## 1. Average Abnormal Returns on Global Capital Markets following the September 11 Terrorist Attacks

## Source details

**Canonical URL:** [1. Average Abnormal Returns on Global Capital Markets following the September 11 Terrorist Attacks](https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/wp/2005/_wp0560.pdf)

## Other formats

- [Markdown version](/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/wp/2005/_wp0560.pdf.md)
- [Structured JSON version](/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/wp/2005/_wp0560.pdf.json)

---

### Introduction
- Financial institutions can be victims, perpetrators, or instrumentalities of financial crime; terrorism similarly affects financial markets in multiple ways.
- The paper examines cases where financial markets became direct or indirect victims of terrorist acts, the consequences for financial markets, and policy and regulatory responses.
- Structure: Section II — direct and indirect economic consequences of terrorism; Section III — market reaction to September 11, 2001 and March 11, 2004; Section IV — authorities’ crisis management responses; Section V — regulatory responses; Section VI — conclusions.

### Economic consequences of terrorism
- Terrorism shifted toward civilian and business targets; business facilities have been the preferred target of international terrorist attacks since 1998.
- Economic consequences categorized as:
  - Short-term direct effects: destruction of life and property, emergency response, restoration, temporary living assistance.
  - Medium-term confidence effects: reduced consumption, reduced investment, flight to quality.
  - Longer-term productivity effects: higher transaction costs from security, higher insurance premiums, costs of counterterrorism regulations.
- Direct cost example:
  - OECD estimate of direct economic damage from the September 11 attacks: $27.2 billion.
  - Breakdown: $14 billion for the private sector, $1.5 billion for the state and local government enterprises, $0.7 billion for the U.S. federal government, and $11 billion for rescue and clean-up operations.
  - $27.2 billion represented only about ¼ percent of U.S. annual GDP.
- Indirect costs and distribution:
  - Deterioration of consumer and investor confidence can reduce spending and trigger asset price declines and higher borrowing costs for riskier borrowers.
  - Size and distribution depend on nature of attacks, multipliers, policy responses, and market resilience.
  - After September 11:
    - Major industrial countries: fall in demand from loss of confidence.
    - Emerging markets: slowing external demand and flight to quality.
    - Other developing countries: potential impacts via commodity markets.

### Impact on financial markets (September 11, 2001 and March 11, 2004)
- September 11 struck the core of the world’s main financial center, causing major activity disruptions and soaring uncertainty and volatility.
- Human impact on financial industry:
  - Financial industry accounted for over 74 percent of the total civilian casualties in the World Trade Center attacks.
- Infrastructure and market disruptions:
  - Major disruption to communications system of the Bank of New York (largest custodian and settlement bank).
  - Bank of New York and J.P. Morgan Chase relocated to backup sites; manual processing caused significant delays in clearing and settlement.
  - Government securities market severely affected by loss of interdealer brokers located in the World Trade Center.
  - Traders shifted to online platforms (e.g., BrokerTec, eSpeed Inc.) when phone contacts were disrupted.
  - Repo market: inability to trade and reluctance to lend securities created lack of supply and required immediate intervention by authorities.
  - Several federal funds brokers disabled; some ATM networks crashed; facilities of the New York Board of Trade destroyed.
  - Widespread payment system disruption caused growing liquidity shortages.
- Liquidity and payments signals prompting Federal Reserve response:
  - Large buildup of Federal Reserve account balances: $120 billion - almost ten times the pre-September 11 levels, limited to a few banks while others ran huge negative positions and faced acute liquidity needs.
  - On September 11, transfers through Fedwire were down more than 40 percent and the total value was down 25 percent.
- Insurance industry:
  - Losses estimated at more than $50 billion.
  - Insurers were able to raise premiums and some used act-of-war clauses to exempt paying some claims.
- Capital market closures and volatility:
  - NYSE and NASDAQ never opened for trading on September 11; U.S. securities markets resumed trading on September 17 after consultations with the private sector and the Securities and Exchange Commission.
  - Conditions for reopening included safety of personnel and viability of infrastructure and communication systems.
  - Between September 17 and September 21:
    - Standard and Poor’s 500 index fell by 11.6 percent.
    - NASDAQ index fell by 16.1.
  - Between September 11 and September 21:
    - Dow Jones EURO STOXX index was down 17.3 percent.
- March 11, 2004 (Spain) comparison:
  - Effects on capital and financial markets were much less than September 11.
  - In the euro area, Dow Jones EURO STOXX fell by about 3 percent on March 11 and continued to drop in following days but recovered almost completely by the end of the month.
  - Standard and Poor’s 500 returned to pre-March 11 levels in less than a month after a small decline.
- Market dynamics and recovery:
  - Both attacks produced cross-border contagion effects and deteriorated investor confidence beyond national boundaries.
  - U.S. markets tended to suffer less and recover faster, demonstrating enhanced resilience.
  - After initial shocks, markets generally bounced back within weeks to pre-September 11 levels and continued to rise thereafter.
  - Financial markets initially may overreact under heightened uncertainty but, once long-term impacts are assessed, markets return to pre-crisis conditions and adjust according to investors’ perceptions of crisis resolution.

