Critics of anti-money laundering (AML) often point to the fact that just a tiny fraction of 1% of criminal proceeds are seized every year, their point being that AML is not working. Either update our approach to AML, they say, or just throw in the towel and legalize money laundering. (Here's a good example of this genre of critique).
But the critics' focus on the money-that-gets-caught misses out on one of the key channels through which AML works; by making crime more expensive. It isn't just the caught cash, but the costly detours that criminals are forced into along the way, or what I call the AML tax, that are signs of AML performing adequately.
I was reminded of this when I recently read Cash and Carry: the high cost of currency smuggling
in the drug trade, a fascinating paper about drug trafficking and high denomination banknotes. According to the paper, drug traffickers operating between Holland and Colombia typically contract with third-party broker specialists to move their funds back to Colombia. In six different situations from 2003 to 2011, coordinators of these Dutch brokerage operations were arrested. Everything from sketchy financial notes to detailed Excel spreadsheets were seized, allowing the authors of the paper to crunch the costs of running these businesses.
Put differently, we get to see a juicy insiders' view on how much criminal resources must be sacrificed to successfully evade AML measures.
The authors report that the typical cash shipment to Colombia measured €300,000. The massive 500 euro note was the most popular medium for packaging shipments. The brokers relied on coordinators residing in Holland to supervise individual couriers traveling home to their families to carry these €300,000 packages. Couriers carried these funds in specially built parts of their suitcase.
The cost of moving these €300,000 packages to Colombia adds up very quickly. First, the coordinator had to absorb a 3% fee to convert the trafficker's original low denomination euro banknotes to the very compact 500 euro note. To that, add a 2-3% fee to pay the individual courier and 0.5% on airline tickets, as well as additional administrative costs like modifying luggage and bringing couriers to and from the airport.
A table of costs for the six apprehended coordinators is inserted below:
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| Data from six criminal investigations by the Dutch police showing the costs of smuggling cash [source] |
Not listed in the table above, the broker had to absorb the cost of the occasional intercepted courier as well as having to pay their coordinators to manage the whole process. Lastly, brokers would have added a profit margin of their own. Adding all these amounts up, the authors peg the all-in cost of smuggling cash from Holland to Colombia at 10–15%, with a recorded maximum of 17%.
(This doesn't includes the costs that traffickers had to absorb back in Colombia in order to recycle the euro banknotes back into the local banking system.)
If AML doesn't work, as its critics claim, then Colombian drug traffickers wouldn't have had to contract with cash-smuggling specialists to move their funds in the first place. They'd have just used a bank, their cost of getting their funds transferred from Holland to Colombia falling from 15% to the fee of a wire transfer; a minuscule 0.5% or so. And so drug traffickers' profits would be 15% higher. (Or, if the cost savings are entirely passed on to the public, the price of cocaine would by around 15% lower, which would mean more Dutch cocaine consumption.)
But Dutch AML isn't toothless, the evidence being that drug lords must take a costly detour through the criminal note brokerage industry. This effectively acts as a tax on traffickers, hurting them in their wallets and probably putting a few of the marginal ones out of business. This AML tax may also result in higher cocaine prices, which helps to nudge Dutch consumers into legal alternatives.
These are all successes of AML, even when none of the cash is actually being confiscated. Those who claim AML is a "99% design failure" because it only intercepts a tiny amount of dirty money are naively omitting these benefits from their cost-benefit calculation. Sure, AML suffers from a boatload of costs, but the positive side effects of the AML tax deserve to be accounted for.
Don't you have to also account for the costs that everyone else has to pay to deal with it and calculate if they're higher than these benefits? It could easily be 99% design failure or >100% design failure (I have no idea).
ReplyDeleteYep, you also have to account for those costs. The thrust of my post is to flesh out the benefit side of the cost-benefit calculus for AML, and make the point that interdicted funds aren't the only measure of success. The sand thrown in criminal gears also counts.
DeleteAnd all of this is a rounding error compared to the money-laundering major multinational banks like HSBC do *daily*.
