recently the world of podcasts. To date he has conducted over ten-thousand interviews with authors, journalists, and thought leaders. Since March of 2015, he has conducted over 315 podcasts for WhoWhatWhy.org

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