### Impact on financial markets after terrorist attacks — differences and drivers
- Differences in market behavior between September 11, 2001 and March 11, 2004 attributed to:
  - New York attacks raised uncertainty about the stability of the global financial system; Madrid attacks perceived as mostly regional.
  - September 11 occurred amid a global economic downturn; Madrid occurred when the world economy was growing strongly (European Central Bank, 2004).
  - Madrid attacks did not directly target financial markets and did not damage infrastructure and communication systems.
- Financial firms affected by September 11 were largely able to revert to backup sites and resume activity "instantly or within days."
- Prompt intervention by the Federal Reserve, in cooperation with other authorities, resolved liquidity shortages and maintained business and consumer confidence domestically and abroad.
- Main conclusion quoted: "financial markets were efficient in absorbing the shocks determined by terror attacks and continued to perform their functions in an effective way." (Eldor and Melnick (2004); SEC (2001) quote: "[The markets] did what they do best: they assessed, and responded to the crisis rationally. Unlike human beings, capital markets are capable of absorbing great shocks quickly".)

### Empirical evidence — abnormal returns (Chen and Siems, 2004)
- Method: measure deviation of index returns from their average; large and statistically significant deviations interpreted as markets seeing events as important.
- Table: Average Abnormal Returns on Global Capital Markets following the September 11 Terrorist Attacks — banking/financial sectors
  - NYSE: Event-day AR -4.79; 6-day CAR -6.69; 11-day CAR -0.45; Days to rebound 13
  - London: Event-day AR -10.09; 6-day CAR -8.64; 11-day CAR -14.14; Days to rebound 22
  - Frankfurt: Event-day AR -10.06; 6-day CAR -14.54; 11-day CAR -15.79; Days to rebound 42
  - Europe-Bloomberg: Event-day AR -8.54; 6-day CAR -11.50; 11-day CAR -14.82; Days to rebound 40
  - Helsinki: Event-day AR -6.17; 6-day CAR -6.43; 11-day CAR -11.35; Days to rebound 31
  - Norway: Event-day AR -5.79; 6-day CAR -14.18; 11-day CAR -25.55; Days to rebound 107
  - Tokyo: Event-day AR -6.50; 6-day CAR -1.70; 11-day CAR -12.18; Days to rebound 6
  - Hong Kong: Event-day AR -7.87; 6-day CAR -11.02; 11-day CAR -14.34; Days to rebound 30
  - Korea: Event-day AR -13.33; 6-day CAR -13.78; 11-day CAR -19.84; Days to rebound 28
  - Jakarta: Event-day AR -2.83; 6-day CAR -3.73; 11-day CAR -6.23; Days to rebound 86
  - Kuala Lampur: Event-day AR -5.20; 6-day CAR -13.36; 11-day CAR -18.68; Days to rebound 65
  - Australia: Event-day AR -3.98; 6-day CAR -9.46; 11-day CAR -11.07; Days to rebound 26
  - New Zealand: Event-day AR -3.67; 6-day CAR -11.39; 11-day CAR -14.93; Days to rebound 33
  - Johannesburg: Event-day AR -5.27; 6-day CAR -14.43; 11-day CAR -11.00; Days to rebound 162
- Observations:
  - The event had a widespread negative impact across markets.
  - Impact was smaller on the U.S. market (least adverse 11-day CAR and second fastest recovery).
  - U.S. markets rebounded and stabilized quicker than other markets following September 11 compared with earlier surprise shocks.

### Authorities’ response to September 11 (Federal Reserve and others)
- Immediate Federal Reserve message: "[t]he Federal Reserve System is open and operating. The discount window is available to meet liquidity needs".
- Federal Reserve actions:
  - Deployed a wide range of instruments to provide liquidity, ensure payment systems operability, and keep markets open (Ferguson, 2003).
  - Unprecedented liquidity injections, "estimated at more than $100 billion" (Lacker, 2004).
  - Liquidity instruments used included extensive discount window lending, open market operations, waiving overdraft fees, and decreasing intended federal funds and discount rates.
  - Reciprocal currency facilities of "up to $80 billion" through swaps with the European Central Bank and the Bank of England; raised ceiling of a preexisting swap with the Bank of Canada (Huang and Johnston, 2004).
- Operational steps:
  - Continued to provide credit for checks on usual availability schedules despite U.S. airspace closure.
  - Encouraged state member banks and bank holding companies to work flexibly with affected customers and contact regulators (Ferguson, 2003).
- Other authorities and fiscal measures:
  - U.S. Securities and Exchange Commission relaxed trading rules on securities lending and share repurchases and kept communication channels open (SEC, 2001).
  - Government assistance to insurance and airline industries; U.S. administration and Congress announced intention to act as an "insurer of last resort".
  - One year later, a "Terrorism Risk Insurance Act" passed, providing a shared public and private compensation system for insured losses from acts of terrorism.
- Monetary and fiscal stimulus:
  - Fed continued to lower targeted federal funds and discount rates an additional "1.25 points" in the weeks after the attacks; further downward adjustments followed in 2002 and 2003 (Figure 4).
  - Expansionary fiscal policies implemented to help recovery.
  - International coordinated liquidity injections and immediate interest rate cuts from major monetary authorities (Canada, euro area, Japan, Switzerland, United Kingdom), followed by other economies (Denmark, Hong Kong SAR, Korea, New Zealand, Sweden) (IMF, 2001b).
- Contrast with Madrid (11 March 2004):
  - Madrid attacks produced muted Spanish and global financial market effects (ECB, 2004); little economic policy response required.
  - European Central Bank announced on April 1, 2004 that main intervention rates were to remain unchanged (ECB, 2004).
  - No fiscal stimulus or other economic measures deemed necessary beyond aid to victims and facilities directly struck.

