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### Executive summary: program evolution, scope, and key decisions
- Fund’s AML/CFT program components:
  - Assessments under the ROSC program against the FATF AML/CFT standard.
  - Examination of AML/CFT issues in Article IV surveillance.
  - Provision of technical assistance (TA).
  - Research and policy development.
- Recent program evolution and funding:
  - Over the past five years AML/CFT TA is delivered more strategically and is almost exclusively externally funded.
  - The AML/CFT Topical Trust Fund (TTF) is the central pillar of external financing.
- Key Executive Board decisions (selected):
  - April 2001: Fund role in combating money laundering via TA and Article IV surveillance.
  - November 2001: Inclusion of terrorist financing in Fund work.
  - 2002–2006: Adoption and routinization of FATF standard for ROSCs; FSAPs and FSAP updates required to be accompanied by AML/CFT assessments (implementation modalities specified in 2006).
- Integration and burden-sharing:
  - AML/CFT assessments are integral to joint Bank/Fund ROSC and FSAP programs and rely on cooperation with FATF and the World Bank.
  - Fund and World Bank rely on FATF and FSRB assessments under burden-sharing arrangements; these arrangements have generally worked well.

### Compliance, assessment process, and costs
- Compliance patterns and statistics (2004–April 2011, 161 countries assessed):
  - Full compliance on any principle occurred in 12.3 percent of observations.
  - “Largely compliant” occurred 25.5 percent of the time.
  - Average compliance score: 20.8 or 42.5 percent (scale where 49 represents full compliance).
  - Degree of compliance: AML Recommendations 45 percent; CFT Special Recommendations 31.5 percent.
  - Recommendation 5 (customer due diligence): 22.1 percent of theoretical maximum.
- Assessment process inputs and outputs:
  - Assessments examine some 285 criteria in the FATF methodology.
  - Mission duration: up to 2 ½ weeks on site; typical IMF team size: 4–6 assessors.
  - Pre- and post-assessment work: average 17 weeks of staff work per assessor.
  - IMF assessments cost, on average, $310,000.
  - Data ROSCs average cost $225,000.
  - Factoring in assessments by other bodies, AML/CFT ROSC cost to the Fund is some $112,000.
  - Detailed reports often exceed 300 pages; recent France report exceeded 600 pages.
  - Current policy requires all AML/CFT assessments to be comprehensive; targeted assessments are not permitted under existing policy.

### Burden-sharing, quality, and coordination issues
- Burden-sharing successes and challenges:
  - Common methodology and collaboration have leveraged Fund resources.
  - Differences in report quality among assessor bodies have caused difficulties; a 2006 independent study found significant weaknesses in some reports.
  - Fund staff provided pre-assessment training to officials from 31 countries and helped strengthen FSRBs through training, comments on reports, participation in plenaries, and preparatory work.
  - Improving report quality and consistency remains a work in progress.

### Recent assessment activity and publications (outputs)
- Fund activity (missions completed December 2004–January 2011):
  - Fund conducted detailed assessments of 34 countries, producing 30 ROSCs (27 published).
  - The World Bank, FATF, and FSRBs produced an additional 152 assessments with 140 published detailed reports and 23 ROSCs.
  - Together these reports provide a comprehensive public baseline worldwide.

### FATF institutional facts (Box 1 highlights)
- FATF membership expanded from 14 to 34 jurisdictions; complemented by eight FSRBs comprising an additional 146 jurisdictions.
- The FATF’s 40+9 Recommendations constitute the international AML/CFT standard.
- FATF requires periodic mutual evaluations, publication of results, and regular follow-up.

### Key lessons and proposed way forward (Executive Board recommendations)
- Adopt a targeted (risk-focused) approach to AML/CFT ROSCs:
  - Permit partial AML/CFT assessments focusing on areas with greatest ML/TF risk.
  - Align AML/CFT ROSCs with ROSC policy for other standards by introducing targeted, risk-focused assessments.
  - Consider revising the policy requiring all FSAPs and FSAP updates to include a full AML/CFT component; abandoning the mandatory link would better align with other standards and reduce costs.
  - Caveat: abandoning the mandatory link may be perceived as withdrawal from Board emphasis on AML/CFT.
  - If Boards support change, Fund and Bank staff will seek agreement with FATF and stakeholders on operational implications and present proposals to Boards for approval.
- Establish criteria for when AML/CFT issues pose risks to domestic financial stability or external stability:
  - Criteria to consider member circumstances, relative importance of AML/CFT to stability, and spillover risk.
  - Use criteria to guide Article IV surveillance and decisions on including AML/CFT in modular financial stability assessments.

---

### Compliance and assessment findings (detailed)
- Empirical compliance distribution (161 countries, 2004–2011; almost 7,889 observations):
  - Full compliance occurred in 12.3 percent of observations.
  - Largely compliant: 25.5 percent.
  - Partially compliant: 35.6 percent.
  - Noncompliant: 24.9 percent.
  - Not Available: 1.59 percent.
- Variation by income and governance:
  - Advanced economies (46 in sample): degree of compliance 56.8 percent.
  - Emerging economies (115 in sample): degree of compliance 37 percent.
  - GDP per capita (PPP) positively associated with compliance; better regulatory quality and lower corruption associated with higher compliance.
  - No statistical correlation found between compliance and a country’s involvement in the global drug economy (UNODC index).

### Assessment process: scope and resource metrics (Box 2)
- Assessment criteria: some 285 criteria.
- Team and time: 4–6 assessors; up to 2 ½ weeks on site; 17 weeks staff work per assessor on average.
- Costs:
  - IMF assessment average cost: $310,000.
  - Data ROSC average cost: $225,000.
  - AML/CFT ROSC cost to Fund when accounting for burden-sharing: some $112,000.
- Report length and interviews:
  - Reports often exceed 300 pages; France report exceeded 600 pages.
  - Assessors interview officials across multiple agencies and private sector actors.

### ICRG / NCJ processes and ROSC voluntariness
- FATF’s ICRG identifies jurisdictions posing significant risk to international financial system; ICRG uses Fund and Bank ROSCs.
- NCJ processes introduce coercive elements that challenge ROSC’s cooperative/voluntary nature.
- Fund and Bank staff participate as observers, provide TA information with member consent, and refrain from coercive aspects like public statements.

---

### Technical assistance (TA), transition to external financing, and TTF details
- Transition timeline and TTF resources:
  - Internal financing abandoned in FY2008; AML/CFT TA financed almost entirely by external resources thereafter.
  - AML/CFT TTF established in FY2009; supported by twelve donors pledging $25,274,610 for five years through FY2014.
  - TTF had received $15,940,265 of pledged funds as of April 16, 2011 (Technical Assistance Information Management System).
- TTF governance and allocation strategy:
  - Steering Committee of donors meets annually to guide strategy, approve work and financial plans, and facilitate coordination.
  - Allocation priorities: systemically-important countries, middle-income countries, countries with significant ML/TF risks; focus on Fund core competencies; balance bilateral and regional approaches; enhance TA delivery via long-term planning and quality control.
- TTF-financed TA outcomes and early successes:
  - Important project in Thailand (strategic 3–5 year partnership launched April 2009; Master Implementation Plan endorsed by Cabinet; National AML/CFT Strategy endorsed December 2010).
  - Regional awareness effort: two regional workshops that raised awareness in 13 countries and moved to tailored TA.
- Risks and challenges:
  - Donor priorities may diverge from Fund priorities.
  - Fund staff has almost no internal resources to respond to TA requests that support broader Fund initiatives.
  - Donors expect Fund to demonstrate internal commitment, including analytical AML/CFT work.

### External contributions (FY2006–FY2011) — exact figures
- AML/CFT TTF: Contributions pledged $25,274,610; Contributions received $15,940,265.
- Canada Subaccount: Pledged $1,152,374; Received $1,203,768 (includes interest).
- Qatar Reimbursement Agreement: Pledged $968,876; Received $0 (invoice to be submitted; project concludes July 2012).
- Italy Subaccount: Pledged $455,256; Received $455,256.
- The Netherlands Subaccount: Pledged $432,701; Received $469,849 (includes interest).
- Libya Subaccount: Pledged $313,617; Received $313,617.
- Iraq Subaccount: Pledged $63,736; Received $63,736.
- Total: Contributions pledged $28,661,170; Contributions received $18,446,491.

### TA delivery and results (May 2007–April 2011)
- Direct TA to 69 countries, requiring 796 missions and direct HQ advice.
- 73 regional workshops reached 2,468 country officials.
- AML/CFT capacity-building required 85.19 person years.
- Drafting assistance and institutional results include adoption or revision of AML/CFT frameworks in multiple jurisdictions; establishment of FIUs in Nigeria and Mauritius with Egmont membership; regional harmonization projects in Central America and Eastern Caribbean; pre- and post-assessment TA in numerous countries.

### Box 4 — IMF AML/CFT TA to Thailand (selected factual milestones)
- FSAP 2007: Thailand showed poor compliance; ICRG identified strategic AML/CFT deficiencies.
- Thai authorities requested 3–5 year strategic partnership; Fund entered partnership April 2009 after TTF financing secured.
- Master Implementation Plan (MIP) endorsed by Thai Cabinet; national seminar October 28–29, 2009 attended by over 50 agencies and private sector stakeholders.
- December 2010: Cabinet formally endorsed a detailed National AML/CFT Strategy.
- TA outputs: comprehensive draft AML/CFT legislation prepared; assistance responding to FATF ICRG process; training underway; Fund coordinating with other TA providers.

