Treasury's War on Terror: What It Means for Banking and Global Commerce

Panel Overview and Context

• Event: 2016 Milken Institute Global Conference panel on "Treasury's War on Terror."
• Core Problem: The panel identifies an "intractable" systemic deadlock where rational actors (governments, banks, and illicit actors) operate in ways that collectively exacerbate global financial friction.
• Strategic Shift: The discussion moved from the causes of regulatory overreach ("whining") to solutions focusing on efficiency, technology, and cooperation ("forward thinking").

Historical Evolution of Sanctions and Compliance

• Post-9/11 Era: The U.S. utilized Executive Order 13224 to disrupt financial flows to terrorist groups like Al-Qaeda, modeling the approach on 1990s counter-narcotics efforts.
• Iran Sanctions (2005-2006): The Bush administration leveraged sanctions to coerce Iran regarding its nuclear program, focusing on educating private sector CEOs on compliance and highlighting Iran's support for terrorist activity.
• North Korea Sanctions (2007): The U.S. blacklisted a Macau bank under Section 311 of the Patriot Act, significantly impacting the North Korean government's access to foreign currency and international banking services.
• Obama Administration Enforcement: Congress and the DOJ increased pressure, levying fines against banks in the hundreds of millions and billions for sanctions violations, utilizing the U.S. dollar's centrality in global commerce to extend jurisdiction to transactions with no direct U.S. nexus (e.g., remittances transiting through New York).

The Crisis of De-Risking

• Definition of De-Risking: The panel distinguished between "risk-based de-risking" (refusing to bank specific high-risk entities) and "wholesale de-risking" (rejecting entire sectors, countries, or industries due to perceived difficulty).
• Scale of Compliance Costs:
  • Western Union increased compliance personnel from six in 2001 to 2,200, with a budget representing approximately 3% of company revenue.
  • Banks cite the high cost of compliance relative to low margins in correspondent banking as a primary driver for exiting markets.
• Unintended Consequences:
  • Financial Exclusion: De-risking pushes unbanked populations toward informal, unmonitored channels (e.g., Hawala), reducing transparency and consumer protection.
  • Economic Impact: Critical remittance flows, which can exceed 50% of GDP for nations like Somalia, are threatened by the refusal of banks to serve entire industries.
• Regulatory Ambiguity:
  • Conflicting signals from different government agencies (e.g., State Department urging engagement in Iran while DOJ/regulators warn against it) create a "zero-tolerance" environment where banks opt to exit rather than navigate uncertainty.
  • Standard-setters like FATF have failed to provide sufficient clarity to offset the reputational and financial risks perceived by bank boards.

Effectiveness of Current Anti-Money Laundering (AML) Regimes

• Low Detection Rates:
  • The IMF and World Bank estimate $2–6 trillion USD in money laundering annually.
  • UN estimates suggest less than 1% of global illicit financial flows are detected and prevented.
  • Raymond Baker's analysis of Treasury data suggests the U.S. detects approximately 0.1% of global illicit flows.
  • The U.S. government seized roughly $1.5 billion in illicit proceeds in 2015, representing a fraction of the estimated global total.
• Resource Misallocation:
  • Banks spend vast resources on "Know Your Customer" (KYC) for the general population rather than focusing on the relatively small number of known bad actors (estimated in the low 100,000s including related parties).
  • The system is described as a "compliance regime" designed to protect banks from government liability rather than a collaborative framework to stop bad actors.
• SAR Inefficiency: The volume of Suspicious Activity Reports (SARs) filed has become so high that their intelligence value is questioned, with the system generating "noise" rather than actionable leads.

Proposed Solutions and Forward-Looking Strategies

• Targeted De-Risking via Intelligence:
  • Focus on Known Bad Actors: Leverage open-source data and existing blacklists (OFAC, DOJ targets) to surgically identify and cut off known criminals rather than broadly excluding entire regions.
  • Network Mapping: Use technology to map the evolving networks of sanctioned entities, including proxy shareholders and shell companies, to counter dynamic evasion tactics.
• Collaborative Frameworks:
  • Joint Money Laundering Task Force (UK Model): Replicate the UK's "Gymlet" model, where pre-cleared bank staff and law enforcement work side-by-side to review cases and share intelligence in real-time.
  • Information Sharing: Establish safe harbors and data utilities to allow institutions and governments to share risk data without violating privacy laws or triggering legal liability.
• Regulatory Reform:
  • Joint Guidance: Regulators (Treasury, OCC, FDIC, FATF) should issue clear, unified statements defining what constitutes a "risk-based" approach to clarify that wholesale de-risking is not required if a client has a robust compliance program.
  • Cost Sharing: Explore mechanisms to redistribute compliance costs, potentially requiring emerging market financial institutions to share the burden of due diligence on correspondent relationships.
  • Incentivization: Propose Community Reinvestment Act (CRA) credits for banks that maintain services for the unbanked in high-risk jurisdictions.
• Technology and Innovation:
  • AI and Automation: Implement artificial intelligence and machine learning to automate onboarding and transaction monitoring, reducing reliance on manual compliance teams.
  • Regulatory Sandboxes: Create environments (as seen in London and Australia) where fintech startups can test AML solutions with suspended regulations to foster innovation in financial inclusion.
  • Biometric ID: Adopt biometric identification systems (citing India's 80% adoption) to streamline customer verification and reduce fraud.
  • Standardization: Utilize tools like SWIFT's compliance analytics to create shared portals for monitoring transaction chains, reducing duplication of effort across institutions.
• Legal and Structural Shifts:
  • Clarify "Know Your Customer's Customer": Issue guidance clarifying the scope of due diligence required for correspondent banking relationships to prevent impossible operational burdens.
  • Pilot Programs: Launch a U.S.-based pilot program mirroring the UK's joint initiative to test collaborative intelligence gathering between banks and law enforcement.