### Lessons for crisis containment and market resilience
- Central bank role:
  - Importance of central bank as lender of last resort in safeguarding financial stability during crisis (Ferguson, 2003).
  - Prompt Fed action helped manage acute liquidity shortage and prevent public panic and possible bank runs.
- Cooperation and coordination:
  - Critical importance of synchronized domestic regulatory action and international coordination among central banks to provide liquidity and support payment systems.
  - Non-traditional emergency measures (waivers, relaxed rules) helped markets return to normal functioning quickly.
- Operational preparedness:
  - Diversified forms of risk intermediation enhance financial system robustness (Ferguson, 2003).
  - Importance of operative business continuity plans across the financial sector to counter operational risk from severe activity disruption.
  - Y2K preparations improved backup IT and communication systems that helped market participants during September 11 (Ferguson, 2003).

### Regulatory perspective: operational risk and countering terrorist financing
- A. Operational risk perspective
  - Basel Committee on Banking Supervision (2003) identifies terrorism as an operational risk event with potential for substantial losses.
  - Supervisors must require banks to have frameworks to identify, assess, monitor, and control or mitigate material operational risks from terrorism.
  - Banks should ensure ongoing operability via contingency and business continuity plans.
  - Joint U.S. report (U.S. Federal Reserve et al, 2002) findings:
    - Business continuity plans not designed for wide-area disasters or significant loss/inaccessibility of critical staff.
    - Critical market functions (clearing and settlement) depended on a small number of institutions concentrated in a single area.
    - Telecommunications had single points of failure.
  - Business continuity objectives emphasized:
    - Rapid recovery and timely resumption of critical operations following wide-scale disruption.
    - High confidence through ongoing use or robust testing of internal and external continuity arrangements.
  - Four sound practices to minimize systemic effects of wide-scale disruption:
    1. Identify critical clearing and settlement activities in support of financial markets.
    2. Determine appropriate recovery and resumption objectives for clearing and settlement activities.
    3. Maintain sufficient geographically dispersed resources to meet recovery and resumption objectives.
    4. Routinely use or test recovery and resumption arrangements.
  - Central banks and other official financial institutions are also potential targets (central bank bombing in Sri Lanka, January 1996); contingency planning must extend beyond commercial financial services.
- B. Countering terrorist financing
  - FATF (2002): little difference between terrorist and other criminal methods in use of the financial system; terrorist financing shares multiple characteristics with money laundering.
  - Terrorists use laundering methods including cash smuggling, structured deposits and withdrawals, purchases of monetary instruments, credit/debit cards, and informal remittance networks; they adapt techniques as prior methods are detected.
  - Special challenges in countering terrorist financing:
    - Use of legally earned funds alongside illegal funds complicates tracking and enforcement.
    - Sums used by terrorists for specific attacks can be very small and harder to detect (example: sums circulated between September 11 hijackers and overseas accounts "amounted to less than $10,000" and often via simple wire transfers).
    - Terrorist organizations overall require considerable funds and thus may be susceptible to detection.
    - Countering terrorist financing requires a multidisciplinary approach with close cooperation among intelligence, law enforcement, financial institutions, and market supervisors.
  - International response:
    - UN International Convention for the Suppression of the Financing of Terrorism adopted by the General Assembly in December 1999; broader international commitment intensified after September 11, 2001.
    - By end-2001, FATF mandate expanded to combat terrorist financing; October 2001 FATF "Special Eight Recommendations" issued to deny terrorists access to the international financial system (note: Special Eight Recommendations expanded to Nine Recommendations in October 2004).
    - UN Security Council Resolution 1373 (September 2001) called on states to prevent and suppress financing of terrorist acts, criminalize terrorist financing, and freeze terrorist assets.
    - Regional and international bodies (FATF-style regional bodies, Egmont Group of Financial Intelligence Units, IMF, World Bank) moved to support international efforts against terrorist financing, increasing the number of countries engaged in the fight.