---

### Risk-focused approach: operational challenges and FSAP linkage options
- Operational challenges of risk-focused assessments:
  - Need to develop methodology for selecting principles for reassessment in cooperation with FATF and FSRBs.
  - Assessors must gain deeper understanding of domestic criminal/underground economies and identify mission-specific high-risk areas.
  - Consultations with the member and other assessor bodies likely required.
  - Risk-focused approach may or may not yield significant Fund/Bank cost savings but should improve assessment quality and usefulness of advice.
- Two options for AML/CFT–FSAP linkage:
  - Option 1: Apply targeted approach used for other financial sector standards:
    - Require AML/CFT assessment (full or targeted) in FSAP only when staff determine relevance (notably if AML/CFT risks are substantial).
    - Scope based on jurisdiction-specific risk and joint methodology.
    - Advantages: consistency across standards; more efficient resource allocation; aligns with trend toward customizable FSAP scope.
    - Potential concern: perceived withdrawal from AML/CFT emphasis in FSAPs.
  - Option 2: Maintain current requirement that all FSAPs incorporate AML/CFT assessment:
    - Full assessment required if member not previously assessed under current standard; otherwise normally allow targeted assessment.
    - Maintain timing rule: assessments within 18 months before/after FSAP mission.
    - Replace strict five-year full reassessment rule with time-since-last-assessment as a factor in scope.
    - Advantages: signals continued commitment; leverages FSAP framework for consistent coverage.
    - Limitation: retains unique status of AML/CFT among surveillance components.

### Consistency, burden-sharing, and next steps
- Under either FSAP option:
  - Retain existing Fund/Bank burden-sharing with other assessor bodies.
  - Need to ensure consistent coverage and mutual recognition of assessments.
  - Clear criteria and methodology for risk assessment and principle selection required.
- Next steps if Boards approve in principle:
  - Staff will discuss modalities with FATF and FSRBs; FATF to discuss feasibility over the next year with Fund/Bank participation.
  - If consensus emerges, staff will return to Executive Boards with specific proposals and operational details.

---

### Transmission channels: how ML/TF and predicate crimes can threaten stability
- Mechanisms through which ML/TF can undermine stability:
  - Loss of access to global financial markets: counterparties may prohibit or restrict dealings with banks from weak AML/CFT jurisdictions.
  - Destabilizing inflows/outflows: criminal proceeds or “hot money” can generate large cross-border or domestic flows that destabilize economies.
  - Financial sector fraud: large-scale fraud (e.g., “ponzi schemes”) can cause insolvencies, capital outflows, reputational damage.
  - Weak supervision: criminal ownership or regulatory capture impedes detection and corrective action.
  - Corruption: proceeds of grand corruption are major laundered funds; governance failures pose reputational and stability risks.
  - Terrorist financing: may cause sectoral declines and sanction-driven counterpart reluctance.
  - Tax fraud: associated laundering can erode government revenue and fiscal balance.
- Cross-border spillovers and contagion:
  - Illicit transfers and short-term capital flows can destabilize recipient countries, especially small jurisdictions.
  - Availability of money laundering services in one jurisdiction can facilitate tax evasion and harm neighboring countries’ fiscal positions.

### Transmission channels to macroeconomic variables and policy
- In countries with rudimentary banking systems, cash-based illegal transactions:
  - Impede banking development and formal intermediation.
  - Distort official statistics (employment, consumption, FX transactions), complicating policymaking.
  - Adversely affect growth via corruption, narcotics production, illegal logging, and diversion of resources from productive activity.
- Example empirical figures (Andean coca/cocaine impacts — Box 7 key figures):
  - UNODC: 167,600 hectares cultivated in Bolivia, Colombia, and Peru in 2008; implied potential manufacture of cocaine 845 metric tons in 2008.
  - Estimated sector shares of GDP:
    - Peru: 0.9 percent of total GDP in 2009 (staff estimate).
    - Bolivia: cultivation of coca leaf represents some 1/8–1 1/4 percent of total GDP during 1990–2008.
    - Colombia: share ranged between 3/4–3 3/4 percent of total GDP from 2000 to 2008.
  - Peru regional result: one standard deviation positive shock to illegal regional coca production decreases formal regional GDP by 1/4 percent in two years.
- Modular Financial Stability Assessments (FSSAs) required components:
  - Evaluate source, probability, and potential impact of main macro-financial risks in near term.
  - Assess financial stability policy framework.
  - Assess authorities’ capacity to manage and resolve financial crises.

### Criteria for including AML/CFT in modular assessments and Article IV
- Proposed considerations to include AML/CFT in modular assessments (examples preserved verbatim):
  - A country‘s access to global financial markets is vulnerable to AML/CFT-related sanctions and blacklisting.
  - The actual or potential level of abuse of financial institutions as instrumentalities for ML/TF is large relative to the country‘s financial sector or GDP.
  - Estimated level of proceeds of crime generated in the country is large relative to formal sector GDP.
  - Transactions in specific illegal markets (e.g., drug production and trafficking) are large relative to formal GDP.
  - Criminal elements own, control, or hold significant proportion of financial sector assets or equity.
  - Regulatory capture or weaknesses hamper effective supervision.
  - Significant risk of financial sector fraud capable of undermining domestic stability.
  - Corruption by officials significant relative to economy or government budget.
  - Recent terrorist attack or credible threat that makes key sectors vulnerable.
- Article IV mandatory discussion cases (three broad cases):
  - Where ML/TF/predicate crimes may undermine domestic financial stability (same considerations as modular assessments).
  - Where problems may have important spillover effects on other members.
  - Where problems may undermine external stability even if not affecting the financial system (e.g., unrecorded illegal transactions impair policymaking).

---

### National ML/TF Risk Assessment (NRA) framework and indicators
- Purpose and generic objective:
  - Develop a framework to assess ML and TF risks focusing on minimizing the amount of ML/TF that occurs successfully.
  - Focus on substantial ML (example pilot threshold: at least $100 million annually) and substantial TF (indicator suggested $10 million annually).
- Risk decomposition:
  - Risk R = f[(T), (V)] x C where T = threat, V = vulnerability, C = consequence.
  - Threat: nature and scale of proceeds of crime (domestic and foreign) or funds for terrorism.
  - Vulnerability: products, services, channels, institutions, systems, and jurisdictional characteristics enabling abuse.
  - Consequences: outcomes from successful ML/TF including economic, financial, social, and political effects (25 categories listed).
- Scoring and aggregation mechanics:
  - Semi-qualitative scores for objective and subjective indicators on a seven-point ordinal scale.
  - Aggregation uses geometric mean (n√A) across indicators to smooth outliers and preserve relationships.
  - Likelihood and consequence proxies combined via geometric mean or pre-determined matrix to derive national ML/TF risk level.
  - Example risk level scale (Table 1 exact descriptors preserved):
    -  6-7 — Extremely higher risk — Urgent priority
    -  5-6 — Much higher risk — Much higher priority
    -  4-5 — Higher risk — Higher priority
    -  3-4 — Higher medium risk — Higher medium priority
    -  2-3 — Lower medium risk — Lower medium priority
    -  1-2 — Lower risk — Lower priority
    -  0-1 — Much lower risk — Much lower priority
- Implementation notes:
  - Use objective public data where possible; supplement with non-public data or surveys.
  - Consequence proxies derived largely from informed officials via structured judgment after being presented likelihood analysis.
  - Framework intended to evolve through application in TA, assessments, and surveillance; validation and refinement of indicators and decision criteria required.

---

### Resource implications, staffing, and operational approach
- Resource trends FY2006–FY2011:
  - FY2006: approximately 36 person years expended on AML/CFT.
  - FY2011: reduced to approximately 20 person years.
  - Fund now devotes about half the level of resources it did six years earlier.
  - AML/CFT program share of Fund overall budget declined from 1 percent to 0.4 percent.
  - FY2006 budgeting context: Fund budgeted $9 million and approximately 39 person years to AML/CFT and OFC work.
  - FY2011 allocation/context: $5.9 million for approximately 24 person years.
- ROSC production and costs (2004–2010):
  - Fund produced 30 AML/CFT ROSCs at estimated average cost $310,000 per assessment.
  - Including 53 ROSCs by other assessor bodies reduces average AML/CFT ROSC cost to some $112,000.
  - Fund expenditures on AML/CFT exceeded combined expenditures on all other ROSCs.
- Uncertainty of resource implications for proposed risk-based approach:
  - Precise resource impact cannot be assessed without agreement on framework features with AML/CFT community and number of assessments to be done.
  - Dropping mandatory FSAP linkage might yield some savings but probably not substantial because most assessments are by outside bodies and staff still must scope risks.
  - Better integration of AML/CFT in modular assessments and Article IV would require preparatory work and likely a statistical database of economic and criminal justice statistics.
- Operational approach and contingencies:
  - Staff to monitor country conditions, provide briefings and data to country teams, relying on Legal Department’s Financial Integrity Group experts.
  - If staff capacity insufficient, resource implications of revised program revisited via budget process or Executive Board update.
  - Creation of economic, financial, and criminal justice statistics database envisaged to support risk analysis and effectiveness measurement.
- Questions posed to Directors:
  - Whether to explore targeted, risk-focused AML/CFT assessments with FATF and other assessor bodies and report back within two years.
  - Preference between the two FSAP linkage options.
  - Whether the proposed systemic risk framework is a useful basis for integrating AML/CFT into modular assessments and Article IV surveillance.

---

### Annex highlights: jurisdictions’ compliance, TA record, and prioritization insight
- Annex compliance recap (161 countries, 2004–2011):
  - Average compliance score 20.8 or 42.5 percent on 49-point scale.
  - Full compliance on any FATF Recommendation: 12.3 percent of observations.
  - Distribution: LC 25.5 percent; PC 35.6 percent; NC 24.9 percent; NA 1.59 percent.
- Time-in-place and subject variation:
  - AML Recommendations degree of compliance: 45 percent.
  - CFT Special Recommendations degree of compliance: 31.5 percent.
  - DNFBPs (subject to standard only in 2003): averaged 12.1 percent of theoretical maximum.
- Empirical relationships:
  - Advanced economies degree of compliance 56.8 percent; emerging economies 37 percent.
  - GDP per capita (PPP) significant positive explanatory variable for compliance.
  - Higher regulatory quality and lower corruption associated with higher compliance.
  - Jurisdictions' systemic importance and low compliance can identify priorities for TA and surveillance.
- TA record FY2006–FY2011 (selected metrics repeated):
  - Direct TA: 69 countries, 796 missions, direct HQ advice.
  - Regional workshops: 73 events, 2,468 country officials trained.
  - TA person years: 85.19.
  - Examples of TA outcomes: new/revised AML/CFT frameworks; FIU establishments; supervisory manuals; regional harmonization.

