Stung by Big Fines, Big Banks Beef Up Money-Laundering Controls

(Bloomberg) -- When U.S. authorities shut the sex-ad site last year, financial-crime monitors at an HSBC Holdings Plc office in New York sprang into action.

They started looking at hundreds of thousands of HSBC accounts in the U.S., searching for patterns of activity that might suggest involvement with sex trafficking, according to bank executives interviewed in March. The list was narrowed to several hundred names, then to a few dozen. Months later, after reviewing customer transactions for things like condom purchases and hotel reservations, HSBC closed the accounts of a handful of people and turned over their findings to police.

That wouldn’t have happened a few years ago. Stung by a $1.9 billion fine in 2012 for failure to prevent money laundering by Latin American drug cartels and facilitating trading with sanctioned countries, HSBC has been trying to get its house in order. It quintupled the number of employees assigned to spot suspicious activity to 5,000, upgraded its technology and, in 2016, hired Jennifer Calvery, the U.S. Treasury Department’s top anti-money-laundering official, to oversee its efforts – the same woman who helped slap the 2012 fine on the bank.

HSBC’s efforts to catch a few sex traffickers shows how far many of the biggest banks have come since a wave of fines got their attention half a decade ago. The changes help explain why few recent money-laundering scandals have involved big global banks.

“If we’re not flagging these risks more effectively, it hurts our brand and reputation when these things are discovered by regulators or law enforcement,” Calvery said in an interview at a March anti-money-laundering conference in Florida. “If we have criminals infiltrating our bank, it’s in our interest to find them first. So the goal is to keep making our monitoring more efficient and more effective.”

Doubling Staff

It’s a mindset echoed in conversations with financial-crime executives at four other global banks. All have at least doubled staff levels in the past five years, as fines piled up. Nine big banks paid a total of $20 billion from 2012 through 2015 for having lax controls against money laundering, helping clients evade taxes or violating U.S. sanctions. Most of the settlements came with deferred-prosecution agreements and outside monitors.

Stung by Big Fines, Big Banks Beef Up Money-Laundering Controls

Like HSBC, other banks have hired officials from Treasury, law enforcement and regulatory agencies to help with their efforts. Regulators and compliance officers in the U.S., the U.K. and the European Union have established new channels for sharing information. And banks are throwing more money at the problem: The 14 largest now spend $2.6 billion a year fighting financial crime, according to the Bank Policy Institute, an industry association.

That doesn’t mean big banks have eradicated money laundering. Executives acknowledge their efforts can only make it harder, not impossible, for criminals to use the financial system and that there’s more to be done.

“Despite all of the money we’re spending — and we’re spending a lot of money to keep criminal money out of our institutions — it’s still getting in every single day, right by all those controls,” said HSBC’s Calvery, referring to the industry’s efforts. “So we’re not doing as well as we’d like to be doing.”

One reason: Adding more crime-fighting personnel doesn’t always mean you get better at catching the criminals. Deutsche Bank AG’s compliance staff in the U.S. flagged money flowing from an Estonia unit of Danske Bank A/S, only to be told to ignore the red flags, according to former and current employees at the bank.

Then there are the suspicious activity reports filed by banks to U.S. authorities, which jumped after 2012 from roughly 60,000 to more than a million the following year. They have been rising since. Yet law enforcement agencies inquire about only 4 percent of those alerts, according to a Bank Policy Institute survey. Only 1 percent of illicit money in the financial system is confiscated, the United Nations estimates.

Stung by Big Fines, Big Banks Beef Up Money-Laundering Controls

As part of their clean-up, big banks withdrew from some countries where money-laundering risk was high and dropped correspondent-banking ties with hundreds of lenders. That’s what happened when JPMorgan Chase & Co. cut off Danske’s Estonia unit in 2013. Danske admitted in September that much of the $230 billion that flowed through that unit between 2007 and 2015 was probably suspicious. Deutsche Bank continued being a correspondent until 2015.

De-Risking Consequences

This process, known as de-risking, meant that former customers had to search for new banks that could move their money around.

“When de-risking happened, other, possibly smaller, second-tier banks were picking up those opportunities,” said Sanford Brown, a partner at Alston & Bird in Dallas and a former bank regulator. “If you don’t have a correspondent bank and nobody wants you, you have to pay more to find one who will take you. That makes it more lucrative for the new correspondent willing to take the risk.”

New York’s financial regulator has questioned Sweden’s Swedbank AB and two other Nordic lenders about their dealings with Danske’s Estonia unit. Swedbank’s suspicious transactions extend to 2016, according to Swedish broadcast reports, but it’s not clear whether those involved dollar clearing or the Swedish bank’s own Estonia business. All three Nordic banks have New York branches and are part of the U.S. Fedwire, the domestic dollar clearing network.

Several other midsize European lenders were connected to a separate Russian money-laundering operation revealed through leaks published in March.

Correspondent Banking

Lenders in most countries need a correspondent bank to settle dollar or euro transactions on their behalf. All banks in euro-zone countries, regardless of size, can clear fund transfers in euros, and the largest global banks usually can do both. That has helped make cash management a lucrative business for HSBC, Citigroup Inc. and JPMorgan.

The de-risking by the biggest banks forced some countries to overhaul their regulations and practices as the loss of correspondent ties threatened their ability to transfer funds internationally. Mexico and Argentina both established official dialogues with the U.S. Treasury on fighting illicit finance.

“These measures helped provide more comfort to U.S. regulators and U.S. banks,” said Mariano Federici, head of Argentina’s Financial Intelligence Unit. “The increased comfort has led to the reversal of the trend in correspondent account closures.”

Mexico developed restricted accounts with lower identity verification in an effort to bring banking services to more people without undermining the fight against financial crime. People can open accounts without going through the usual know-your-customer process, but they’re closed to international money wires and have monthly cash withdrawal and deposit limits.

Tighter rules, stricter enforcement and enhanced efforts by the biggest banks have made moving money and hiding it from authorities more difficult, according to a lawyer who helps Russian and Middle Eastern clients set up offshore accounts. It’s still possible, he said, but it requires more steps in more places and more front people involved to be successful.

Gaping Hole

Even though the U.S. has been tougher on money laundering than other countries, it still has a gaping hole in its defenses: It’s easy to set up an anonymous shell company in some states without having to declare who the ultimate beneficiaries are.

Last year the U.S. Treasury required all financial institutions to ask for beneficial ownership of corporate accounts. Big banks were already doing that as part of their know-your-customer practices, but making it a hard rule means financial firms of all sizes will have to comply.

Even that rule won’t catch someone who registers a shell company in Delaware and opens an account on a Caribbean island that doesn’t require its banks to demand beneficial ownership information. A criminal trying to hide the illicit cash gets an air of legitimacy by the final destination appearing to be the U.S., even when it isn’t, said Tom Cardamone, managing director of Global Financial Integrity, a Washington-based organization tracking illegal money flows worldwide.

“There’s no logic to why the U.S. still allows anonymous shell companies, when the rest of the developed world has moved toward corporate transparency,” said Cardamone. “Until Congress passes a law that forces ownership out into the open, the U.S. will lag other countries with this weak spot.”

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