## Part 1: Assessing the AML/CFT in the legal and institutional framework ## Source details **Canonical URL:** [Part 1: Assessing the AML/CFT in the legal and institutional framework](https://www.imf.org/-/media/files/publications/ofca/english/cr04170.pdf) ## Other formats - [Markdown version](/-/media/files/publications/ofca/english/cr04170.pdf.md) - [Structured JSON version](/-/media/files/publications/ofca/english/cr04170.pdf.json) --- ### Overview of the IMF assessment - The mission conducted an assessment of Palau’s observance of the Basel Core Principles for Effective Banking Supervision as part of a Module 2 assessment under the IMF’s Offshore Financial Centers initiative. - Sources relied upon: laws and draft regulations, material provided by the MAE Banking Supervision Advisor, and discussions with Palauan government officials and the Financial Institutions Commission (FIC). - The FIC was described as being in a “very early/formative stage”; where Core Principles centered on implementation, qualifiers note implementation remained outstanding. ### Institutional and market structure — key findings - Financial sector composition: - 12 commercial banks, including 3 branches of U.S.-based banks. - 1 development bank: National Development Bank of Palau (NDBP). - 11 non-bank financial institutions (three reportedly not in operation and eight providing limited financial services). - A number of small credit unions. - Offshore banking not allowed since 1982 (Offshore Banking Act repealed). - No capital markets and no International Business Companies (IBCs) registered/operational. - Market concentration and asset flows: - The largest three U.S.-based banks account for approximately 84 percent of total deposits. - The Bank of Hawaii accounts for nearly 57 percent of total deposits. - U.S.-based branches place the majority of their deposits at their U.S. headquarters for investment elsewhere. - Lending, guarantees, and arrears: - NDBP guarantees 90 percent of commercial loans and can assume title to land in case of default. - NDBP portfolio size is about $7 million, of which one-third is in residential housing. - Loans in arrears (“judgment loans”) stand at about $0.7 million, or 10 percent of total loans. - Profitability and interest rates (1997–2000 period): - Deposit rates on 30-day time savings accounts: in the range 2 ¼–5 percent. - Deposit rates on certificates of deposit: in the range of 4–8 percent. - Lending rates for consumer loans: between 10–18 percent. - Lending rates for commercial loans: 9 ¼–13 percent. - Nonperforming customer loans have historically been very low; aggregate profit reported for Palau’s nine largest banks. ### Legal, institutional and supervisory preconditions - Legal system and accounting: - Palau’s legal system closely resembles the United States. - U.S. lawyers play an important role due to scarcity of local accounting and legal professionals. - Until adoption of the Financial Institutions Act (FIA) of June 2001, financial institutions followed cash-basis accounting dictated by tax considerations. - Pursuant to the FIA, financial institutions will be required to follow Generally Accepted Accounting Principles (GAAP). - Transparency and audit requirements: - Disclosure rules were deficient; financial institutions not legally required to have audited balance sheets and income statements by reputable external auditors (domestic banks exempt). - Safety net: - FIA provides for receivership of banks in case of insolvency, but no formal deposit insurance system envisaged for domestic banks. - U.S. branches are FDIC-insured and account for some 84 percent of total deposits. - Legislation and timing: - Basic financial legislation enacted June 2001 included the FIA and four anti-money laundering laws. - FIA established the FIC and set licensing “grandfathering” deadline of December 17, 2001 (extended to February 15, 2002); twelve banks submitted documents; licenses due to be processed by June 30, 2002. - Transition and delayed implementation: - FIA transitional rules: chapter 4 in force within two years from date all Governing Board positions filled; prudential requirements three-year transitional period; chapter 6 (accounts, financial statements, audit, reporting and examination) four-year transitional period. - Governing Board instituted on February 21, 2002 with a quorum; appointment of Executive Commissioner and permanent staff delayed. - FIC operational start-up resources: - FIA provides for supervisory fees: annual fees may not exceed 0.25% of a bank’s assets or $5,000 whichever is less. - Initial budget proposal (April to September 2002): start-up costs of $36,000 and recurring costs for the first six months of about $55,000. - Permanent Executive Commissioner expected to be appointed in October 2002. ### Assessment of compliance with the Basel Core Principles — summary - Compliance tallies: - Compliant: 1 Core Principle. - Largely compliant: 6 Core Principles. - Materially non-compliant: 7 Core Principles. - The report additionally states verbatim: “Eleven of the principles have been found to be non-compliant.” - Overall observation: - Relatively low level of compliance with the Basel Core Principles, linked to the formative state of the FIC and legal/regulatory constraints on effective supervisory implementation. ### Key legal and supervisory shortcomings identified - Supervisory powers and independence: - Section 61(c) frames examinations mainly for disclosure of irregularities and malfeasance; FIC lacks a clear statutory risk management provision for qualitative judgments on a bank’s general risk situation and timely corrective action. - FIC regulations require OEK and Presidential approval before taking effect, limiting independent regulatory powers. - Governing Board predominant decision-making authority; Executive Commissioner appointed/dismissed by Governing Board (representative of banking/business interests), detracting from operational independence. - FIC budget submission to OEK creates potential constraints; section 12(a)(2) needs clarification regarding OEK powers to revise the FIC’s budget. - Legal immunity for commission members and staff was lacking and contributed to delays in constituting the FIC. - Capital, licensing, and consolidated supervision: - Legal capital adequacy requirement set at 5 percent; recommendation to raise to internationally accepted Basel minimum standard of 8 percent. - Capital adequacy should be calculated on a consolidated basis. - Law lacks detailed definition of regulatory capital and risk-weighting of different assets. - Breach of minimum capital adequacy ratio should be explicit grounds for revocation of a license. - FIC should be empowered to take remedial action before a bank experiences a loss of 25 percent or more of its minimum capital requirements. - Regulatory scope and approvals: - Need clear rules on which investments require supervisory approval versus notification only. - Provisions should assess whether planned corporate affiliations (domestic and overseas) would jeopardize effective supervision. ### Principle 1 — objectives, autonomy, powers, and resources (highlights) - Objectives (Principle 1(1)): - FIA preamble government policy objectives: (1) protect interests of consumers of financial services, (2) prevent systemic risk, (3) provide sufficient scope for market forces, (4) protect the Republic’s international reputation. - Section 6: FIC primary objectives: ensure liquidity and solvency, provide authorizations, perform supervision and issue regulations. - Basic prudential regulations in the FIA: capital to risk-weighted assets ratio (5%) and large exposures ratio (20%/800%). - Assessment: LARGELY COMPLIANT. - Comment: FIC formative; practical implementation postponed by transitional provisions. - Operational independence and resources (Principle 1(2)): - Governing Board: six members; five appointed by the President from candidates proposed by the Palau Chamber of Commerce; majority must be Palauan citizens; members must have recognized integrity and professional experience. - Assessment: MATERIALLY NON-COMPLIANT. - Comments: Operational independence undermined by Governing Board selection, potential OEK powers over budget, lack of legal immunity, and Governing Board’s predominant role. - Legal framework for authorization and ongoing supervision (Principle 1(3)): - FIA obliges cooperation with FIC examiners; but FIC regulations require OEK and Presidential approval to become effective. - Assessment: MATERIALLY NON-COMPLIANT. - Comment: Independent regulatory powers effectively limited by required approvals. - Powers to address compliance, safety and soundness (Principle 1(4)): - FIC has access to a bank’s offices and right to examine accounts, books, documents and other records (section 78). (Assessment continues beyond excerpt.) - Overall assessments in related sections emphasize limitations due to section 61(c) and requirement of Supreme Court confirmation for some remedial orders. ### Recommendations (select, preserved verbatim where numeric) - Enact in the FIA a risk management provision to give the FIC powers to make a qualitative judgment on a bank’s general risk situation to enable timely corrective action (addressing limitation in section 61(c)). - Establish clear rules on which investments require supervisory approval versus notification only; assess whether planned corporate affiliations could jeopardize effective supervision. - Raise the legal capital adequacy requirement of 5 percent to conform with the internationally accepted Basel minimum standard of 8 percent. - Calculate capital adequacy on a consolidated basis; amend the law to provide a more detailed definition of regulatory capital and the risk weighting of different kinds of assets. - State explicitly that a breach of the minimum capital adequacy ratio is grounds for revocation of a license. - Give the FIC power to take remedial action before a bank experiences a loss of 25 percent or more of its minimum capital requirements. - Amend the legal provision that gives the power to appoint the Executive Commissioner to the Board; vest the power with the President of the Republic. - Abolish the provision that gives the OEK powers to pre-empt issuance of a prudential regulation by the FIC. - Lift the legal cap on supervisory fees charged to banks. ### Licensing, capital, and corporate governance — statutory specifics - Licensing and revocation (Section 36): - License revocation grounds include obtaining a license on the basis of false information or that another financial institution holding a significant interest has had its license revoked. - Assessment label: MATERIALLY NON-COMPLIANT (licensing implementation). - Comments: Existing banks were grandfathered and not required at the time to undergo full licensing; two-year interim period for compliance; no provision requiring license conditions to be fulfilled at all times; no detailed licensing guidelines on “fit and proper” tests. - Minimum capital requirements: - $500,000 (Palau banks). - $5,000,000 (foreign bank subsidiaries in Palau). - Consolidated capital requirement for foreign parent bank for a Palau subsidiary or branch: not less than $75,000,000. - Exemptions: Banks existing before FIA enactment are exempt from minimum capital requirements. - For Palau banks whose capital is than three-quarters of $500,000 required minimum, the Commission shall require adoption of a satisfactory capital restoration plan aiming to attain capital adequacy within six months from the Commission’s determination. - Assessment: NON-COMPLIANT (capital adequacy framework). - Corporate governance and committees: - Board of Directors: 5 to 9 members; administrators must be of good repute; Section 45 lists ineligibility/dismissal grounds. - Audit Committee: mandatory three members; duties include accounting procedures and controls, supervising compliance, recommending appointment of auditors; meet at least once per quarter. - Risk Management Committee: mandatory three board members; duties include credit appraisal, loan administration, asset and liability management, approval of large credits and equity investments, collateral requirements, classification and provisioning; must meet at least once per month. - Assessment: internal control and audit LARGELY COMPLIANT; other risk management arrangements NON-COMPLIANT. ### Onsite and offsite supervision; accounting and reporting - Onsite and offsite (Principles 16–19): - Section 61: cooperation with examiners required; primary legal purpose of examinations focused on fraud/irregularities rather than general risk assessment. - Offsite powers: Section 26 requires the Commission to collect information, but law does not provide general powers to require information from banks; off-site reporting not required on a consolidated basis. - Assessments: Principle 16 NON-COMPLIANT; Principle 18 MATERIALLY NON-COMPLIANT; Principle 19 MATERIALLY NON-COMPLIANT. - TA for 2002 planned development of off-site monitoring, key ratios, database, reporting formats, and CAMELS-style guidelines. - Accounting standards and auditor oversight (Principle 21): - Section 57 requires GAAP; Section 59 requires annual balance sheet by June 30 for the previous year. - Domestic banks exempt from obligation to disclose financial statements publicly; only branches of foreign banks must make audited accounts public. - Assessment: MATERIALLY NON-COMPLIANT. - Comments: Supervisor lacks powers to revoke appointment of an auditor; auditors have no legal obligation to report to the FIC. ### Remedial measures and consolidated supervision - Remedial measures (Principle 22): - FIC powers include written warnings; written agreements on remedial programs; cease and desist orders subject to Supreme Court; fines up to $10,000 per day; suspension/dismissal of administrators; revocation of license; appointment of receiver; liquidation. - Specific capital-restoration rule: if capital less than three-quarters of required minimum, a satisfactory capital restoration plan required within six months of determination. - Assessment: LARGELY COMPLIANT. - Comments: A breach of minimum capital adequacy ratio is not explicitly grounds for revocation; FIC should be empowered to act when less than 25% of the minimum amount has been lost. - Consolidated and cross-border supervision (Principles 20, 23–25): - No consolidated supervision provisions for Palau banks; consolidated supervision applies only to foreign banks. - Supervisor lacks powers to require closing of overseas branches or to undertake inspections at Palau branches of foreign banks; no MoUs established. - Assessments: Principle 20 NON-COMPLIANT; Principle 23 NON-COMPLIANT; Principle 24 NON-COMPLIANT; Principle 25 LARGELY COMPLIANT (subject to MoUs). ### Money laundering and AML/CFT legal framework — overview - Legislative package June 2001 included the Money Laundering and Proceeds of Crime Act 2001 (AML Law), Mutual Assistance in Criminal Matters Act 2001, Financial Institutions Act 2001, Foreign Evidence Act 2001, and Extradition Act 2001. - FIU established in November 2001 (Coordinator appointed November 19, 2001). - Overall AML/CFT assessment (IMF/World Bank methodology, banks): - Compliant with 2 criteria. - Largely compliant with 5 criteria. - Materially non-compliant with 3 criteria. - Non-compliant with 2 criteria. - Key implementation gaps identified: - AML legislation does not provide FIU with clear powers for on-site inspections, enforcement, or ensuring compliance by reporting entities. - FIU understaffed and lacks sufficient expertise for analysis of suspicious transactions. - Banks lack clear FIU guidelines on identifying suspicious transactions. ### FIU placement, powers, limitations, and recommended enhancements - Statutory placement and powers: - FIU situated within the Office of the Attorney General (Section 15). - FIU powers include receiving, analyzing and processing reports (Section 16), accessing information from public authorities and persons within scope of investigations (Section 17), and exchanging information with foreign FIUs subject to reciprocal arrangements (Section 18). - FIU must submit an annual report to the President, the Minister of Justice, and the OEK. - Operational constraints and legal limitations: - FIU has no inherent power to disseminate information to law enforcement on its own initiative. - FIU has no specific power to audit compliance or conduct on-site inspections; requires Supreme Court orders for certain measures (monitoring accounts, stopping transactions). - FIU members are prohibited from concurrently holding other public or private employment, which the mission recommended removing given resource constraints. - Assessment: MATERIALLY NON-COMPLIANT. - Recommended FIU powers and institutional changes: - Grant FIU power to disseminate information to law enforcement (on initiative or on request) with confidentiality safeguards. - Grant FIU power to audit compliance, conduct on-site inspections, and impose enforcement measures for reporting entities. - Authorize FIU to access public authority information without court order. - Allow FIU to undertake research, training, advisory and public education activities. - Remove prohibition on concurrent public employment for FIU members given resource constraints. - Provide adequate legal protection for the FIU and its information from suits and compulsory legal process. - Staff, organize, and provide technical assistance to the FIU. ### Customer due diligence (CDD), record keeping, and suspicious transaction reporting (STR) - CDD and identification: - Section 7: verification required before opening ordinary accounts/passbooks, taking securities into safekeeping, granting safe-deposit facilities, managing assets, or effecting/receiving payments; identification documents for natural and legal persons specified. - Section 8: casual customers must be identified for transactions over $10,000 or where transactions reasonably appear to have an unlawful purpose. - Section 9: identification of beneficial owners where it is uncertain whether the customer acts on own behalf. - Over the counter exchange dealers: identity verification required for transactions > $2,500 or where unusual complexity; photographic ID