by Wing Commander Udith Pathirana
Published on Ceylon Today on 02nd August 2023
Introduction
In recent years, global financial regulators have given precedence in addressing the growing apprehension regarding the regulation of illicit financial activities. This heightened focus is primarily driven by the escalating risk posed by various forms of terrorist activities, including extremism, global terrorism, and criminal operations. Thus, regulators were merely targeting to curtail the lacuna of the regulations, strengthening Anti Money Laundering (AML) mechanisms and mitigating the plethora of avenues available for Money Laundering (ML) and Terrorist Financing (TF) within the global financial system. Accordingly, the Financial Action Task Force (FATF) being an independent intergovernmental organization plays a pivotal role in an international forum to combat ML, TF and other potential threats to the integrity of the international monetary system. Thereby, FATF influence to establish viable standards on the financial mechanism and promotes the enactment of operative measures to prevent and detect these illegitimate finance activities globally.
Subsequently, the purpose of the FATF Asia/Pacific Group on ML (APG) is to guarantee the adoption, implementation and enforcement of internationally accepted AML and counter-terrorist financing (CTF) standards as set out in the FATF Forty Recommendations (FATF APG, 2015). As a result, the effort includes assisting regional countries in enacting laws and regulations to mitigate and prosecute financial crimes and providing professional legal assistance for confiscation, forfeiture and extradition. Especially, FATF APG offers guidance in setting up profound mechanisms for reporting and investigating suspicious money transactions and the establishment of Financial Intelligence Units (FIU) (FATF, 2023).
Consequently, the Mutual Evaluation Report (MER) conducted by the FATF APG and Central Bank of Sri Lanka (CBSL) in 2015 provides a comprehensive analysis of deficiencies related to Sri Lanka's financial mechanism (Pathirana, 2023). Specifically, the absence of Know Your Customer (KYC) and Customer Due Diligence (CDD) procedures for authorized moneychangers, Informal Money or Value Transfer Services (MVTS), and Non-Bank Financial Institutions (NBFIs) was identified as non-compliant by MER, but it was elevated to the level of Largely complaint by the FATF 6th Follow-Up Report in 2021 (FATF APG, 2015, 2021).
Existing Problem
Nevertheless, the FIU's oversight of regulating MVTS entities in Sri Lanka has been relatively limited, leading to significant implications for the country's financial mechanism. Therefore, it is crucial to identify that MVTS pose severe vulnerability to any nation's security since they are directly facilitating the conversion of money into different currencies. Thereby, the increased potential remains to make criminals conduct ML operations safely and less traceably due to the alteration of its original form. As a result, addressing and strengthening regulations concerning these entities becomes of paramount importance to bolstering Sri Lanka's efforts in combating ML/TF and preserving the integrity of its financial system. Accordingly, this revised discussion underscores the requirement of implementing mandatory requirements to curb ML/TF by emphasizing the significance of robust regulatory frameworks for MVTS.
Discussion
Indeed, MVTS operate as private entities with the primary goal of generating profits from their business activities. Nevertheless, the absence of a well-coordinated platform for monitoring and investigating KYC processes poses critical challenges for legislative authorities in tracking money trails during investigations. At times, despite significant sums being converted through MVTS, even such transactions are not adequately scrutinized, allowing small amounts of money to be converted without thorough inquiry into the associated details. Consequently, this creates an opportunity for ML/TF activities, specifically the technique known as "smurfing," to be easily conducted through MVTS.
It is vital to understand the negative effects of unregulated MVTS functioning in Sri Lanka as mentioned below.
• Increasing Criminal Activities The ease of converting currency through MVTS would encourage criminals to conduct illicit activities to acquire money posing significant threats to both economic and national security.
• Smuggling and Illicit Trade Across Borders. MVTS could inadvertently facilitate smuggling and illicit trade across borders by undermining the country's regulatory mechanisms by adopting a system interlinked with Hawala and Hundi (also known as Undial).
• Evasion of Currency Controls. During an economic instability, MVTS could facilitate the money flow outside financial controls imposed by the CBSL while making efforts of stabilizing rates into failure.
