In April 2016 revelations from the Panama Papers spotlighted the role that banking secrecy - which is offered in the so called tax and financial centres and territories - performs in the global economy. The facts have caused increasing concern that banking secrecy lies at the centre of an international web of illegal and criminal conduct. In parallel, several policymakers in advanced countries have emphasised the need to enforce the blacklisting tool against the territories that breach transparency standards. But does blacklisting work?
Banking secrecy is an evergreen issue for the national and international debate. In the aftermath of the Global Financial Crisis the fight against bank secrecy as well as against tax and financial havens has become a political priority in advanced countries.
It is often the case that international organisations and national governments do not have strong legal instruments to impose strict measures to prevent and combat banking secrecy. For this reason, soft law practices, such as blacklisting, have been introduced. The aim of soft law tools is to put the investigated country under intense international financial pressures, using the “name and shame” approach. Under this approach, institutional regulatory organisations and/or national governments disclose names of non-compliant countries and/or non-compliant banks to the public, supplementing the disclosure with forms of official opprobrium. This approach is increasingly applied in the international context and it aims to address policy coordination problems among national policymakers and regulators.
Country compliance with the international standards of the blacklisting policy named Anti-Money Laundering and Combating the Financing of Terrorism (AML/CFT) has gained momentum in national policymaking all around the world in the last two decades.
Established by the Financial Action Task Force (FATF) in 1999, nowadays the international standard consists of 49 Recommendations, dealing respectively with anti-money laundering (forty recommendations) and combating terrorist financing (nine recommendations). Since 2000, FATF has periodically issued lists (of Non-Cooperative Countries and Territories (NCCTs)), which identify the jurisdictions that FATF believes to be non-compliant with international best practices.
The aim of the listing procedure is to produce the so-called stigma effect. The stigma effect represents an inverse relationship between blacklisting and international capital flows. Indeed, the event of being blacklisted is intended to decrease the international capital flows towards a country. Two sources of pressures on the BLC are expected to work.
On the one side, most countries that interact with a BLC evaluate its financial transactions as suspicious. This occurrence leads to more stringent and costly monitoring procedures. Banks operating in multiple jurisdictions are the most concerned about these monetary costs, including compliance costs. The AML/CFT cost of compliance seems to continuously increase.
Along with monitoring costs, financial transactions with a BLC can give rise to reputational costs. Suspicious financial transactions attract more and more attention from supranational organisations, national policymakers and regulators, and international media. For banking institutions, engagement in opaque financial transactions can increase reputational risks. For example, in 2012-15 various international banks were investigated for alleged illicit financial transactions and fined to improve their compliance. Transactions with BLCs can produce similar negative reputational effects.
Because of the potential damage caused by the stigma effect, international banks may have a strong incentive to avoid business with BLCs. However both the existence and the direction of the stigma effect are far from being obvious. The AML/CFT non-compliance of a country can be attractive under specific conditions, such as the potential existence of a worldwide demand for non-transparent financial transactions. A BLC can be attractive for banking and non-banking institutions seeking to promote lightly regulated products and services to their wealthy and/or sophisticated clients. The international banking industry as a whole can have incentives to take advantage of the existence of BLCs. Therefore the stigma effect, meant to be “a stick” for all the countries not in compliance with the regulation, can turn into “a carrot”.
A paper I recently co-authored–(Balakina, D’Andrea and Masciandaro 2016, (available here)) - aims to find empirical evidence of whether and to what extent FATF blacklisting affects the volume of financial transactions.
We studied the relationship between international capital movements and FATF listing/delisting events in a sample of 126 countries in the years from 1996 to 2014. Twenty-nine countries have been blacklisted since the introduction of the FATF List; twelve of these countries are developed. We tested whether international banking activities respond to the “name and shame” approach. Consequently, we wonder if it is possible to detect financial gains for a country that implements AML/CFT policies consistent with the international standards. To understand the effects that FATF decisions produce over listed countries, we focus on how banks react to higher potential costs that can emerge (disappear) when a country is listed (delisted). Our empirical conclusion is that in general the stigma effect doesn’t exist.
Therefore, is the era of banking secrecy definitively over, as a G20 official document stated in 2009? Probably not. The economic rationale of our results is easy to discover: if it is assumed that banking secrecy is the result of market mechanisms, it is easy to forecast that the worldwide demand and supply of banking secrecy is likely to be relevant for a long time to come, and consequently the existence of tax and financial heavens.
The bottom line is that the growth of criminal and illegal activities systematically generates the demand for banking secrecy, while economic and political incentives can motivate national politicians and international banks to demand and supply banking secrecy. Using a soft law tool such as blacklisting is likely to be a weak policy solution for a structural problem with deep roots in the incentive structures of both offshore and onshore countries. In fact, banking secrecy is unlikely to disappear; it is more accurate to describe it as a dynamic variable with its booms and busts motivated by the changing preferences of national policymakers. Banking secrecy is like a tango: it takes two to dance it. And blacklisting is unlikely to stop the music.
Donato Masciandaro is a Professor at the Department of Economics and Baffi Carefin Centre, Bocconi University and SUERF.