required. - Mission recommendations: lower or remove $10,000 threshold for customer identification; prohibit anonymous accounts; require customer identification for wire transfers; require originator information to remain through payment chain. - Record keeping: - Section 5: require records of cash or bearer securities transactions in excess of $10,000. - Section 11: customer identification records to be kept for five years after account closure; records for FIU-reportable cases must be kept for 10 years. - Unified Tax Act requires records for three years (less than international standard of five years). - Mission recommendation: require record keeping for all transactions for five years and permit FIU inspection without Supreme Court order. - Suspicious transaction reporting: - Section 10: report transactions > $10,000 conducted in a manner that appears to have an unlawful purpose to FIU and Attorney General; Section 19 extends reporting obligations to persons engaged in financial operations. - Section 21: exemption from liability for bona fide reporting. - Section 12: limits availability of certain records to FIU and AG only upon Supreme Court order (mission considers STRs can be sent to FIU without Supreme Court order; recommends clarifying law and removing court-order requirement for FIU receipt of STRs). - Tipping off: Section 12(d) prohibits disclosure of existence/content of confidential information received by AG; Section 31 provides penalties up to two years imprisonment or fine not to exceed $10,000 for tipping off or failing to make an STR. ### Criminalization, confiscation, and provisional measures - Money laundering offense (Section 3 and Section 48 references): - Defined to cover conversion/transfer to conceal illegal origin; concealment/disguise of illegal nature, source, location, disposition, movement or ownership; acquisition/possession/control where person knows property is proceeds of crime. - Mens rea: knowledge, intent, or purpose required and may be inferred from objective factual circumstances; mission notes uncertainty on precise subject-matter to which knowledge must relate and recommends clearer mens rea articulation. - Financing of terrorism not specifically criminalized; mission recommends criminalization with appropriate mens rea. - Penalties: - Natural persons: fined at least $5,000 or imprisoned for up to ten years (Section 28). - Corporate entities: fines up to two times fines for natural persons; repeated offenders face business bans or closure (Section 29). - Confiscation and provisional measures: - Confiscation allowed upon conviction; may extend to enrichment during a three-year period prior to conviction. - Section 27: temporary freezing orders valid for three months unless conviction; Section 20: Supreme Court may issue 72-hour stoppage orders, extendable up to eight days. - Mission gaps/recommendations: enable confiscation of property of equivalent value where proceeds unavailable; extend confiscation/seizing/freezing to assets used for financing of terrorism; provide adequate protection for bona fide third-party interests; enable confiscation through civil process. ### Supervisory and sectoral AML/CFT measures (banking sector) - Supervisory responsibilities: - Gap identified: day-to-day AML supervisory responsibility not clearly identified; mission recommends FIC set AML policies for banks and FIU be responsible for day-to-day implementation, including on-site inspection and enforcement across all reporting entities. - Supervisory findings for banks: - FIC has general supervisory powers (including section 48 prohibition on concealment/conversion of criminal property) but had not issued AML guidance at time of mission. - Assessment for banks: FIC supervisory AML implementation MATERIALLY NON-COMPLIANT. - Customer identification: FIA does not require customer identification; in practice FDIC-regulated banks have procedures. - Monitoring and reporting: FIU issued advisories and STR form; FIU has no power to determine that banks have procedures or to prevent tipping off. - Record keeping: FIU has no power to check compliance with record keeping; some FDIC banks maintain such requirements. - Recommendations: FIC to issue AML guidelines and fit-and-proper regulations; FIU to be empowered and resourced to audit, inspect, and enforce; provide training for banks and FIU staff. ### Cross-border cooperation and mutual assistance - Mutual Assistance in Criminal Matters Act 2001 and Extradition/Foreign Evidence Acts: - Provide procedures for assistance, seizure, freezing, and sharing confiscated property; mutual assistance available for serious offenses (imprisonment > 1 year). - Provisions not yet operationally utilized; requests to date handled under special COMPACT arrangement with U.S. - Assessment: COMPLIANT, with recommendations to include mutual assistance in terrorism financing and to prepare detailed regulations for enforcement of foreign restraining/confiscation orders. ### Consolidated recommendations and suggested actions (topics and actions) - Legal and regulatory amendments: - Remove $10,000 threshold for identification and record keeping; prohibit anonymous accounts; require customer identification for wire transfers; clarify STR requirements in sections 10 and 19. - Amend AML law to vest FIU with powers to disseminate information, audit and inspect reporting entities, conduct on-site inspections, enforce compliance, access public information without court order, and be protected from suits and compulsory legal process. - Expand confiscation powers to include equivalent-value confiscation and civil confiscation; extend to terrorism financing. - Criminalize financing of terrorism; ratify Palermo Convention. - Supervisory and institutional actions: - Staff, organize, and resource the FIU; remove prohibition on concurrent public employment given resource constraints. - FIC to issue AML guidance, fit-and-proper regulations, and internal control/regulatory instruments for banks. - Issue regulations under the AML law and the FIA; prepare registration and oversight rules for over-the-counter exchange dealers and money remitters. - Establish MoUs with foreign supervisory authorities and FIUs. - Capacity building and training: - Provide training programs for FIU, financial intermediaries, Attorney General’s office, and police investigators. - Seek technical assistance from MAE and LEG for drafting regulations, regulatory guidance, and operational procedures. - Operational sequencing and clarifications: - Begin immediate implementation of existing AML provisions. - Clarify supervisory responsibilities and designate supervisors for non-bank reporting entities. - Conduct study before imposing formal cross-border cash reporting regime; consider legal mechanisms for cross-border cash reporting. ### Authorities’ response - FIC Governing Board reviewed the draft IMF Module II Assessment Executive Summary and found recommendations in line with final review and evaluation meeting. - FIC agreed to work closely with Mr. John Vaught, Technical Consultant from the IMF, to formulate regulations and supervisory policies to bring the Republic of Palau into compliance with the Basel Core Principles. - Official statement: “The Republic of Palau is committed to bringing Palau into compliance with international banking and anti-money laundering standards. The recommendations of the IMF Module II assessment team will be taken into very serious consideration and either incorporated into proposed legislative changes to be presented to the National Congress for adoption or into regulations for implementation, whichever is appropriate. Please understand, however, that Palau does have limited resources and expertise and will be in need of technical assistance where necessary in order to implement proper banking regulation and supervision.” *The mission (IMF Module II Assessment).* ### Part 1: Assessing the AML/CFT in the legal and institutional framework......33 ### Part 1: Assessing the AML/CFT in the legal and institutional framework ### Overview of the IMF assessment - The assessment of Palau’s observance of the Basel Core Principles for Effective Banking Supervision was conducted as part of a Module 2 assessment in the context of the IMF’s Offshore Financial Centers (OFC) initiative. - The mission relied on relevant legal documents (laws and draft regulations), material provided by the MAE Banking Supervision Advisor assigned to Palau on a peripatetic basis, and extensive discussions with Palauan government officials and the Financial Institutions Commission (FIC). - The Financial Institutions Commission’s (FIC) work was in a very early/formative stage at the time of the assessment; where Core Principles centered on implementation, the assessment includes qualifiers in the “Comments” that implementation remained outstanding. ### Institutional and market structure — key findings - Financial sector composition: - 12 commercial banks, including 3 branches of U.S.-based banks. - 1 development bank (the National Development Bank of Palau, NDBP). - 11 non-bank financial institutions (three reportedly not in operation and eight providing limited financial services). - A number of small credit unions. - Offshore banking is not allowed in Palau since 1982 (Offshore Banking Act repealed). - No capital markets and no International Business Companies (IBCs) registered/operational in Palau. - Market concentration and asset flows: - The largest three U.S.-based banks account for approximately 84 percent of total deposits. - The Bank of Hawaii accounts for nearly 57 percent of total deposits. - These U.S.-based branches place the majority of their deposits at their U.S. headquarters for investment elsewhere. - Lending, guarantees, and arrears: - Most local loans are well-secured consumer loans rather than business/commercial loans. - The National Development Bank of Palau guarantees 90 percent of commercial loans and can assume title to land in case of default. - NDBP’s portfolio size is about $7 million, of which one-third is in residential housing. - Loans in arrears (so-called “judgment loans”) stand at about $0.7 million, or 10 percent of total loans. - Profitability and interest rates (1997–2000 period): - Deposit rates on 30-day time savings accounts: in the range 2 ¼–5 percent. - Deposit rates on certificates of deposit: in the range of 4–8 percent. - Lending rates for consumer loans: between 10–18 percent. - Lending rates for commercial loans: 9 ¼–13 percent. - Nonperforming customer loans have historically been very low; aggregate profit reported for Palau’s nine largest banks. ### Legal, institutional and supervisory preconditions - Legal system and accounting: - Palau’s legal system closely resembles that of the United States. - Local accounting and legal professionals are relatively scarce; U.S. lawyers play an important role. - Until adoption of the Financial Institutions Act (FIA) of June 2001, financial institutions followed cash-basis accounting dictated by tax considerations. - Pursuant to the FIA, financial institutions will be required to follow Generally Accepted Accounting Principles (GAAP). - Transparency and audit requirements: - Disclosure rules for financial statements were deficient; financial institutions not legally required to have audited balance sheets and income statements by reputable external auditors. - Safety net: - The FIA provides for receivership of banks in case of insolvency, but no legal safety net such as a formal deposit insurance system is envisaged for domestic banks. - U.S. branches operating in Palau are FDIC-insured; these branches account for some 84 percent of total deposits. - Legislation and timing: - Basic financial legislation enacted in June 2001 included the FIA and four anti-money laundering (AML) laws. - The FIA established the FIC as the agency charged with regulation and supervision of banks. - The FIA set a licensing “grandfathering” deadline of December 17, 2001 for banks in operation at enactment; that deadline was subsequently extended to February 15, 2002. Twelve banks submitted necessary documents by the deadline. Licenses were due to be processed by June 30, 2002. - Transition and delayed implementation: - The FIA contains transitional rules delaying implementation: chapter 4 comes into force within two years from the date all Governing Board positions are filled; prudential requirements have a three-year transitional period; chapter 6 on accounts, financial statements, audit, reporting and examination has a four-year transitional period. - The appointment of an Executive Commissioner, permanent staff, and all Governing Board members had been delayed; the Governing Board was instituted on February 21, 2002 with a quorum. - FIC operational start-up resources: - The FIC’s budget must be proposed and submitted to the Olbiil Era Kelulau (OEK). - The FIA provides for fees to be charged to financial institutions for supervisory/regulatory services: annual fees may not exceed 0.25% of a bank’s assets or $5,000 whichever is less. - The initial budget proposal (April to September 2002) includes start-up costs of $36,000 and recurring costs for the first six months of about $55,000. - The permanent Executive Commissioner was expected to be appointed in October 2002. ### Assessment of compliance with the Basel Core Principles — summary - Compliance tallies: - Palau is compliant with 1 of the Core Principles. - Palau is largely compliant with 6 of the Core Principles. - Palau is materially non-compliant with 7 of the Core Principles. - The report also states: “Eleven of the principles have been found to be non-compliant” (assessment text preserved verbatim). - Overall observation: - There is a relatively low level of compliance with the Basel Core Principles for Effective Banking Supervision, with notable weaknesses linked to the formative state of the FIC and legal/regulatory constraints on effective supervisory implementation. ### Key legal and supervisory shortcomings identified - Limitations on supervisory powers and independence: - Section 61(c) of the FIA frames examinations mainly for disclosure of irregularities and malfeasance; the FIC lacks a clear statutory risk management provision enabling qualitative judgments on a bank’s general risk situation and timely corrective action. - FIC regulations do not become effective without OEK and Presidential approval; this limits the FIC’s independent regulatory powers. - The Governing Board has predominant decision-making authority; the Executive Commissioner is appointed and can be dismissed by the Governing Board (which is largely representative of banking/ business interests), detracting from operational independence. - The FIC’s budget submission to the OEK creates potential constraints on operational independence; section 12(a)(2) requires clarification regarding OEK powers to revise the FIC’s budget. - Legal immunity for commission members and staff was lacking and contributed to delays in constituting the FIC. - Capital, licensing and consolidated supervision: - Legal capital adequacy requirement set at 5 percent; recommendation to raise to internationally accepted Basel minimum standard of 8 percent. - Capital adequacy should be calculated on a consolidated basis. - The law lacks a detailed definition of regulatory capital and risk-weighting of different assets. - A breach of the minimum capital adequacy ratio should be explicitly stated as grounds for revocation of a license. - The FIC should be empowered to take remedial action before a bank experiences a loss of 25 percent or more of its minimum capital requirements. - Regulatory scope and approvals: - Clear rules needed on which kinds of investments require supervisory approval versus notification only. - Provisions should assess whether planned corporate affiliations (domestic and overseas) would jeopardize effective supervision. ### Principle 1 — detailed highlights (Objectives, Autonomy, Powers, and Resources) - Principle 1(1) — Objectives: - FIA preamble sets government policy objectives: (1) protect interests of consumers of financial services, (2) prevent systemic risk, (3) provide sufficient scope for market forces, (4) protect the Republic’s international reputation. - Section 6 states FIC’s primary objectives: ensure liquidity and solvency of financial institutions pursuant to the FIA and other regulations; provide authorizations and perform supervision and issue regulations. - Basic prudential regulations in the FIA: capital to risk-weighted assets ratio (5%) and the large exposures ratio (20%/800 %). - Transitional timing: chapter 4 deferred two years after Governing Board is filled; prudential requirements three years; chapter 6 four years. - Receivership provisions in chapter 9 empower the Commission to determine insolvency, revoke licenses, take possession/control of banks; receivership/liquidation supervised by the Supreme Court’s Trial Division. - Assessment: LARGELY COMPLIANT. - Comment: FIC in a formative phase; Executive Commissioner and permanent staff not yet appointed; practical implementation postponed by transitional provisions. - Principle 1(2) — Operational independence and resources: - Governing Board: six members; five appointed by the President from candidates proposed by the Palau Chamber of Commerce; majority must be Palauan citizens; members must have recognized integrity and professional experience. - Executive Commissioner expected appointment by Governing Board (October 2002 anticipated); appointment/dismissal by Governing Board reduces operational independence. - External auditors and independent examiners must be certified public accountants with at least five years' relevant experience. - Section 61 provides protections against harassment/intimidation of examiners and auditors. - Assessment: MATERIALLY NON-COMPLIANT. - Comments: Operational independence undermined by Governing Board selection process, potential OEK powers over FIC budget and overrule of FIC regulations, lack of legal immunity provisions, and predominant role of the Governing Board especially during initial phases with caretaker Executive Commissioner. - Principle 1(3) — Legal framework for authorization and ongoing supervision: - FIA stipulates licensing powers and obliges financial institutions to cooperate with FIC examiners and auditors (section 61). - Transitional provisions empower the FIC to issue regulations, examine accounts and records, and visit offices; however, FIC regulations must be promulgated according to the Administrative Procedure Act and cannot become effective without OEK approval by joint resolution of both chambers, and Presidential review within 20 days. - Assessment: MATERIALLY NON-COMPLIANT. - Comment: FIC’s independent regulatory powers are effectively limited by the requirement that its regulations receive OEK and Presidential approval before taking effect. - Principle 1(4) — Powers to address compliance, safety and soundness: - Description begins: “The FIC has access to a bank’s offices and a right to examine their accounts, books, documents and other records as the FIC deems necessary (section 78).” (assessment continues beyond the provided excerpt) ### Recommendations (select, preserved verbatim where numeric) - Enact in the FIA a risk management provision to give the FIC powers to make a qualitative judgment on a bank’s general risk situation to enable timely corrective action (addressing limitation in section 61(c)). - Establish clear rules on which investments require supervisory approval versus notification only; assess whether planned corporate affiliations could jeopardize effective supervision. - Raise the legal capital adequacy requirement of 5 percent to conform with the internationally accepted Basel minimum standard of 8 percent. - Calculate capital adequacy on a consolidated basis; amend the law to provide a more detailed definition of regulatory capital and the risk weighting of different kinds of assets. - State explicitly that a breach of the minimum capital adequacy ratio is grounds for revocation of a license. - Give the FIC power to take remedial action before a bank experiences a loss of 25 percent or more of its minimum capital requirements. *IMF assessment of Palau’s observance of the Basel Core Principles for Effective Banking Supervision.