### Box 1. FATF Special Recommendations on Terrorist Financing — legal, institutional, and operational issues
- Legal and institutional framework required by AML/CFT standards:
  - (i) laws that create money laundering (ML) and financing of terrorism (FT) offenses and provide for the freezing, seizure, and confiscation of the proceeds of crime and terrorist funding;
  - (ii) laws, regulations, or other enforceable means that impose the required obligations on financial institutions and designated non-financial business and professions;
  - (iii) an appropriate institutional or administrative framework, and laws that provide competent authorities with the necessary duties, powers and sanctions; and
  - (iv) laws and other measures that give a country the ability to provide the widest range of international cooperation.
- FATF Special 8 (subsequently 9) Recommendations commit countries to:
  - Take immediate steps to ratify and implement the relevant UN instruments;
  - Criminalize the financing of terrorism, terrorist acts, and terrorist organizations;
  - Freeze and confiscate terrorist assets;
  - Report suspicious transactions linked to terrorism;
  - Provide the widest possible range of assistance to other countries’ law enforcement and regulatory authorities for terrorist financing investigations;
  - Impose anti-money-laundering requirements on alternative remittance systems;
  - Strengthen customer identification measures in international and domestic wire transfers;
  - Ensure that entities, in particular non-profit organizations, cannot be misused to finance terrorism; and
  - Detect the physical cross-border transportation of cash and bearer-negotiable instruments.
- IMF/World Bank adoption and operational work:
  - In 2002, the IMF and World Bank adopted the FATF Recommendations as one of 12 standards important to their operational work.
  - Fund/Bank work has focused on:
    - conducting assessments to identify strengths and weaknesses in countries’ AML/CFT regimes in collaboration with the FATF and FATF-style regional bodies;
    - providing technical assistance to strengthen AML/CFT legal and regulatory arrangements and capacity to implement such systems; and
    - regional training and outreach.
  - FATF standards require that all banks, insurance companies, and securities dealers be fully regulated and supervised for AML/CFT purposes, including:
    - effective know your customer (KYC) measures and enhanced customer due diligence (CDD) in high-risk cases;
    - record keeping and suspicious transaction reporting (STRs).
  - In June 2003, the FATF revised its 40 recommendations and expanded AML/CFT coverage to a range of new sectors, including casinos, real estate agents, dealers in precious metals and stones, lawyers, notaries and other independent legal professionals, accountants, and trust and company service providers.
- Regulatory challenges and operational implications:
  - Informal funds transfer systems present ML/TF risks because they allow rapid, inexpensive international transmission of funds without adequate scrutiny of originators and beneficiaries.
  - Transfers through informal channels (including Hawala) are believed to be significant in many developing countries, ranging from 10 to 50 percent of total remittances (in 2001, worker remittance receipts of developing countries totaled $72.3 billion).
  - Economic research underscores that antiterrorist policies are more successful if conducted across the entire spectrum of potential terrorist activities to reduce substitution possibilities (Sandler and Enders, 2004).
- Costs, industry response, and operational implications:
  - KPMG International’s Global Anti-Money Laundering Survey–2004: 83 percent of respondent banks indicated that AML/CFT compliance costs have risen, on average, about 61 percent over the past three years.
  - The KPMG survey included 209 respondent banks from 41 countries.
  - Despite increased compliance costs, 84 percent of respondents regarded the regulatory burden as acceptable.
  - Key compliance components and risks:
    - Adequate KYC policies and procedures are important for prudential and financial integrity objectives beyond AML/CFT.
    - Without adequate customer due diligence, financial institutions face reputational, credit, operational, legal, and concentration risks.
    - The AML/CFT framework incorporates a risk-based component allowing institutions to tailor CDD measures to customer circumstances.
  - Industry-requested improvements:
    - Better feedback from governments and financial intelligence units (FIUs) to enable financial institutions to “red flag” potential terrorist transactions and to assess the usefulness of their STRs.
    - Improved coordination of AML policy at the global level and guidance by supranational bodies.
- Market access, exclusion risks, and balance between costs and benefits:
  - Some major banks have cut overseas customer and correspondent banking relationships because of ML/TF concerns and enforcement actions.
  - Several banks have closed accounts of money service providers due to ML/TF concerns, disrupting money service businesses and remittance transfers.
  - Countries and financial institutions with weak AML/CFT regimes risk exclusion from access to major financial institutions and markets.
  - Policy implication: need to achieve the right balance between costs and benefits in implementing AML/CFT measures, sensitive to national economic circumstances, integrity risks of jurisdictions, importance of payment channels, and capacity to develop legal and regulatory systems.
  - Technical assistance from international organizations and bilateral donors will play a key role.

*Source: _wp0560 (excerpted content).*

### 1. Average Abnormal Returns on Global Capital Markets following the September 11

### 1. Average Abnormal Returns on Global Capital Markets following the September 11 Terrorist Attacks

### Introduction
- Financial institutions can be victims, perpetrators, or instrumentalities of financial crime; terrorism similarly affects financial markets in multiple ways.
- The paper examines cases where financial markets became direct or indirect victims of terrorist acts, the consequences for financial markets, and policy and regulatory responses.
- Structure: Section II — direct and indirect economic consequences of terrorism; Section III — market reaction to September 11, 2001 and March 11, 2004; Section IV — authorities’ crisis management responses; Section V — regulatory responses; Section VI — conclusions.