---

*Italic: Source: Executive Summary and selected sections from IMF staff paper on the Fund’s AML/CFT program (content unit: _051111pdf).*

### Executive Summary ......................................................................................................

### Executive Summary

### Program evolution and role
- The Fund’s Anti-Money Laundering and Combating the Financing of Terrorism (AML/CFT) program has significantly contributed to the international community’s response to money laundering and the financing of terrorism.
- Over the past five years the Fund’s AML/CFT technical assistance program:
  - Is now being delivered more strategically than in the past.
  - Is almost exclusively funded by external resources.
  - Has the AML/CFT Topical Trust Fund as its central pillar.
- The Fund’s AML/CFT program encompasses:
  - Assessments under the ROSC program of countries’ compliance with the FATF AML/CFT standard.
  - Examination of AML/CFT issues in the context of Article IV surveillance.
  - Provision of technical assistance.
  - Research and policy development.

### Key Executive Board decisions shaping the program
- April 2001: Fund would play a role in combating money laundering through technical assistance and Article IV surveillance.
- November 2001: Fund expanded work to cover terrorist financing through technical assistance and Article IV surveillance.
- 2002: Board approved Fund involvement in assessments against the FATF standard, adopting it for ROSCs and launching a twelve-month pilot program.
- 2004: Board made AML/CFT assessments a regular feature of the ROSC program, endorsed the revised FATF standard, and affirmed that all FSAPs and FSAP updates be accompanied by an AML/CFT assessment.
- 2006: Board reaffirmed that every FSAP and FSAP update be accompanied by an AML/CFT assessment and specified implementation modalities.

### Integration and partnerships
- AML/CFT assessments are an important part of the joint Bank/Fund ROSC and FSAP programs and rely on close cooperation with other key players, notably the Financial Action Task Force (FATF) and the World Bank.
- Unique burden-sharing arrangements exist under which the Fund and the World Bank rely on assessments conducted by other assessor bodies (FATF and FSRBs) for FSAP and ROSC purposes; these arrangements have generally worked well.

### Scope and challenges of the FATF standard
- The FATF standard and associated methodology are comprehensive and exacting, reflecting the breadth of potential ML and TF avenues across many sectors.
- The comprehensiveness yields demonstrable benefits (e.g., assessing institutional arrangements and effectiveness) but also poses challenges:
  - Jurisdictions’ compliance has been generally low.
  - The assessment process has been relatively time consuming and expensive.

### Recent assessment activity and publications
- Since 2004, the Fund has conducted detailed assessments of 34 countries (covering assessment missions completed between December 2004 and January 2011).
- These Fund assessments have generated 30 ROSCs, of which 27 have been published.
- The World Bank, the FATF, and the FSRBs have conducted an additional 152 assessments that produced 140 published detailed reports and 23 ROSCs.
- In total these reports provide a comprehensive baseline of public information on AML/CFT regimes worldwide.

### FATF institutional facts noted in Box 1
- Membership and network:
  - FATF membership grew from 14 countries at its inception to 34 jurisdictions at present.
  - FATF is complemented by eight FATF-style regional bodies (FSRBs) whose membership comprises an additional 146 jurisdictions.
- Recommendations:
  - The FATF’s 40+9 Recommendations constitute the international standard for AML/CFT.
- Peer Review, Transparency, and Follow-up:
  - FATF requires periodic mutual evaluations, publication of results, and regular discussion of jurisdictions’ progress.

### Lessons from the Fund’s AML/CFT assessment program
- Three important lessons relate to:
  - The comprehensiveness of the FATF standard and the assessment process.
  - Burden-sharing arrangements with other assessor bodies.
  - Use of Fund assessments in the context of FATF initiatives to address “non-cooperative jurisdictions.”
- The current AML/CFT assessment framework differs from ROSC rules in other areas:
  - FSAP policy requires every full FSAP and FSAP update to incorporate a full AML/CFT assessment; AML/CFT assessments should be conducted within 18 months before or after the relevant FSAP mission and approximately every five years.
  - Although the ROSC program is voluntary, most Fund members are required to undergo a full AML/CFT assessment approximately every five years and to publish results by virtue of FATF/FSRB membership (only 22 Fund members are not part of the FATF/FSRB network).
  - The Fund and Bank use assessments prepared by FATF and FSRBs for FSAP and ROSC purposes; FATF/FSRB mutual evaluations in turn make use of Fund and Bank assessments.

### Resource and procedural implications
- The comprehensiveness of the FATF standard and methodology has made assessments relatively time consuming and expensive.
- Burden-sharing has significantly leveraged Fund resources allocated to the assessment program.
- The ROSC assessments produced by other assessor bodies are subject to a pro forma review by Fund staff.

### Recommendations and the proposed way forward
- Adopt a targeted (risk-focused) approach to AML/CFT ROSCs:
  - Allow conduct of partial AML/CFT assessments focusing on areas with the greatest risk of money laundering or terrorist financing occurring without detection or sanction.
  - Align AML/CFT ROSCs with ROSC policy for other standards by introducing a framework for targeted, risk-focused assessments.
  - Consider revising the current policy requiring all FSAPs and FSAP updates to include a full AML/CFT component; abandoning this mandatory link would further align AML/CFT ROSC policy with practices for other standards and facilitate a more cost-effective approach.
  - Caveat: Abandoning the mandatory link may signal a withdrawal from the emphasis the Executive Boards have placed on these issues over past years.
  - If the Boards support targeted, risk-focused ROSCs and/or revised FSAP linkage, Fund and Bank staff would seek agreement with FATF and other stakeholders on operational implications and present proposals to the Executive Boards for approval.
- Establish criteria to determine when AML/CFT issues may pose risks to a member’s domestic financial system stability or external stability:
  - Criteria would consider the member’s circumstances, including the relative importance of AML/CFT versus other issues to external and financial stability, and the risk of spillover effects on other members.
  - These considerations would guide staff in Article IV surveillance and decisions on whether to include AML/CFT issues in a modular financial stability assessment.

_Italic: Source: Executive Summary of IMF paper on the Fund’s AML/CFT program (content unit: _051111pdf - Executive Summary)._

### 10.      The comprehensive nature of the standard sets a high benchmark both with

### _051111pdf - 10.      The comprehensive nature of the standard sets a high benchmark both with

### Compliance and Assessment Findings
- Compliance by countries with the standard is low: of the 161 countries assessed using the current methodology from 2004 to April 2011, full compliance with any principle was rare, occurring in only 12.3 percent of the cases.
- Countries achieved the second highest score, largely compliant, only 25.5 percent of the time.
- High levels of compliance have been achieved by countries with higher per capita income levels and more well-developed frameworks for financial regulation and fighting corruption.
- Compliance by many emerging market and low-income countries is impeded by a relatively poor understanding of AML/CFT best practices, inadequate budgets for training staff, and the absence of important preconditions (e.g., rule of law, transparency, and good governance).
- The AML/CFT methodology focuses not just on formal compliance, but also the extent to which the standard is effectively implemented in the relevant country; this focus on effectiveness is a key driver of the low scores and the resource requirements.

### Assessment Process: Time, Scope, and Cost (Box 2)
- Assessments examine some 285 criteria set out in the FATF assessment methodology.
- Assessment missions take up to 2 ½ weeks on site and, in the case of the Fund, typically involve teams of 4–6 assessors.
- Pre-and post-assessment work has taken on average 17 weeks of staff work per assessor.
- IMF assessments cost, on average, some $310,000.
- Data ROSCs, the second costliest ROSC, cost, on average, $225,000.
- Factoring in assessments prepared by other AML/CFT assessor bodies under burden-sharing arrangements, the cost of an AML/CFT ROSC to the Fund (some $112,000) is closer to the average cost for all ROSCs.
- Detailed assessment reports often exceed 300 pages in length, plus appendices; the recent report on France exceeded 600 pages.
- Assessors interview officials from many agencies and the private sector (e.g., finance ministry, regulators, customs, law enforcement, prosecutors, financial sector, lawyers, notaries, and casinos).
- The comprehensive nature of the methodology does not allow targeted assessments under current policy: all AML/CFT assessments must be comprehensive and cannot be targeted to the circumstances of individual countries.

### Burden Sharing, Quality, and Coordination
- Burden-sharing arrangements between the Fund, the World Bank, the FATF, and the FSRBs have generally worked well, applying a common methodology and enabling collaboration on technical assistance and training.
- Differences in the quality of reports prepared by some assessor bodies have given rise to difficulties; an independent panel study in 2006 pointed to differences in report quality and significant weaknesses in some cases.
- Fund staff has helped strengthen FSRBs by training assessors, providing comments on assessment reports, participating in plenary meetings, and preparing authorities of countries about to undergo an assessment.
- Fund staff has provided pre-assessment training to officials from 31 countries over the past five years.
- Improving the quality and consistency of assessment reports remains a work in progress.

### The FATF International Cooperation Review Group (ICRG) and NCJ Processes
- The FATF engages in the International Cooperation Review Group or "ICRG" to identify and engage with jurisdictions considered "to pose a significant risk to the international financial system."
- The ICRG is a "non-cooperative jurisdiction-type" ("NCJ") process that applies to FATF members and nonmembers alike and makes use of Fund and Bank ROSCs in assessing countries' compliance.
- NCJ processes like the ICRG present challenges to the cooperative and voluntary nature of the ROSC program because they involve coercive elements.
- The FATF designed the ICRG process to respect ROSC principles: it does not issue public statements about a jurisdiction's deficiencies before engaging in dialogue and differentiates between jurisdictions that have committed to an action plan and those that have not.
- Fund and Bank staff participate in the ICRG process as observers, provide information on Fund and Bank TA with member consent, and refrain from participation in coercive aspects such as issuing public statements.

