Leslie Johns 0:02

Welcome everybody. My name is Leslie Johns and I'm the host of today's Burkle book talk. Before we get started, a few brief announcements. First of all, today's webinar is being recorded. Only the speakers will be visible and audible in the recording. The audience cannot be seen or heard so we are respecting your privacy. Both video and audio recordings of this talk will be available on the Burkle Center website after the talk, as well as on YouTube and an Apple Podcasts. At the bottom of your screen, you should see a button marked Q&A. During the talk, please feel free to push that button and go ahead and submit any questions you might have for our speaker. Later on, during the talk, I will go ahead and I will look at those questions and I will be sure to share them with our speaker during the Q&A portion of the talk. So today's speaker is Julia Morse. Julia is an accomplished young academic who is now an assistant professor at the University of California, Santa Barbara. She was educated at Duke University, as well as Princeton University. Before entering academia, she worked as an intelligence analyst at the FBI, as well as a presidential management fellow at the US State Department. So, she has a lot of experience working in government. And the project that she's going to be presenting today is her first book manuscript. It's called the Bankers Blacklist: Unofficial Market Enforcement and the Global Fight Against Illicit Financing. So I'd like to go ahead and welcome Julia Morse. Welcome, Julia.

Julia Morse 1:54

Thank you. Thank you so much for having me. I'm really excited to be here today to talk about my book. So I will go ahead and share my screen. All right, and we can go ahead and get started. So today, I'm going to talk about my book The Bankers Blacklist, which looks at an area of international cooperation related to stopping money laundering and terrorist financing that is really interesting, because it's one of these areas where policy has changed really, really rapidly, and countries have been able to really work together to kind of implement rules, which is a kind of cooperation that we often don't see as successfully in other areas of international politics. And so there's a lot of kind of broader implications and lessons of the research. So to motivate this project, it's useful, I think, to start with the 9/11 terrorist attacks. So we might remember that when 9/11 happened shortly after there was a lot of attention on how Al Qaeda had paid for this operation and terrorist attack. Actually, it was a relatively expensive attack. So the estimates from the 9/11 Commission are that it cost between $300,000 and $500,000 to pay for the training and all of these different expenses. But what's particularly noticeable about this attack is that the money to fund the hijackers moved primarily through the formal financial system. So primarily from bank to bank transfers from the overseas to the United States. None of these transfers were flagged as suspicious. People did not do anything covert to try and bypass the financial system. And so what this made clear to US policymakers and to policymakers in other countries, was that there was there was a major problem related to the financial system that essentially, if it was this easy for terrorists to transfer funds through global finance, then it was going to be challenging to stop terrorism. And so one of the cornerstones for global counterterrorism was going to need to be countering terrorist financing. So after 9/11 happened, there were a number of international organizations that took action on combating terrorism. And those were bodies that many of you might be more familiar with, things like the UN Security Council, the G8, NATO countries. All of these different organizations were involved in trying to stop terrorism. But the one I want to talk about, in particular, was what was viewed as, is the organization that's responsible for the foundation of kind of broader global counterterrorism efforts and that was an organization that has to deal with terrorist financing. So to give you a sense of the change that has taken place on combating terrorist financing, in 2001, fewer than 10 countries had laws criminalizing terrorist financing. So what does this mean? This means that in most countries in the world, if you gave money to a terrorist who then launched a terrorist attack, used your funds either to pay for the attack or to support themselves, it was not a crime. And so obviously, from a security perspective, this poses some significant challenges. What's interesting about this is that even though there was this surge of political will after 9/11, countries clearly recognize that terrorist financing was important, we didn't get a lot of policy action in this space. There wasn't, immediately after there were a lot of laws passed that were really problematic. They had big gaps. But right around 2010, we saw a huge shift in how this issue was dealt with. And we saw from in 2009, when there was about 20 countries who had these strong laws and terrorist financing, to about 6 years later, more than 100. And today, basically every country in the world has a really strong law on terrorist financing. And so this kind of really rapid policy change is something we don't observe that often in international politics. And so it leads to this question, right, what explains such rapid diffusion of these laws on terrorist financing? And in particular, what is happening in this period between 2010 and 2016 that might help us understand this change? So the answer that I give in this book is tied in part to this organization called The Financial Action Task Force, the FATF, or as the US government likes to call it FATF. So what's interesting about FATF is that it's a small organization that largely flies below the radar. So this is an organization that doesn't get a lot of public attention. It only has 39 member countries, so it's relatively small. It does not have a standing charter or even legally binding authority, technically. And it is primarily a rule setter and compliance monitor. But despite that description, it is an organization that has actually affected the life of everyone in this room, or in this virtual room we should say, because it has drastically altered the global banking system in ways that affect you if you go to open an account, or to send money overseas. So the argument that I make about how FATF has really had an impact in terms of shaping kind of how countries deal with the issues of terrorist financing, and relatedly money laundering, is that they've really driven policy change through something called, that I termed, the non-complier list. And this is the blacklist that's kind of referenced in the title. So since 2010, they have issued what amounts to a public non-complier list, which basically just identifies countries that are failing to meet their standards. Now, on the surface, this list doesn't look particularly coercive. This is not US sanctions, right. This is just a list of countries that aren't doing enough to stop money laundering and terrorist financing. But what happens is that it hurts the reputation of listed countries in a way that ends up being very financially costly. And this is because of the process of unofficial market enforcement. Okay, so global banks use this FATF list to change how they allocate resources to listed countries. As a result, when you're listed, listed countries experience payment delays and higher costs. So the financial costs of listing are felt by banks, firms and private individuals in listed countries, that find it harder and more expensive to engage in cross border banking. And this financial consequence turns into political consequences, where banks are actually advocating for stronger regulation, which is not something we typically see. They want their governments to comply with these standards, so that their country can be removed from the list. So that's the argument, in summary. I want to give you now an outline for the talk and for where we are going today. I'm going to talk first about why banks might care about illicit financing risk, to start. It's not necessarily naturally intuitive or profit based. Then I'll talk about why FATF is a useful signal for global banks. I'll discuss this process of unofficial market enforcement and policy change, and then conclude by talking about some implications and extensions of the project.