* ### section 61(c), the FIC cannot be deemed to have powers to address the safety and soundness ### cr04170 - section 61(c), the FIC cannot be deemed to have powers to address the safety and soundness ### FIC powers to address safety and soundness and compliance (Section 61(c) and Section 62) - Finding: section 61(c) — the FIC cannot be deemed to have powers to address the safety and soundness concerns of a bank. - Purpose of examinations: The primary purpose of an audit or examination is to inform the Commission about fraudulent acts within a bank or any irregularity or deficiency in the bank's administration or operations that may result in a material loss for the bank or a subsidiary. - Section 62 powers: The FIC can, inter alia, issue written warnings; conclude a written agreement with a bank on a program of remedial action; or issue cease and desist orders, subject to approval of the Supreme Court for issuance of cease and desist orders. - Assessment: MATERIALLY NON-COMPLIANT - Comments: - The FIC’s powers to address compliance and to apply judgments on banks’ performance are largely untested. - The primary purpose of bank examinations is not to form a view of a bank’s general risk situation but to learn of wrong doings in a bank. - The FIC’s independent powers are curtailed by it having to seek Supreme Court confirmation for the issuance of cease and desist orders. ### Legal framework for banking supervision and legal protection for supervisors (Principle 1(5)) - Description: - An amendment to the FIA is to be adopted by the OEK in the spring session of 2002; the contents of the original bill for the FIA are going to be incorporated in law during the Spring session of the OEK. - In a court proceeding, commission members, officers, employees and agents of the Commission can only be convicted for their supervisory activities if the person has acted in an arbitrary or capricious manner. - Liability: The person is liable for damages or liable for acts or omissions if intentional wrongful conduct has been in evidence. - Immunity: The above persons enjoy in all other respects immunity for any act or omission in the course of their duties and responsibilities. - Protection against interference: The present law includes a provision against attempts to harass, intimidate, or exert undue influence on an examiner of the Commission or the auditors appointed by it. Complaints may be made against such actions. - Legal defense costs: The legal costs that supervisory personnel has incurred in defending their cases are born by the Attorney General’s Office. - Assessment: COMPLIANT - Comments: - At the time of the mission, the present wording of law was found to be non-compliant with the principle of legal immunity. - The assessment “compliant” is subject to the OEK adopting during the spring session the amendment to the FIA that was presented to the mission. ### Information sharing and confidentiality (Principle 1(6)) - Description: - The Commission is required to cooperate with public authorities in pursuing its objectives, and by law it must also take action to promote such cooperation. - The Commission shall provide general information, unless constrained by the confidentiality and secrecy provisions of the FIA, if requested by the Ministry of Finance or other government agencies. - By law the FIC is the official agency for information as to the status of any bank or other financial institution licensed in Palau. - The Commission is authorized to the extent set forth in law to cooperate and exchange information with foreign government and international agencies. - Section 24 of the FIA: no past or present member of the Commission or FIC staff or an auditor or agent appointed by the Commission may unless authorized by law permit access to, disclose or publicize nonpublic confidential information obtained in the performance of duties; or use such information, or allow such information to be used, for personal gain. - All information derived in supervisory work in the possession of the FIC is to be kept confidential unless authorized by the person to whom it relates or required by law or a court order. - Assessment: LARGELY COMPLIANT - Comments: - The law does not provide clear rules on information sharing. - No memoranda of understanding have been established with foreign supervisory authorities. ### Permissible activities of banks (Principle 2) - Scope and definitions: - The FIA is applied to banks, securities brokers, and securities dealers (“financial institutions”), their shareholders, administrators, employees, agents and affiliated entities, and applicants for bank credit. - A bank is defined as a person engaged in the business of accepting deposits in the Republic of Palau from residents and non-residents and using such funds to make extensions of credit or investments for the account of and at the risk of the person carrying on the business, including branches of banks organized in other jurisdictions. - "Deposit" means a sum of money paid on such terms that it is to be repaid in full, with or without interest or premium of any kind, and either on demand or at a time agreed by or on behalf of the person making the payment and the person receiving it; and it is not referable to the provision of property or services or the giving of security. The deposit may or may not be evidenced by any entry in a record of the person receiving the sum, or by any receipt, certificate, note or other document. - Activities authorized to banks under section 51 of the FIA: 1. receiving deposits; 2. buying and selling for a bank’s own account debt securities issued or guaranteed by the Government of Palau or by governments or central banks of G-10 or European Union countries that are denominated and payable in Dollars with a maturity not exceeding one year; 3. payment and collection services; 4. issuing and administering e.g. payment cards, travelers' checks and bankers' drafts; 5. buying and selling foreign exchange for cash for the account of the bank and a customer; 6. safekeeping of securities and other valuables; 7. receiving deposits in more than one currency; 8. extending credit to enterprises, including, factoring with or without recourse; 9. borrowing funds and buying and selling for a bank’s own account or for the account of customers (excluding underwriting) of money market instruments; debt securities; futures and options relating to debt securities or interest rates; or interest rate instruments. 10. money brokering; 11. financial leasing; 12. credit reference services; 13. providing services as a financial agent or consultant (not including deposit taking and debt securities); 14. dealing in foreign exchange; 15. trust services, including, the investment and administration of funds received in trust and administration of securities; 16. services as an investment portfolio manager or investment adviser; 17. underwriting and distribution of debt and equity securities and brokering and dealing in equity securities. - Restrictions and limitations: - Section 53(d): it is explicitly prohibited for a bank to engage directly in industry, commerce, or other non-financial services in the Republic of Palau. - The application of the limitations on permissible activities are, however, effectively postponed by three years by virtue of the provision requiring the appointment of all Commission members, FIA section 77(b). - The range of activities a bank is entitled to be engaged in is not limited by any considerations as to the level of the bank’s regulatory capital. - Section 3: no person shall use the words "bank," "trust," "trust company," or "financial corporation" or derivatives without being licensed to operate as a bank; exceptions include establishment or recognition by law or international agreement or clear contextual non-financial use. Violators are subjected to the sanctions of section 62. - Assessment: COMPLIANT - Comments: - The definitions for a bank and financial institution are in place. - However, banks existing before the enactment of the FIA are by law allowed to engage in non-financial activities for a transitional period of three years. - There are no provisions that would limit the scope of a bank’s permissible activities depending on the amount of its capital base. ### Licensing criteria and process (Principle 3) - Application requirements (section 32 of the FIA): - New banks need to apply for a license to the FIC. - An application must be accompanied by documentation concerning: - the qualification and experience of each member of the management of a bank with a CV for the past 10 years; - the amount of the capital of the new institution; - a business plan including projected financial statements for three years; - a business and professional history for the past three years of a principal shareholder (more than a 10 % stake); - the balance sheet and profit and loss statement for the most recent fiscal year. - The Commission may require supplemental information. - Licensing conditions and approval: - A license may only be approved if the business plan is based on reasonable assumptions demonstrating that the bank will become profitable within a reasonable time; the bank will comply with all provisions of the FIA; and that the experience and integrity of management as well as the capitalization are appropriate to the business plan and the activities it is going to pursue. - The FIC may impose conditions on a license concerning the payment of the capital; the hiring and training of staff; the lease or purchase of equipment and the establishment of operations systems, including internal audit and controls; the lease or purchase of business premises; and the engagement of an auditor or chief accountant. - A bank has to comply within one year with the conditions set. If upon an on-site inspection of the applicant’s premises, the FIC finds that the conditions have been met, the FIC issues an approval for a bank to commence operations. - Transitional arrangements: - The new FIA came into force on June 18, 2001. - Section 30 on the licensing of existing banks (EFIs): at the time of the FIA’s promulgation, EFIs had a 180 day transitional period within which the banks had to provide the FIC with only minor statements, i.e. a copy of the bank’s charter and a certificate of good standing from the Registrar Authority. - The banks are under the grandfathering provision licensed to engage in all the permissible activities regardless of whether they have been engaged in them before the FIA. The existing banks were deemed to be in full compliance of the legal conditions for a banking license. - Due to the belated commencing of the FIC’s operations, the EFI’s licenses are expected to be acted upon by June 30, 2002, at the earliest. - At the time of the mission they are only equipped with a business license from the Tax Office. *International Monetary Fund — cr04170* ### Section 36 of the FIA states that a bank’s license can be revoked on specified grounds, ### Section 36 of the FIA — Licensing, Prudential Requirements, and Supervisory Assessments ### Licensing and Grounds for Revocation - The FIA states that a bank’s license can be revoked on specified grounds, most importantly: - that the license has been obtained on the basis of false information; or - that another financial institution that holds a significant interest in the bank has had its license revoked. - Assessment label (from the IMF assessment): MATERIALLY NON-COMPLIANT (with respect to licensing implementation). - Comments: - Banks existing when the FIA was passed have not been required to undergo the proper licensing process; only marginal information (e.g., a registrar certificate on the institution’s bank status and good standing) has been furnished to authorities. - EFIs were categorically deemed to fulfill all prudential requirements of the FIA at the time of enactment. - The law provides a two-year interim period for existing banks to comply with the FIA. - The FIC’s powers to require supervisory reports during the interim period need clarification. - The supervisor lacks powers to require banks to furnish practical plans to maintain an adequate level of capital and profitability. - There is no provision requiring the conditions for a bank’s license to be fulfilled at all times. - No detailed licensing guidelines exist concerning “fit and proper” tests, operational policies, or internal control procedures of applicants. ### Minimum Capital, Foreign Subsidiaries, and Consolidated Parent Capital - Minimum capital requirements: - $500,000 (Palau banks) - $5,000,000 (foreign bank subsidiaries in Palau) - Consolidated capital requirement for foreign parent bank for a Palau subsidiary or branch: not less than $75,000,000. - Exemptions and transitional rules: - Banks existing before the enactment of the FIA are exempt from the minimum capital requirements. - For Palau banks whose capital is than three-quarters of the required minimum capital of $500,000, the Commission shall require the bank to adopt a satisfactory capital restoration plan requiring attainment of capital adequacy within six months from the Commission’s determination. - Assessment: NON-COMPLIANT (capital adequacy framework). - Comments: - The legal capital adequacy requirement of 5% does not conform to the internationally accepted minimum standard of 8%. - No regulations exist defining regulatory capital, risk-based capital, and risk-weighted assets. - The capital adequacy rule does not provide for application on a consolidated basis nor for regular reporting to the supervisor. - A breach of the minimum capital adequacy ratio is not explicitly stated as grounds for revocation of a license; the FIC may act on weakening of the capital base only after 25% of the minimum amount has been lost. ### Corporate Governance and Internal Committees - FIA Chapter 4 contains provisions on corporate governance, including charters and instituting audit committees. - Board and management: - Board of Directors: 5 to 9 members; majority may not be members of management; appointed by shareholders for a maximum period of four years; board or its members may not delegate their responsibilities. - Administrators (members of management) must be of good repute and meet Commission regulation criteria regarding qualifications, experience, and integrity. - Section 45 lists ineligibility/dismissal grounds for board members, including felony conviction, prior deprivation by a court/regulatory body, final judgment for non-payment of a debt, and other items. - The FIC may relieve a board member of duties if shareholders fail to act within thirty days of notice of disqualification. - Audit Committee: - Each Palau financial institution shall establish an Audit Committee of three members appointed by the board for periods of up to two years. - Audit Committee duties include establishing appropriate accounting procedures and controls, supervising compliance, recommending appointment of internal or external auditors, monitoring compliance with the FIA, and meeting at least once per quarter. - Risk Management Committee: - All Palau banks must establish a Risk Management Committee of three board members for a term not to exceed two years. - Committee duties include policies/procedures for credit appraisal, loan administration, asset and liability management, approval of large credits and equity investments, collateral requirements, classification and provisioning for impaired assets, pursuit of defaulters, and managing interest rate, market, and country risk. - The Risk Management Committee must meet at least once per month. - Assessment: - Internal control and audit: LARGELY COMPLIANT. - Other risk management and committee effectiveness: NON-COMPLIANT (supervisory arrangements were formative; no definite assessment possible). - Comments: - The role of the board is largely satisfactorily defined on a legal basis. - The internal audit committee is obligatory by law, but establishment and organization of the internal audit function are left to the board’s discretion. - Guidelines on minimum criteria to evaluate adequacy of a bank’s internal audit procedures were scheduled in the TA program at later stages. ### Licensing Conditions