### Technical Assistance (TA) and Transition to External Financing
- Over the past three years the IMF's AML/CFT TA model underwent a complete transformation: internal financing was abandoned in FY2008 and replaced with a new framework under which almost all AML/CFT TA would be financed with external resources.
- The AML/CFT Topical Trust Fund (TTF) was established in FY2009 as a multi-donor trust fund to finance virtually all of the Fund's AML/CFT TA.
- The TTF is supported by twelve donors who have pledged $25,274,610 for five years of operations through FY2014.
- The TTF donors comprise a steering committee that meets annually, provides strategic guidance, reviews and approves TTF work and financial plans, and facilitates cooperation among donors and other AML/CFT TA providers.
- Allocation of AML/CFT TTF resources follows a four-pronged prioritized strategy:
  - Focusing on systemically-important countries, middle-income countries, and countries with significant ML or TF risks;
  - Focusing on areas related to the Fund's core competencies: overall system design, financial sector regulatory issues, law reform, good governance, and institution building;
  - Striking a balance between bilateral programs for systemically-important members and regional approaches;
  - Enhancing TA delivery through long-term planning, regional and country strategies, maximizing external resources, combining staff expertise with field experts, and implementing strict quality control measures.
- The TTF-financed TA program has had early successes, including an important project in Thailand and a regional awareness effort that raised awareness in 13 countries through two regional workshops and is moving to direct tailored technical assistance.
- Risks and challenges:
  - Donor-set priorities may not always align with Fund priorities.
  - Fund staff currently has almost no internal resources to respond to TA requests, even where such TA may be necessary to support broader Fund initiatives.
  - Donors expect the Fund to demonstrate internal commitment, including supporting some analytical work on AML/CFT.

* _051111pdf - 10.      The comprehensive nature of the standard sets a high benchmark both with_*

### Box 4. IMF AML/CFT TA to Thailand

### Box 4. IMF AML/CFT TA to Thailand

### Background and objectives
- The Kingdom of Thailand demonstrated poor compliance with the international AML/CFT standard during a 2007 FSAP.
- The FATF’s International Cooperation Review Group (ICRG) identified Thailand as a country with strategic AML/CFT deficiencies.
- Following the FSAP, Thai authorities requested a 3–5 year strategic partnership with the Fund to enhance the performance and capacities of its Anti-Money Laundering Office (AMLO) and other primary AML/CFT-related agencies.
- The overall objective of the program: for Thailand to establish a comprehensive AML/CFT legal, regulatory, and institutional framework (including laws, regulations, guidelines, and training of personnel) to comply with AML/CFT standards.

### Program design and implementation
- The Fund entered into the strategic partnership with Thailand in April 2009 after securing financial support from the externally-financed AML/CFT TTF.
- The program was designed around a high-level Master Implementation Plan (MIP) endorsed by the Thai Cabinet.
- Structure of the TA program:
  - A series of modules delivered by a core project team of experts operating peripatetically.
  - Specialized expertise to address specific issues.
  - Oversight by HQ staff.
- Design considerations:
  - Accounted for absorptive capacity and consensus-oriented culture of the Thai authorities.
  - Took into account resource capacity of Fund staff and the timetable for implementation of the MIP.
- Launch and national engagement:
  - The MIP and the 3–5 year TA program of planned TTF modules was officially launched by the Minister of Justice at a national seminar convened by the Thai authorities on October 28–29, 2009.
  - The seminar was attended by over 50 key agencies and private sector stakeholders, helping secure broad national commitment.
- Cabinet endorsement:
  - In December 2010, the Cabinet formally endorsed a detailed National AML/CFT Strategy that articulates detailed objectives, timelines, and responsible parties across the full range of measures required for an effective AML/CFT regime.

### Outputs, capacity-building, and coordination
- The TA program helped the authorities:
  - Prepare comprehensive draft legislation on AML and CFT.
  - Respond to the FATF ICRG process.
- Training of personnel is underway.
- Fund staff is coordinating effectively with other TA providers.

*Source: _051111pdf - Box 4. IMF AML/CFT TA to Thailand*

### 36.      Implementing a risk-focused approach to AML/CFT assessments would present

### _051111pdf - 36.      Implementing a risk-focused approach to AML/CFT assessments would present

### Operational challenges of a risk-focused approach
- A methodology for choosing the principles selected for reassessment would have to be developed in cooperation with the FATF and FSRBs.
- Assessors would need to:
  - develop a deeper understanding of the economies (including the criminal and underground economies) they would assess;
  - identify in advance the areas that merit detailed examination for each mission;
  - determine whether measures adopted by assessed countries would be effective in addressing AML/CFT risks.
- Assessments would likely need to be preceded by consultations with the relevant member and with other assessor bodies.
- A risk-focused approach may or may not result in significant savings for the Fund and the Bank, but would help improve the quality of assessments and the usefulness of advice to members.

### Options for the link between AML/CFT assessments and the FSAP
- Two options are presented regarding the mandatory link between FSAPs and AML/CFT assessments.

- Option 1: Apply the same targeted approach used for other financial sector standards in FSAPs.
  - AML/CFT assessments—full or targeted—would be required in the context of an FSAP only if staff determine such an assessment is relevant for the member (notably, if the risks of AML/CFT occurring in that jurisdiction are substantial).
  - The scope would be based upon the particular risk and compliance profile presented by the jurisdiction and the joint methodology among assessor bodies.
  - Advantages:
    - Establishes consistency across standard assessments in FSAPs.
    - Allows more efficient and strategic allocation of scarce resources.
    - Aligns with recent trends toward greater flexibility and customizing FSAP scope and depth to individual members.
    - Recognizes that regular AML/CFT assessments are now the norm for the vast majority of IMF members.
  - Potential concern: May be seen as implying a withdrawal by the Bank and the Fund from AML/CFT issues and the attention they have received in the FSAP context.

- Option 2: Maintain the current requirement that all FSAPs incorporate an AML/CFT assessment.
  - If the member had not been previously assessed under the current AML/CFT standard, a full assessment would be required.
  - In other cases, provision would normally be made for a targeted, risk-focused assessment.
  - The current policy on timing would continue to apply: assessments must take place within 18 months preceding or following the date of the FSAP or FSAP update mission.
  - The current requirement that full reassessments be conducted every five years would be replaced with an approach under which the length of time since the last assessment would be one factor in determining scope (e.g., if five years had passed since the last full assessment, a full reassessment may or may not be appropriate, depending on circumstances).
  - Advantages:
    - Signals the Fund’s and the Bank’s continuing commitment to international efforts to combat money laundering and terrorist financing.
    - Recognizes the FSAP framework as an effective mechanism to ensure consistent AML/CFT coverage.
  - Limitation:
    - Would retain the unique status of the AML/CFT standard among other components of financial surveillance and standards.
    - Differential treatment with respect to modular stability assessments would be maintained (AML/CFT required for every FSAP/FSAP update; no similar requirement for modular stability assessments).

### Consistency, burden-sharing, and mutual recognition
- Under either option:
  - The Fund and the Bank would retain the existing burden-sharing arrangement with other assessor bodies.
  - They would need to ensure assessments are conducted in a consistent manner.
  - A targeted approach could increase the risk of inconsistencies in coverage across assessments.
  - To maintain mutual recognition of assessments, the Fund and Bank would need to be satisfied that assessments by other bodies cover the relevant issues.
  - Clear criteria and a methodology for assessing risks and for choosing principles to be assessed would help address these challenges.
  - Rely on mechanisms and working arrangements among assessor bodies established over the past six years, including joint consultations.

### Next steps and coordination with FATF/FSRBs
- If Boards approve in principle moving to targeted, risk-focused assessments:
  - Fund and Bank staff will discuss modalities of implementation with FATF and the FSRBs.
  - FATF will be discussing the feasibility of a risk-focused approach over the course of the next year; Bank and Fund staff intend to participate actively.
  - Following Board guidance on the relationship between AML/CFT assessments and FSAPs/FSAP updates, Fund and Bank staff would discuss operational implications with external stakeholders.
  - If consensus emerges favoring a revised approach, Fund and Bank staff would return to their respective Executive Boards with a specific proposal; at that time operational details would be spelled out and, if approved, staff could begin targeted, risk-focused assessments in concert with FATF and FSRBs.

### Treatment of AML/CFT in modular stability assessments and Article IV surveillance
- Any rules for coverage must be based on an assessment of risk, but the relevant types of risk differ:
  - Risk-focused ROSCs: concerned with risk of substantial ML or TF taking place without detection or sanction.
  - Modular FSAP stability assessments: concerned with risks that threaten the stability of the domestic financial system.
  - Bilateral Article IV surveillance: concerned with risks to the “external stability” of the member—defined as “a balance of payments position that does not, and is not likely to, give rise to disruptive exchange rate movements.”
  - External stability encompasses domestic financial stability and extends to the stability of the economy generally.
- The challenge: identify cases where money laundering or terrorist financing is so serious as to threaten domestic financial stability (modular assessments) or external stability (Article IV surveillance). A conceptual framework and factors for analysis are set out and applied.

### How money laundering, terrorist financing, and predicate crimes can threaten financial or external stability
- Background:
  - Money laundering and financial abuse can undermine financial system stability or the broader economy because financial systems depend on trust and professional, legal, and ethical standards.
  - It is often difficult to separate money laundering or terrorist financing from related predicate crimes; FATF calls for measures that deal with predicate crimes as well as ML/TF.

