Role of Non-Banking Financial Institutions in Facilitating Money Laundering and Terrorist Financing
July 26, 2023by Wing Commander Udith Pathirana
Published on Ceylon Today on 10th July 2023
Sri Lanka is currently experiencing severe economic turmoil due to crippling debts locally and internationally which has intensified various internal issues. As a result, Sri Lanka has requested financial assistance from institutions such as the International Monetary Fund (IMF) and requested to restructure repayments from money lenders to overcome the financial crisis (IMF 2023). Nevertheless, owing to the conclusion of a mutually conducted investigation into Sri Lanka’s financial activities, the Asia Pacific Group (APG) of the Financial Action Task Force (FATF) released a mutual evaluation report (MER) in 2015 that rated those activities according to 40 different categories. Moreover, FATF-APG (2015) has identified eighteen (18) key findings and assessed the level of effectiveness against the financial mechanism of Sri Lanka. In accordance with that, the Central Bank of Sri Lanka (CBSL) and the legal framework had improved its legal framework on financial activities at a greater extent since 2015 when the gradings were evaluated on six different occasions until the year 2022, yet CBSL was unable to uplift the majority of standards up to date (FATF-APG, 2021).
Thus, Sri Lanka poses a distinct Parliamentary Act termed the ‘Prevention of Money Laundering Act (PMLA)’ that was enacted on 6 March 2006 aiming to prevent money laundering actions (Patabendige, 2022). Supplementary, PMLA was amended in 2011 targeting to expand the legal provisions in Anti Money Laundering (AML) (Law Net, 2023). Undoubtedly, this Act is a viable foundation for the AML mechanism of Sri Lanka, but the utilisation of the same was merely a doubt in analysing the prosecutions against the reported cases as emphasised by the FATF MER 2015. According to figures provided by FATF-APG (2015), between the years 2008 and 2013, 7,706 cases of bribery and corruption were reported in Sri Lanka, but of all reported cases, only 336 cases were prosecuted, where only one case led to an AML investigation.
Corollary, FATF-APG (2015) characterised Sri Lanka as a nation with a high-risk grading in corruption through the MER. Accordingly, it comprehends that the existing finance machinery enables the exploitation of financial assets without getting prosecuted in Sri Lanka. Thereby, it is vital to understand the correlation and collaboration between existing financial mechanisms and legislation is insufficient or whether the total system is incompetent in AML. Further, a lacuna of prosecutions would cause a plethora of augmented risks in illicit activities which would directly affect the economy. Directly, the existing opportunity available for Money Laundering (ML) creates numerous consequences for the Sri Lankan economy as mentioned below:
Economic Distortion: ML distorts the economy by inserting illegitimate funds into the financial systems which could lead to price falsifications and an irregular distribution of assets which could ultimately undermine the solidity and fairness.
Decreased Foreign Investment: Opacity and uncertainty due to the lack of an AML mechanism would discourage legitimate foreign investors that can be considered a severe risk at this juncture.
Fiscal Implications: Illicit funds would reduce the Government income revenue due to tax evasion. Further, it deprives revenue to be utilised for the public sector, infrastructure and citizens’ welfare which invariably hinders economic growth.
Damaged Reputation: FATF is a globally recognised independent regulator that has a major impact on global financial activities. Thereby, the lack of a profound AML system could lead to tarnishing Sri Lanka’s reputation among the international community while increasing the scrutiny from international regulatory bodies. As a result, a reduction of foreign aid and restrictions on financial services could be expected while having grave consequences on international trade.
Existing problem
Even though the Sri Lankan financial sector poses a well-established banking system, it is doubtful whether the compliance staff is adequate to fulfil the requirement of auditing for AML activities. However, the Know Your Customer details (KYC) are to be submitted to justify the source of income on various occasions while dealing with the banking sector. Further, it is a mandatory process to investigate, identify and verify the client’s details, source of income, requirement of account operation and type of transactions made during the opening stage of an account which is to be updated periodically over time. Besides, the bank is to verify that their clients are genuine and not using financial mechanisms to conduct any violation of the law and order of the country. Nonetheless, any suspicious ML activity must be forwarded to the FIU for further investigations and subsequently forwarded for investigations to prosecutors.
However, there are both licensed and unlicensed financial intermediaries who are also activated in the Sri Lankan finance market such as Non-Banking Finance Institutions (NBFI), insurance companies, investment funds, leasing firms, stockbrokers, microfinance institutions, and credit unions. Non-Bank Financial Institutions (NBFI), such as several mobile service providers, also act as mediators in the money transactions without posing KYC of the client. Consequently, these mobile service providers are highly attractive among criminals due to factors such as less stringent regulations, complex transaction structures and limited customer due diligence measures. Further, transactions occurred via a code and application software that does not adhere to the financial regulations provided by the FATF and are not regulated under the FIU as well.