Okay, so, to understand why banks care about illicit financing, it's important to go back in the United States to the Bank Secrecy Act in 1970, which becomes the basis for subsequent legislation, which has a move of basically enlisting banks in the fight against financial crime. And this move of putting banks on the forefront of this issue actually is part of what makes this issue area very interesting, and gives market actors and unusual amount of power and influence over policy. So then, in the 1980s, we get the war on drugs and a broader attention to the problem of money laundering. Money laundering, for those of you who might not be aware, it's when you're trying to basically take ill-gotten proceeds from things like crime and whitewash it so that it's clean and can be used through the system. So it's clearly tied to crime, tied to the war on drugs. And the US passes a law criminalizing money laundering, but realizes pretty early on, okay, we can criminalize this. But if it's not criminalized in other countries, one, our financial system institutions are going to be at a competitive disadvantage, and two, it's not going to solve the problem. And so they decide they're going to internationalize the effort by working with G7 countries and a handful of European states and creating this Financial Action Task Force. So in 1990, the FATF was relatively small and largely concentrated in a small number of OECD countries. Since this time membership has expanded. So this is what FATF membership looks like today. And what I would highlight here is that basically all strategically important economies are in this list. So on the one hand, it's much broader, but importantly, it is still a club organization. Most countries are not officially members of the FATF. So how is it that they're able to motivate countries all over to change their policy? Well, they that's part of what this listing process that I'm going to talk about does. But the other thing they've done is basically said, even though we are a club institution, and the group of countries making the rules are just this group that I'm talking to you about right now, we have a much larger global network. So the dark blue countries here are the countries that are officially FATF members. The light blue countries, though, are all countries that belong to sort of regional bodies that have said they will follow the FATF standards. So this is a very unequal system. And I can talk a little bit in the Q&A if people are interested about why these regional bodies formed. But essentially, there was an early coercive process that said, it doesn't matter if you're involved in making these standards, we need you to comply with them anyways. So FATF has two kinds of core missions. The first are that they set global standards on how countries can best combat money laundering and terrorist financing. And then the other thing that they do is that they have a really robust monitoring process, where this organization and the bureaucrats from member states go out and they assess, are countries actually implementing these standards? And they actually rate technical compliance, you know - fully compliant, largely compliant, partially compliant, non compliant - and how effective the implementation is. So, to give a sense of what these standards look like, I want to talk about one standard in particular, that is one of the ones that affects day-to-day banking and has particularly been important for pushing banks to the forefront of security. And these are FATF standards related to know your customer requirements. This is also called KYC. So know your customer requirements basically say that all banks have to take steps to verify who they are doing business with. So for an example of this, this means in practice, okay, banks need to do things like identify and verify who their customers are, understand the purposes of business, and also subject riskier clients to greater scrutiny. Now, in theory, this sounds like an easy task, right to be able to screen your customers and figure out who they are. It's maybe just the baseline that you should know what their business are. However, this last part of subjecting riskier clients to greater scrutiny introduces a lot of ambiguity into bank decision making. So KYC, these kinds of requirements, are everywhere and they are a big industry for banks. So all banks and financial institutions have these kinds of KYC systems and they are regulated by countries. And so FATF sets these sorts of global standards and then countries adopt laws at the domestic level that require banks to do this. And the important part to understand about this is that if you fail to do it, you will pay a penalty. So regulators actually enforce these kinds of procedures. So there are many different fines that I can talk, in 2021 fines related to kind of anti-money laundering failures, which meant like banks didn't set up proper controls to try and screen customers, were close to $2 billion. But then we have specific fines like Standard Chartered, which was fined $1.1 billion for money laundering and sanctions breaches. So this is something that banks have to take seriously because they face financial and then also reputational penalties for not taking it seriously. So for banks, taking KYC seriously means you have to subject riskier clients to greater scrutiny. But this leaves a problem. So how do banks know who the are the risky clients and individuals? One of the solutions that banks use, so banks tend to maintain these really complex risk metric systems, but a primary input into those systems is, what country are you coming from? So if you go today to open an account, or send money from the United States, and let's say you're sending money to someone in Europe, probably your transaction will be screened significantly less than if you are someone in Mexico and you're sending money to Honduras, or if you are even a US citizen who is sending money to Somalia. So depending on what the location of your business is, they will subject it to different kinds of screening. So one of the ways that banks try and figure out a country's risk related to money laundering and terrorist financing is this FATF list that I'm going to talk about. So how, and that's what the next part of the talk is about, is about why the FATF list is such a useful signal for banks when they're evaluating customer risk. So the FATF as an international body has this dilemma, in that they have this club membership where they're able to get deep cooperation, they're able to agree to strong rules, but they technically don't have any real power, because their rules are non-binding. They're not legally enforceable. This isn't the Security Council where they can impose sanctions directly on countries. And so they have to find a way to convince countries to change their policies on this issue. And so the solution that FATF has found since 2010, is this non-complier list. So the non-complier list is based on this compliance evaluation process that I described, where you're essentially evaluating how compliant are countries with these different aspects of things. And part of what makes it really useful and credible for banks is this idea that there is a clear bureaucratic cut point or threshold by which countries are evaluated. So when you're listed, essentially, if you have a certain number of failing ratings, you're automatically eligible for listing. There's a process by which you have time to kind of show that you're working on it. And if you're not making enough compliance improvements, you're publicly identified on this list. Basically saying, hey, these countries aren't doing enough to change their policy. They are, you know, pose a greater risk related to money laundering and terrorist financing. So the first list was issued in February 2010. And less you think this is a list that is a very public kind of blacklist naming and shaming, most countries that are put on this list are listed under what is this particular announcement, improving global anti money laundering, combating the financing of terrorism compliance. So it's a very kind of cooperative sounding announcement. And that's in part because FATF countries don't want to pay really strong political costs for directly sanctioning countries. So this list looks a little bit more cooperative and less coercive than it ends up being in practice.