• Exchange Rate Volatility. Implementing effective monetary policies would become ineffective due to additional liquidity and unpredictability in the foreign exchange market, leading to increased exchange rate volatility.
• Impact on Balance of Payments. Unregulated money flow through MVTS could imbalance the country's balance of payments which would lead to a depletion of foreign reserves, affecting the ability to make international expenses.
Further, the presence of unregulated MVTS activities in Sri Lanka can have significant adverse effects on the country's national security as mentioned below.
• ML and TF. Unregulated MVTS are creating opportunities for criminals and terrorists to launder illicit funds and finance their activities without proper oversight.
• Weakening in AML and CTF Efforts. The lack of regulation against MVTS would weaken AML and CTF measures imposed by the government that leaves the country vulnerable to financial crimes.
• Loss of Revenue. Invariably MVTS would result in revenue leakage of the government due to non-reception of fund essential services and security measures.
• Economic Instability. The unregulated flow of foreign currency through money exchange services can lead to economic instability. It may create volatility in the exchange rates and impact the value of the local currency, making it susceptible to external economic shocks.
• Creation of Criminal Finance Medium. MVTS are providing a medium interlinked with Hawala and Hundi for criminal networks to fund across borders discreetly which can threaten national security.
Sri Lanka, being a tourist destination, strives to boost its income through diverse strategies. On the other hand, MVTS facilitates the integration of foreign currency into the local monetary system with fewer restrictions and minimal government taxes. Unfortunately, several consequences that could occur due to money integration without proper oversight might open the door to potential misuse, as it could be exploited by individuals with malicious intentions, including those involved in ML and TF.
The Easter Sunday Bombings served as a stark reminder of the vulnerability to extremism and terrorism in our nation. Hence, to address these concerns, the CBSL has implemented measures in collaboration with the Sri Lankan Customs Department to meet the FATF recommendations by limiting the amount of foreign currency an individual can bring into the country to USD 15,000 during arrival (AASL, 2023; FATF APG, 2021). This restriction is intended to prevent large sums of foreign currency from entering the country unchecked and unmonitored. However, it is crucial to consider that even with this limitation, there is a significant potential to use MVTS for currency exchange and integrate it into the local monetary system for ML and TF activities using the "smurfing" technique due to the non-availability of KYC and money trail.
In conclusion, while Sri Lanka aims to boost its income through tourism, it must be vigilant in adopting measures that strike a balance between facilitating legitimate economic activities and safeguarding against potential risks associated with ML/TF. Close cooperation between relevant authorities, strict monitoring, and continuous evaluation of regulations are essential in maintaining the integrity of the financial system and ensuring the nation's security.
Way Forward
Sri Lanka could enhance the effectiveness of its currency exchange rate control mechanisms by strengthening oversight and promoting transparency in the MVTS sector during economic fluctuations. Further, it includes enhancing supervision and regulation of MVTS, promoting international cooperation to combat cross-border financial crimes, and improving intelligence-sharing among relevant agencies. Moreover, to mitigate the adverse effects of MVTS activities on AML/CTF and overall economic stability, responsible agencies should take the undermentioned proactive measures to ensure national security.
• Enhancing the regulation and supervision of MVTS providers to ensure compliance with currency control measures to avoid exchange rate volatility.
• Governments must enforce strict KYC and AML regulations to mandate the record keeping of KYC to identify money trails during any investigation while imposing liability to penalize during illicit conversion authorisation.
• Provide adequate resources to the FIU for efficient monitoring and investigation of suspicious conversions and conduct regular audits of MVTS.
• Establishing a shared information system with MVTS. In such situations, FIU can collaborate with legislative authorities to facilitate suspicious money exchange activity reporting systems.
• Fostering financial literacy and promoting the use of formal banking channels for foreign currency transactions can help curb the informal or illicit use of money exchange services. Thereby, striking a balance between promoting economic growth and safeguarding national security remains crucial in managing the impact of money exchange activities on Sri Lanka's overall well-being.
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* Wing Commander Udith Pathirana is a Military Research Officer at the Institute of National Security Studies (INSS), the premier think tank on National Security established under the Ministry of Defence. The opinions expressed are his own and not necessarily reflective of the institute or the Ministry of Defence.