Financial flows between jurisdictions pose regulatory challenges for rich and poor countries alike. When such flows are kept hidden from regulators they can facilitate corruption, tax evasion, money laundering, and terrorism financing. Though scale is hard to measure (these are after all secret transactions) annual illicit flows from developing countries to banking secrecy jurisdictions run by rich countries may exceed total aid flows.
At the same time, anti-money laundering and combating the financing of terrorism (AML/CFT) enforcement has led banks in rich countries increasingly to “de-bank” nonprofits and money-transfer organizations, thereby raising costs or removing services for users, some of whom then turn to informal channels. By undermining nonprofit transfers, remittances and small volume trade, this shift may have detrimental effects on poor people as well as on the security situation.
CGD research on financial flows and tax transparency seeks to provide a solid knowledge base for the growing international effort to combat illicit financial flows. Over the past few years, it has focused on tax evasion and financial secrecy. Currently, it is focused on how rich countries might rebalance their policies to continue to protect against money laundering and terrorism financing without hindering the ability of people from poor countries to conduct business and transfer money across borders.
Addressing the unintended consequences of rich countries’ anti-money laundering policies
Migrants send over $400 billion of remittances home through formal systems and at least an additional $130 billion through informal channels. Businesses in poor countries also engage in cross-border transactions whether it is to export goods or import inputs. But formal money transfer operators (MTOs), which primarily service poor countries, are often identified as high-risk customers. Banks are therefore de-banking MTOs who are not judged to be implementing “know your customer” requirements to an adequate standard. The withdrawal of banking to some customers or even sectors is also driven by the cost of the compliance measures necessary to reduce banks’ reputational risk and the risk of punitive regulatory action to an acceptable level. De-banking of some remittance providers can thus be viewed mostly as an unintended consequence of the risk-based AML/CFT approach.
This situation implies an increase in the proportion of transfers conducted through informal channels and an increase in costs for formal and informal money transfer operators. These, in turn, imply detrimental effects for the very security situation which motivates AML/CTF enforcement.
CGD has convened a working group to investigate this issue with the goal of producing a short report with specific policy recommendations for rich country governments.
Illicit financial flows from poor countries
Over several decades, developed-country ﬁnancial centers (and increasingly those in emerging markets) have become recipients of funds transferred out of poor countries as a result of theft, tax evasion, trade mispricing, or revenues from illicit activity. Stolen funds are often very diﬃcult to repatriate to impoverished nations and to their true owners. Illicit financial flows include cross-border components of tax evasion, laundering of proceeds associated with crime, bribery of public officials, and the theft of public assets. In each case, the flows rely on being hidden, typically through the exploitation of financial secrecy provided by foreign jurisdictions, many of which are located in rich countries.
Most analyses of illicit flows have focused on estimating the global total or the amounts leaving specific countries or arriving in specific secrecy jurisdictions. While the scale estimates allow us to imagine the amount of damage that is being done, less can be said about the type of damage, the degree of vulnerability of developing countries to illicit flows, and the development impacts of different policy measures to curtail illicit flows. These issues provide the central motivation for CGD’s work. Understanding issues of national and international tax policy form an important subsection of the research agenda.
CGD’s research on financial flows and tax transparency is led by senior fellow Vijaya Ramachandran. It was previously led by Alex Cobham, who joined the Tax Justice Network in January 2015. Senior fellows Owen Barder, William Savedoff, Alan Gelb and research fellow Matthew Collin also contribute to this work. Peter Reuter, professor of public policy and criminology at the University of Maryland and visiting fellow at CGD, is also a member of the team.