Growth in Banking Calls for Strong Global System
When the epicenter of the ongoing eurozone crisis shifted to Cyprus in March, it was only the latest case of a globalized banking industry finding itself at the center of an international controversy.
Many commentators have pointed to Cyprus as an example of financial sector run amok, given that its banking industry was more than seven times the economy as a whole, employing 70 percent of Cypriots. The island’s overexposure to bad Greek assets spelled doom for the entire economy and pushed the country to the brink of exiting the euro, threatening the stability of the entire common currency.
Yet the urge to paint Cyprus as a unique case is misplaced. According to the European Commission, Cyprus had Europe’s fourth-largest banking sector by share of gross domestic product, behind Luxembourg, Ireland and Malta. On average, EU nations have financial sectors that are 3½ times the size of their GDP. These are not quite Cyprus levels, but they do demonstrate that the rapid growth of banking is not an isolated phenomenon.
Cyprus represents, rather, the new normal — the rise of sprawling, complex and profoundly interconnected financial sectors. There is good reason to believe that globalized banking is good for our prosperity, facilitating international trade and fomenting cross-border investment. But there also is a dark side. The unintended consequences of instantaneous global financial connectivity include a number of security challenges, from the potential for money laundering and terrorist financing to cyberattacks that threaten the integrity of our bank accounts and the privacy of our personal information.
Nor is this only a problem of far-flung island jurisdictions or tropical tax havens. Recent history has revealed how uncomfortably close to home these problems really are. A growing list of major U.S. and U.K. institutions — including Wachovia, HSBC and most recently Standard Chartered — have been scrutinized by regulators and fined for their alleged involvement in the laundering of significant sums of money, including funds from Mexican cartels and sanction-busting Iranian banks. Martin Woods, the compliance officer that uncovered Wachovia’s problematic relationship with the cartel-dominated casas de cambio in Mexico, says the real challenge is “[n]ot the Cayman Islands, not the Isle of Man or Jersey. The big laundering is right through the city of London and Wall Street.”
The infiltration of organized crime or terrorist groups into our financial systems presents such a conundrum precisely because it is tied up in an otherwise positive trend — the growth and integration of emerging markets into the broader global economy. Mexico, for instance, is the third-largest trading partner of the U.S., and it receives more than $20 billion in remittances yearly.
Banks understandably are eager to facilitate these impressive capital flows, most of which are legitimate — but which, in high-risk jurisdictions, also blur together with illicit funds in often convoluted ways. The same goes for financial markets in Africa, where drug money is funneled through existing businesses — in one case, through used cars from the U.S. sold in Benin and Gambia — and from there transferred to dollar-denominated accounts in Europe and the Middle East.
Combating these threats requires innovative thinking. Punitive actions may sometimes be appropriate, but it is important to remember that simply layering on additional regulation is unlikely to be effective. The laws in Europe and the U.S., where the biggest banks are based, already prohibit laundering and financial fraud, and an alphabet soup of international oversight agencies energetically seek to crack down on institutions that lack proper safeguards. In the U.S., the Bank Secrecy Act of 1970 and the 2001 PATRIOT Act empower the Securities and Exchange Commission, the Treasury Department and other federal bodies to ensure compliance with anti-money laundering and terrorist-financing frameworks. Internationally, the Organisation for Economic Co-operation and Development’s Financial Action Task Force pressures noncompliant countries into reform.
Yet financial crime has only increased. The U.N. Office of Drugs and Crime estimates that 70 percent of the proceeds from transnational crime is laundered through the financial system centered in the U.S. and Europe. This shouldn’t be surprising, given the complex and multi-layered nature of multinational banks, which often access emerging markets through extended networks of local correspondent institutions. With millions of transactions daily, no regulator can monitor even a fraction of global financial activity. The sheer number of redundant regulations and overlapping but underfunded authorities confuses global oversight. And the bankers themselves are, save a tiny minority, law-abiding professionals simply struggling to adjust to the overwhelming new realities of their industry.
Changing this dynamic will require a fundamental shift in internal culture in the world’s biggest banks as well as among government watchdogs. No regulator, however zealous, can track down financial criminals or prevent future abuses without the cooperation of the banks themselves. Nor can banks comply merely with the minimum requirements of the law and believe that their responsibility ends there.
We need to work together to prevent financial crimes and illicit activities. The government and the private sector must stop seeing each other as antagonists and start seeing themselves as partners in a collaborative effort to weed out the worst abuses of the financial system. This is where the policy community can help, by serving as an intellectual, disinterested facilitator of public-private cooperation. For instance, a new “Financial Threats Initiative,” led by the national security think tank Center for a New American Security, is bringing together stakeholders in government, academia and private industry to develop a new framework for addressing financial security issues.
The effort comes not a moment too soon. The CNAS initiative will address the “interlocking problems of money laundering and financial crime, cybercrime and cyber financial security” based on the premise that “current approaches are not only too expensive but are ineffective.” Central to this effort will be cooperative efforts such as more streamlined public-private data sharing (with input from experts at industry leaders such as Google Ideas), and government support for improvements to IT infrastructure that will lower the banks’ burden to comply with existing know-your-customer and due diligence requirements.
As we live more of our lives online, creating a secure global financial system — much more than the current obsession with preventing “another Cyprus” — must be the priority for policymakers and bankers alike. The first step is admitting that there is a real and growing problem — and engaging in earnest in a dialogue on how all parties can work together to fix it. Through collaboration, not “gotcha” enforcement, we can rise to the challenge.
Sally Painter is co-founder and COO of Blue Star Strategies and a member of the Board of the Truman National Security Project. This article originally appeared in Politico.