So just to give you a sense of early listing, here's two of the countries that were listed: Greece and Indonesia. And you can see that there is specific sort of descriptions of the problems that they need to address in order to be removed from from the list. The FATF also issues a second public statement that is a little bit more overtly coercive. They call on members to apply countermeasures. Countermeasures have really only ever been applied to North Korea. Korea and Iran, and again, they're just calling on members. So that's, it's not really a full threat. Most countries that are listed are listed under this announcement that basically says, we're working with these countries and trying to change them. And then occasionally, there are countries listed under this public statement, where they say, okay, countries need to think about the strategic deficiencies, these countries could be higher risk. But even this second public statement list, by and large, it never gets used. It's really the first first kind of list that I'm talking about. Okay, so there are so many countries listed, it's really kind of hard to give you a sense of all of them. But these are ones just that were listed between 2010 and 2020. What I want you to take away is that this list is very broad and applies to a really wide variety of countries. And some of the countries where you look at them, you think Yemen or Syria, of course, there's a terrorism risk. You see, Ecuador, maybe you think there's a money laundering risk, or you know, Panama. But a lot of them are actually countries that are middle power emerging economies, that maybe on the surface don't seem like they would be risky places. And this is part of the power of the list, right? You group all of these countries together, and you're suddenly associated with countries that really do seem super high risk. And that's kind of a stigmatization effect for countries that end up listed. And this is just to give you a sense of some of the news coverage on this. So if you are someone in the financial services industry, these lists are covered extensively, right. So it's a it's a big deal if a country is facing the list, because there is concern about how this is going to affect the economy. So why is the list so useful to banks? Well, as I talked about banks know they're supposed to be screening customers, they know one of the ways they can do this is what country a customer is coming from or sending money to. But it's not clear what the right way is to evaluate a country's risk of money laundering or terrorist financing. And so the FATF list is a really clear, precise signal that it's easy to integrate into quantitative models and has credibility. And how does this get integrated? Well, it gets integrated in a lot of different ways. Here, I pulled a quote just from Moody's, when Panama returned to the list, "Panama returning to the FATF list has the potential to eventually limit bank's business development efforts as some international financial institutions curtail their interactions with Panamanian banks and other financial companies." Right, so these are the kinds of warning messages that are put out there, which then lead both financial institutions and investors to change how they're doing business with countries when they're on this list. So what happens when a country is listing? Well, part of what I show in this book is that listing really leads to the shift in these know your customer procedures, where there's a lot more scrutiny and payment delays for clients in listed countries, which raises the costs of cross border transactions and, in some cases, we get suspension of services actually, or closure of banking channels, where basically banks decide it is too risky to do business with these high risk low yield jurisdictions and so they're just going to cut off that relationship. And that raises some more concerning ethical implications that I'd be happy to talk about in the Q&A. And I'll return to at the end of the talk. So the direct impacts of listing are on things like cross border bank payments. There are also impacts on remittances, so remittances are also subject to know your customer and risk based requirements. And then there's spillover effects on things like trade financing. So part of what makes this list so powerful and so influential in getting countries to change their policy is that cross border banking is connected to so many different types of financial activity. And that's, you know, we've seen the power of banking when we've seen some of what's happened with Russia. The banking system is just an incredibly strong lever to be able to punish countries if they do something that you want them to change their policy for. So just to give you some, a few case examples of how this looks in practice, so these are cross border liabilities, which is bank to bank lending. International banks lending to the Philippines. And what you can see is that here we have when the Philippines ends up on the gray list, there is not too much of a consequence. But then as it moves on, the longer they're listed, and particularly when they get threatened with a higher level of listing, there is a huge drop in cross border liabilities that they suffer from. And this is in part related to changes in remittance flows too, that it becomes a lot more expensive to send remittances during this time. And for the Philippines, the remittance industry was a really important advocate for policy change on this issue, because the Philippines relies on remittances for a lot of, for part of their economic growth. In Turkey, we see a similar process, it's basically a mainly strong downward trend. This trend was driven, in Turkey's case, they were not just threatened with listing, they were also threatened with actually expulsion. So Turkey is an FATF member and the fact that they were so slow to change their policy FATF at some point had to basically say, if you do not change your policy we will threaten to suspend you from membership, which was part of how they ended up changing it. And actually, Turkey is again facing similar, similar concerns and threats. So what happens in listed countries, across many countries that the Banking Association ends up being the ones that sound the alarm. So sometimes, because the FATF is a much more technical body, the high level is not aware of how this list works and they haven't heard about FATF before. But the bank really works strongly to advocate and say, hey, we need to change our policies because if we don't get removed from this list we're going to have major financial problems. And so across a number of different countries, we see a lot of movement in that regard. So what does this mean for compliance with these standards? Or in in the book I'm looking specifically at, you know, do you create a robust law on terrorist financing? And what these plots show basically is on the left side, you have countries that aren't listed by the FATF, the probability if you're not listed by the FATF that you have this really strong terrorist financing law, even 60 months out, is only around 25%. Whereas, if you are listed, the probability that you adopt one of these really strong terrorist financing laws 60 months out is almost 100% of countries do. So to give you a sense, this is another one that shows kind of the reverse and trajectory. If we take the group of countries that ends up on this list, which remember are the countries that have the biggest problems in their anti money laundering and terrorist financing regimes, and we say, okay, what are the policy trajectories of those countries, as of 2009, about 20% of countries that are never listed have strong laws on terrorist financing, and 0% of listed countries. But then after this listing process gets created and gets going, these trends reverse. And so listed countries, which remember, often these countries that we think are more problematic from a terrorist financing perspective, they almost all adopt these strong laws on terrorist financing. Whereas non-listed countries are much slower to adopt strong laws. So just to give you a few more facts about compliance, listed countries are eight times more likely to adopt strong terrorist financing than non-listed countries. And so we get some strange trajectories, like countries like Germany and Brazil, that aren't listed by the FATF, are much slower to adopt comprehensive laws on terrorist financing than some of the countries that are on this list. And the mechanism that I show in the book is that the countries that are the quickest to comply are these where cross border banking is really important.

