By Joshua Kirschenbaum and Jennifer DeNardis
Introduction
Russia in recent years has been the most conspicuous source of illicit flows into European banks and the Western financial system. The Russian government weaponizes these opaque channels to export corruption, facilitate influence operations, and prop up the domestic patronage system. Despite a money laundering crackdown by the Central Bank of Russia (CBR), the country’s main financial supervisor, recent history poses serious questions about the effectiveness of the central bank, law enforcement agencies, and prosecutors in combating illicit financial activity.
The Financial Action Task Force (FATF) sets international anti-money laundering (AML) standards (PDF 6.37 MB) and evaluates its member states for compliance. It was created in 1989 and is housed at the Organization for Economic Co-operation and Development. Russia joined in 2003. FATF last evaluated Russia over a decade ago under the old “technical compliance” review process, which largely focused on the country’s legal framework. FATF now evaluates (PDF 1.51 MB) jurisdictions on the basis of the effectiveness of their AML regimes. The new method focuses on enforcement and outcomes. That makes this year’s FATF evaluation of Russia a unique opportunity to protect democratic countries from corrosive financial flows.
Should FATF conclude that Russia falls short, it could “greylist” the jurisdiction, which would have immediate reputational effects. It could ultimately lead to a process by which other FATF members, would require their financial institutions to take special steps in dealing with Russian banks. This would raise the cost of international business and banking in Russia. Such a decision against an FATF member state would be unprecedented but not necessarily unjustified.
Evaluation Under the New Methodology
The last full-scope FATF evaluation of Russia was in 2008. Although it identified deficiencies in the Russian AML regime and established a follow-up process to fix them, it did not result in greylisting. Russia is now deemed (PDF 1.14 MB) “largely compliant” or “compliant” with FATF’s technical requirements – but that was under the old approach, which did not assess effectiveness. Despite this apparent compliance, other organizations such as the International Monetary Fund have correctly suggested that the Russian AML regime is a work in progress. The IMF has also called for improvements to prudential banking supervision.
FATF should take a close look at the CBR’s bank cleanup campaign. Under the leadership of Chairwoman Elvira Nabiullina, the CBR shut down over 440 mostly small banks between 2013 and 2018 (a 50% reduction), many of which were involved in illicit activity. It is unclear whether the central bank’s crackdown is designed to be timely and effective; is intended to allow illicit activity and revoke licenses only after the fact; is politicized to favor certain factions over others; or some combination of those elements. It is likewise unclear whether the central bank can exercise effective oversight over the state-run banking sector, which now has the lion’s share of the market, particularly following the central bank’s takeover of three large privately-owned banks.
The central bank’s closure of bad banks, while welcome, has tended to come only after the illicit activity happened and has not seemed to do much to prevent its recurrence somewhere else. One must also question why so many licenses were issued to bad actors to begin with. Large fines, fairly imposed, would have a deterrent effect on all players, but the central bank has levied only paltry penalties, an odd practice given its aggressive campaign of license revocations. Maximum fines are about $12,600 on banks and $600 on individuals, according to a 2016 joint World Bank-IMF assessment (PDF 1.95 MB). The report remarked that administrative fines on legal and individual entities are “low and not a sufficient deterrent” to prevent money laundering. Dissuasive fines against small banks must be in the millions of dollars, and against large banks in the hundreds of millions.
Corruption, organized crime, and a flawed justice system have also made Western countries reluctant to extradite bank executives who have fled charges in Russia. While many defendants accused of money laundering or other financial crimes may be guilty, the lack of an independent judiciary and politically-motivated cases limit the deterrent value of prosecutions. The lesson seems less to abstain from criminality than to avoid falling out of favor.
This year’s FATF evaluation should explicitly address the numerous multi-billion dollar money laundering operations that originated in Russia, including the Russian Laundromat in Moldova and Latvia; the Deutsche Bank mirror trading scandal in the United Kingdom; the Troika Laundromat affair in Lithuania; and the Danske Bank and Swedbank scandals in Estonia, among others. The original financial institutions on the Russian side, such as Russian Land Bank, Promsberbank, and Troika Dialog, have often been publicly reported in the media. It is imperative that FATF examine how Russian authorities dealt with this activity both as it occurred and in its aftermath. It is equally important that FATF and the Russian government find an effective strategy for combating industrial-scale money laundering in the future, since the best efforts of the central bank have clearly been insufficient. If politics make it impossible for the CBR to be effective, then FATF should recognize that reality.
The main FATF standards to watch for on the 2019 evaluation of Russia will be the criminal prosecution of money laundering; customer due diligence and enhanced customer due diligence for high-risk scenarios; supervision of and imposition of fines against banks; and vetting of bank management and owners.
The Implications of Greylisting
There is little precedent for greylisting a FATF member state or a country with the economic and political clout of today’s Russia.[1] Given the shift in evaluation from technical compliance to effectiveness, though, past precedent is little guide to future outcomes. In its most recent evaluations of Czechia (PDF: 2.83 MB), Latvia (PDF: 3.43 MB), and Lithuania (PDF: 2.63 MB), Moneyval – a FATF-style regional body that uses FATF standards – found significant deficiencies related to those standards and invited those jurisdictions into enhanced follow-up processes.
The FATF evaluation process is an important pressure point that might change the Russian government’s calculus regarding illicit finance. Greylisting would mean that FATF would continue to monitor Russia’s AML regime closely. The reputational harm would be immediate and would likely make non-Russian banks more cautious in their approach. And it could potentially begin a process – should Russia not take swift steps to address identified deficiencies in its AML regime — that would lead FATF member states to impose special requirements on their financial institutions’ dealings with Russia (“blacklisting”).[2] These steps could include enhanced due diligence measures; limiting business relationships or financial transactions with Russia; prohibiting financial institutions from relying on third parties within Russia for compliance purposes; requiring financial institutions to review, amend, and possibly terminate relationships with financial institutions in Russia; or creating increased supervisory examination or external audit requirements for subsidiaries located in Russia.
Greylisting would no doubt anger the Russian government and potentially provoke some form of retaliation. It would also hurt Russian economic growth, which would be felt by ordinary Russian citizens already dealing with massive corruption and a stagnant economy. At the same time, avoiding the greylisting process even if FATF finds serious deficiencies in the effectiveness of Russia’s AML regime would be a missed opportunity to impose costs on the Russian government through a consensus-driven, international organization under clearly defined, apolitical standards. Greylisting may lead to policy change by the Russian government. At the very least, elevated risk aversion on the part of the private sector and the prospect of enhanced due diligence requirements to come could help protect the Western financial system from illicit financial activity that continues to penetrate our most important institutions.
Footnotes
[1] Russia was blacklisted by FATF under the old technical compliance methodology in 2000 and removed (PDF: 168 KB) from the blacklist in 2002. Russia was not then a member state and acceded to FATF only in 2003.
[2] The technical term for blacklisting is placement on the list of “non-cooperative jurisdictions”, which leads to a call for “counter-measures.” The technical term for greylisting is placement on the list of “high-risk and other monitored jurisdictions.”
Joshua Kirschenbaum is Senior Fellow for Illicit Finance at the German Marshall Fund’s Alliance for Securing Democracy and Jennifer DeNardis is a graduate student at George Washington University’s Elliot School of International Affairs.
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