Attestation Update – A&A for CPAs

Technical stuff for CPAs providing attestation services

Surprise! Enforcement efforts against money laundering have unintended consequences.

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Image courtesy of DollarPhotoClub.com.

Image courtesy of DollarPhotoClub.com.

Severe fines against large banks for violating anti-money laundering rules has led the banks to place a heavy focus on making sure their customers are legit. The result is a closing accounts of customers who have too high a risk of being shady. The unintended consequence is legitimate businesses and legitimate charities have difficulty finding a place to do their banking.

In a wonderful irony, articles at The Wall Street Journal on two successive days illustrate the tension. The articles leave you wondering in opposite directions. One article makes you think the banks ought to get serious about screening clients and shut down a bunch of accounts. The other article makes you wonder why these charities doing such wonderful work are getting all their accounts closed for no good reason.

First, charities finding themselves without bank accounts.

3/30 – Wall Street Journal – Cautious Banks Hinder Charity Financing / Account shutdowns and holdups of money transfers hinder ability to deliver aid to refugees – A charity that funds a school in Turkey which provides education to around 400 refugees from Syria had their account closed by JP Morgan for no stated reason. After an inquiry from the WSJ, the bank reversed their decision.

Another charity that operates a hospital in Syria had their accounts closed by BofA. After moving to Wells Fargo, their accounts were closed there. Staff at the hospital went four months without pay while the charity tried to figure how to get money into the country.

Authors have spoken to eight other charities who have had their accounts closed. Many others have had money transfers going into Syria, Turkey, or Lebanon held up for varying lengths of time.

Article mentions that banks are under pressure from the U.S. federal government to monitor their customers accounts and close those accounts which could be related to money laundering, whether related to drug running, terrorist financing, or other illegal activity.

From my research, I know that banks are required to check every customer and every wire transfer against multiple lists of banned parties and companies.

Consider this very sad comment, which I will quote because it makes the point so well:

U.S. government officials say shutting customer accounts is a business decision made by financial firms. A spokesman for the Office of the Comptroller of the Currency said recent penalties against banks “should not deter other banks that operate in a safe and sound manner from conducting business in a legal way.”

Translation: It is not the fault of the government that banks are closing all those accounts for no good reason. It’s the fault of those heartless bankers. We have nothing to do with it. Banks merely need to comply with the law and they can do business with anyone they want.

Reminds me of a comment by the boss in That Hideous Strength, the last book in C.S. Lewis’ Space Trilogy. My paraphrase, which I will put in quotes – the boss says his underlings can do anything they want to solve the crisis.

There are merely two mistakes you must avoid. First, not doing something you should. Second, doing something you shouldn’t.

What possible reason could there be for these mean ol’ bankers being so heartless to these wonderful charities doing fantastic work caring for helpless refugees?

Maybe we can find a clue by pulling out the previous day’s paper.

3/29 – Wall Street Journal – Iranian Miniskirts, Bags of Cash Raise Doubts Over Controls at HSBC – Letting druggies launder something in the range of $7 billion in currency and somewhere around $10 billion of wire transfers resulted in a fine against HSBC back in 2012 of $1,915,000,000.

That’s $1.9 billion.

In addition, the bank has a deferred prosecution agreement, explicit compliance requirements, and oversight from a monitor for five years to check up on them. If they don’t do a good enough job, as unilaterally determined by DoJ, the deferred prosecution agreement can be opened up again and the bank could be prosecuted on the original charges. Keep in mind the bank admitted to charges in the DPA, so seems to me that getting a conviction ought to be relatively simple.

Monitor’s report

The monitor’s current report indicates there are still concerns about whether the bank is identifying all risky transactions and customers and performing the appropriate followup. The number of incidents found is not mentioned in the report and there is no indication of context or significance.

Someone is leaking details. Seeing how the details make the bank look bad, where do you suppose the leaks are coming from?

Specific leaks mentioned several egregious examples. A 19-year-old shrimp farmer opened an account in Mexico with bags filled with currency. A borrower in Brazil subsequently wired money into several subsidiaries in countries known for being loose on following the rules – that should have triggered follow-up.

Another HSBC client was exporting miniskirts to Iran. The problem is transactions with the Iranian companies are banned categorically.

Hmm. Miniskirts to Iran. Not tools for enhancing uranium. Not parts for fighter aircraft. Not machine tools to manufacture weapons.

Miniskirts.

Since the goal of money laundering restrictions is to restrict commerce in order to hurt the country involved, I’m wondering if shipping miniskirts into Iran might actually further the implicit goals of the anti-money laundering regimen.

Compliance costs

If HSBC doesn’t meet the DoJ expectations for complying with the DPA, the consequences will be severe. There could be more years of monitoring, maybe more fines, the initial case could be brought to trial, or they could even lose their banking license to do business in the United States (which would be fatal to an international bank).

It’s not as if HSBC isn’t trying. Look at the number of compliance staff addressing possible financial crime, according to a graph in the article, from which I will interpolate the number of staff:

  • 2010 – 1,800
  • 2011 – 2,600
  • 2012 – 2,700
  • 2013 – 5,300
  • 2014 – 7,000
  • 2015 – 9,000

That is a massive expansion in staffing. Going from under 3,000 full-time staff focused on compliance for possible financial crimes in 2012 to 9,000 staff in 2015.

Look at the costs, which I interpolate from the graph:

  • 2013 – $0.6 billion
  • 2014 – $2.3 billion (increase of $1.7B)
  • 2015 – $2.9 billion (increase of $2.3B over 2013)

That $2.9B cost of financial crime compliance efforts is in relation to $13.5M of net profits in 2015.

Fallout from the problems back in 2012 include the $1.9B fine, increased compliance costs of $1.7B in 2014 , increased compliance costs of $2.3B in 2015. By my back-of-the-envelope calculations that is $5.9B of extra costs, with my guess of an extra $2.5B for each year left in the monitoring term.

And if HSBC doesn’t do a good enough job (as determined by DoJ after the fact), those costs will continue or even increase.

My wild guess of an extra $2.5B for the remaining three years (another guess), puts the total tab from the 2011/2012 fiasco at something in the range of $13 billion (5.9b +2.5B x 3 = 13.4B). This specific mess will cost HSBC something in the range of a year’s net income.

Consequences for customers

Dumping customers is called ‘de-risking.’

I previously discussed Unintended consequences of anti-money laundering enforcement.

HSBC currently operates in 71 countries, after having completely shut down their operations in 17 countries. Many branches were closed in riskier areas of countries where they still operate.

In Mexico, the bank has closed accounts for millions of customers and closed dozens of their branches. In Mexico, the bank doesn’t allow any transactions in US dollars.

So yeah, there are some exquisitely strong reasons major banks are getting really aggressive on monitoring their clients and closing accounts.

The banks can’t tell individual customers, but there are good reasons charities doing wonderful work in the Middle East get a letter that says “we are closing your account.”

Written by Jim Ulvog

March 31, 2016, 8:24 am at 8:24 am

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