So to just conclude by talking about the implications, the global policy impact in this area is really astounding. So in the 1990s, very few countries have any anti money laundering laws, and no countries have laws on terrorist financing. Today, nearly every country in the world has robust laws, regulations, and even financial intelligence units, which are a separate arm of the bureaucracy that countries are required to create to process what is called suspicious transaction reports about, you know, this person is a little bit suspicious and they're trying to do business through our financial system. So this is a really, really rapid diffusion, if we think about it, compared to many other kinds of policy change, and it's really, I think, explained in part by the reputation of this organization and then the success in using this listing process to encourage countries to change their policies. The financial impact of FATF is also important to talk about. So today there exists this multibillion dollar anti money laundering industry. And the compliance costs for banks are pretty high. So the estimates are about $31-32 billion for just US and Canada financial institutions. However, there's also been some really unintended negative impacts. So if you remember when I was talking about how banks respond to listing, one of the things that happens sometimes is that banks decide not to do business with certain countries or jurisdictions. And that creates some unintended negative consequences, where poor people in vulnerable fragile states can end up finding it very difficult to access the financial system. And so there is a, I think, a kind of ethical cost to these policies that hasn't been fully considered. And then, of course, there are some broader challenges that I'm happy to talk about. So we've had, you know, the Panama Papers, the Pandora Papers, various exposes that have revealed there is still broad efforts to hide money around the world. Some of these are due to gaps and regulations. And then these papers have revealed that, you know, the US, for example, hold some amount of money because of its laws on trust and real estate. And so FATF is currently trying to kind of tackle those. The other challenge that they're trying to tackle are these of course, cryptocurrencies, new technologies and I'm happy to talk about those in the Q&A if people are interested. So that's what I have for today. I really look forward to all of your questions and comments. Thank you!