### Economic consequences of terrorism
- Terrorism has shifted toward civilian and business targets; business facilities have been the preferred target of international terrorist attacks since 1998.
- Economic consequences broken down into:
  - Short-term direct effects (destruction of life and property, emergency response, restoration, temporary living assistance).
  - Medium-term confidence effects (reduced consumption, reduced investment, flight to quality).
  - Longer-term productivity effects (higher transaction costs from security, higher insurance premiums, costs of counterterrorism regulations).
- Direct cost example:
  - OECD estimate of direct economic damage from the September 11 attacks: $27.2 billion.
  - Breakdown cited: $14 billion for the private sector, $1.5 billion for the state and local government enterprises, $0.7 billion for the U.S. federal government, and $11 billion for rescue and clean-up operations.
  - $27.2 billion represented only about ¼ percent of U.S. annual GDP.
- Indirect costs:
  - Deterioration of consumer and investor confidence can reduce spending and trigger asset price declines and higher borrowing costs for riskier borrowers.
  - Size and distribution of effects depend on nature of attacks, multipliers, policy responses, and market resilience.
- Distribution of effects after September 11:
  - Major industrial countries: fall in demand from loss of confidence.
  - Emerging markets: slowing external demand and flight to quality.
  - Other developing countries: potential impacts via commodity markets.

### Impact on financial markets (September 11, 2001 and March 11, 2004)
- September 11 attacks struck core of world’s main financial center, causing major activity disruptions and soaring uncertainty and volatility.
- Human impact on financial industry:
  - Financial industry accounted for over 74 percent of the total civilian casualties in the World Trade Center attacks.
- Infrastructure and market disruptions:
  - Major disruption to communications system of the Bank of New York (largest custodian and settlement bank).
  - Bank of New York and J.P. Morgan Chase relocated to backup sites; manual processing caused significant delays in clearing and settlement.
  - Government securities market severely affected by loss of interdealer brokers located in the World Trade Center.
  - Traders shifted to online platforms (e.g., BrokerTec, eSpeed Inc.) when phone contacts were disrupted.
  - Repo market: inability to trade and reluctance to lend securities created lack of supply and required immediate intervention by authorities.
  - Several federal funds brokers disabled; some ATM networks crashed; facilities of the New York Board of Trade destroyed.
  - Widespread payment system disruption caused growing liquidity shortages.
- Liquidity and payments signals prompting Federal Reserve response:
  - Large buildup of Federal Reserve account balances: $120 billion - almost ten times the pre-September 11 levels, limited to a few banks while others ran huge negative positions and faced acute liquidity needs.
  - On September 11, transfers through Fedwire were down more than 40 percent and the total value was down 25 percent.
- Insurance industry:
  - Losses estimated at more than $50 billion.
  - Insurers were able to raise premiums and some used act-of-war clauses to exempt paying some claims.
- Capital market closures and volatility:
  - NYSE and NASDAQ never opened for trading on September 11; U.S. securities markets resumed trading on September 17 after consultations with the private sector and the Securities and Exchange Commission.
  - Conditions for reopening included safety of personnel and viability of infrastructure and communication systems.
  - Between September 17 and September 21:
    - Standard and Poor’s 500 index fell by 11.6 percent.
    - NASDAQ index fell by 16.1.
  - Between September 11 and September 21:
    - Dow Jones EURO STOXX index was down 17.3 percent.
- March 11, 2004 (Spain) comparison:
  - Effects on capital and financial markets were much less than September 11.
  - In the euro area, Dow Jones EURO STOXX fell by about 3 percent on March 11 and continued to drop in following days but recovered almost completely by the end of the month.
  - Standard and Poor’s 500 returned to pre-March 11 levels in less than a month after a small decline.
- Market dynamics and recovery:
  - Both attacks produced cross-border contagion effects and deteriorated investor confidence beyond national boundaries.
  - U.S. markets tended to suffer less and recover faster, demonstrating enhanced resilience.
  - After initial shocks, markets generally bounced back within weeks to pre-September 11 levels and continued to rise thereafter.
  - Financial markets initially may overreact under heightened uncertainty but, once long-term impacts are assessed, markets return to pre-crisis conditions and adjust according to investors’ perceptions of crisis resolution.

*Source: 1. Average Abnormal Returns on Global Capital Markets following the September 11 Terrorist Attacks*

### 2001. The horizontal axis shows the number of

### _wp0560 - 2001. The horizontal axis shows the number of

### Impact on financial markets after terrorist attacks
- Differences in market behavior between September 11, 2001 and March 11, 2004 (Madrid) attributed to:
  - New York attacks raised uncertainty about the stability of the global financial system; Madrid attacks perceived as mostly regional.
  - September 11 occurred amid a global economic downturn; Madrid occurred when the world economy was growing strongly (European Central Bank, 2004).
  - Madrid attacks did not directly target financial markets and did not damage infrastructure and communication systems.
- Financial firms affected by September 11 were largely able to revert to backup sites and resume activity "instantly or within days."
- Prompt intervention by the Federal Reserve, in cooperation with other authorities, resolved liquidity shortages and maintained business and consumer confidence domestically and abroad.
- Main conclusion: "financial markets were efficient in absorbing the shocks determined by terror attacks and continued to perform their functions in an effective way." (Eldor and Melnick (2004); SEC (2001) quote: "[The markets] did what they do best: they assessed, and responded to the crisis rationally. Unlike human beings, capital markets are capable of absorbing great shocks quickly".)