- Ways these activities can undermine stability (summarized):
  - Loss of Access to global financial markets:
    - Failure to deal effectively with ML/TF may result in loss of access of a member’s financial system to global markets, harming financial stability and the economy.
    - Increasing practice for national supervisors to prohibit their banks from dealing with institutions from countries with weak AML/CFT frameworks or to subject transactions with such institutions to stricter conditions.
    - Financial institutions may be reluctant to deal with banks from jurisdictions where ML/TF is a major concern.
  - Destabilizing Inflows and Outflows:
    - ML/TF activities may generate significant criminal proceeds or “hot money” flows into and out of financial institutions in destabilizing ways (cross-border or domestic).
    - Where such transactions are significant relative to the formal sector, they can affect the entire financial system.
  - Financial Sector Fraud:
    - ML may be associated with broader financial sector fraud (e.g., large-scale “ponzi schemes”), causing bank insolvencies, large capital outflows, or loss of access to international markets due to reputational deterioration.
  - Problems with Financial Sector Supervision:
    - ML/TF may evidence deeper weaknesses in financial supervision; criminal ownership or control of important institutions can impede effective supervision and problem identification.
  - Corruption:
    - Proceeds of grand corruption are major sources of laundered funds.
    - Bribery, corruption, and governance issues can directly and indirectly impact financial stability, pose reputational risk for receiving institutions, threaten offshore financial centers (OFCs) with smaller sectors, and represent destabilizing outflows from source countries.
  - Terrorist Financing and Economic Paralysis:
    - Terrorism and terrorist financing can undermine financial stability through incidents or history of incidents, making sectors vulnerable to declines in activity and threatening bank stability.
    - Banks viewed as conduits for terrorist financing may face international sanctions or counterparties’ reluctance to deal, undermining their stability.
  - Tax Fraud:
    - ML may be associated with tax fraud that undermines financial or macroeconomic activity.
    - Significant tax fraud can erode government revenue and fiscal balance; injection of “hot money” from tax evasion can subject banking systems to volatile inflows/outflows.
    - Robust AML/CFT controls can limit opportunities to launder proceeds of tax evasion and thus help combat tax evasion.
    - Note: tax crimes have not yet been incorporated as a predicate crime into the FATF standard; discussions are underway in FATF to do so.

*Source: _051111pdf - 36. Implementing a risk-focused approach to AML/CFT assessments would present*

### 50.      In most cases of money laundering, these problems will be transmitted through a

### _051111pdf - 50.      In most cases of money laundering, these problems will be transmitted through a

### Transmission channels and macroeconomic effects
- Money laundering and terrorist financing are generally transmitted through a country’s financial system: criminal proceeds and terrorist financing are placed within a country‘s financial system and may remain or be transferred abroad.
- In countries with rudimentary banking systems, illegal transactions may be conducted in cash and proceeds may never enter the banking system; this:
  - Impedes banking system development because funds are not used for formal intermediation and thus impedes economic growth.
  - Can undermine broader macroeconomic stability through at least two mechanisms:
    - Problems with economic policymaking:
      - When the illegal sector forms a significant share of the economy and proceeds remain in cash, official data on employment, consumption, and foreign exchange transactions may not reflect underlying realities, making policymaking difficult.
    - Adverse effects on growth:
      - Corruption, especially grand corruption at the national level, negatively affects fiscal balances, FDI, and growth.
      - Production and trafficking in illegal narcotics divert resources from legal and productive investments and activity.
      - Illegal logging and environmental crimes despoil natural resource wealth incompatible with sustainable growth.
      - Large illegal sectors can be deadweights on formal economies, producing sub-optimal growth and, in extreme cases, threatening state functions and the rule of law.

### Cross-border spillovers and contagion
- Money laundering, terrorist financing, and predicate crimes can undermine the originating country’s stability and cause adverse spillovers to other countries:
  - Extensive criminal activity may generate illicit transfers from or large short-term capital flows to other countries, destabilizing their economies.
  - Availability of money laundering services in one jurisdiction may facilitate tax evasion in neighboring countries, harming their fiscal positions.
- Example risk: a sudden influx of significant foreign proceeds of crime into a relatively small jurisdiction can cause substantial interest and exchange rate volatility for that jurisdiction, even if inflows originate from a much larger jurisdiction largely unaffected domestically.

### Determinants of overall risk
- Key determinant: the magnitude of consequences from the threat combined with vulnerabilities in the financial sector or economy.
  - A relatively large threat + significant vulnerabilities in a relatively small financial sector/economy → relatively high overall risk.
- Consequences may arise even when the originating jurisdiction is much larger than the recipient.

### Guidance for inclusion of AML/CFT issues in modular stability assessments
- Because of the risks, AML/CFT issues should be considered in modular stability assessments and bilateral surveillance under Article IV where appropriate.
- The Fund would examine the manner and extent to which a country‘s AML/CFT controls are effective and identify steps to strengthen such controls, but clearer guidance is required on when such coverage is appropriate.
- Staff will continue to deepen understanding of linkages between AML/CFT issues and financial and external stability and improve indicators for measuring those linkages.

### Box 7 — Effect of coca production on non-coca GDP in Andean countries (key figures and findings)
- UNODC data: 167,600 hectares cultivated in Bolivia, Colombia, and Peru in 2008.
- Implied potential manufacture of cocaine: 845 metric tons in 2008—nearly 100 percent of world‘s coca production.
- Official/national estimates of coca/cocaine sector share of GDP:
  - Peru: staff estimate 0.9 percent of total GDP in 2009 (Peru’s national statistics do not include an estimate).
  - Bolivia: cultivation of coca leaf represents some ⅛-1¼ percent of total GDP during 1990–2008.
  - Colombia: share ranged between ¾–3¾ percent of total GDP from 2000 to 2008, declining toward the end of the period.
- Staff findings on indirect effects:
  - For Peru, Pedroni and Verdugo (2010) find illegal coca and cocaine production tends to crowd out legal formal sector production at regional level.
    - One standard deviation positive shock to illegal regional coca production decreases formal GDP in the same region typically by ¼ percent in a two-year horizon.
  - For Colombia and Bolivia (national VAR approach):
    - Colombia: a negative impact on non-coca real GDP growth is found.
    - Bolivia: the opposite effect is found (may reflect measurement errors since cocaine production is not measured).

### Modular Financial Stability Assessments (FSSAs) — required components
- Modular financial stability assessments must include:
  - An evaluation of the source, probability, and potential impact of the main risks to macro-financial stability in the near term;
  - An assessment of the country‘s financial stability policy framework; and
  - An assessment of the authorities‘ capacity to manage and resolve a financial crisis, should the risks materialize.
- All three elements are expected in all FSSAs; individual cases may cover additional areas or be accompanied by detailed standards assessments.

### Modalities and criteria for including AML/CFT in modular assessments
- Modular assessments may be voluntary (technical assistance) or mandatory (Article IV bilateral surveillance); neither form requires inclusion of AML/CFT issues by default.
- If included, the scope may range from comprehensive reassessment to partial ROSC update, technical note, or incorporation of key issues into the FSSA.
- Staff proposes inclusion of AML/CFT issues when the member agrees and staff judges AML/CFT issues important to domestic financial stability, guided by considerations such as:
  - A country‘s access to global financial markets is vulnerable to AML/CFT-related sanctions and blacklisting;
  - The actual or potential level of abuse of financial institutions as instrumentalities for money laundering or terrorist financing is large relative to the country‘s financial sector or GDP;
  - The estimated level of proceeds of crime generated in the country is large relative to the country‘s formal sector (official) GDP;
  - Transactions in specific illegal markets (e.g., drug production and trafficking) are large relative to the country‘s formal sector (official) GDP;
  - Criminal elements own, control, or hold a significant proportion of financial sector assets, or a significant equity interest in key financial institutions;
  - Regulatory capture by criminal elements or weaknesses in the regulatory and criminal justice systems hamper effective supervision of the financial sector;
  - There is a significant risk of financial sector fraud of a magnitude that could undermine domestic financial stability;
  - Corruption by government or elected officials is significant relative to the size of the economy or the government budget;
  - A recent terrorist attack or the threat of one makes key sectors vulnerable (e.g., banking, tourism, foreign investment), or the level and nature of terrorist incidents otherwise threatens domestic financial stability.

### Article IV surveillance: when AML/CFT issues may be mandatory
- Bilateral surveillance under Article IV focuses on external stability per the 2007 Surveillance Decision; financial sector policies that influence external stability are always within scope.
- Three broad cases where AML/CFT may be appropriate for mandatory discussion in bilateral surveillance:
  - Where money laundering, terrorist financing, or predicate crimes may undermine the member’s domestic financial system stability (same considerations as modular assessments).
  - Where problems in a member country may have important spillover effects on other members (surveillance examines spillovers arising from external policies or from domestic policies when the member is in a state of domestic instability). Examples include problems in international payments and transfers or weak domestic supervision causing cross-border effects.
  - Where problems do not affect the financial system but may still undermine the member’s external stability (e.g., large unrecorded illegal transactions impair macroeconomic policymaking and external stability).
- Additional factors for Article IV consideration include:
  - The actual or potential level of abuse of financial institutions posing spillover risks;
  - Significant risk of financial sector fraud with cross-border effects;
  - Significant risk of tax fraud undermining fiscal balances or producing spillovers;
  - Corruption by governmental or elected officials significant relative to economy or budget;
  - Macroeconomic policy execution impaired by unaccounted economic transactions in informal or illegal sectors.

*Source: _051111pdf - 50.      In most cases of money laundering, these problems will be transmitted through a*

### 63.      While the 2007 Surveillance Decision specifies the circumstances in which issues

### IV. RESOURCE IMPLICATIONS

### AML/CFT inclusion in Article IV consultations
- The Fund’s legal framework permits the Fund and members to voluntarily agree to discuss issues in an Article IV consultation even where they fall outside the scope of Article IV; such discussions constitute a form of "policy advice" under Article V, Section 2(b) of the Fund‘s Articles.
- It is proposed that the inclusion of AML/CFT issues in Article IV consultations on a voluntary basis should continue to be possible.