Thanks so much. Thanks so much, Julia. So, oh wonderful. Thanks so much. So I just wanted to start off, you know, obviously, this is a really fascinating case that you put together in the book, I was really enthralled to read it. Really interesting story about terrorist financing. But as I was reading the book, you know, I was really interested in and wondering, you know, to what extent the lessons put together by by FATF? Is that how you say it, FATF? Right?

Leslie Johns 32:30

Yeah, that's how the US says it. FATF.

You know, to what extent the lessons learned from that regime might help the US and other states and international organizations to think more broadly about sort of efforts towards sanctions and regulation of of other international issues, like thinking about, you know, the Russian invasion of Ukraine, for example. So, you know, to what extent can we generalize these lessons to thinking about, you know, sort of market enforcement of, you know, upholding international law more broadly. I was wondering if you could riff on that a little bit.

Julia Morse 33:13

Yeah. So thank you for that. Yeah, I definitely think watching everything that's happened with Russia and Ukraine, there's clear kind of spillovers and implications for that area. And what has struck me is there's the official sanctions that have played out in the context of Russia. So there's two things I'd highlight. One is that there's the official sanctions, the official penalties, and then there's all the stuff that has happened where actors have gone above and beyond and have essentially, I think the latest thing I saw was something like 1000 companies have pulled out of Russia or gone beyond what's required by sanctions. And so the question we ask is why, why do companies do that? Well, that's because there's a negative reputational cost associated with still being in Russia with still doing business. And so they face pressure from shareholders and consumers, and, you know, other actors essentially, to not be associated with this, this kind of bad actor. And, you know, on the one hand, that's a really positive thing, if we think this is going to raise the costs of what Russia has done. On the other hand, the downside, let's say we get to a point where, you know, you, ideally, there's a settlement, things move on, and we're trying to roll back the sanctions. You can roll back sanctions. You can roll back sanctions. You can allow business. But, one of the things that happened with the Iran sanctions is that companies aren't necessarily willing to go in there. And so when you think about reintegrating a country into the international system, one of the challenges with using market enforcement processes is that you can't fully control it, right? So they can, they can go out on their own, and they can punish and they can say, this is like, look, we don't want to do business with Russia anymore. But if we get to a point where Russia, you know, ideally pulls back from Ukraine, and you were to think about the next steps of reintegrating them into the international system, that's a lot harder to do if all of these firms have said, no, we don't want to do business with them. So that's not to say that they're wrong to say that, right? That might be the right moral and ethical decision for them. It just means down the line, when you think about trying to move a country back in or integrate it, it's not so easy to undo this process. The other thing that I think really comes out with the Russia story is the power of the Swift messaging system. So those links between banks. So early on, there was a lot of attention given to the fact that Swift, which is this messaging system that connects banks, was essentially weaponized. And they basically said, okay, we're gonna cut Russian banks off from this system. So they did not have an ability to send secure messages to other banks. This was one of the first times this had ever been done. And it was it, it created a much bigger penalty cutting off those banks than just regular sanctions do. So I think there was an awareness that, you know, as you know Leslie, there's this big debate, do sanctions work? Do they not work? Maybe they work sometimes. But I think it what happened with Russia and Ukraine pointed to the fact the realization that banking really offers a different kind of tool of power and influence that can have pretty profound effects on countries, even if this didn't, of course, ultimately end the war or change what Putin did. It certainly raised the costs above what traditional sanctions would be.