### Empirical evidence — abnormal returns (Chen and Siems, 2004)
- Method: measure deviation of index returns from their average; large and statistically significant deviations interpreted as markets seeing events as important.
- Table 1: Average Abnormal Returns on Global Capital Markets following the September 11 Terrorist Attacks — banking/financial sectors (Event-day AR (%); 6-day CAR (%); 11-day CAR (%); Days to rebound (number of trading days to return to pre-attack level))
  - NYSE: Event-day AR -4.79; 6-day CAR -6.69; 11-day CAR -0.45; Days to rebound 13
  - London: Event-day AR -10.09; 6-day CAR -8.64; 11-day CAR -14.14; Days to rebound 22
  - Frankfurt: Event-day AR -10.06; 6-day CAR -14.54; 11-day CAR -15.79; Days to rebound 42
  - Europe-Bloomberg: Event-day AR -8.54; 6-day CAR -11.50; 11-day CAR -14.82; Days to rebound 40
  - Helsinki: Event-day AR -6.17; 6-day CAR -6.43; 11-day CAR -11.35; Days to rebound 31
  - Norway: Event-day AR -5.79; 6-day CAR -14.18; 11-day CAR -25.55; Days to rebound 107
  - Tokyo: Event-day AR -6.50; 6-day CAR -1.70; 11-day CAR -12.18; Days to rebound 6
  - Hong Kong: Event-day AR -7.87; 6-day CAR -11.02; 11-day CAR -14.34; Days to rebound 30
  - Korea: Event-day AR -13.33; 6-day CAR -13.78; 11-day CAR -19.84; Days to rebound 28
  - Jakarta: Event-day AR -2.83; 6-day CAR -3.73; 11-day CAR -6.23; Days to rebound 86
  - Kuala Lampur: Event-day AR -5.20; 6-day CAR -13.36; 11-day CAR -18.68; Days to rebound 65
  - Australia: Event-day AR -3.98; 6-day CAR -9.46; 11-day CAR -11.07; Days to rebound 26
  - New Zealand: Event-day AR -3.67; 6-day CAR -11.39; 11-day CAR -14.93; Days to rebound 33
  - Johannesburg: Event-day AR -5.27; 6-day CAR -14.43; 11-day CAR -11.00; Days to rebound 162
- Observations:
  - The event had a widespread negative impact across markets.
  - Impact was smaller on the U.S. market (least adverse 11-day CAR and second fastest recovery).
  - U.S. markets rebounded and stabilized quicker than other markets following September 11 compared with earlier surprise shocks.

### Authorities’ response to September 11 (Federal Reserve and others)
- Immediate Federal Reserve message: "[t]he Federal Reserve System is open and operating. The discount window is available to meet liquidity needs".
- Federal Reserve actions:
  - Deployed a wide range of instruments to provide liquidity, ensure payment systems operability, and keep markets open (Ferguson, 2003).
  - Unprecedented liquidity injections, "estimated at more than $100 billion" (Lacker, 2004).
  - Liquidity instruments used included extensive discount window lending, open market operations, waiving overdraft fees, and decreasing intended federal funds and discount rates.
  - Reciprocal currency facilities of "up to $80 billion" through swaps with the European Central Bank and the Bank of England; raised ceiling of a preexisting swap with the Bank of Canada (Huang and Johnston, 2004).
- Operational steps:
  - Continued to provide credit for checks on usual availability schedules despite U.S. airspace closure.
  - Encouraged state member banks and bank holding companies to work flexibly with affected customers and contact regulators (Ferguson, 2003).
- Other authorities and fiscal measures:
  - U.S. Securities and Exchange Commission relaxed trading rules on securities lending and share repurchases and kept communication channels open (SEC, 2001).
  - Government assistance to insurance and airline industries; U.S. administration and Congress announced intention to act as an "insurer of last resort".
  - One year later, a "Terrorism Risk Insurance Act" passed, providing a shared public and private compensation system for insured losses from acts of terrorism.
- Monetary and fiscal stimulus:
  - Fed continued to lower targeted federal funds and discount rates an additional "1.25 points" in the weeks after the attacks; further downward adjustments followed in 2002 and 2003 (Figure 4).
  - Expansionary fiscal policies implemented to help recovery.
  - International coordinated liquidity injections and immediate interest rate cuts from major monetary authorities (Canada, euro area, Japan, Switzerland, United Kingdom), followed by other economies (Denmark, Hong Kong SAR, Korea, New Zealand, Sweden) (IMF, 2001b).
- Contrast with Madrid (11 March 2004):
  - Madrid attacks produced muted Spanish and global financial market effects (ECB, 2004); little economic policy response required.
  - European Central Bank announced on April 1, 2004 that main intervention rates were to remain unchanged (ECB, 2004).
  - No fiscal stimulus or other economic measures deemed necessary beyond aid to victims and facilities directly struck.