### Resource trends and staffing (FY2006–FY2011)
- In FY2006, approximately 36 person years were expended in AML/CFT work.
- By FY2011, the expenditure in AML/CFT had been reduced to approximately 20 person years.
- In real terms, the Fund now devotes about half the level of resources it did six years ago.
- As a percentage of the Fund‘s overall budget, the AML/CFT program has gone from 1 percent to 0.4 percent.
- The Fund‘s internal AML/CFT resources are now largely devoted to complying with the May 2006 Executive Board decision that staff should conduct 6–7 AML/CFT assessments per year across the Fund‘s membership, and to some related policy and surveillance support.
- FY2006 budgeting/context note: the Fund budgeted $9 million and approximately 39 person years to AML/CFT and OFC work.
- FY2011 allocation/context note: $5.9 million for approximately 24 person years.

### Comparative costs and ROSC outputs
- Between 2004 to 2010, Fund staff produced 30 AML/CFT ROSCs at an estimated average cost $310,000 per assessment.
- Factoring in the 53 ROSCs produced by other assessor bodies reduces the average cost of AML/CFT ROSCs to some $112,000 (closer to the average cost for all ROSCs).
- Fund expenditures on AML/CFT have exceeded the combined expenditures on all other ROSCs.
- Factors contributing to this include complexities of AML/CFT assessments and a decline in the annual number of assessments and associated ROSCs for other standards (reasons: (i) decrease in overall budget allocated to ROSCs; (ii) reduction in number of countries undergoing initial assessments; (iii) shift from formal ROSCs towards technical notes; (iv) sharp decline in FSAP-related ROSCs—the average number of standards assessments conducted during FSAP missions dropped from about four in 2000–2004 to about one in 2008 and 2009).

### External funding and technical assistance
- Pledges to the AML/CFT TTF of $25.2 million have permitted the Fund to finance five years of AML/CFT technical assistance and have resulted in an increase in the relative proportion and the absolute level of resources devoted to technical assistance.

### Uncertainty of resource implications for proposed changes
- The resource implications of a move to risk-based AML/CFT ROSCs cannot be fully assessed without agreement on the precise features of such a framework with the broader AML/CFT community and determining the number of assessments that can be carried out within a given resource envelope.
- If agreement were reached with FATF and other stakeholders on a system of targeted, risk-focused AML/CFT ROSCs, staff would return to the Board with a specific proposal that would include an assessment of the resource implications.
- Dropping the current requirement that all FSAP/FSAP updates incorporate an AML/CFT component might yield some resource savings, but these would likely not be substantial because the majority of such assessments are conducted by outside assessor bodies and staff would still need to scope risks in advance.
- Efforts to better integrate AML/CFT in modular financial stability assessments and Article IV surveillance would have resource implications, including additional preparatory work and possible demand to create and maintain a statistical database to support more robust assessments of risk and effectiveness.
- Staff does not expect the outlined approach to lead to a significant increase in coverage of AML/CFT issues in modular stability assessments or Article IV surveillance and would exploit synergies between assessment, technical assistance and research work.

### Operational approach and contingencies
- Staff would systematically monitor country conditions and provide briefings and data to relevant country teams, usually in the context of pre-mission briefings, relying on existing AML/CFT experts in the Legal Department‘s Financial Integrity Group.
- If staff appear unable to provide sufficient support for the Fund‘s AML/CFT program, staff would revisit the resource implications of the revised program either through the budget process or through an update to the Executive Board.
- To conduct risk analysis and better measure effectiveness of AML/CFT systems would require economic and financial statistics and criminal justice statistics; Fund staff would work on creating such a database and seek synergies to avoid duplication.

### Issues for Discussion (questions posed to Directors)
- Do Directors agree that the Fund and Bank should explore further the modalities for conducting targeted, risk-focused AML/CFT assessments with the FATF and other assessor bodies and return to the Board within two years for a report on the status of these discussions?
- As regards the relationship between AML/CFT assessments and FSAPs and FSAP updates, which option would Directors favor going forward?
- Do Directors agree with the framework outlined above for assessing the systemic risks of AML/CFT issues? Does it provide a useful basis for deciding on how these issues should be integrated into modular financial stability assessments and bilateral surveillance under Article IV?

---

### ANNEX 1. JURISDICTIONS’ COMPLIANCE WITH THE AML/CFT STANDARD

- The international standard (FATF 40+9) assesses conformity and effective implementation across over 285 essential criteria; a team of 4–5 assessors typically takes two weeks on-site.
- Ratings use a four point scale: noncompliant (NC), partially compliant (PC), largely compliant (LC), compliant (C); compliant is given only if all essential criteria are fully met.
- For the 161 countries assessed using the current methodology from 2004 to 2011:
  - A scale where a score of 49 represents full compliance was used.
  - The average compliance score was 20.8 or 42.5 percent.
  - Full compliance on any FATF Recommendation occurred in 12.3 percent of the almost 7,889 observations.
  - Countries achieved "largely compliant" 25.5 percent of the time, "partially compliant" 35.6 percent of the time, and "noncompliant" 24.9 percent of the time.
  - Not Available occurs 1.59 percent of the time.
- Time-in-place effects and variation by subject:
  - The degree of compliance for the 40 AML Recommendations was 45 percent.
  - The degree of compliance for the 9 Special Recommendations on CFT was 31.5 percent.
  - Recommendations for designated nonfinancial businesses and professions (subject to the standard only in 2003) averaged only 12.1 percent of the theoretical maximum.
- Functionality versus legislation:
  - Criminalization of ML and TF: degree of compliance 45.1 percent.
  - Broader measure of legal system strength: 41.4 percent.
  - Strength of AML/CFT institutions (FIU, specialized supervisory bodies, police, judiciary): 50.6 percent.
  - Preventive measures in financial institutions: 40.1 percent.
  - Recommendation 5 (customer due diligence measures in financial institutions): 22.1 percent of the theoretical maximum.
- International cooperation and transparency:
  - Compliance on applicable Recommendations for international cooperation: 56.3 percent.
  - Compliance on transparency of legal persons and arrangements: 40.1 percent.
- Empirical relationships from econometric analysis:
  - Advanced economies (46 in sample): degree of compliance 56.8 percent.
  - Emerging economies (115 in sample): degree of compliance 37 percent.
  - GDP per capita (PPP) is a significant explanatory variable of compliance (positive sign).
  - M2/GDP was not statistically significant.
  - Stronger domestic governance (better regulatory quality, lower corruption) is associated with higher compliance.
  - Jurisdictions with high net interest margins show lesser overall compliance; an increase in net interest margin is estimated to have a negative and statistically significant impact on compliance.
  - Compliance levels do not correlate with a country’s involvement in the global drug economy (UNODC index); high or low compliance countries are randomly distributed over the UNODC index.
- Research and future metrics:
  - Fund staff has been working with FATF to analyze ML and TF risks based on threat, vulnerability, and consequence.
  - Future research should develop broader metrics for ML/TF risk and criminal activity and better methods of capturing and presenting cross-border flows.
- Prioritization insight:
  - Analysis shows that smaller, less-connected financial systems are generally less compliant.
  - The negative relationship between compliance and systemic importance can identify relatively large and interconnected financial systems that are also vulnerable to money laundering based on low compliance—useful for prioritizing TA and surveillance.

*Source: Excerpts from the IMF document provided.*

### 11.      These pictures, therefore, contribute to the Fund‘s analysis of risk, although, of

### 11.      These pictures, therefore, contribute to the Fund‘s analysis of risk, although, of course, they are only a point of departure.

### Limitations of compliance-based risk analysis
- Compliance scores and simple ratings are a point of departure but do not provide a complete proxy for systemic vulnerability: "A more complete analysis would require both a better proxy for systemic vulnerability than can be provided by compliance scores and other variables which add to the threat dimension."
- Work remains to be done on:
  - testing the relationship of compliance to ML/TF risks; and
  - measuring the effectiveness of AML/CFT regimes.
- Continued refinements could yield "a more nuanced understanding of where the ML/TF-related threats to the international financial system lie than can be derived from simple comparisons of countries‘ ratings on their AML/CFT assessments."
- Caveats on proxies:
  - "UNODC‘s index of contribution to the global drug problem is a proxy for proceeds of crime related to drugs only. However, this proxy does not account for other crimes and the financing of terrorism as well as the international dimension of ML/TF."
  - "one would need to account for the possibility that participation in the drug economy may be independent of vulnerability to laundering activity because laundering may often take place in jurisdictions other than those that produce or consume large quantities of drugs."

### Measurement and methodology (how compliance was quantified)
- Original qualitative ratings used: C („Compliant‟), LC („Largely Compliant‟), PC („Partially Compliant‟), NC („Non-Compliant‟), NA („Not Applicable‟).
- Conversion to quantitative scores applied uniformly:
  - C -> "1"
  - LC -> "0.66"
  - PC -> "0.33"
  - NC -> "0"
  - NA -> "1"
- Components and the FATF Recommendations mapped to cells:
  - Legal measures include: R.1, R.2, R.3, SR.I, SR.II, SR.III.
  - Institutional measures include: R.26, R.27, R.28, R.29, R.30, R.31, R.32.
  - Preventive financial sector measures include: R.4, R.5, R.6, R.7, R.8, R.9, R.10, R.11, R.13, R.14, R.15, R.17, R.18, R.19, R.21, R.22, R.23, R.25, SR.IV, SR.VI, SR.VII.
  - Preventive DNFBPs measures: R.12, R.16, R.24.
  - Measures for preventing abuse of the informal sector: R.20, SR.IX.
  - Entity transparency measures: R.33, R.34, SR.VIII.
  - International cooperation measures: R.35, R.36, R.37, R.38, R.39, R.40, SR.V.
  - AML-specific compliance measured by FATF Recommendations 1 to 40; CFT-specific compliance measured by FATF Special Recommendations I to IX.
- Cell values are sums of converted recommendation scores for the subset (example given for informal sector: R.20 and SR.IX; if both PC -> "0.66"; maximum if both C -> "2").