Leslie Johns 37:01

Yeah. Okay. Just as a reminder for our guests, you know, I'm getting started with a few questions. But if you would like to submit a question for Julia, please use the Q&A box. You mentioned crypto at the end of your talk. I was so happy to hear you say that. Because you know, one thing that we know, that many of the, you know, advocates of crypto are putting forward is is that this might be one way around the systems of regulation, right. The ability, you know, to get around government control and government regulation. And obviously over the last few months, we've seen a lot of a lot of the balloons being burst about you know, about cryptocurrency. And so I guess, what do the people behind FATF think about crypto? Does it keep them up at night? Do they think it's a fad? I mean, what is their perception about cryptocurrency and the challenges it poses?

Julia Morse 38:04

Yeah, I think there is a view that it poses, I mean, it's a pretty significant challenge and growing, you know, growing moreso. There's concern things like, you know, ransomware attacks. Like in 2017, there was the WannaCry ransomware attacks where information was stolen, and then they were asked to pay in Bitcoin with the idea that then it would be transferred out. And that obviously, there's a lot of ransomware attacks where people are asked to pay in cryptocurrency, with the idea that the money will then be cleaned through this various process where the hackers can use, use it for other things. And then I was just at this conference in the Bahamas where people were talking about how there are towns in Switzerland where you can pay with everything with cryptocurrency now. And so you know, as some places, so it's an area where there is not a clear consensus, I would say, on how to handle it. Some countries have banned virtual currencies and virtual assets completely. Other countries have some kind of regulations. A lot of countries have nothing and it's just a big gap. FATF is trying to regulate it. They're trying to set standards on it and adopt what's called a risk based approach, thinking about the different kinds of policies that you can put in place. And they're about to begin their new round of evaluation. So I think they will be, there'll be a lot more pressure on countries to do something related to this, to regulating that sector. But there is a lot of concern, and I know among law enforcement people there's a lot of concern about the dark web and the things that are being peddled on there. So, you know, there's a lot of unsavory action happening related to cryptocurrency. And so, you know, I don't know how much of terrorists, how many terrorists or criminals are rerouting, but if anything, it's almost a new growth industry of other kinds of people engaging in nefarious activity.

Leslie Johns 40:11

Yeah. Okay. And I guess my final question before going to the to the questions of our guests is, aside from sort of cryptocurrency, what other challenges is FATF focusing on? You know, what are they talking about when you go to the conferences in Bermuda? I must confess, I was a little jealous to see on your Twitter account when you are off, jetting off to Bermuda as like, wow, Julia knows what kind of research to focus on. Yeah, yeah.

Julia Morse 40:43

Yeah. So it's actually Bahamas.

Oh, Bahamas! I'm sorry.

But for me, either way. That conference is run by the Central Bank of the Bahamas, actually. And it's part of their broader, it's interesting, it is part of their broader effort to basically improve their reputation on money laundering. They're basically trying to say, look, we are we are trying to counter money laundering, we, we care about the anti money laundering and illicit financing regime. And so we run this conference of bringing together researchers and practitioners and people working in this issue space. Yeah, it is, I have to say, not a bad thing to have to go to the Bahamas every January to talk about these issues. So I think, I think the issues outside of cryptocurrency, there's a couple. One is about, so they've tackled the technical compliance aspect, but they're really trying to say, okay, if you have the laws, can we actually ask, does this matter for the effectiveness? So putting on my IO scholar hat, it's really interesting, because they're one of the first international organizations to try and say, not just do you have laws, but how effective are the laws you have, and they're trying to come up with a methodology for evaluating that, and to encourage people to move more towards the effectiveness aspect of policy. But that is creating challenges as to what do effective laws look like? And there's not necessarily agreement on that. And how do you evaluate effectiveness? So there's some issues related to that. And then, you know, there's some broader legitimacy questions that always come up in this issue area. Which is, is this just an effort of powerful strong, you know, economies to push these standards on a bunch of like poor countries that may or may not prioritize this issue? And so if you're Fiji, maybe you don't really need strong laws on money laundering or terrorist financing. You know, that might be something that they would say. If you're low capacity, and you don't have a lot of financial crime, why are you being forced to kind of adopt these policies? And really, the approach is very global in nature. And so it doesn't matter if you're a small economy, you have to have these laws on the books. And so there's some inequity concerns that I think FATF was dealing with in an ongoing basis.

