REGULATORY RISK: Money laundering

WSJ coverage of banks’ money laundering activities in July of this year makes for compelling reading: BaFin (Germany’s top financial authority) saw the former CEO of Wirecard AG trustworthy and remained reluctant to detailed warnings since 2008 (Fairless et al., 2020). More often, however, it makes for depressing reading in terms of the confidence we can have in the integrity of financial institutions, especially as many banks involved are household names.

Given the large imbalance in resources available to banks and to their regulators, it also makes one suspicious that money laundering coming to light as a result of regulatory enforcements is likely to be just the tip of the iceberg, despite the extraordinary growth in anti-money laundering legislation in many countries over the last 30 years.

It is fair to say that the growth in legislation has been driven mainly by the fight against terrorism and organised crime, and that less attention has been given to the financial stability aspects of money laundering. Though regulatory authorities have paid lip service to money laundering as potentially a financial stability issue, assessing its impact in this regard is complicated by the lack of quantitative data on the extent of it – even the Financial Action Task Force abandoned efforts to collect such data several years ago.

However, an assessment of the implications for financial stability can be made by examining whether money laundering-related enforcements issued by regulatory agencies impact on different measures of bank risk. My recent research with Prof John Thornton at the University of East Anglia and Prof Yener Altunbas at Bangor University in this area does that (Money laundering and bank risk: Evidence from U.S. banks, forthcoming in the International Journal of Finance and Economics).

Using US banks as an example, we find that being the subject of enforcements by the main US regulatory agencies not only exposes money laundering banks to a greater risk of default, but also increases the risk of systemic bank failure and weakens the ability of the banking system as a whole to deal with external shocks.

In other words, the anti-money laundering fight is not just about penalising those involved in laundering, but about protecting the interests of other bank stakeholders, such as shareholders and depositors, together with other financial institutions and taxpayers, in the welfare of the bank. Enforcements should have a key place in assessing the vulnerability of banks and the stability of the financial system more generally.

We also argue that in their anti-money laundering activities, regulators would be wise to focus on those banks that have long tenured CEOs, relatively small and less independent executive boards, and weaker balance sheets.


This article was published in the September-October 2020 issue of CIR Magazine.

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