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The Risk Watch Column
By Dr Alan Waring
Mutual Recrimination
In recent months, we have endured a deluge of brouhaha about alleged large scale money laundering through Cyprus banks. On the one hand, we have had the accusers from outside Cyprus led by a posse of northern EU finance ministers and their acolytes. To them, Cyprus had gone ‘beyond the Pale’, a renegade state in which the financial management of the government and the banks was so chaotic, incompetent and corrupt that money laundering had become an accepted part of the country’s business model.
The ‘money laundering’ issue, of course, attracts huge media attention and is a populist politician’s dream-come-true for vote-catching propaganda. In particular, the German Finance Minister Herr Dr Schäuble, the self-appointed EU Witchfinder General, knew this only too well but he was not alone. Other politicians, officials and technocrats in a range of EU countries followed suit. Cyprus had to be made an example as a warning ‘pour encourager les autres’ among other EU countries that might think that they too could get away with gross financial mismanagement, including money laundering, and still expect to receive an EU bailout without tough terms and conditions. For this, and its perceived obstructive attitude and behaviour over the bail-out, Cyprus had to be punished, as one very senior Eurogroup official involved in the bailout negotiations has reportedly admitted.
On the other hand, inside Cyprus there has been an equal cacophony of politicians, bankers and others crying ‘Foul! Unfair! Anti-Cypriot! Outrageous!’, against any and all suggestions that the Cyprus financial mess was anything more than an unfortunate accident. The government and Cypriot bankers were not really to blame. It was the unforeseeable consequences of the Greek bonds haircut and a downturn in the tourism and property markets. Once again, Cyprus is portrayed as an innocent victim. The real villains, the story went, were foreigners and the worst offenders of all were the northern EU political leaders. The existence of money laundering (ML) in Cyprus is flatly denied, while other northern EU countries are accused of being the real ML centres.
What is the Truth?
No one can offer any absolute truth, only perspective, interpretation and opinion which hopefully draw on facts (accepted or not) and evidence.
Both camps are right and both wrong. It is difficult to believe that any country could claim realistically to be 100% free of ML since it is virtually impossible to eradicate completely any kind of crime. I do not recall that UK and Germany, for example, have ever claimed that their countries are ML-free. Such crimes are inevitable there, given their size and position as international financial centres. However, they do have in place not only stringent anti-money laundering (AML) systems, but also the political will to implement them, to investigate allegations thoroughly and to enforce stiff penalties. People are prosecuted, companies are massively fined and individuals do go to jail. Cyprus, however, flatly denies any money laundering and, moreover, according to the latest Report from Moneyval and the Independent Auditor (Deloitte) dated 10 May 2013, lacks the will and credible AML systems in the banks. The report states that ‘the banks failed to report a significant number of suspicious transactions to the authorities, including very compelling cases’.
The continuing blanket denial by Cypriot authorities and banks that there ever has been any ML, or even suspicious money movements, not only implies possible official complicity as part of a corrupted national business model but also flies in the face of evidence. The Moneyval/Deloitte Report states that of the 390 bank customers of Cyprus banks in their sample, only four internal investigations for possible money laundering were recorded during the period 2008-2012. The auditor also “observed a general lack of traceability of controls performed within customers’ files (with specific reference to high risk customers)”. Further, “the banks’ awareness of the measures to be taken at client take-on and on an on-going basis was found to be insufficient”. In other words, due diligence by Cyprus banks towards customer risks in general was found to be weak.
The ‘Cyprus is innocent’ camp has argued that (a) its AML systems and procedures are robust, and (b) its AML regime works as evidenced by so few cases arising and resulting in convictions. Part (a) of that argument has now been demolished by the Moneyval/Deloitte report. The evidence in support of part (b) is flimsy at best. If, the banks’ AML systems are failing to identify possible cases, these will not be referred to the authorities. If MOKAS, the serious financial crimes unit, has few referrals and the administration of justice and political leadership prefer to turn a blind, laissez-faire eye, it is hardly surprising that virtually no cases ever get to court. Passage of the Milosevic millions (or possibly billions) through Cyprus against UN sanctions has been air-brushed out of the picture. So too has the on-going Raja case in India where the former Telecoms Minster Mr A. Raja is on trial accused of, among other things, channelling a large part of €479mln in bribes allegedly taken in India through the Cyprus accounts of a suite of 22 dummy Cyprus companies all registered at a single address in Strovolos and out to his wife’s accounts in Mauritius and the Seychelles. Indian trials are notoriously slow but, when the evidence is aired in court, how will the ‘Cyprus is Innocent’ camp respond? More denial and obfuscation, perhaps?
The ‘Cyprus is Innocent’ camp is right in one respect. Schäuble & Co have over-egged their ‘Cyprus is Guilty’ omelette as far as ML is concerned. By exaggerating the ML issue, they have led the world to believe that ML is the major Cyprus topic at issue. This grandstanding for the northern EU electorates may be good PR from their point of view but, apart from its dubious probity, it has had two bad effects in Cyprus. First, it provoked the ‘Cyprus is Innocent’ camp to utter much denial and defensive rhetoric which, the Moneyval/Deloitte report now reveals, was very unwise. The result: hubris. Schäuble & Co can now crow ‘We told you so’. Second, it cast attention away from other equally important risk issues for the banks and the economy. Due diligence is not just about AML, as my latest book Corporate Risk and Governance shows. The book’s 75 case studies include a number involving Cyprus.
Due Diligence Requirements
According to the Troika memorandum on Cyprus, risk failures such as credit, loans and mortgages given by banks too freely at the start, followed by laxity in Non-Performing Loan monitoring and then failure to apply NPL recovery procedures, were clearly involved in the collapse of Marfin Laiki and the difficulties at BoC. The collapse of the sub-prime mortgage market in the U.S. is another example. Although such risk failures were not the primary cause, similar ‘soft’ factors were clearly involved in the poor risk management at banks such as HBOS and RBS. All of these examples involved poor due diligence by the banks.
Due diligence may be defined as: the exercise by a party to a relationship, contract, transaction or deal which seeks to demonstrate an appropriate and adequate degree of searching examination of an individual or entity to establish their probity, honesty and bona fides, and to uncover any hidden relevant facts, from which it may be reasonably deduced whether or not that party should proceed with the relationship, contract, transaction or deal. The product is a customer risk profile for informing bank decisions about the customer.
Due diligence cannot rely solely on credit rating agency reports as they tend to focus on financials at the expense of other germane information. Personal knowledge of applicants by bank staff is a two-edge sword. While it may prove helpful in many cases, friendships may also blind the bank employee to weaknesses in the customer that may be risk factors. In the worst case, a personal relationship may open up the possibility of collusion, fraud and corruption.
Due diligence therefore requires evaluation of the customer on a range of topics, including background checks on individual applicants or the business owners and senior personnel of companies (evidence of honesty and probity; financial statements and tax records; source of funds; loan and debt records; previous bankruptcies; court cases; press and media reports; life-style risk-taking (e.g. drugs, gambling) that might affect income, debt and actions; debt servicing etc). Customer due diligence is required at both take-on and periodically, since their risk profile may change.
The Moneyval-Deloitte report: http://www.financialmirror.com/news-details.php?nid=29943
For over 30 years, Dr Alan Waring has been an international risk management consultant with extensive experience in Europe, Asia and the Middle East. His latest book Corporate Risk & Governance will be published on 31 May 2013 (www.gowerpublishing.com/isbn/9781409448365 ). Contact [email protected]
©2013 Alan Waring