### Empirical patterns and key table statistics
- Advanced Economies (as presented in Table 1):
  - "Total countries46.0"
  - Example aggregate lines shown in the table (as printed):
    - "No. of Recommendations6.0 7.0 21.0 3.0 2.0 3.0 7.0 40.0 9.0 49.0"
    - "Theoretical Compliance276.0 322.0 966.0 138.0 92.0 138.0 322.0 1840.0 414.0 2254.0"
    - "Real Compliance157.22 217.95 21.73 0.95 8.0 66.6 226.9 1072.1 207.1 1279.2"
    - "Degree of Compliance57.0 67.75 4.0 22.46 3.0 48.27 70.55 8.35 50.0 56.8"
    - "Average Compliance3.4 4.7 11.3 0.7 1.3 1.4 4.9 23.3 4.5 27.8"
- Emerging and Developing Economies (as presented in Table 1):
  - "Total countries115"
  - Example aggregate lines shown in the table (as printed):
    - "No. of Recommendations67 21 32 37 40 94 9"  (table displays recommendation counts across columns)
    - "Theoretical Compliance690 805 2415 34 5230 34580 54600 103556 35" (as printed across the group's columns)
    - "Real Compliance243.33 52.68 39.92 8.08 5.21 126.94 07.6 1833.22 250.3 2083.5" (as printed across the group's columns)
    - "Degree of Compliance35.34 43.83 4.8 8.13 7.03 6.85 0.63 9.92 4.23 7.0" (as printed across the group's columns)
    - "Average Compliance2.1 3.1 7.3 0.2 0.7 1.1 3.5 15.9 2.2 18.1"
- Figures presented in the annex explore relationships between:
  - jurisdictions' size and interconnectedness (ranking of jurisdictions with systemically important financial sectors, 2008) and
  - jurisdictions' compliance with the full AML/CFT international standard and with the subset of Recommendations on preventing financial institutions from ML/TF (2004–2011).
- Chart notes:
  - Rankings use a 2008 size and interconnectedness dataset; rankings "might change over time (Staff used 2008 data for the paper) when data on size and interconnectedness are updated and/or methodology gets revisited."
  - Certain jurisdictions identified by ICRG are not included in the charts due to absence of an assessment during 2004–2011 (Angola, The Democratic Popular Republic of Korea, Ethiopia, Iran, Kenya, Sao Tome and Principe, Turkmenistan).

### Technical assistance on AML/CFT (TA Record: FY2006–FY2011)
- Role: "Technical assistance (TA) represents one of the main pillars of the Fund’s AML/CFT program."
- Scope of Fund TA: advice on AML/CFT strategy and coordination; drafting legislation and regulations; establishment and operation of financial intelligence units (FIUs); development of specialized AML/CFT supervisory units, manuals, and procedures; advancing countries' understanding of money laundering risk to better allocate scarce resources.
- Activity and inputs (May 2007–April 2011):
  - "staff delivered direct TA to 69 countries, requiring 796 missions as well as direct advice from headquarters."
  - "staff delivered 73 regional workshops over the same period, reaching 2,468 country officials."
  - "The Fund‘s AML/CFT capacity-building activities during this period required 85.19 person years."
- Results and examples of TA contributions:
  - Drafting assistance led to adoption of new or revised AML/CFT frameworks in multiple jurisdictions including: Cambodia, Lao PDR, Mongolia, Guinea, Lesotho, The Gambia, China, Syria, Iran, Mauritania, Mauritius, Moldova, the Kyrgyz Republic, Turkmenistan, and the West Bank and Gaza.
  - TA helped establish FIUs in Nigeria and Mauritius that subsequently obtained membership in the Egmont Group of FIUs; "The Kyrgyz Republic, Seychelles, and Bangladesh are currently seeking Egmont Group membership following receipt of Fund TA."
  - Major bilateral and regional projects in Central America and the Eastern Caribbean on risk-based approaches to supervision are "resulting in harmonized and cost-effective AML/CFT approaches throughout the region."
  - TA programs helped develop and improve AML/CFT on-site inspection procedures for banks and regulators in: Albania, Armenia, Kosovo, Georgia, Kyrgyz Republic, Moldova, Macao SAR, Argentina.
  - Pre-assessment TA helped familiarize countries with the FATF AML/CFT standard and raised policy-level engagement in Mexico, China, Djibouti, Vietnam, Paraguay.
  - Post-assessment TA addressed weaknesses highlighted in assessments in Belarus, Cape Verde, Mauritius, Mexico, Mongolia, Uruguay, Thailand.

*Source: Staff calculations and annexed text from the provided IMF content unit.*

### 4.      Since 2006, the Fund’s AML/CFT TA delivery has evolved from an orientation

### Since 2006, the Fund’s AML/CFT TA delivery has evolved from an orientation around stand-alone, mission-based interventions financed mainly by internal resources towards medium-term, results-oriented, externally-financed projects

### Evolution of TA delivery and modalities
- Since 2006, delivery shifted from stand-alone, mission-based interventions financed mainly by internal resources towards medium-term, results-oriented, externally-financed projects.
- Staff trained 2,468 country officials across all regions during the reported period.
- The Fund’s AML/CFT TA has evolved away from regional workshops in favor of bilateral delivery.
  - Regional workshops remain useful for issues of common concern at relatively low cost and continue to be in demand.
  - Effectiveness of regional workshops is often difficult to measure; several external donors have expressed a preference for longer-term bilateral TA.
  - Staff will continue to use regional workshops judiciously, especially to address emerging issues of common concern.

### External financing and institutional drivers
- Increased reliance on external financing has driven the shift in emphasis from internally financed missions to externally financed, longer-term projects.
- In FY2007, approximately 10 percent of the AML/CFT TA program was financed through external sources.
- In FY2011, external financing covered approximately 90 percent of the Fund‘s AML/CFT TA.
- The shift occurred in the context of the FY2008 institution-wide comprehensive reform and downsizing exercise.

### AML/CFT Topical Trust Fund (TTF) role and governance
- The largest portion of external resources is channeled through the multi-donor AML/CFT Topical Trust Fund (TTF).
- Purposes and advantages of the AML/CFT TTF:
  - Enables cost efficiencies.
  - Increases accountability and transparency.
  - Improves donor coordination.
  - Allows strategic and prioritized use of resources.
  - Ensures sustainability through a longer-term program.
- TTF governance and delivery:
  - Work program delivered under strategic guidance of a Steering Committee composed of donor representatives and Fund staff, with participation by other AML/CFT TA providers as needed.
  - The Steering Committee meets annually to set policies and priorities, endorse annual work and financial plans, and review progress and performance.

### Other external financing arrangements
- Fund staff continued to deliver AML/CFT TA financed by sources outside the TTF for projects that do not meet TTF selection criteria.
- Examples of other funding instruments mentioned:
  - Iraq Subaccount
  - Canada, the Netherlands, Italy and Libya subaccounts
  - Reimbursement agreement with Qatar (Qatar has been funding TA for its own national agencies through its subaccount)
- TTF selection priorities (as described) include: (i) level of economic development, (ii) institutional weaknesses and capacity needs, (iii) risk exposure to ML and TF, and (iv) long-term commitment to improvements. Contributors to the TTF and FATF member countries are disqualified.

### External contributions for AML/CFT TA (FY2006–FY2011)
- Contributions pledged and received (as reported):
  - AML/CFT TTF: Contributions pledged $25,274,610; Contributions received $15,940,265
  - Canada Subaccount: Contributions pledged $1,152,374; Contributions received $1,203,768 (Includes interest earned.)
  - Qatar Reimbursement Agreement: Contributions pledged $968,876; Contributions received $0 (Fund will submit invoice to recipient to recover actual costs at the project‘s conclusion in July 2012.)
  - Italy Subaccount: Contributions pledged $455,256; Contributions received $455,256
  - The Netherlands Subaccount: Contributions pledged $432,701; Contributions received $469,849 (Includes interest earned.)
  - Libya Subaccount: Contributions pledged $313,617; Contributions received $313,617
  - Iraq Subaccount: Contributions pledged $63,736; Contributions received $63,736
  - Total: Contributions pledged $28,661,170; Contributions received $18,446,491
- Source for contributions: Technical Assistance Information Management System (April 16, 2011)

### Results-Based Management (RBM) orientation
- The Fund’s AML/CFT TA program has reflected the Fund’s broader shift towards an improved results-based management system (RBM).
- RBM purpose and features:
  - Enable the Fund to monitor and evaluate TA achievements more effectively.
  - Set priorities for resource allocation through information on results.
  - Focus on outcomes (e.g., laws enacted, systems improved, capacity increased) and outputs (e.g., laws drafted; strategies articulated and adopted; supervision manuals completed, adopted; training conducted) rather than inputs (e.g., missions, STX weeks, seminars delivered).
- Elements already in place for AML/CFT TTF:
  - An overarching logical framework detailing outcomes foreseen at module level within a recipient country.
  - Each country-specific module is designed using the IMF‘s TAIMS system, with reports on progress at project objectives and outcome levels.