Leslie Johns 43:12

Okay, okay. Very cool. Okay. Let me go ahead and turn over to our Q&A portal. It seems like some of the questions that came in early are things that have sort of been addressed through our discussion and through through things you addressed in your presentation. Let's see. One of our audience members wrote in about whether you think technology and AI will affect FATF's work and the broader fight against illicit financial flows? Have there been any talk about the use of like AI and technology in terms of like identifying suspect transactions and things like that?

Julia Morse 44:00

Yes, actually, that's a great question. So at this conference I went to, there were a couple people from private industry presenting on, you know, AI technologies that have been developing and some of those technologies were doing things like trying to use AI to identify, okay, let's look at a bank, who a bank does business with, let's look at the kinds of transactions that are moving through, let's look at the country that is located in. And does everything align? Or do we see some discrepancies? So if you're in a country where the logging industry represents 1% of trade, for example, and then this one bank is reporting 70% of things marked as logging transactions, that might be a flag, right. Something weird is happening here that you need to look at more. So there is there are attempts to kind of think about how do you merge together these perspectives. We also saw in the way that the compliance industry is evolving. So the compliance industry and trying to evaluate how to integrate information and think about country risk is. But they're still kind of the same questions because at some level, there's a conceptual, you know, even if I asked policymakers, what does a high risk country for money laundering look like? There's not an agreement about that, right. So that's why the FATF is useful. We can say, yes, these countries don't have regulation. So it's a good indicator of risk. But what about the US, which is has one of the it has the biggest financial system in the world? Even if we have strong laws and regulations we might have, if 1% of proceeds traveling through here are criminal proceeds, in aggregate, that's a much bigger, right, that's still there's still a lot of flows. And so how do you weigh the risk related to the quantity of of stuff moving, versus regulations and policy? So there's some disagreement in that space, too.

Leslie Johns 46:13

Okay. One of our guests wrote in about correlation between countries being included in the list and a decrease in money laundering activities and terrorist financing. Is that what you meant by talking about effectiveness, right, where you can say, we can look at laws, but we can't necessarily look at effectiveness in the sense because we don't have measures of of the actual levels of laundering and terrorist financing. Is that what you meant?

Julia Morse 46:42

Yes. So for terrorism it's a little easier, because we can look at attacks. There is data on the number of attacks. And we can show that when you adopt a really comprehensive law and terrorist financing, there is a decrease in the number of terrorist attacks, the seriousness of terrorist attacks, the number of people killed. Now, any political scientists will say, well, that could be selection bias. Maybe you adopt a law because you're already concerned, and you're doing all of these other things. So there's a clear correlation. We can't say causally. Money laundering is a lot harder, because there isn't really good data on that. So one of the FATF's initiatives, actually, the the FATF president was telling me this, when we were at the conference in the Bahamas, that one of their new initiatives is to really focus on assets, like to acquire assets, asset recovery, essentially. Like how much money is a country, not just your laws, but are you freezing money that looks like it's coming from criminal proceeds? And what does that look like? And even though that's only a partial window into the money laundering question, it still gives a lot of useful insight and helps us understand what the kind of flows are that are moving through a country.

Leslie Johns 47:56

Okay. One of our guests wrote in that, it seems like FATF is focused on targeting nations, but it seems like the people who are actually doing the wrongdoing is really occurring at the level of the banks. So has there been an attempt to sort of focus on targeting individual banks involved in terrorist financing, rather than focusing at the level of the country?

Julia Morse 48:28

Yeah, so it's complicated. There's two kinds of levels. The first is that in some cases, in some cases, governments, particularly early on, governments themselves were just not adopting the right kind of laws to regulate their banking center. Or if they had laws on the book they weren't, you know, enforcing them. And so there was a government, part of the reason that FATF focuses on the government is because, I mean, one, it's easier from a policy perspective, but also you do need government buy in and cooperation. So, you need governments to have laws that criminalize terrorist financing, even for things like mutual legal assistance assistance, right? If you want to extradite someone, it's going to be harder if whatever they're doing is not a crime in that country. Whereas if you have a treaty or if you have an agreement. So you do need government buy in. That being said, one of the things that happened early on, was that banks in some, particularly in these emerging economies, started to say, well, we don't care really if our government is doing this thing, like we are going to over comply, we are going to implement these policies because we don't want to be cut off from the global financial system. And so there was a kind of spread of best practices among the banks. Distinguishing between, you know, which banks are doing those kinds of robust due diligence procedures in which banks are not is harder. But that actually is one of these things that this new AI technology is part of what. That might be something that it would have allow you to do. So instead of saying, I can't do business with everyone in Iraq, for example, I can look at the specific bank in question and say, what is their actual risk profile like, and base my lending policies on how much I charge and all of that on their specific risk price profile. And that's part of how this is a private company, it's based in Germany that does this, that is it's trying to sell this to banks as this alternative mechanism.