ReplyDeleteSure, big banks like HSBC launder a lot of funds, both intentionally and unintentionally. But their AML policies also repel billions of dollars of criminally derived funds every day, forcing this money onto awkward and expensive pathways like the one I described in my blog post.
DeleteOkay, fair point. In that sense, lots of things 'work' if you're willing to accept a shit-ton of collateral damage (see also: the drug war itself). Examples in the comments: https://news.ycombinator.com/item?id=37099604
DeleteThe paper itself does not assert AML works! It opines that the lack of alternative value transfer systems forced six Dutch brokers to use banknotes.
ReplyDeleteQuoting the paper linked: "the six cases here are almost certainly not all operations of this type that were operating in the Netherlands during this time" and "Obviously this is a highly speculative and incomplete explanation for the choice of such an expensive method. Resolution of the issue will require
more empirical study of how drug smugglers repatriate their moneys to their home countries."
IMHO it's a leap to take a limit case study of six busts and assert that "drug lords *must* take a costly detour…" Survivorship (or the opposite in this case) bias!
The paper doesn't assert it, I did that on my own.
DeleteBut what I said more specifically is that these types of instances in which criminals are pushed away from banks into inferior types of exchange should be counted as a win for AML, even if nothing gets confiscated. I'm sure that you're right that not all drug transactions are pushed away from banks, but the ones that do (like those described above) are signs of success.
Why not legalize drugs?
ReplyDeleteIemand met een Nederlandse achternaam zou toch moeten weten dat het land Nederland heet, en zou in staat moeten zijn dat correct te vertalen.
ReplyDeleteThe FATF and/or IMF (one of the chief FATF rule enforcers at the country level) should have their feet held to the fire to prove that the benefits of AML and its enforcement outweighs the damage done (e.g., to financial inclusion).
ReplyDeleteTwo thoughts.
Delete1. It's probably impossible to prove the benefits, for the reasons I brought up in my post. How can you possibly add up the many ways that crime is made more expensive?
2. Why is such a calculation necessary? We don't have to do a cost/benefit calculation to justify the criminalization of theft. We criminalize it because stealing is wrong. Why shouldn't the same apply to money laundering?
But we do implicitly do cost/benefit studies before imposing theft reduction measures. If not, governments could justify imposing police state conditions. The calculation is necessary because the damage that the crime mitigation imposes. The FATF's AML/CFT framework is basically a guilty-until-proven-inncocent financial integrity police state framework. Maybe I'm wrong and you can't pin any financial inclusion costs on the rules, but the question should be asked, and answering them should be attempted, even if it is hard.
DeleteWhat I meant is that we don't do a cost/benefit study on the initial criminalization of theft. Sure, once it's criminalized we have to spread our law enforcement capacity over the full range of actions we've criminalized in as optimal a way as possible, and that involves a cost/benefit calculation. But not so the initial criminalization.
DeleteThe same goes for money laundering, I'd argue. It's either wrong or right for a banker to knowingly launder money for the mob. If it's wrong, then is there an optimal way to allocate scarce law enforcement and criminal justice resources to punish it?
My point is the same as the one made by "Anonymous" above. The collateral damage should be factored in to ensure that the "cure" isn't worse than the "disease". If you ignore collateral damage you can justify just about anything that deters criminal and illicit activity.
Delete"It's probably impossible to prove the benefits"
DeleteFaith based law enforcement doesn't seem a viable policy stance.
Either there's a reduction in crime, or there isn't.
Looking around, I don't see any reduction, though the faithful will no doubt claim, unsupported as are many of their other claims, that it would be worse if we didn't have AML/KYC/CFT laws that violate the presumption of innocence among other principles and compel the innocent and ill-equipped (a bank as judge⁉) to perform, how did he put it, "pre-crime enforcement."
I don't agree with the interpretation in this article.
ReplyDeleteOk, going through the back door has a cost for criminals who want to launder their money, but 1) it's a ridiculous cost compared to the immense profits they reap, and 2) those costs are themselves paid to criminals.
So, from the point of view of the criminal industry as a whole, the total value of the profits is equivalent to the total value of the money laundered.