for Foreign Bank Branches and Subsidiaries (Section 33) - Conditions for issuing a license to a branch or subsidiary of a foreign bank: - the foreign bank is authorized to engage in receiving money deposits or other repayable funds in the jurisdiction/country of its head office; - the competent authorities that supervise the financial activities at the head office have given their written consent to the granting of such license; and - the Commission has determined that the foreign bank is adequately supervised on a consolidated basis by the home country supervisory authorities. ### Ownership (Principle 4) - Description: - Significant interest: direct or indirect holding of at least 20% of equity or any class of shares with voting rights, or that makes it possible to exercise significant influence over management or policies. - Transfer of equity interest to be legally effective requires prior authorization of the Commission if any person(s) acting in concert would directly or indirectly hold a significant interest. - Qualifications, experience, and integrity of proposed shareholders must be appropriate relative to their significant ownership. - Assessment: LARGELY COMPLIANT. - Comments: - Changes in ownership must be reported to the FIC. - No regular reporting arrangements on beneficial owners have been instituted. - Technical assistance plans include developing regulations requiring existing banks to provide information on beneficial owners. ### Investment Criteria (Principle 5) - Description: - No provisions identifying what types of acquisitions need supervisory approval or notification; no risk elements are taken into account in regulations. - Section 40: No domestic bank may alone or in concert hold equity interest in a non-financial undertaking that (a) represents a significant interest (20%) or (b) exceeds as to net current value the equivalent of fifteen percent (15%) of the bank's capital. - Aggregate net current value of all such equity interests may not exceed fifty percent (50%) of the bank’s capital. - No authorization required for equity interests acquired in lieu of repayment of credit; such interests must be disposed of within one year or within a longer period not exceeding two years as granted by the Commission. - Section 53(b): banks must observe Commission regulations concerning maximum aggregate amount of real estate investments. - Assessment: MATERIALLY NON-COMPLIANT. - Comments: - No legal provisions define which investments need supervisory approval. - Supervisor lacks powers to prevent corporate affiliations that would hinder effective supervision. ### Capital Adequacy (Principle 6) - Description: - Section 53: capital adequacy ratio shall not be less than five percent (5%) concerning assets, risk-weighted assets, and off-balance-sheet items. - No regulations issued on definition of regulatory capital, risk-based capital, and risk-weighted assets. - No provision for consolidated application or regular reporting to the supervisor. - Technical assistance envisaged clearer prudential guidelines in the last quarter of 2002. - Assessment: NON-COMPLIANT. - Comments: - The 5% legal requirement does not meet the internationally accepted minimum of 8%. - Law exempts EFIs from minimum absolute amount of regulatory capital. - FIC may take action on weakening of capital base only after 25% of the minimum amount has been lost. ### Credit Policies (Principle 7) - Description: - The FIA article on the obligatory Risk Management Committee provides an elementary institutional framework for formulating credit policies and procedures. - Assessment: NON-COMPLIANT. - Comments: - FIC was in a very formative phase at the time of the mission; no definite assessment of supervisory arrangements possible. ### Loan Evaluation and Loan-Loss Provisioning (Principle 8) - Description: - FIA gives the FIC powers to issue regulations on classification and evaluation of assets and provisions against substandard and non-performing loans, and timing for cessation of accrual of earnings on non-performing loans. - The Risk Management Committee must establish policies for approval of large credits, collateral requirements, classification and provisioning, and pursuit of defaulters. - TA recommended regulations within the third quarter of 2002 for asset classification, minimum provisioning, and non-accrual accounting. - Assessment: NON-COMPLIANT. - Comments: - Supervisor had not issued regulations on asset classification, loan loss provisioning, and reporting of substandard loans. - Supervisor lacks powers to require a bank to strengthen lending practices and provisioning levels. ### Large Exposure Limits (Principle 9) - Description: - Section 53(a)(2) and (3): - maximum aggregate amount of credits to any single person or group of interrelated persons may not exceed twenty percent (20%) of its capital; - aggregate amount of credits that exceed ten percent (10%) of a bank’s capital shall not exceed eight hundred percent (800%) of a bank’s capital. - Transitional period of three years applicable to these rules. - No provisions on how different types of credit and contingent liabilities are to be included; group of interrelated clients is not defined; rules not applied on a consolidated basis; no reporting arrangements on size of exposures. - TA planned regulations on reporting and calculation of large credits within the third quarter of 2002. - Assessment: MATERIALLY NON-COMPLIANT. - Comments: - No specific regulations for calculation of large exposures and regular reporting of such exposures. ### Connected Lending (Principle 10) - Description: - Definition of connected parties includes: members of management (administrator), significant shareholders, persons related by marriage or consanguinity to the second degree, business interest; legal persons with significant interest in a person in which the bank has a significant interest. - FIC may give further regulations concerning credit extended to any related financial institution. - Section 56: Palau banks may not enter into transactions with or for the benefit of related persons on terms more favorable than for unrelated persons. - Conflict-of-interest rules: a board/management member with a material interest must leave meetings and refrain from voting; a court may set aside undisclosed material conflicts. - Exposure limits to related persons: - No bank shall extend credit to a related person if aggregate outstanding to that person would exceed twenty percent (20%) of a bank’s capital; - Aggregate credits to all related persons shall not exceed one hundred percent (100%) of the bank's capital. - Assessment: LARGELY COMPLIANT. - Comments: - Definitions and arm’s-length lending requirements exist. - No procedural rules enacted concerning decision-making, reporting, or information systems. - Application of provisions is limited to Palau banks. ### Country Risk (Principle 11) - Description: - No legal provisions or regulations concerning country or transfer risk. - The Risk Management Committee shall establish and monitor policies and procedures for country risk. - Assessment: NON-COMPLIANT. - Comments: - FIC was in a very formative phase; no supervisory experience in this area; no definite comment on supervisory arrangement. ### Market Risks (Principle 12) - Description: - No detailed legal provisions or regulations concerning market risks; no supervisory experience. - FIA authorizes the FIC to issue regulations concerning minimum aggregate liquid assets, matching of assets and liabilities as to maturity and interest rate, and unhedged positions in foreign currencies, precious metals, or precious stones. - Risk Management Committee must establish and monitor policies for interest rate and market risk. - Assessment: NON-COMPLIANT. - Comments: - FIC was in a very formative phase; no definite comment on supervisory arrangement. ### Other Risks and Comprehensive Risk Management (Principle 13) - Description: - Risk Management Committee obligations (see above) encompass credit appraisal, loan administration, asset/liability management, underwriting standards, approval of large credits and equity investments, collateral requirements, classification/provisioning for impaired assets, pursuit of defaulters, and managing interest rate, market, and country risk. - Committee must monitor compliance and deliver opinions to the board. - Assessment: NON-COMPLIANT. - Comments: - FIC formative; no definite assessment of supervisory arrangements. ### Internal Control and Audit (Principle 14) - Description: - Board responsibility for policies and supervision of implementation (Section 43). - Eligibility and disqualification criteria for administrators and board members (Section 45). - No explicit requirement in the FIA to establish an independent internal audit function; Audit Committee is mandatory. - Assessment: LARGELY COMPLIANT. - Comments: - Legal basis allows supervisory influence on board appointments. - Internal audit committee is obligatory, but detailed organization and independent internal audit function are left to the board. ### Money Laundering (Principle 15) - Description: - Section 13 of the Money Laundering Act (MLA): banks must have written policies and procedures for prevention of money laundering covering: - centralization of information on identity of customers, principals, beneficiaries, authorized agents, beneficial owners, and suspicious transactions; - designation of compliance officers at central management level, in each branch, and at each agency or local office; - on-going training for officials or employees; and - internal audit arrangements to check compliance. - Section 8 of the MLA: casual customers shall be identified in the case of transactions involving a sum greater than the equivalent of $10,000; customers with smaller transactions must be identified if there is reasonable doubt of unlawful purpose. - Banks are required to identify beneficial owners if it is uncertain whether a customer is acting on his or her own behalf. - Assessment: (Assessment label not provided in excerpt for Principle 15.) *Source: IMF assessment of the Financial Institutions Act (FIA) and related supervisory arrangements as described in the provided IMF document.* ### Section 11 of the MLA provides that banks maintain and hold at the disposal of the ### cr04170 - Section 11 of the MLA provides that banks maintain and hold at the disposal of the ### Anti–Money Laundering / Suspicious Transaction Framework (MLA / FIA) - Section 11 of the MLA: - Banks must maintain and hold at the disposal of the authorities records and customer identification for five years after the account has been closed or the customer relationship has ended. - For cases that have to be reported to the Financial Intelligence Unit (FIU), records must be maintained for 10 years. - Reporting thresholds and criteria: - Banks are to report to the FIU and the Attorney General transactions larger than $10,000 if they are conducted in a manner that appears to have an unlawful purpose, including information on the origin and destination of the money, the purpose of the transaction, and the identity of the transacting parties. - Transactions smaller than $10,000 are also to be reported to the FIU if there reasonably appears to be an unlawful purpose. - Section 19 of the MLA: - Reporting requirement applies to all natural or legal persons who, in connection with their trade or occupation, carry out or advise on operations involving deposits, exchange operations, investments, conversions, or any other movements of capital. - Credit and financial institutions in particular are required to report to the FIU transactions involving money that reasonably appears to be derived from the perpetration of a money laundering crime. - Reports must be made even if it was not feasible to defer execution or if it became clear only after completion of a transaction that it involved a money laundering offense. - Section 21 of the MLA: - Provides exemption from liability for bona fide reporting of suspicions. - No judicial proceeding for breach of banking or professional secrecy may be instituted against a person who in good faith carried out a transaction later determined to be suspect, or who transmitted information or submitted a report to authorities according to the MLA. - No civil or criminal action, nor professional sanction, may be taken against a person who in good faith transmits information or submits reports pursuant to the Act, even if the investigation or judicial decision does not lead to a charge. - No civil or criminal action may be brought against any person by reason of any material or non-material loss or economic or non-economic damage resulting from the freezing of a transaction or the reporting of suspicious transactions or possible violations under the MLA. - Definition and criminal sanctions (Section 48 of the FIA and MLA definitions): - Money laundering defined as: - the conversion or transfer of property for the purpose of concealing or disguising the illegal origin of such property; or - the concealment or disguise of the illegal nature, source, location, disposition, movement, or ownership of property; or - the acquisition, possession, or control of property by any person who knows that the property constitutes the proceeds of crime as defined herein. - Criminal penalties: - Natural persons convicted of money laundering may be fined at least $5,000 or imprisoned for up to ten years. - Corporate entities may be fined for up to two times the fines for natural persons. - Corporate entities convicted of three or more offenses within a five-year period may face measures including permanent or maximum five-year bans from carrying on the business activities in Palau for which they are licensed or conducted at the time of the offense; or ordered to close permanently or for a maximum of five years their premises used for the commission of the offense. - Civil penalties may also be applied to natural persons on the application of the Attorney General’s Office. - There are provisions on confiscation of property and proceeds. - FIU placement and reporting: - The FIU is situated within the Office of the Attorney General. - Other government agencies may be assigned to assist the FIU by the President at the request of the Attorney General. - The FIU shall submit an annual report to the President, the Minister of Justice, and the OEK that provides an overall analysis and evaluation of the reports received and of money laundering trends. - Section 7 of the FIA: - The FIC shall provide general information, as limited by confidentiality and secrecy provisions of the Act, as requested from time to time by the Ministry of Administration or other government agencies as may be necessary for the performance of its duties. ### Assessments and Gaps in AML/CFT Implementation - Assessment: LARGELY COMPLIANT - Key comments and shortcomings: - There are no FIC or FIU guidelines on what may constitute a potentially suspicious transaction. - The FIC has no explicit legal obligation to report suspicious transactions to the FIU or to share with judicial authorities information related to criminal activities. - There are no regulations under the MLA governing its implementation. ### Banking Supervision: Onsite and Offsite (Principles 16–25) — legal provisions and assessments - Principle 16. Onsite and Offsite Supervision - Section 61 of the FIA: all Palau financial institutions and their Palau subsidiaries and Palau branches of foreign banks shall cooperate with the examiners of the Commission and any auditors appointed by the Commission. - Section 24 of the FIA: confidentiality for Commission and FIC staff, auditors, and agents; nonpublic confidential information may not be disclosed or used for personal gain; supervisory information kept confidential unless authorized or required by law or court order. - Assessment: NON-COMPLIANT - Comment: FIC was in a formative phase at the time of the mission; no definite assessment could be made on supervisory arrangements. - Principle 17. Bank Management Contact - Description: Supervisor has no powers to require a bank to notify of substantive changes in activities or material adverse developments. - Assessment: NON-COMPLIANT - Comment: FIC formative; no definite assessment. - Principle 18. Offsite Supervision - Section 26 of the FIA: Commission collects statistical and related information to fulfill duties, but the law does not provide general powers to require information from banks. - Section 26(b): Commission has to issue regulations on the information that must be submitted to it. - Independence compromised by power of approval accorded to the OEK. - Law does not require off-site reporting to be produced on a consolidated basis. - No regular reporting arrangements had been implemented at the time of the mission. - Technical assistance (TA) for 2002: calls for development of off-site monitoring procedures; identification of key ratios for capital adequacy, asset quality, earnings performance and liquidity; development of a database and automated calculation of key ratios; draft reporting formats and schedules prepared by the MAE Advisor; hands-on training to FIC staff; guidelines on rating of banks (e.g., CAMELS) expected toward end of 2002. - Assessment: MATERIALLY NON-COMPLIANT - Comment: FIC lacks explicit powers to require information for supervisory purposes; framework of standardized reports is in process. - Principle 19. Validation of Supervisory Information - Section 61: external auditors used by Commission must be certified public accountants with at least five years’ experience auditing banks; independent bank examiners must be certified public accountants with at least five years' experience examining banks. - Primary purpose of audit/examination in law: to inform the Commission about fraudulent acts by bank employees or irregularities/deficiencies expected to result in a material loss. - Assessment: MATERIALLY NON-COMPLIANT - Comment: On-site examination powers exist but are hampered by emphasis on disclosure of fraud/deficiencies as primary purpose; domestic banks exempt from requirement to have annual financial statement audited by an external auditor. - Principle 20. Consolidated Supervision - No provisions in place