TRANSFORMING INDUSTRY, DEVELOPING ZAMBIA

IN last week’s edition, we discussed the role of the banking sector in combating money laundering and we also briefly discussed how the banking sector works in close collaboration with the Financial Intelligence Centre in achieving this.

This week, we delve deeper in the conversation on money laundering and its effects on a country’s economy, as well as the risk it poses to the banking sector.

In his paper: The Role of the Banking Sector in Combating Money Laundering, former Bank of Zambia Governor-Dr. Caleb Fundanga (2003) explains that money laundering poses effects on a country’s economic, political, and social structures, and has effects on the financial systems.

He identified the following as some of the effects of money laundering:

The undermining of legitimate private sector efforts. Money launderers use front companies, to disguise the proceeds of illicit activities and in the process hide the ill-gotten gains. These companies have access to substantial illicit funds, therefore allowing them to subsidise the from company and offer its products and services at levels below market rates. Because they can afford to quote prices below the production cost, they tend to have competitive advantage over business entities that source their funding from financial markets. This unfair competitive edge makes disadvantages competition for legitimate businesses against these front companies, and ultimately crowding out the legitimate private sector entities, by the criminal entities.

Another very important factor to note is that money laundering can also affect currencies and interest rates as launderers reinvest their funds where their schemes are less likely to be detected, rather than where rates of return are higher. Money laundering also poses a threat to monetary instability, owing to the misallocation of resources. This is largely because the practice could result in inexplicable changes in money demand and increase volatility of international capital flows, interest, and exchange rates, thereby tending to reverse the gains of well-intended sound economic policies.

Because money launderers are not necessarily interested in profit generation from their investments, but rather in protecting their proceeds, they tend to invest their funds in activities that may not be of economic benefit to the country.

Money laundering is known to lead to loss of revenue, by way of making tax collection efforts difficult, thus leading to decline in tax revenue. This entails government setting higher tax rates than would normally be the case.

The practice of money laundering activities also poses a risk to governments’ economic reform efforts, especially privatisation of state-owned enterprises. This is because, money launderers have the financial muscle to out-bid legitimate investors. While privatisation initiatives are often economically beneficial, they can also serve as a vehicle to launder funds. Criminals have been known to purchase privatised entities to hide their illicit proceeds and further their criminal activities. It is for this reason that Dr. Fundanga explains that developing countries, risk being exposed to the threat of money laundering because in the process of attracting investments, they become more vulnerable to accepting laundered money.

Money laundering could also expose any recipient country to reputation risk. In today’s global economy, nations cannot afford to have their reputations eroded by associating themselves with money laundering activities. Money laundering and other financial crimes tend to erode confidence in the financial markets. Furthermore, the negative reputation resulting from these activities diminishes legitimate global opportunities available to any country and this could result in slowed down sustainable economic growth.

The above account for the effects of money laundering on any economy in the world. However, money laundering also has effects that directly impact the banking sector.

Owing to banks’ confidentiality principles and their ability of handle huge cashless transactions and transmit funds efficiently, they are normally the targets of money laundering activities. Some of the effects this vice has on banks include the following;

1. Reputation Risk: banks become vulnerable to reputation risk because they can easily become a conduit for illegal activities perpetuated by their customers. The association of banks in such activities tends to taint their reputation and they risk losing customer confidence. It is therefore imperative that banks continue being vigilant and constantly evaluating their customer base. Theis entails that in their quest as banks to mobilise deposits and improve liquidity, must not be an overriding factor to accepting money from uncertain sources.

2. Legal Risk: banks could be subjected to lawsuits resulting from failure to observe the ‘know Your Customer’ (KYC), standards of from the failure to practice due diligence in customer evaluation and acceptance. As a result of this, banks could suffer fines and penalties.

3. Concentration Risk: banks are expected to have information systems to identify credit concentration and to set prudential limits to restrict exposures to single borrowers or groups of related borrowers. The challenge for banks, therefore, is to adopt vigorous measures for the detection of suspicious transactions, since failure to report such transactions under the money laundering legislation may subject the bank to criminal sanctions.

The lack practices of measures to curb money laundering in a bank may also affect the bank’s relationships with correspondent banks because reputable international banks would not want to be associated with banks that do not practice basic anti-money laundering techniques.

This tends to threaten a bank’s own operations. Money laundering also compromises the corporate structure of banks, and this is especially true for smaller banks, in their quest for deposit mobilisation and customer selection.

As always, your feedback is highly valuable, and this platform offers an opportunity for further engagement with members of the public on matters relating to Commercial Banking. Please share your feedback with us via E-mail: Mirriam.Zimba@baz.co.zm