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Enhancing the Asian Development Bank's Role in Combating Money Laundering and the Financing of Terrorism : II. The Policy Context
D. Negative Effects of Money Laundering513. The negative economic effects of ML on economic development are difficult to quantify, yet it is clear that such activity damages the financial sector institutions that are critical to economic growth; reduces productivity in the economy's real sector by diverting resources and encouraging crime and corruption, which slow economic growth; and can distort the economy's external sector–international trade and capital flows–to the detriment of long-term economic development. Developing countries' strategies forestablishing OFCs as vehicles for economic development are also impaired by significant ML activity through OFC channels. On the other hand, effective AML policies reinforce a variety of other good-governance policies that help sustain economic development, particularly by strengthening the financial sector. 14. The Financial Sector. A broad range of recent economic analyses all point to the conclusion that strong developing country financial institutions–such as banks, nonbank financial institutions (NBFIs), and equity markets–are critical to economic growth. Such institutions allow for the concentration of capital resources from domestic savings–and perhaps even funds from abroad–and the efficient allocation of such resources to investment projects that generate sustained economic development. 15. ML impairs the development of these important financial institutions for two reasons. First, ML erodes financial institutions themselves. Within these institutions, there is often a correlation between ML and fraudulent activities undertaken by employees. At higher volumes of ML activity, entire financial institutions in developing countries are vulnerable to corruption by criminal elements seeking to gain further influence over their ML channels. Second, particularly in developing countries, customer trust is fundamental to the growth of sound financial institutions, and the perceived risk to depositors and investors from institutional fraud and corruption is an obstacle to such trust. 16. The adoption of AML policies by government financial supervisors and regulators, as well as by banks, NBFIs, and equity markets themselves, will not only protect such institutions from the negative effects of ML, but also reinforce the other good-governance practices that are important to the development of these economically critical institutions. Indeed, several of the basic AML policies, such as know-yourcustomer (KYC) rules and strong internal controls, are also fundamental, long-standing principles of prudential banking operation, supervision, and regulation. 17. The Real Sector. Aside from eroding developing countries' financial sectors, ML has a more direct negative effect on economic growth in the real sector by diverting resources to less productive activities and by facilitating domestic corruption and crime, which in turn depress economic growth. 18. As can be seen from the various ML typology reports, money laundered through channels other than financial institutions is often placed in what are known as "sterile" investments–real estate, art, antiques, jewelry, and luxury automobiles–or investments that generate little additional productivity for the broader economy. For developing countries, the diversion of such scarce resources to less productive domestic assets or luxury imports is a serious deterrent to economic growth. Moreover, criminal organizations can transform productive enterprises into sterile investments by operating them for the purposes of laundering illicit proceeds rather than as profit-maximizing enterprises responsive to consumer demand and worthy of legitimate investment capital. 19. Within developing economies, ML also facilitates crime and corruption, which are antithetical to sustainable economic growth. Just as an efficient financial sector is a key contributor to a country’s economic development, an efficient AML regime should raise the transaction costs associated with ML and thus help deter crime by making it less profitable. As numerous studies and statistical and anecdotal evidence have demonstrated, substantial crime and corruption act as a brake on economicdevelopment. Other studies have shown that AML policies can prevent this adverse situation. 20. The External Sector. Unabated ML can also impair a developing country's economy through the country's trade and international capital flows. The well-recognized problem of illicit capital flight from developing countries is typically facilitated by either domestic financial institutions or by foreign financial institutions ranging from OFCs to major money-center institutions such as those in New York, London, or Tokyo. Given that illicit capital flight drains scarce resources from developing economies, transnational ML activity impairs developing-country growth. On the other hand, there is little evidence that the imposition of AML policies in a given jurisdiction spurs a significant flight of capital to more lax jurisdictions. Moreover, just as the confidence that developingcountry citizens have in their own domestic financial institutions is critical to economic growth, the confidence that foreign investors and foreign financial institutions have in a developing country's financial institutions is also important for developing economies because of the role such confidence plays in investment decisions and capital flows. 21. ML can also be associated with significant distortions to a country's imports and exports. On the import side, criminal elements often use illicit proceeds to purchase imported luxury goods, either with laundered funds or as part of the process of laundering such funds. Such imports do not generate domestic economic activity or employment, and in some cases can artificially depress domestic prices, thus reducing the profitability of domestic enterprises. 22. Offshore Financial Centers as a Development Strategy. Over the past decade, dozens of OFCs have been created as part of developing countries' (or territories') efforts to develop their domestic economies through the provision of international financial services. These OFCs can be classified along a spectrum from "notional" OFCs that provide minimal financial services and are simply a jurisdiction in which "nameplate" operations may be established to "functional" OFCs that provide a wide range of value-added financial services. 23. Studies of the effectiveness of establishing an OFC as an economicdevelopment strategy have shown that notional OFCs contribute little to the surrounding economy and do not form the basis for sustained economic growth. First, notional OFCs are virtually costless to establish, and therefore competition among them for customers is severe. Second, because they provide little value-added services, notional OFCs generate almost no economic demand for the surrounding "real" economy in terms of employment, goods, or services. 24. On the other hand, truly functional OFCs require significant investments in infrastructure–communication facilities and even a skilled labor force. Thus, their number is small and the commercial returns to the ones that emerge as strong competitors are high. Moreover, functional OFCs benefit their surrounding "real" economies through their demand for goods, services, and an educated workforce to support the OFCs' valueadded activities. 25. This distinction between notional and functional OFCs becomes critical in assessing the economic effect of ML on OFCs as an economic development tool. ML per se does not require the more costly value-added services of a functional OFC, and therefore may gravitate to merely notional OFCs–the very type of OFC least able tocontribute to the country's real economy. In contrast, legitimate international capital is more likely to require the services of a functional OFC and will be deterred from making extensive use of an OFC tainted by widespread allegations of ML and the associated activities of fraud and corruption. Thus, for a country to implement a successful economic-development strategy based on the establishment of an OFC, the strategy must adopt measures to control ML activity through the OFC. ____________________
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