on consolidated supervision of Palau banks; only reference concerns application of certain provisions to branches of foreign banks on a consolidated basis. - Assessment: NON-COMPLIANT - Comment: FIC formative; no definite comment. - Principle 21. Accounting Standards - Board responsible for establishing policies and supervising implementation. - Section 57: financial institutions shall maintain accounts and records and prepare annual financial statements adequate to reflect operations and financial condition in accordance with consistently maintained Generally Accepted Accounting Principles (GAAP) promulgated by the Financial Accounting Standards Board or other generally accepted accounting standards approved by the Commission. - Foreign bank accounts, records, and financial statements must reflect operations and condition of subsidiaries and Palau branch offices on individual and consolidated basis; FIA does not require Palau banks to draw up consolidated accounts. - At end of each calendar year, each Palau bank shall internally or externally audit itself and produce an annual financial statement presenting a full and fair view. - Section 58: foreign banks must produce financial statements prepared by a licensed certified public accounting firm presenting a full and fair view. - Audit presented to the Commission on June 30 for the previous calendar year. - The Commission may require submission of additional information on site or off site or require off-site evaluation by independent external auditor or bank examiner, subject to showing good cause. - External auditors and independent examiners must have at least five years' experience in auditing/examining banks. - Section 59: each Palau financial institution shall annually by June 30 provide the Commission with a balance sheet as of December 31 of the previous year. Branches of foreign banks must make available to the public their annual audited reports on a consolidated basis. - Assessment: MATERIALLY NON-COMPLIANT - Comments: - Law exempts Palau banks from obligation to disclose their financial statements. - Only branches of foreign banks must make audited accounts public. - Only foreign banks must employ external auditors. - Supervisor has no powers to revoke the appointment of an auditor; auditors have no legal obligation to report to the FIC (e.g., material events or violations of banking law). - Principle 22. Remedial Measures - “Remedial action” may include: (1) establishment of a plan to increase capital to achieve compliance; (2) establishment of new committees for credit administration, asset and liability management, or internal audit and controls; (3) replacement of heads of departments; (4) establishing and enforcing internal controls. - Section 62: remedial measures and penalties are determined by the Commission and imposed subject to the Administrative Procedure Act, 6 PNC Chapter 1. - Commission must take action or impose penalties if a financial institution, its administrators, or principal shareholders violate the FIA, Commission regulation, or conditions of authorization. - Commission powers include: written warnings; written agreements concerning remedial programs; written orders to cease and desist; application to the Supreme Court, Trial Division, for a cease and desist order; fines up to $10,000 per day for each day that the violation continues; suspension or dismissal of administrators; restrictions on operations; revocation of license and ordering dissolution; appointment of a receiver under FIA; liquidation under receivership in case of insolvency. - FIC empowered to have a member of a bank’s board disqualified. - Specific capital-restoration rule for Palau (domestic) banks: - If capital is determined by the Commission to be less than three-quarters of the required minimum capital, the Commission shall require the bank to adopt a capital restoration plan satisfactory to the Commission that provides for the bank to attain capital adequacy within six months from the determination by the Commission. - A breach of the minimum capital adequacy ratio is not explicitly stated as a ground for revocation of a license. - Assessment: LARGELY COMPLIANT - Comments: - Supervisory authority has a range of measures. - A breach of the minimum capital adequacy ratio ought to be explicitly stated as grounds for revocation. - FIC should be able to take remedial action when less than 25% of the minimum amount is lost. - FIC’s powers to form views of safety and soundness and take prompt remedial action are constrained by the FIA’s emphasis on disclosure of wrongdoing as the primary purpose of examinations and by the Supreme Court’s role in issuing cease and desist orders. - Principle 23. Globally Consolidated Supervision - No provisions on an approval procedure for the foreign operations of Palau banks; supervisor has no powers to require closing of overseas branches. - Consolidated supervision is only applied to foreign banks. - Assessment: NON-COMPLIANT - Comment: FIA deficient in not providing consolidated supervision of Palau banks and FIC has no powers to limit scope of foreign operations. - Principle 24. Host Country Supervision - Section 8 of the FIA empowers the FIC to exchange information with foreign authorities. - FIC has no legal powers to prohibit banks from establishing foreign operations where secrecy laws limit exchange of information between authorities. - Assessment: NON-COMPLIANT - Comment: FIC formative; no definite comment. - Principle 25. Supervision Over Foreign Banks’ Establishments - Prudential regulations of section 53 applied only on a consolidated basis to foreign banks; provisions applied only insofar as consistent with national law of foreign bank's home jurisdiction. - Specific provisions for foreign banks include absolute capital amount and obligation to employ external auditors. - Section 33(c): license for a subsidiary or branch of a foreign bank can only be granted if: - (1) foreign bank is authorized to receive deposits or repayable funds in its head office jurisdiction; - (2) competent authorities supervising the head office have given written consent to granting such license; - (3) Commission determines foreign bank is adequately supervised on a consolidated basis by its supervisory authorities. - Law silent on rights of foreign supervisory authorities to undertake inspections at Palau branches and subsidiaries. - No standing arrangements on cooperation with foreign supervisory authorities established as yet. - Assessment: LARGELY COMPLIANT - Comment: Arrangements for exchange of information with foreign supervisors would need to be established in Memoranda of Understanding. *Source: cr04170 (International Monetary Fund).* ### 1. Objectives, Autonomy, Powers, and Resources ### 1. Objectives, Autonomy, Powers, and Resources ### Objectives and institutional independence - The mission emphasizes that an effective system of banking supervision requires clear responsibilities and objectives for each agency involved. - Recommended governance changes to enable the Financial Institutions Act (FIA) provisions to become applicable: - All posts of the Board should be filled. - Amend the eligibility provision to make a wider array of people eligible for Board membership. - Operational independence recommendations for the Financial Institutions Commission (FIC): - Amend the legal provision that gives the power to appoint the Executive Commissioner to the Board; the power should be vested with the President of the Republic. - Abolish the provision that gives the OEK powers to pre-empt the issuance of a prudential regulation by the FIC. - Lift the legal limit on supervisory fees that banks are charged to provide the FIC with adequate resources. ### Legal framework and supervisory powers - The FIA’s current framing limits the FIC’s powers to address safety and soundness because it states disclosure of irregularities and malfeasance as the primary purpose of bank examinations. - Recommended legal and regulatory enhancements: - Enact a general risk management provision in the FIA giving the FIC powers to judge a bank’s general risk situation. - Empower the FIC to issue cease and desist orders without seeking a court order. - Issue a legal provision to limit the scope of a bank’s permissible activities depending on the amount of its capital base. ### Enforcement powers, legal protection, and information sharing - The mission recommends strengthening the FIC’s enforcement and supervisory toolkit and removing provisions that materially undermine independence or delay prudential action. - The FIC should be given explicit powers to require any information needed for supervisory purposes and to build an analytical base for monitoring banks and planning examinations. ### Resources and operational capacity - To ensure adequate resources and operational effectiveness: - Lift the legal cap on supervisory fees charged to banks. - Vest appointment powers with the President to bolster independence. - Fill all Board posts and broaden eligibility for Board membership. ### Recommended actions on licensing, ownership, and investment supervision - Licensing criteria and grandfathering: - Remove ambiguity in grandfathering provisions regarding the FIC’s supervisory powers vis-à-vis existing banks (for example, by circulating a FIC statement to the banking sector). - Require banks admitted under simplified licensing to furnish practical plans on their capital and profitability and preliminary information on compliance with major prudential standards. - Provide more detailed licensing guidelines covering fit & proper tests, operational policies, and internal control procedures. - Ownership and investment criteria: - Establish clear rules distinguishing investments requiring supervisory approval from those subject to notification only. - Assess whether planned corporate affiliations would impair effective supervision. ### Capital adequacy, provisioning, and large exposures - Capital adequacy: - Raise the legal capital adequacy requirement from 5% to conform with the internationally accepted minimum standard of 8%. - Calculate capital adequacy on a consolidated basis. - Amend the law to provide a more detailed definition of regulatory capital and the risk weighting of different kinds of assets. - State explicitly that breach of the minimum capital adequacy ratio is grounds for revocation of a license. - Allow the FIC to take remedial action when less than 25% of the minimum amount is lost. - Loan evaluation and provisioning: - Issue regulations concerning asset classification, loan loss provisioning, and reporting of substandard loans. - Empower the FIC to require banks to strengthen lending practices and levels of provisions. - Large exposures: - Enact legal provisions or regulations on how different types of credit and contingent liabilities are included in large exposure calculations. - Apply large exposure regulations on a consolidated basis. ### Risk management, on-site/off-site supervision, and reporting - The FIC should establish guidelines and procedures for management of country risk, market risk, and other risk categories as applicable. - Develop an operational mode combining on-site examinations and a framework of prudential reporting appropriate to market conditions. - Require banks to inform the supervisor of substantive changes or adverse developments that might breach legal or prudential requirements. - Build an analytical off-site supervision base and enhance powers to require supervisory information. ### Accounting, auditing, and cross-border supervision - Accounting standards and auditor oversight: - Require all banks to disclose their financial statements. - Require external audits for all banks and give the supervisor powers to revoke the appointment of an auditor. - Impose a legal obligation on auditors to report material events in a bank’s activity or violations of banking law to the supervisor. - Supervision of foreign operations: - Give the FIC powers to control the foreign operations of Palau banks; establishment of branches/subsidiaries should be subject to FIC approval. - Provide FIC explicit powers to close down foreign operations. - Establish memoranda of understanding between the FIC and foreign supervisory authorities to secure exchange of information. ### Authorities’ response - The Financial Institutions Commission’s Governing Board reviewed the Executive Summary of the draft IMF Module II Assessment Report and finds the recommendations in line with the final review and evaluation meeting. - The FIC agrees that the recommended changes should be implemented and will work closely with Mr. John Vaught, Technical Consultant from the IMF, to formulate regulations and supervisory policies to bring the Republic of Palau into compliance with the Basel Core Principles. - The FIC intends to work with the Ministry of Finance and relevant agencies to build sound standards for regulation and supervision of financial institutions within the Republic of Palau. *The mission (IMF Module II Assessment).* ### II. Assessment of AML/CFT Legal, Institutional, and Supervisory Aspects — Summary ### Overall assessment and principal findings - The mission assessed Palau’s AML/CFT measures using the IMF and World Bank Methodology for Assessing Legal, Institutional, and Supervisory Aspects of Anti-Money Laundering and Combating the Financing of Terrorism. - Overall assessment: Palau has a largely satisfactory legal and institutional framework for preventing and detecting money laundering in the banking sector, but implementation capabilities need strengthening because: - (i) The AML legislation does not provide the Financial Intelligence Unit (FIU) with clear powers to conduct on-site inspections, to undertake enforcement, and to ensure compliance by reporting entities. - (ii) The FIU is understaffed and lacks sufficient expertise for analysis of suspicious transactions. - (iii) Banks lack clear guidelines and recommendations from the FIU on practical day-to-day implementation, particularly identification of suspicious transactions. ### Legal framework developments and institutional arrangements - Legislative developments: - In June 2001, Palau enacted a package of anti-money laundering laws including the Money Laundering and Proceeds of Crime Act 2001 (AML Law) and the Mutual Assistance in Criminal Matters Act 2001. - Additional laws augmenting the AML framework include the Financial Institutions Act 2001, the Foreign Evidence Act 2001 and the Extradition Act 2001. - The FIU was created in November 2001. - International engagement: - Palau demonstrated political commitment: signatory to the Honiara Declaration; volunteered to participate in a Forum Secretariat/Asia/Pacific Group initiative funded by the IMF Legal Department (LEG); intends to join the Asia/Pacific Group on Money Laundering. - The draft AML/CFT methodology guidance observed was issued to the IMF’s Executive Board on February 7, 2002. ### Supervisory responsibilities and gaps - The mission identified a gap in AML supervisory responsibilities because the supervisory authority for day-to-day AML implementation was not clearly identified. - Initial government thinking assigned responsibility to the FIC, but some reporting entities (e.g., exchange offices and money transmitters) would remain unregulated by the FIC. - The mission’s recommended allocation of responsibilities: - The FIC should be responsible for establishing AML policies and procedures for banks. - The FIU should be given responsibility for day-to-day implementation (including on-site inspection) and enforcement of AML requirements for all reporting entities, including banks. ### Specific recommended legal amendments and capacity building - Immediate and technical legal amendments recommended: - Begin implementation of existing AML provisions immediately. - Amend the AML law to include: - Specific record keeping requirements. - Lowering the threshold when identifying casual clients. - Removal of the threshold of $10,000 for the record keeping requirement for customer identification. - Prohibition of anonymous accounts. - Clarifying suspicious transaction reporting requirements. - Extending the scope of provisions overriding secrecy and the tipping off provisions. - Redefining the definition of money laundering so that the mens rea element is clearly set out. - Setting out the predicate offenses to which the money laundering offence relate, based on the concept that all crimes would be considered predicate offenses and including similar extraterritorial offenses. - Extending the power to confiscate the proceeds of money laundering and predicate offenses, instrumentalities and subject matter of money laundering offenses; where proceeds/instrumentalities are not available, permit the court to order confiscation of property of an equivalent value or a penalty sum equivalent to the value of property. - Including adequate procedures for protection of innocent and bona fide third party interest. - Requiring customer identification for wire transfers. - Amend the AML law to vest the FIU with powers to: - Disseminate information it receives to relevant law enforcement agencies, foreign and local, where it suspects a money laundering offense, with adequate confidentiality safeguards. - Audit compliance and conduct on-site inspection of financial intermediaries and have enforcement authority with respect to reporting entities. - Facilitate advisory activity, research, training and public education. - Protect the FIU and the information it receives from suit and compulsory legal process. - Access public information. - Capacity and regulation recommendations: - Provide the FIU with adequate staffing and expertise. - Provide the FIU with powers to issue regulations for effective implementation of the AML Law. - Establish a training program for the FIU, financial intermediaries, and the Attorney General’s office; technical assistance from MAE and LEG is being envisaged. - Consider applying “fit-and-proper” tests to controlling shareholders and management of the 12 institutions which have applied for a banking license under the FIA’s grandfathering provisions. - Enact anti-terrorism legislation as soon as possible and issue regulations for registration of over-the-counter exchange dealers. ### Detailed assessment outcomes and institutional cooperation - Assessment methodology and coverage: - The mission assessed Palau’s AML system against Part 1 and Part 2, module one, of the AML/CFT methodology with respect to banks. - The assessment drew on legislation review and interviews with Ministry of Finance, FIU, Attorney General, Ministry of Justice, five of Palau’s twelve banks, and the FIC. - Summary compliance findings: - Of the 12 broad criteria assessed, the mission found Palau to be: - Compliant with 2 criteria. - Largely compliant with 5 criteria. - Materially non-compliant with 3 criteria. - Non-compliant with 2 criteria. - The FIU provided extensive cooperation and documentation to the mission and organized meetings with government and private sector stakeholders. *The mission (IMF Module II Assessment).