Discussion
ML is the method of concealing the source of illegally gained cash to disguise it as legitimate where it entails a series of intricate financial transactions. Besides, criminal organisations, including terrorist groups, organised crime gangs, and drug cartels frequently attempt ML. Further, these organisations strive to incorporate their illegally obtained money into the legal financial system by attempting various types of ML operations. Hence, ML techniques entail several phases such as placement, layering, and integration, which would reincarnate the source of illegal earns. Therefore, it is vital to detect, investigate, curtail and prosecute to restrict ML activities through strong AML regulatory mechanisms and enforcement procedures.
FATF MER has clearly indicated lapses in the Sri Lankan financial sector which is regulated and controlled by the CBSL. Even though the Sri Lankan Constitution has provided legal provisions to act against money laundering, persecuted figures illustrate the vacuum and the non-availability of sound mechanisms to fight against ML. Nevertheless, despite being under the wings of the established financial sector, it was evident by analysing the statistics between the years 2008 to 2015 which is the finally evaluated period under the MER that prosecution of reported cases has dropped down to 4.4 per cent where less than 0.1 per cent of cases are prosecuted under the PMLA.
Unfortunately, while having enormous lapses in the established financial mechanism in addition to mobile service providers acting as limitedly regulated NBFI, they are also involved in the money flow inside Sri Lanka, which does not have a sufficient mechanism to identify the source of income, the reason for the transaction, end customer details etc. Evidently, these NBFI Mobile Service Providers (MSPs) provide a less vulnerable, easily accessed and limitedly revealable platform for criminals in the present context. Undoubtedly, a massive amount of drug dealers, criminal activities, prostitution and other crimes were immensely facilitated by this method due to the money flow through less monitoring mechanisms. Globally, countries are taking numerous remedial actions to control and mitigate illegal finance activities to restrict crimes, where our financial mechanism permits money flow through NBFI MSPs systems which would augment the crime rates of the country.
Further, it is vital to note that contemporary NBFI MSPs have created financial platforms that have intertwined with drug trafficking, organised crime syndicates, and illicit activities whilst providing a shared network for conducting their financial procedures. Further, in the circumstance of Sri Lanka, it has been challenged in prosecuting identified charges using the established banking network and the PMLA via the CBSL. Nonetheless, authorising illicit transactions and trade through an unregulated mobile finance system in the country is widely deemed highly intolerable in any circumstance.
Eventually, terrorist organisations will potentially exploit NBFI MSPs as a method of financing terrorism, thereby avoiding financial trails within an extremely secure setting. Nonetheless, the predominant contention posits that terrorist financing demands a substantial influx of reserves, which cannot be accommodated through existing mobile cash mechanisms deprived of comprehensive knowledge of the fundamental principles of money laundering. Consequently, the structuring or smurfing appears as useful a money laundering technique that splits substantial cash volumes into smaller increments and subsequently dispenses or transfers those amounts across a greater array of diverse mobile accounts, therefore permitting the discovery of illicit funds almost impracticable.
Certainly, the operational infrastructure of terrorist administrations finds it progressively convenient to acquire financial support through the utilisation of mobile financial transactions. Thereby, these NBFI MSPs methods assist as a means to procure funds for the facilitation of operatives, organisational functioning, and the execution of violent activities.
Way forward
It is of paramount importance that Sri Lanka is to mitigate aforesaid implications. Thereby, Sri Lanka needs to strengthen its AML framework by enhancing regulatory oversight, improving collaboration with global partners, and raising consciousness amongst financial institutions and the public about the risks and consequences of ML. Further, the undermentioned actions could be taken by the CBSL to curtail ML activities in Sri Lanka.
Prosecution of Culprits: Competent and trained staff is to be appointed to prosecute ML culprits under available PMLA.
Conduct NBFI MSPs Risk Assessments: CBSL is to conduct Risk Assessments pertaining to the NBFI MSPs to identify vulnerabilities and implement appropriate risk mitigation measures.
The necessity of AML Specialists: It is vital to maintain a competent AML staff by the NBFI MSPs to monitor financial transactions to mitigate crimes and terrorist financing activities.
Regulatory Requirement: It is required to make necessary arrangements by the CBSL to regulate NBFI MSPs under their purview while mandating the KYC details and details of the source of funds during the authorisation process of money transactions.
Foster Collaboration: Encourage NBFI MSPs for information-sharing and proactive reporting of suspicious transactions to FIU and government regulatory authorities.
Embrace Technology Solutions: Adopt automated transaction monitoring systems, artificial intelligence and robotic usage for data analytics and digital identity verification to enhance AML efforts within NBFI MSPs.
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* Wing Commander Udith Pathirana is a Military Research Officer at the Institute of National Security Studies (INSS), the premier think tank on National Security established under the Ministry of Defence. The opinions expressed are his own and not necessarily reflective of the institute or the Ministry of Defence.
-The Ministry of Defence bears no responsibility for the ideas and views expressed by the contributors to the Opinion section of this web site-