Leslie Johns 50:29

I see. Okay. And one of our guests asked you to go back to some of the ethical issues you talked about towards the end of the presentation, particularly pertaining to middle and low income countries that restrict listing country's banks from international bank transactions, asking how you feel about that? Do you think FATF is too liberal or too conservative in listing countries? I don't know if you feel comfortable going there, but it can't hurt to ask I guess, since you are an expert on the topic.

Julia Morse 51:06

Yeah, no, I'm happy to talk about it. I think I will give my musings but probably won't come down on one side or the other. Because I think it's a really complicated issue.

Leslie Johns 51:15

Just among a few friends and YouTube and Apple podcasts, feel free to share your intimate thoughts.

Julia Morse 51:25

I think that when they first started this process, and when the list first got going in 2010, there wasn't much of a recognition of the negative consequences. To be honest, I don't think they fully anticipated how the global banking system was going to change as a result of this. So I have, one of the things that has happened is that the number of correspondent banking relationships, which are the sort of things that link a bank to other banks and make it really easy to send money, these have declined significantly over the last decade. Some of that is related to anti money laundering and KYC costs. Some of that is related to Basel III regulation. It's there's a whole bunch of different reasons. But regardless, what it means is that, for example, banks in the Caribbean that used to have four or five different international banks who were based there, and who would do business with them, now, there's only one in each country. There's one bank, one regional bank that does bank with all of these local businesses, which obviously means you can charge more for money. And it creates these problems. And in some very rare cases, we have seen countries that got completely debanked. So this happened in Vanuatu, for a little while, and Nauru, where countries were just, there were no banks willing to go in there. So over time, the World Bank, the IMF, the Inter-American Development Bank, some of these other other institutions have become more aware of the problem. FATF has become more aware of the problem. They've tried to tell banks take a risk based approach, don't just cut off relationships, you know. They've really tried to, to suggest that they should think more about it. But this is where it goes back to, to my answer on Russia, right? The problem with markets is that you can't fully control their processes. And what banks say is, these are clients that weren't particularly to begin with and now they're just too risky. You know, it's just not worth doing business with them. And so I think the workaround that the international community is trying to get at is to provide alternative ways to engage these countries in the financial system. So alternative financial access points. If they're not going through the formal banking system, can we create an international body there that's able to like connect them or offer alternative ways so that we prioritize financial inclusion. So I do think there is a thoughtful conversation about this issue happening. That being said, it's really hard to weigh, you know, concerns about terrorism and money laundering against things like economic opportunity and development. And I don't think we have enough research to kind of come down on one side or the other. But I do think being in a space where policy is being made, that is cognizant that that choice is happening sometimes, is really important. And that it's not just, you can't just go out and shift the banking system and deploy it whenever you want. For these things, without these other unintended consequences that might end up really affecting the lives of people who are already fairly vulnerable. Yeah, so that's not a decisive issue one way but that these are I think the things that I at least I'm thinking about.

Leslie Johns 54:58

Okay, well thank you so much for joining us, Julia. You know, we have some other questions in the queue. But they're all pretty basic. And I feel like they're all on matters that we've already kind of touched upon. And we only have a couple of minutes left anyway. So I think that's a good point to end the our talk on. Thank you so much for joining us. I think as you guys can all tell in the audience, it's a really fascinating project. It touches on so many really interesting issues, both of national security, international security, as well as economics. So I really encourage you guys great spring break book for those of you who are students in the audience. Get it, take it to Cabo, take it to Florida. Read it at the beach, great way to pick up girls or boys or whatever you enjoy. So, thank you so much, Julia. It was wonderful to see you and thanks so much to everyone in the audience. Next week, we will be featuring a book by Susan Shirk from UC San Diego. She'll be talking to us about her new book on China. So I hope to see you all soon. Thank you so much.

Julia Morse 56:09

Bye. Thank you for having me.

Transcribed by https://otter.ai