### Lessons for crisis containment and market resilience
- Central bank role:
  - Importance of central bank as lender of last resort in safeguarding financial stability during crisis (Ferguson, 2003).
  - Prompt Fed action helped manage acute liquidity shortage and prevent public panic and possible bank runs.
- Cooperation and coordination:
  - Critical importance of synchronized domestic regulatory action and international coordination among central banks to provide liquidity and support payment systems.
  - Non-traditional emergency measures (waivers, relaxed rules) helped markets return to normal functioning quickly.
- Operational preparedness:
  - Diversified forms of risk intermediation enhance financial system robustness (Ferguson, 2003).
  - Importance of operative business continuity plans across the financial sector to counter operational risk from severe activity disruption.
  - Y2K preparations improved backup IT and communication systems that helped market participants during September 11 (Ferguson, 2003).

### Regulatory perspective: operational risk and countering terrorist financing
- A. Operational risk perspective
  - Basel Committee on Banking Supervision (2003) identifies terrorism as an operational risk event with potential for substantial losses.
  - Supervisors must require banks to have frameworks to identify, assess, monitor, and control or mitigate material operational risks from terrorism.
  - Banks should ensure ongoing operability via contingency and business continuity plans.
  - Joint U.S. report (U.S. Federal Reserve et al, 2002) findings:
    - Business continuity plans not designed for wide-area disasters or significant loss/inaccessibility of critical staff.
    - Critical market functions (clearing and settlement) depended on a small number of institutions concentrated in a single area.
    - Telecommunications had single points of failure.
  - Business continuity objectives emphasized:
    - Rapid recovery and timely resumption of critical operations following wide-scale disruption.
    - High confidence through ongoing use or robust testing of internal and external continuity arrangements.
  - Four sound practices to minimize systemic effects of wide-scale disruption:
    1. Identify critical clearing and settlement activities in support of financial markets.
    2. Determine appropriate recovery and resumption objectives for clearing and settlement activities.
    3. Maintain sufficient geographically dispersed resources to meet recovery and resumption objectives.
    4. Routinely use or test recovery and resumption arrangements.
  - Central banks and other official financial institutions are also potential targets (central bank bombing in Sri Lanka, January 1996); contingency planning must extend beyond commercial financial services.
- B. Countering terrorist financing
  - FATF (2002): little difference between terrorist and other criminal methods in use of the financial system; terrorist financing shares multiple characteristics with money laundering.
  - Terrorists use laundering methods including cash smuggling, structured deposits and withdrawals, purchases of monetary instruments, credit/debit cards, and informal remittance networks; they adapt techniques as prior methods are detected.
  - Special challenges in countering terrorist financing:
    - Use of legally earned funds alongside illegal funds complicates tracking and enforcement.
    - Sums used by terrorists for specific attacks can be very small and harder to detect (example: sums circulated between September 11 hijackers and overseas accounts "amounted to less than $10,000" and often via simple wire transfers).
    - Terrorist organizations overall require considerable funds and thus may be susceptible to detection.
    - Countering terrorist financing requires a multidisciplinary approach with close cooperation among intelligence, law enforcement, financial institutions, and market supervisors.
  - International response:
    - UN International Convention for the Suppression of the Financing of Terrorism adopted by the General Assembly in December 1999; broader international commitment intensified after September 11, 2001.
    - By end-2001, FATF mandate expanded to combat terrorist financing; October 2001 FATF "Special Eight Recommendations" issued to deny terrorists access to the international financial system (note: Special Eight Recommendations expanded to Nine Recommendations in October 2004).
    - UN Security Council Resolution 1373 (September 2001) called on states to prevent and suppress financing of terrorist acts, criminalize terrorist financing, and freeze terrorist assets.
    - Regional and international bodies (FATF-style regional bodies, Egmont Group of Financial Intelligence Units, IMF, World Bank) moved to support international efforts against terrorist financing, increasing the number of countries engaged in the fight.

*Source: _wp0560 (excerpted content).*

### Box 1. FATF Special Recommendations on Terrorist Financing

### Box 1. FATF Special Recommendations on Terrorist Financing

### Legal and institutional framework required by AML/CFT standards
- AML/CFT standards require an adequate legal and institutional framework, including:
  - (i) laws that create money laundering (ML) and financing of terrorism (FT) offenses and provide for the freezing, seizure, and confiscation of the proceeds of crime and terrorist funding;
  - (ii) laws, regulations, or other enforceable means that impose the required obligations on financial institutions and designated non-financial business and professions;
  - (iii) an appropriate institutional or administrative framework, and laws that provide competent authorities with the necessary duties, powers and sanctions; and
  - (iv) laws and other measures that give a country the ability to provide the widest range of international cooperation.

### FATF Special Recommendations on Terrorist Financing (Special 8, subsequently 9)
- The FATF Special 8 (subsequently 9) Recommendations on Terrorist Financing, combined with the previous 40 Recommendations on money laundering, constitute international standards for detecting, preventing, and suppressing the financing of terrorism. They commit countries to:
  - Take immediate steps to ratify and implement the relevant UN instruments;
  - Criminalize the financing of terrorism, terrorist acts, and terrorist organizations;
  - Freeze and confiscate terrorist assets;
  - Report suspicious transactions linked to terrorism;
  - Provide the widest possible range of assistance to other countries’ law enforcement and regulatory authorities for terrorist financing investigations;
  - Impose anti-money-laundering requirements on alternative remittance systems;
  - Strengthen customer identification measures in international and domestic wire transfers;
  - Ensure that entities, in particular non-profit organizations, cannot be misused to finance terrorism; and
  - Detect the physical cross-border transportation of cash and bearer-negotiable instruments.