* ### 28. Palau’s legal framework in anti-money laundering is largely contained in the AML ### 28. Palau’s legal framework in anti-money laundering is largely contained in the AML ### Legal and institutional framework — overview - Primary laws: - AML law: criminalizes money laundering; creates an FIU with powers to receive suspicious transaction reports and analyze them; sets comprehensive customer identification requirements; some record keeping requirements; suspicious transaction reporting requirements; provisions overriding secrecy for purposes of reporting under the AML law; protection for those reporting from suit; prohibition against tipping off; confiscation of the subject of money laundering offenses and the benefits derived therefrom; provisional measures such as seizing and freezing powers during money laundering investigations. - Mutual Assistance in Criminal Matters Act 2001: provides assistance to and by Palau in investigations and prosecutions including powers for production of documents, seizure of documents and property and freezing, seizing and confiscation of proceeds of money laundering offenses. - Foreign Evidence Act: provides for admissibility of some types of foreign evidence. - Extradition Act: provides for extradition for money laundering offenses. - Supervisory and regulatory instruments under the FIA (Financial Institutions Act) are envisaged, but regulations under the FIA and the AML law have yet to be issued; the framework is a work in progress. - Key implementing agencies identified: FIU (Coordinator appointed November 19, 2001), FIC, MOF, Attorney General, Police Department Criminal Investigation Division, Supreme Court. ### Money laundering offense - Scope of the offense: - Covers conversion or transfer of property for purpose of concealing or disguising the illegal origin; concealment or disguise of the illegal nature, source, location, disposition, movement, or ownership of property; acquisition, possession, or control of property by any person who knows that the property constitutes the proceeds of crime as defined herein. - Mens rea: - Law provides that knowledge, intent, or purpose is required as an element and may be inferred from objective factual circumstances. - Uncertainty remains regarding the precise subject-matter to which this required knowledge must relate. ### FIU, coordination, and operational status - FIU powers and actions: - Responsible for receiving suspicious transaction reports, analyzing them, freezing funds suspected of being involved in money laundering, providing assistance to counterpart FIUs, and assisting in money laundering investigations. - Coordinator appointed on November 19, 2001. - Issued two advisories to financial intermediaries: one setting out obligations and STR form; another directing banks to investigate U.S. and U.N. lists of terrorism-connected entities and individuals (no assets connected with names provided were located in Palau). - Operational gaps: - FIU lacks full operational capability, expertise, and resources; only a Coordinator appointed. - FIU has indicated it requires technical assistance to draft regulations for over the counter exchange dealers and other regulatory guidance. - MOF does not maintain a direct role in AML supervision; MOF together with Ministry of Justice would be responsible for changes in legal framework. ### Scope of regulated financial intermediaries - AML law applies to a broad range of intermediaries including: - banks, savings and loan institutions, credit unions, securities brokers or dealers, entities accepting deposits and other repayable funds from the public; lending (consumer credit, mortgage credit, factoring, financing of commercial transactions); financial leasing; money transmission services; issuing and administering means of payment; guarantees and commitments; trading for customers in money market instruments, foreign exchange, financial futures and options, exchange and interest rate instruments and transferable securities; underwriting share issues; money brokering; portfolio management and advice; safekeeping and administration of securities; credit reference services; safe custody services. - Some intermediary types do not currently exist in Palau. - Over the counter exchange dealers: - AML law requires registration of over the counter exchange dealers by the FIU. - Regulatory framework and registration regulations have not been established. ### Client due diligence (CDD) and identification requirements (statutory provisions) - Section 7 (Verification): - Requires verification of customer identity and address before opening ordinary accounts or passbooks, taking stocks, bonds or other securities into safekeeping, granting safe-deposit facilities, managing assets, or effecting or receiving payments for natural or legal persons. - Any person who opens an account in a false name is guilty of an offence. - Section 7 sets out identification documents required for natural and legal persons. - Verification limited to transactions listed in section 7. - Section 8 (Casual customers): - Requires identification of all casual customers if the sum of the transaction is over $10,000. - If the amount is unknown at time of operation, the customer shall be identified as soon as the threshold amount of $10,000 becomes known or is reached. - Casual customers must also be identified if transactions are conducted in a manner that reasonably appears to have an unlawful criminal purpose. - It is not stated what kind of identification documents are required for casual customers; "casual customers" are not defined. - Section 9 (Beneficial owners): - Requires identification of the beneficial owner where it is uncertain whether the customer is acting on his or her own behalf; financial intermediary to seek information by any legal or reasonable means. - Section 14 (Over the counter exchange dealers): - Requires identity verification where transaction > $2,500 or where transaction conducted in conditions of unusual or unjustified complexity. - Verification documentation for these transactions specified: an official original document of identification that is unexpired and bears a photograph, a copy of which shall be taken. ### Record keeping (statutory provisions) - Section 5: - Requires financial intermediaries to keep regular reports of all transactions made in cash or bearer securities in excess of $10,000 or its equivalent in foreign cash or bearer securities. - Section 11: - Requires financial intermediaries to maintain and hold at disposal of authorities, pursuant to an order of the Supreme Court, records of customer identification for five years after the account has been closed or relations ended. - Requires retention of records of transactions where the transaction involves a sum greater than $10,000 and is conducted in a manner that appears to have an unlawful purpose. - Records of all other transactions are not required to be kept under the AML law. - Unified Tax Act requires records of transactions to be kept for three years for tax purposes (less than minimum international standard of five years). - Section 12: - Customer verification records can only be delivered to the FIU and the Office of the Attorney General upon the Office of the Attorney General applying to the Supreme Court, Trial Division, for an order based on a finding of probable cause. ### Suspicious transaction reporting (STR) provisions - Section 10: - For transactions > $10,000 conducted in a manner that appears to have an unlawful purpose, financial intermediaries shall provide information on origin and destination of money, purpose of the transaction, identity of transacting parties, methods of the transaction and identity of the principal to the FIU and the Office of the Attorney General. - Section 12 imposes further requirement that these records can only be made available upon obtaining an order from the Supreme Court when an investigation is under way. - Section 19: - Requires any natural or legal person who in connection with trade or occupation carries out or advises on operations involving deposits, exchange operations, investments, conversions, or other movements of capital, to report to the FIU transactions in section 10 involving money that reasonably appears to be derived from money laundering. - Reporting required even where it is not feasible to defer execution or where it becomes clear after transaction completion that it involves money laundering. - Section 19 is narrower than section 10 (relates to transactions that reasonably appear to be derived from money laundering). - No requirement to obtain a court order before such a report can be made to the FIU. - Terrorist financing reporting: - No specific AML law requirement to report suspected terrorist financing as suspicious transaction. - FIU advisory requires financial intermediaries to report as suspicious any transactions or funds related to persons and organizations on the U.S. and U.N. lists. ### Overriding banking secrecy and protection for reporters - Section 25 (Overriding secrecy): - Banking or professional secrecy may not be invoked as grounds for refusal to provide information relating to suspicious transactions under section 10 and record keeping documents or documents required in connection with an investigation which relates to money laundering and is ordered by or carried out pursuant to an order of the Supreme Court. - Not clearly stated that secrecy is overridden for purposes of reporting under section 19. - Section 21(b) (Protection): - No civil or criminal action may be brought, nor any professional sanction taken, against a financial intermediary who in good faith transmits information or submits reports pursuant to the AML law, even if the investigation or judicial decision does not give rise to a charge for any offense. ### Tipping off and sanctions - Section 12(d) (Tipping off): - Upon receipt of confidential information by the Office of the Attorney General pursuant to section 12, the Ministry of Justice, FIU, the Office of the Attorney General, and all related employees and agencies are prohibited from disclosing or making known the existence and content of the information received; such persons shall not be required to transmit the information to any natural or legal person other than the FIU and the Office of the Attorney General. - Section 31 (Penalties): - Penalty for tipping off or for failing to make a suspicious transaction report: not more than two years imprisonment or a fine not to exceed $10,000. - Applies to persons and directors or employees of organizations that carry out or advise on operations involving deposits, exchange operations, investments, conversions, or any other movements of capital, and in particular to financial intermediaries. ### Internal policies, procedures, and training - Section 13: - Requires financial intermediaries, including money remitters and exchange dealers, to develop written policies and procedures for prevention of money laundering where such programs and procedures do not currently exist. - Programs should include centralization of information on identity of customers, principals, beneficiaries, authorized agents, beneficial owners, and suspicious transactions; designation of compliance officers at central management level, in each branch and at each agency or local office; on-going training for officials or employees; internal audit arrangements to check compliance and effectiveness. - Policies and procedures to deter financing of terrorism are not specifically referred to in section 13. - Training needs: - Banks require training for staff on AML Law and recognition of suspicious transactions. - FIU and industry require assistance and guidance to develop detailed procedures, internal controls, and regulations. ### Implementation status, supervisory clarity, and recommendations implied by assessment - Implementation status: - Anti-money laundering requirements for banks: in infancy. - Implementation for other intermediaries: appears to be non-existent. - Institutional framework: FIU not fully operational; resources and expertise lacking. - Supervisory clarity: - AML law is silent on which authority exercises supervisory powers over AML measures and who ensures compliance by financial intermediaries. - FIC has powers under Section 48 of the FIA to ensure financial institutions’ compliance with provisions prohibiting concealment, conversion, or transfer of property derived from criminal activity; however, financial institutions form only a portion of intermediaries covered by the AML law. - FIU envisages working with the FIC and the AG in drafting regulations and guidelines; consultation with FIC recommended for establishing regulatory framework for over the counter exchange dealers. - Key requirements to achieve full effective implementation: - Issuance of regulations under the AML law and the FIA. - Provision of training to financial intermediaries and FIU staff. - Allocation of additional resources to the FIU. - Clarification in law of supervisory responsibilities and designation of supervisor(s). - Role of FDIC-regulated banks: - FDIC-regulated banks in Palau have some AML procedures and controls because of U.S. anti-money laundering obligations; they represent a source of information and experience that could be utilized by the FIU and local bankers. *International Monetary Fund.* ### Section 44 of the FIA provides that all persons elected or appointed as administrators of a ### Section 44 of the FIA provides that all persons elected or appointed as administrators of a financial institution must be of good repute and must meet the criteria established by regulation of the FIC regarding qualifications, experience, and integrity ### Administrator qualification and scope - Section 44 of the FIA: all persons elected or appointed as administrators of a financial institution must be of good repute and must meet the criteria established by regulation of the FIC regarding qualifications, experience, and integrity. - Definition of "Administrator": any person who is an officer of a financial institution or other juridical person, including any member of the board of directors or the Audit Committee, or the head of a department of the organization, but shall only apply to a person who is regularly employed at the Palau office of the financial institution. - No regulations implementing the criteria have been made yet. ### Sanctions for non-compliance with AML provisions - Section 30 of the AML law: any person who fails to comply with the above provisions shall, upon conviction therefor on the basis of clear and convincing evidence, be subject to a civil penalty not to exceed $50,000 upon application by the Office of the Attorney General. - Assessment: LARGELY COMPLIANT ### Key assessment findings and recommended AML/CFT improvements - Customer identification and recordkeeping - The requirement to identify casual clients should have a lower threshold limitation. - There should be a prohibition of anonymous accounts. - There should be record keeping requirements for any transaction conducted by financial intermediaries for at least five years after the termination of the account or business relationship and these records should be available for the inspection of the FIU without the need for an order of the Supreme Court. - Records kept should be sufficient to permit the reconstruction of individual transactions so as to provide evidence for prosecution of criminal behavior. - Minimum records should include: the customer's name, address or other identifying information normally recorded by the intermediary, nature and date of the transaction, type and amount of currency involved and details of the account. - The threshold of $10,000 for the record keeping requirement for customer identification documents should be removed. - Risk-based and suspicious transaction measures - No specific requirement that financial intermediaries give special attention to transactions with persons in jurisdictions that do not have adequate systems in place to prevent or deter money laundering or the financing of terrorism. - Financial intermediaries should be required to identify all complex or unusual transactions and complex or unusual patterns of transactions; transactions that have no apparent or visible economic or lawful purpose; examine the background of such transactions; and send such information to the FIU as suspicious transactions. - Financial intermediaries should be required to include originator information and related messages on funds transfers that should remain through the payment chain. - There should also be customer verification for wire transfers. - Reporting and FIU access - The FIU is of the view that the reporting requirement in section 10 does not require an order of the Supreme Court and in practice this has been done. - The Mission is of the view that suspicious transactions relating to money laundering pursuant to section 10 of the AML law can be reported to the FIU without the order of the court. - If a suspicious transactions report is made because the transaction is conducted in a manner that it appears to have an unlawful purpose then the FIU can only obtain that report from the financial intermediary upon obtaining an order of the Supreme Court. - Recommendation: The FIU should be sent the suspicious transactions reports without having to go to the Supreme Court. - The