### IMF/World Bank adoption and operational work
- In 2002, the IMF and World Bank adopted the FATF Recommendations as one of 12 standards important to their operational work.
- The Fund/Bank work has focused on:
  - conducting assessments to identify strengths and weaknesses in countries’ AML/CFT regimes in collaboration with the FATF and FATF-style regional bodies;
  - providing technical assistance to strengthen AML/CFT legal and regulatory arrangements and capacity to implement such systems; and
  - regional training and outreach.
- FATF standards require that all banks, insurance companies, and securities dealers be fully regulated and supervised for AML/CFT purposes, including:
  - effective know your customer (KYC) measures and enhanced customer due diligence (CDD) in high-risk cases;
  - record keeping and suspicious transaction reporting (STRs).
- In June 2003, the FATF revised its 40 recommendations and expanded AML/CFT coverage to a range of new sectors, including casinos, real estate agents, dealers in precious metals and stones, lawyers, notaries and other independent legal professionals, accountants, and trust and company service providers.

### Regulatory challenges in countering terrorist financing
- Effectiveness requires comprehensive frameworks across countries and financial institutions and rigorous regulatory standards to ensure detection.
- Economic research underscores that antiterrorist policies are more successful if conducted across the entire spectrum of potential terrorist activities to reduce substitution possibilities (Sandler and Enders, 2004). Therefore, efforts must go beyond formal banking to alternative financing mechanisms and emerging methods.
- Informal funds transfer systems present ML/TF risks because they allow rapid, inexpensive international transmission of funds without adequate scrutiny of originators and beneficiaries.
  - International initiatives (e.g., the Second International Conference on Hawala, Abu Dhabi, April 2004) highlighted the importance of remittances to certain populations and the need to raise awareness of ML/FT risks and foster stakeholder dialogue.
  - Designing regulatory/supervisory mechanisms must avoid driving remittance providers further underground or excluding migrants and the unbanked from financial services. This issue is particularly relevant to developing countries where informal funds transfer systems are an important source of external funding and an essential gateway to banking for migrants.
  - Transfers through informal channels (including Hawala) are believed to be significant in many developing countries, ranging from 10 to 50 percent of total remittances (in 2001, worker remittance receipts of developing countries totaled $72.3 billion).

### Costs, industry response, and operational implications
- Within the regulated financial system, there is evidence of significant increases in costs related to AML/CFT regimes:
  - In KPMG International’s Global Anti-Money Laundering Survey–2004, 83 percent of respondent banks indicated that AML/CFT compliance costs have risen, on average, about 61 percent over the past three years.
  - The KPMG survey included 209 respondent banks from 41 countries.
- Despite increased compliance costs, a vast majority (84 percent) of respondents regarded the regulatory burden as acceptable, indicating commitment by the financial industry to protect institutional integrity.
- Key compliance components and risks:
  - Adequate KYC policies and procedures are important for prudential and financial integrity objectives beyond AML/CFT.
  - Without adequate customer due diligence, financial institutions face reputational, credit, operational, legal, and concentration risks.
  - The AML/CFT framework incorporates a risk-based component allowing institutions to tailor CDD measures to customer circumstances.
- Industry-requested improvements:
  - Better feedback from governments and financial intelligence units (FIUs) to enable financial institutions to “red flag” potential terrorist transactions and to assess the usefulness of their STRs.
  - Improved coordination of AML policy at the global level and guidance by supranational bodies.

### Market access, exclusion risks, and balance between costs and benefits
- Enhanced regulatory requirements and enforcement actions have had ripple effects:
  - Some major banks have cut overseas customer and correspondent banking relationships because of ML/TF concerns and enforcement actions.
  - Several banks have closed accounts of money service providers due to ML/TF concerns, disrupting money service businesses and remittance transfers.
- Risks:
  - Countries and financial institutions with weak AML/CFT regimes risk exclusion from access to major financial institutions and markets.
  - There is concern whether least developed economies and smaller financial institutions from advanced countries will have the capacity to meet higher regulatory standards; failure to do so risks segmentation in financial markets between jurisdictions that can comply and those that cannot.
- Policy implication:
  - Need to achieve the right balance between costs and benefits in implementing AML/CFT measures, sensitive to national economic circumstances, integrity risks of jurisdictions, importance of payment channels, and capacity to develop legal and regulatory systems.
  - Technical assistance from international organizations and bilateral donors will play a key role.
  - Assessment of benefits should consider volumes of money laundering and terrorist financing detected/prevented and the impact of AML/CFT regimes on criminal or terrorist investigations (not covered in this paper).

*Source: Box 1. FATF Special Recommendations on Terrorist Financing, as presented in the supplied IMF working paper content.*

---


_Source: https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/wp/2005/_wp0560.pdf_