FIU should have access to reports of all transactions made in cash or bearer securities in excess of $10,000 or its equivalent in foreign cash or bearer security that are kept by financial intermediaries pursuant to section 5 of the AML law. - The suspicious transactions reporting requirement should be clarified. - Overriding secrecy and tipping-off - The overriding of secrecy should be specifically extended to all reporting requirements especially the reporting requirement under section 19 of the AML law. - The tipping off provision in section 12(d) should be amended to make it clear that it covers disclosures made under section 19 of the AML law and should also cover any person who has knowledge of a suspicious transaction report. - The sanctions in section 30 for non-compliance should be made specifically to apply to non-compliance with section 19 of the AML law to prevent ambiguity. - Employment screening and training - There is no specific provision requiring financial intermediaries to screen applicants for employment to prevent the use of their institutions by money launderers or terrorists or to provide employees with training in the recognition and handling of terrorism financing. ### Legal requirements for supervision and regulation: licensing, fit and proper, corporate registration - Licensing and registration - Section 3 of the FIA: licensing of a bank, securities broker, or securities dealer by the FIC. - Section 14 of the AML law: over the counter exchange dealers required to obtain a license from the Minister of Justice. - Fit and proper for controlling shareholders and management - Section 30 of the FIA: FIC shall only grant a license if qualifications, experience, and integrity of administrators and significant shareholders are appropriate for its business plan and licensed financial activities. - Section 40 of the FIA: transfer of an equity interest that results in a significant interest requires prior written authorization of the Commission; determination based on qualifications, experience, and integrity of proposed shareholders. - Section 45 of the FIA: person not eligible to be a member of the board of directors, or may be relieved of membership, if convicted of a felony or a crime of moral turpitude. - Corporate registration and oversight - The Registrar of Corporations and the Foreign Investment Bureau require corporations to be registered and to submit details of directors, officers, management and shareholding. - Regulations (5.4, 5.5): corporations required to file exhibits of state of affairs annually, including accounts; failure can lead to certificate revocation. - No specific provisions preventing these entities from being used as conduits for criminal proceeds or terrorist financing, or prohibiting criminals from owning or controlling these corporations. - Assessment: LARGELY COMPLIANT - Recommendation: Registrar of Companies and the Foreign Investment Bureau should require police clearance and ensure owners, controllers, or managers are not serious criminals; consider licensing money remittance/transmission entities under the AML law. ### Criminalization of money laundering and financing of terrorism - International conventions - Palau has signed the Vienna Convention. - The Palermo Convention has not been signed. - Money laundering criminalization - Section 3 of the AML law: money laundering is criminalized as a separate offense. - Money laundering defined to include: - conversion or transfer of property for the purpose of concealing or disguising the illegal origin of such property; - the concealment or disguise of the illegal nature, source, location, disposition, movement, or ownership of property; - the acquisition, possession, or control of property by any person who knows that the property constitutes the proceeds of crime. - Knowledge, intent, or purpose is required as an element and may be inferred from objective factual circumstances. - Authorities view predicate offenses as extending to all offenses in the Penal Code, though this is not clearly set out. - Except for the third limb of the definition, the mens rea element is not clearly set out. - No necessity for a conviction of the predicate offense to establish a money laundering offense. - Property defined to mean assets of every kind, whether movable or immovable, tangible or intangible, and legal documents or instruments evidencing an interest in such assets. - It is not specifically stated that money laundering extends to predicate offenses committed extraterritorially, though authorities view that it would. - Financing of terrorism - Financing of terrorism has not been specifically criminalized. - Sentencing and corporate liability - Section 28 (natural persons): any natural person convicted of violating section 3 as a principal shall be fined not less than $5,000, nor more than double the amount laundered or attempted to be laundered, whichever is greater, or imprisoned for not more than ten years, or both. Penalties also apply to attempts, accessories, aiders and abettors, and conspirators. - Section 29 (corporate entities): corporate entities, other than the Republic of Palau, on whose behalf or for whose benefit a money laundering offense has been committed by one of their agents or representatives shall be fined in an amount equal to two times the fines specified for natural persons, with prejudice to conviction of individuals. Corporate entities convicted of three or more offenses under section 3 within a five-year period may face: permanent or up to five years ban from carrying on licensed business activities; ordered closure of premises permanently or for up to five years; or required to publicize the judgment in the press or by radio or television. - Assessment: LARGELY COMPLIANT - Recommendations: - Predicate offenses should be set out clearly and explicitly extend to extraterritorial conduct. - Mens rea elements should be clearly specified for the relevant limbs. - The Palau government should ratify the Palermo Convention. - Financing of terrorism should be criminalized with mens rea of at least knowing financing and including a "should have known" element. ### Confiscation, provisional measures, and investigative powers - Confiscation regime - AML law provides for confiscation of proceeds of crime and assets used by criminal organizations. - Confiscation allowed of property forming the subject of the offense and income or other benefits obtained from the offense, but only after conviction of the money laundering offense or an attempt to commit money laundering. - Confiscation may extend to enrichment obtained during a three-year period prior to conviction. - Section 32: upon conviction for actual or attempted money laundering, the Supreme Court shall issue confiscation orders against any person if it can be established that the owner was not a bona fide purchaser for value or did not acquire the property for legitimate grounds; government must establish beyond a reasonable doubt the connection to the offense for additional confiscation of enrichment during the three-year period preceding conviction. - Section 33: provides for confiscation of property of criminal organizations. - No power to confiscate property of equivalent value or to order a penalty sum equivalent to the value of property where proceeds are unavailable. - Limited protections for third parties: except for bona fide purchaser language, there are no other provisions protecting rights of third parties. - Confiscation provisions do not specifically provide for confiscation of proceeds or assets used for the financing of terrorism. - Drug law: separate provision allows confiscation of property as instrumentality of the offense or acquired from proceeds of drug trafficking. - No provision for confiscation through civil process. - Provisional measures and investigative powers - AML law allows seizing of property in the course of investigations and freezing of property by order of the Supreme Court upon a showing of probable cause. - Undercover operations, controlled delivery, surveillance, and tapping of phones are allowed. - Section 23: FIU or Office of the Attorney General may monitor bank accounts; access computer systems, networks, and servers; place under surveillance or tap telephone lines, facsimile machines, or electronic transmission or communication facilities; electronically record acts and behavior or conversations; inspect communications of notarial and private deeds or of bank, financial, and commercial records. Supreme Court may order seizure of aforementioned documents. - These operations require probable cause that such accounts, lines, systems, or documents are or may be used by persons suspected of participating in money laundering offenses. - Absent exigent circumstances, operations permitted only pursuant to a warrant issued by the Supreme Court. - Section 27: Supreme Court may, upon application of the Office of the Attorney General, issue a temporary order freezing capital and financial transactions relating to property liable to seizure or confiscation under the Act; unless there is a conviction this order lasts only three months. - Section 20: if the FIU considers it necessary, the Office of the Attorney General shall petition the Supreme Court for an order to stop execution of a transaction; upon ex parte showing of probable cause the Supreme Court shall order stoppage of the transaction. - When exigent circumstances require it, the Office of the Attorney General may make the application via telephonic communication with any sitting Justice of the Supreme Court (to be followed by a written application). - These orders are valid for 72 hours; there is a right to extend these orders for up to eight days. - Gaps and recommendations - No specific provisions for seizing or freezing assets used for the financing of terrorism. - No provision to confiscate property of equivalent value or impose a penalty sum where proceeds are unavailable. - Recommend enabling confiscation through civil process and strengthening third-party protections consistent with confiscation objectives. *International Monetary Fund — cr04170 (excerpts).* ### Section 34 of the AML law provides for the avoidance of any instrument, the purpose of ### cr04170 - Section 34 of the AML law provides for the avoidance of any instrument, the purpose of ### Confiscation and provisional measures - Section 34 of the AML law provides for the avoidance of any instrument, the purpose of which is to fraudulently convey property and keep it from confiscation, if the Supreme Court determines that the instrument has been done for fraudulent purposes. - Assessment: LARGELY COMPLIANT - Key findings and gaps: - Confiscation provision should be expanded and clarified so that confiscation of all proceeds of money laundering offenses, predicate offenses, instrumentalities and subject matter of money laundering offences should be possible. - If proceeds of crime, instrumentalities or subject matter of the offense are not available for confiscation, the court should have the power to order confiscation of property of an equivalent value or the payment of a penalty sum equivalent to the value of property to be confiscated. - There should be adequate procedures for the protection of innocent and bona fide third party interest. - Palau should sign and ratify the Palermo Convention. - Confiscation and provisional measures should extend to the confiscation, seizing and freezing of assets used for the financing of terrorism. - The powers to freeze property assets should be extendable. ### Financial Intelligence Unit (FIU) — establishment, powers, and limitations - Description and statutory provisions: - The AML law established the FIU. Section 15 of the AML establishes the FIU within the Office of the Attorney General. - Section 15(b): FIU members shall be required to keep confidential any information obtained within the scope of their duties, even after cessation of those duties; such information can only be used for any purposes provided for by the AML law. - Section 15(d): The FIU shall receive reports transmitted by persons referred to in sections 10 and 19 (i.e., suspicious transaction reports), shall analyze the reports on the basis of information at its disposal, and shall gather additional information from organizations and government ministries and agencies involved in combating organized crime. - Section 16: FIU powers include receiving, analyzing, and processing reports required pursuant to the AML law; no specific power to disseminate information to law enforcement agencies on its own initiative. - Section 17: FIU has power to access information and records from public authorities or any natural or legal person within scope of investigations following a report of suspicion; reasonable access to databases of all public authorities shall be granted upon request. - Section 18: FIU may exchange information with foreign FIUs subject to reciprocal arrangements and confidentiality requirements substantially similar to those in the AML law; compliance with requests is permissible if within scope of reciprocal agreement and not in conflict with Palau law. - Section 19: Sets out requirement for suspicious transaction reports and their transmission; FIU advisory has set out the Form for reporting. FIU authorized to seize documents relating to money laundering and to monitor such accounts, subject to an order of the Supreme Court. - FIU must submit an annual report to the President, the Minister of Justice, and the Olbiil Era Kelulau providing an overall analysis and evaluation of reports received and money laundering trends. - Operational history and staffing: - A Coordinator was appointed on November 19, 2001. The Minister of Justice indicated that when the need arises other officers would be assigned. - No regulations have been issued by the Attorney General pertaining to duties and functions of the FIU; the FIU has indicated it needs technical assistance to issue such regulations. - Limitations and legal constraints: - FIU members may not concurrently hold any other public or private employment or hold or pursue any elective office in the Palau National Government or any State Government, or engage in other assignments or activities that might affect independence. - FIU has no specific power to disseminate information to law enforcement agencies on its own initiative. - FIU has no inherent power to audit compliance with AML law obligations (section 23 AML law). - FIU has power to seize documents during an investigation but requires Supreme Court order to monitor accounts or to stop the execution of a transaction (through petition by the Office of the Attorney General). - FIU has no power to effect sanctions and penalties; Attorney General may impose civil penalties against financial intermediaries for non-compliance with verification, reporting and record keeping requirements (section 20 AML law). - Sanctions under section 29: one sanction for a person found guilty of money laundering is the inability to carry on their business permanently or for five years; loss of license for anyone who tips off. - Assessment: MATERIALLY NON-COMPLIANT - Recommended remedial actions for the FIU: - Staff and organize the FIU to ensure proper execution of functions. - Remove prohibition on FIU members from concurrently holding other public employment or pursuing elective office given resource constraints in Palau. - Grant FIU direct access to information of other public authorities without requiring a court order. - Authorize FIU to enter into agreements with foreign FIUs to facilitate cooperation on terrorism financing. - Amend AML law to give FIU power to disseminate information to law enforcement on its own initiative or on request, with adequate confidentiality safeguards. - Give FIU power to audit financial intermediaries' compliance with AML and CFT provisions and to request further documentation. - Authorize FIU to undertake research, advisory, training, and public education activities. - Provide adequate legal protection for the FIU and its information from suits and legal process. - Grant FIU powers to ensure compliance including on-site inspections and a wide range of enforcement tools for serious deficiencies. - Provide technical assistance to implement these measures. ### International cooperation in AML/CFT matters - Legal framework and instruments: - Palau introduced measures for mutual legal assistance through the Mutual Assistance in Criminal Matters Act 2001, which provides procedures and standards for submitting requests to Palau and for Palau to request assistance; provisions are subject to any agreement Palau may enter into with a requesting country. - Palau permits mutual assistance for all serious offenses, defined as any offense for which the punishment is imprisonment of more than one year and offenses that would be punishable by imprisonment of more than one year if they had occurred in Palau; this includes money laundering. - Assistance may be given where the person is charged with money laundering or both money laundering and the predicate offense. - Assistance can only be given to a foreign state if there is an assurance that the requesting foreign state covers all costs associated with the request. - Palau can refuse a request if it is prejudicial to the sovereignty, security or other essential public interest of Palau (section 5, Mutual Assistance in Criminal Matters Act 2001). - Assistance can cover evidence gathering orders, search warrants, consensual transfer of detained persons, detention of persons transferred to Palau (with safe conduct assurances), enforcement of restraining orders, confiscation orders and location of proceeds of crime (Subchapter II). - Section 16 of Mutual Assistance in Criminal Matters Act 2001 allows for sharing of confiscated property. - Foreign Evidence Act 2001 provides for admissibility of certain types of overseas evidence. - Extradition and Transfer Act 2001 allows for extradition of criminals in money laundering cases. - Operational use and procedures: - Provisions of these Acts have not been utilized yet; all requests for assistance to date have been from the United States and handled by a special arrangement (COMPACT). - The Attorney General and the Ministry of State handle requests for foreign assistance. - Assessment: COMPLIANT - Comments and recommended improvements: - Mutual assistance in financing of terrorism is not specifically provided for and should be included. - Prepare regulations that set out detailed procedures especially regarding enforcement of foreign restraining and confiscation orders. - Extradition should cover financing of terrorism. ### Controls and monitoring of cash transactions - Reporting and monitoring: - Palau requires the reporting of import of currency exceeding $5,000; this requirement is not required by law. - All domestic and international transfers are to be effected through the banks and the FIU has power under the AML Law to have access to such records during investigations, subject to court order. - The Customs monitor cross-border movements of large cash amounts. There is no specific requirement under the AML law to report cross-border cash movements in or out of Palau. - Policy stance and operational needs: - Palau considers it not timely to impose a cash reporting regime without studying types and levels of cash activity; assistance would be required to undertake such a study. - The mission found that Palau is largely cash based with some usage of checks. ### AML/CFT in the banking sector — prudential supervision and compliance - Organizational and administrative arrangements: - The FIC under the FIA has general supervisory powers to ensure banks’ compliance with provisions of the FIA, including section 48 which prohibits concealment, conversion, or transfer of property knowing it is derived from criminal activity. - The FIC has powers under section 44 of the FIA to ensure administrators of financial institutions meet fit-and-proper criteria; section 45 disqualifies persons convicted of a felony or crime of moral turpitude from board membership. - The FIC has just been established and has not issued guidance on AML matters or exercised its supervisory powers; no regulations have been made yet. - Assessment: MATERIALLY NON-COMPLIANT - Recommended minimum actions for the FIC: - Issue guidelines on internal controls, policies and procedures for prevention and deterrence of money laundering. - Issue regulations on “fit-and-proper” tests for controlling shareholders and management. - Customer identification and due diligence: - The FIA does not require customer identification. - In practice, some banks (especially FDIC banks subject to U.S. laws) have established customer due diligence procedures. - Banks have not received guidance on implementing customer due diligence under the AML law. - Assessment: NON-COMPLIANT - Recommendation: FIU should be given powers to audit compliance and conduct on-site inspections; FIU should prepare regulations for customer due diligence implementation. - Monitoring and reporting of suspicious activities: - AML law details requirement to report suspicious transactions; reports must be transmitted to the FIU by confidential written communication; telephone reports must be confirmed in writing within the shortest reasonable time; FIU must immediately acknowledge receipt. - FIU issued an Advisory with the Form for reporting and what should be reported. - FIU has no power to determine that banks have procedures for reporting suspicious transactions or to ensure employees do not tip off. - No specific power requiring banks to give special attention to business relations with entities from non-compliant countries, though such measures can be set out in regulations. - FIU administratively required banks to report suspicions of funds related to terrorists and terrorist organizations listed by the U.S. and the U.N.; FIU has checked compliance administratively. - Assessment: MATERIALLY NON-COMPLIANT - Comments: FIU requires assistance to draft detailed regulations and banks require training in recognizing suspicious transactions; notwithstanding lack of regulations, authorities state all suspicious transactions are reported to the FIU. - Record keeping, compliance and audit: - Legal framework for record keeping is detailed in Part I. - FIU has no power to check compliance with record keeping requirements. - Some financial intermediaries (notably FDIC regulated banks) have record keeping requirements in place. - Assessment: MATERIALLY NON-COMPLIANT - Recommendation: FIU should prepare regulations on implementation of record keeping requirements under the AML law. - Cooperation with supervisors and competent authorities: - Section 18 of the AML law allows the FIU to share information with foreign FIUs subject to conditions in agreements between FIUs. - Assessment: COMPLIANT - Comment: Any sharing of information should be subject to safeguards as to confidentiality and use. - Licensing and authorizations: - FIC has powers under section 44 of the FIA regarding qualifications, experience, and integrity for administrators; no regulations have been made yet. - Section 45 disqualifies persons convicted of a felony or crime of moral turpitude from board membership. - Assessment: LARGELY COMPLIANT - Recommendation: FIC should prepare regulations relating to fit-and-proper tests for controlling banks, directors, and senior management. ### Consolidated recommendations (topics and actions) - Expand and clarify confiscation provisions to cover proceeds, predicate offenses, instrumentalities, and subject matter of money laundering; enable confiscation of equivalent-value property or penalty sums when original assets unavailable; protect bona fide third party interests. - Extend confiscation, seizing and freezing measures to assets used for financing of terrorism and make freezing powers extendable. - Staff and organize the FIU; remove restrictions on concurrent public duties given resource constraints; grant FIU power to access public authority information without court order; authorize FIU to disseminate information to law enforcement and to enter into foreign FIU agreements for CFT cooperation. - Amend AML law to give FIU powers to audit, conduct on-site inspections, enforce compliance, request documentation, perform research, advisory and training roles, and obtain legal protection from suits and legal process. - Prepare detailed regulations for FIU operations, suspicious transaction reporting, customer due diligence, record keeping, and enforcement procedures. - Include financing of terrorism explicitly within mutual legal assistance and extradition frameworks; prepare regulations for enforcement of foreign restraining and confiscation orders. - FIC should issue guidance and regulations on internal controls, fit-and-proper criteria, and exercise supervisory powers over financial institutions licensed under the FIA. - Conduct a study (with assistance) before imposing a formal cash reporting regime; consider legal mechanisms for cross-border cash reporting. *Source: International Monetary Fund assessment and description of Palau’s AML/CFT framework contained in the referenced content unit.* ### Part 1: AML/CFT in the legal and institutional framework ### Part 1: AML/CFT in the legal and institutional framework ### Suggested actions for the legal and institutional arrangements - The FIU should be properly established and resourced and trained. - The FIU should be vested with adequate compliance, inspection, and enforcement powers for the AML law. - Existing AML provisions should be implemented beginning immediately. - The FIC would have the supervisory role over the policies and procedures that banks have in place and for implementing fit and proper test for all the relevant persons. - Training for FIU, banks, AG and Police on anti-money laundering matters. - The FIB and the Registrar of Corporations should ensure that entities that they register do not have serious criminals holding significant investments and from holding any management functions. - Legal: Sign and ratify the Palermo Convention and the UN Convention on Suppression of Financing of Terrorism. - Pass legislation on the financing of the terrorism. ### Amendments recommended to the AML law - Lower the threshold when identifying casual clients. Impose a requirement that financial intermediaries identify all complex or unusual transactions and complex or unusual patterns of transactions, transactions that have no apparent or visible economic lawful purpose and to examine the background of such transactions and to send such information to the FIU as a suspicious transactions; - Prohibit anonymous accounts; - Require customer identification for wire transfers; - All records should be routinely available for the inspection of the FIU without the need for an order of the Supreme Court; - Introduce requirement for record keeping for all transactions for five years after the termination of the account or business relationship. Records kept should be sufficient to permit the reconstruction of individual transactions so as to provide evidence for prosecution of criminal behavior. The records should at a minimum include the customers name, address or other identifying information normally recorded by the intermediary), nature and date of the transaction, type and amount of currency involved and details of the account. Remove the threshold of $10,000 for the record keeping requirement for customer identification; - Clarify the suspicious transaction reporting requirement in sections 10 and 19; - Enable the FIU to be sent suspicious transactions reports without having to go to the Supreme Court. The FIU should have access to reports of all transactions made in cash or bearer securities in excess of $10,000 or its equivalent in foreign cash or bearer security that are kept by financial intermediaries pursuant to section 5 of the AML law; - Extend the overriding of secrecy to all reports made under the AML law especially for reports made pursuant to section 19 of the AML law; - Extend the tipping of provision in section 12(d) to disclosures made under section 19 of the AML law to prevent ambiguity, as well as to any person who has knowledge that a suspicious transaction report has been made; - Require financial intermediaries to include originator information and related messages on funds transfer that should remain through the payment chain; - Extend the sanctions in section 30 for non-compliance with section 19 of the AML Law to prevent ambiguity; - Set out the predicate offenses clearly. The predicate offense should also extend to those committed extraterritorially; - Set out the mens rea element for all limbs of the money laundering offense clearly; - Extend the confiscation provision to cover the confiscation of all proceeds of money laundering offenses and the predicate offense, instrumentalities and subject matter of money laundering offences. In the event that the proceeds of crime or instrumentalities or subject matter of the offense are not available for confiscation the court should have the power to order confiscation of property of an equivalent value or a penalty sum equivalent to the value of property to be confiscated; - Include adequate procedures for the protection of innocent and bona fide third party interest. ### FIU powers, functions, and institutional considerations - The FIU to be vested with the power to: - Audit compliance with the AML law including the power to request for further information without the need for a court order; - At a minimum, conduct on-site inspections to check on compliance. If there are serious deficiencies, the FIU should have enforcement powers; - Disseminate information to law enforcement agencies on its own initiative or on request. Adequate safeguards as to the use and confidentiality of the information disseminated should follow such dissemination; - Undertake research and advisory activities relating to money laundering and to devise training materials and programs; - Educate the public; - Have access to information from other public authorities to enable it to analyze suspicious transactions. - The prohibition of FIU members from concurrently holding any other public or private employment or holding or pursuing any elective office in the Palau National Government any State Government should be removed given the lack of resources in Palau. - The FIU should issue regulations on the implementation of the AML law to the financial intermediaries. - The FIU and its information should be adequately protected from legal suits and legal process. - Regulations under the Mutual Assistance in Criminal Matters Act 2001 should be issued that set out detailed procedures especially with regards to enforcement of foreign restraining and confiscation orders. ### Suggested actions for AML/CFT in the banking sector - Supervisory: The FIC to prepare regulations on the internal controls and procedures relating to AML law obligations. - Fit and Proper test: The FIC to prepare regulations for “fit-and-proper” tests for controlling shareholders and management of financial institutions under its purview. ### Authorities’ response to the assessment - “The Republic of Palau is committed to bringing Palau into compliance with international banking and anti-money laundering standards. The recommendations of the IMF Module II assessment team will be taken into very serious consideration and either incorporated into proposed legislative changes to be presented to the National Congress for adoption or into regulations for implementation, whichever is appropriate. Please understand, however, that Palau does have limited resources and expertise and will be in need of technical assistance where necessary in order to implement proper banking regulation and supervision.” ### Key findings from Table 7: Compliance with the FATF Recommendations - Ratification and implementation of the Vienna Convention: graded X. - Secrecy laws consistent with the 40 Recommendations: graded X; note reference to Section 25 AML Law. - Multilateral cooperation and mutual legal assistance in AML: graded X; reference to Mutual Assistance In Criminal Matters Act, Extradition and Transfer Act. - Money laundering a criminal offence (Vienna Convention): graded X; reference to Section 3 AML Law. - Knowledge of money laundering a criminal offence (Vienna Convention): graded X; reference to Section 3 AML Law. - Criminal liability of corporations—and their employees: graded X; reference to Section 29 AML Law. - Legal and administrative conditions for confiscation (Vienna Convention): graded X; reference to Mutual Assistance In Criminal Matters Act, Extradition and Transfer Act. - Recommendations 10-29 apply to non-bank financial institutions: graded X; Definition of financial institutions in AML Law. - Prohibition of anonymous accounts: graded X (noted as non-compliant). - Obligation of reasonable measures for customer identification: graded X; reference to Section 7, 8, 9 AML Law. - Comprehensive record keeping (5 years) for transactions: graded X; reference to Section 5, 11 AML Law. - Detection and analysis of unusual or large transactions: graded X. - Reporting requirement for suspicious transactions: graded X; reference to Section 10, 11 AML Law. - Legal protection for good faith reporting to competent authority: graded X; reference to Section 21 AML Law. - No tipping off customers of reports to competent authority: graded X; reference to Section 12(d) and 31 AML Law. - Internal policies, procedures, controls, audit, and training programs: graded X; reference to Section 13 AML Law. - AML rules and procedures apply to branches and subs abroad: graded X (Not Assessed) — note: No branches and subs abroad. - Adequate AML programs in supervised banks/financial institutions: graded X (Not Assessed) — note: Too early to be assessed. Power is with FIC. - Preventing control of financial institutions by criminals: graded X; reference to Section 44, 45 FIA and Corporations Act and Foreign Investment Act. - Information gathering and dissemination about AML: graded X — note: AML laws just introduced. - International exchange of information relating to suspicious transactions, and to persons or corporations involved: graded X; reference to Section 15 AML Law. - Bilateral or multilateral agreement on information exchange when legal standards are different: graded X; reference to Mutual Assistance in Criminal Matters Act. - Bilateral and multilateral agreements and arrangements for mutual assistance: graded X; reference to Mutual Assistance in Criminal Matters Act. - Ratification and implementation of other international conventions on money laundering: graded X — note: Palermo Convention and Terrorism Convention not signed or ratified. - Cooperative investigations among countries' authorities: graded X; reference to Mutual Assistance in Criminal Matters Act. - Definition of procedures for mutual assistance in criminal matters: graded X; reference to Mutual Assistance in Criminal Matters Act. - Authority to take expeditious actions in response to foreign countries’ requests: graded X; reference to Mutual Assistance in Criminal Matters Act. - Money laundering an extraditable offence: graded X; reference to Extradition and Transfer Act. - FATF Special Recommendations: - SR1 – Take steps to ratify and implement relevant United Nations instruments: graded X; note Anti terrorism bill drafted to enable ratification. - SR2 – Criminalize the financing of terrorism and terrorist organizations: graded X. - SR3 – Freeze and confiscate terrorist assets: graded X; note Anti terrorism bill drafted. - SR4 – Report suspicious transactions linked to terrorism: graded X; note Advisory issued by FIU. - SR5 – provide assistance to other countries’ terrorist financing investigations: graded X; note Anti terrorism bill drafted. - SR6 – impose AML/CFT requirements on alternative remittance systems: graded X; note Inclusion of money remitters in definition of financial intermediaries, Section 14 AML Law, and Anti terrorism bill drafted. - SR7 – Strengthen customer identification measures for wire transfers: graded X; note Anti terrorism bill drafted. - SR8 – Ensure that entities, in particular nonprofit organizations, cannot be misused to finance terrorism: graded X; note Corporation law has possible provisions but no requirements imposed. --- _Source: https://www.imf.org/-/media/files/publications/ofca/english/cr04170.pdf_