### TTF-Financed Technical Assistance Projects by Module (FY2011) — key modules and outcomes
- Diagnostic Module:
  - Purpose: Delivers needs assessment reports identifying strengths and weaknesses in legal, regulatory, and institutional AML/CFT frameworks.
  - Key Outcomes: Identification of key strengths and weaknesses; agreement on action plan for further customized TA.
  - Recipient Countries: Costa Rica, Côte d’Ivoire, Georgia, Morocco, Nigeria.
- National Strategy Module:
  - Purpose: Specialist advice on AML/CFT strategies, coordination and policy issues, including application to banks, insurance, securities, lawyers and DNFBPs.
  - Selected Recipient Countries and Key Outcomes:
    - Armenia: Implementation of a risk-based strategic approach to AML/CFT.
    - Georgia: AML/CFT Working Group established to design the National Strategy and boost domestic coordination.
    - Nepal: Strengthened cooperation domestically and internationally; enhanced AML/CFT legal, institutional and supervisory framework; implementation of a risk-based strategic approach.
    - Peru: Coordination in line with a national AML/CFT strategy based on system-wide assessment of ML and TF threats and vulnerabilities.
    - Thailand: Development and adoption of a National Strategy with stakeholder buy-in.
    - Uruguay: National risk-based AML/CFT strategy document and strengthened stakeholder cooperation domestically and internationally.
- Legislative Drafting Module:
  - Purpose: Advice and assistance in drafting customized AML/CFT laws, regulations and guidelines.
  - Key Outcomes: AML/CFT legislation and/or regulations reformed in line with international standards.
  - Recipient Countries: Armenia, Azerbaijan, China, Georgia, Iran, Mauritius, Morocco, Thailand, Vietnam, West Bank/Gaza.
- Structures and Tools Module:
  - Purpose: Legal and operational advice for formation and development of Financial Intelligence Units (FIUs), enhancement of supervisory oversight, development of specialized AML/CFT supervisory units, manuals and procedures, and training of supervisors.
  - Selected Recipient Countries and Key Outcomes:
    - Armenia: Increased effectiveness of AML/CFT supervisory system and enhanced financial investigations.
    - Azerbaijan: Enhanced capacity of FIU to carry out core financial intelligence functions; increased effectiveness of AML/CFT supervisory system.
    - Chile: Risk-based AML/CFT strategies and procedures adopted for supervision of financial sector and DNFBPs.
    - China: Efficient functioning of key national AML/CFT agencies; improved compliance and enforcement.
    - Costa Rica: Enhanced institutional capacity to enforce AML/CFT supervisory regime; improved compliance by regulated entities.
    - Croatia: Progress towards effective implementation of risk-based AML/CFT measures for DNFBPs.
    - Ghana: Enhanced institutional capacity; new supervisory regulations and guidelines consistent with international standards adopted and implemented.
    - Indonesia: Enhanced institutional capacity; creation of institutions to oversee operation of Nonprofit Organizations.
    - Malaysia: Capacity development in asset management organizations and training on asset forfeiture matters.
    - Mauritius: Enhanced institutional capacity to enforce AML/CFT supervisory regime.
    - Mexico: Efficient functioning of key AML/CFT agencies; improved compliance and enforcement; periodic reporting by national AML/CFT institutions.
    - Oman: Enhanced FIU capacity to carry out core financial intelligence functions.
    - Peru: Enhanced institutional capacity; improved compliance by regulated entities.
    - Thailand: Enhanced institutional capacity to implement AML/CFT regime based on national strategy priorities.
    - Ukraine: Enhanced capacity to enforce AML/CFT supervisory regime; improved effectiveness of financial crime investigations through better FIU and law enforcement cooperation.
    - Vietnam: Enhanced AML/CFT supervision by banking supervisors; development of subsidiary legislation and ‘train the trainer’ manual.

### Fund staff approach to National ML/TF Risk Assessment (NRA)
- Objective and rationale:
  - Staff is developing a framework to assess money laundering (ML) and terrorism financing (TF) risks.
  - A risk-based approach aligns with FATF standards but is challenging due to the hidden, multifaceted nature of ML and TF processes and differing stakeholder perspectives.
  - Purposes of applying risk-management concepts from the Fund’s perspective:
    - Focus limited resources on countries posing or facing substantial ML/TF risks.
    - Identify particularly significant vulnerabilities in financial, legal and institutional frameworks.
    - Through TA, help member countries understand, assess, and mitigate ML/TF risks.
    - Help international community articulate purposes of AML/CFT regimes and assess effectiveness of AML/CFT controls.
  - Acknowledged limitations: reliance on imperfect proxies and estimates that may involve very wide ranges.
- Generic objective:
  - Minimize the amount of ML or TF that occurs.
  - Fund staff believes ML that matters most is typically related to larger-scale criminal activities; the framework focuses on substantial ML occurring successfully.
  - For TF, potentially all successful TF abuse matters for risk management.
- ML and TF process characteristics:
  - ML: Transforms illegal inputs (proceeds of crime) into legitimate-appearing outputs; may involve abuse of a wide range of instrumentalities including banks, securities, insurance, money transfer agents, professional advisers, casinos, dealers in high-value assets, and other businesses.
  - TF: Involves raising and processing funds for terrorist activity; can stem from legal and illicit sources and abuses many of the same instrumentalities as ML.
- Risk assessment core components:
  - Risk defined as a function of likelihood and consequence, where likelihood depends on threat and vulnerability.
  - Formal representation: R = f [(T), (V)] x C, where T = threat, V = vulnerability, and C = consequence.
  - Risk can be mitigated by reducing threats, vulnerabilities, or their consequences.
  - The framework focuses on the risk of substantial, successful occurrences of ML or TF; substantial ML can be a single transaction or a series of transactions over a 12-month period that allow substantial amounts to be laundered.

*Source: IMF staff paper excerpt (pages provided).*

### 9.       In ML, a ―threat‖ is largely related to the nature and scale of the potential

### _051111pdf - 9.       In ML, a ―threat‖ is largely related to the nature and scale of the potential

### Threat: definition and components
- In ML, a "threat" is largely related to the nature and scale of the potential demand for ML, i.e., the pool of illegally-acquired assets that need to be laundered.
- ML threat assessment requires understanding and generating indicators for the proceeds of crime (POC) that are generated in or brought to a jurisdiction.
- For TF risk assessment, threat is mainly related to the nature and scale of the funds raised for use by terrorists that are in a jurisdiction in need of processing.
- Two components determine the POC that need to be laundered in any jurisdiction:
  - (i) the nature and types of domestic predicate crime that exist and the scale of proceeds that they generate;
  - (ii) the nature and scale of proceeds generated outside of the jurisdiction that are likely to enter the jurisdiction for laundering.
- Two parallel components for TF:
  - domestic fundraising efforts and the funds they generate;
  - funds raised outside the jurisdiction likely to enter for processing or use.
- Any transfer of domestic POC out of the jurisdiction is considered to be an ML transaction, so the full amount of domestic POC is considered to be potentially launderable.
- Pilot tests suggested a substantial ML amount in absolute terms might be at least $100 million annually for a given jurisdiction.
- An absolute amount of $10 million annually is suggested as an indicator of substantial TF activity.

### Vulnerability: scope and indicators
- "Vulnerability" encompasses products, services, distribution channels, customer bases, institutions, systems, structures, and jurisdictions (including weaknesses in systems, controls, or measures) that enable ML or TF abuse.
- Vulnerability assessment involves generating indicators across areas associated with successful ML or TF; common categories include:
  - geographic location;
  - financial services and products;
  - levels of informality in various sectors;
  - weaknesses in the AML/CFT systems and the adequacy of existing AML/CFT controls;
  - general levels of corruption;
  - effectiveness of law enforcement agencies (LEAs) and the criminal justice system (CJS);
  - other jurisdictional characteristics that could facilitate ML or TF.
- Vulnerability indicators are aggregated with threat indicators to produce an overall analysis of the likelihood of substantial ML or TF occurring successfully.

### Consequences: types and relevance
- "Consequences" relate to outcomes from risk events and can concern cost, damage, or significance of outcomes.
- Two types of consequence from ML/TF:
  - those associated with laundering itself (e.g., short-term distortion of demand for products, services, or assets);
  - those associated with the use of assets after successful laundering (broader, longer-term social, economic, and political consequences).
- Consequences may encourage further criminal activity and further laundering.
- Literature elaborates 25 categories of social, economic, and political consequences of ML (Box 1). The 25 categories are:
  1) Losses to the victims and gains to the perpetrator
  2) Distortion of consumption
  3) Distortion of investment and savings
  4) Artificial increases in prices
  5) Unfair competition
  6) Changes in imports and exports
  7) Effects on growth rates
  8) Effects on output, income, and employment
  9) Lowers public sector revenues
  10) Threatens privatization
  11) Changes in demand for money, exchange rates, and interest rates
  12) Increases in exchange- and interest-rate volatility
  13) Greater availability of credit
  14) Higher capital inflows and outflows
  15) Changes in FDI
  16) Risks for financial sector solvency and liquidity
  17) Effects on financial sector profits
  18) Effects on financial sector reputation
  19) Illegal business contaminates legal
  20) Distorts economic statistics
  21) Corruption and bribery
  22) Increases in crime
  23) Undermines political institutions
  24) Undermines foreign policy goals
  25) Increases terrorism
- The relevance of any consequence depends on the objectives of the risk-management exercise; four illustrative objectives include:
  - minimizing potential of substantial ML/TF being carried out without detection or sanction (focus on volume/value of laundered assets relative to GDP or financial sector assets);
  - protecting financial stability (distorting impact, reputational damage);
  - protecting the international financial system (volatility or spill-over into other economies);
  - protecting society from harm (nature and scale of social consequences resulting from facilitated criminal activity).
- For the ROSC program, staff intend to focus on minimizing the amount of ML or TF that occurs successfully (the first objective above).

### Scoring ML and TF risk: framework and indicators
- A semi-qualitative risk scoring system focuses on key risk events in the ML/TF process and disaggregates the process into contributing events.
- Scores are generated for objective (quantitative) and subjective (qualitative) indicators that suggest levels of threats, vulnerabilities, and consequences related to drivers and enablers.
- Indicators are drawn from public sources where possible; otherwise, non-public data or generated data (e.g., surveys) are used.
- The scoring approach produces two proxy variables:
  - one for the likelihood of substantial ML or of TF occurring;
  - one for consequences.
- These proxies are combined to measure the national level of ML or TF risk.
- The indicators used are suggestive of likelihood, not perfectly representative.
- The framework initially uses what might be considered first-generation indicators of mainly ML and, to a lesser extent, TF risk.

### Aggregation and scoring mechanics
- Higher scores indicate higher likelihood that substantial ML abuse will occur and/or that consequences will be more severe.
- Scores across indicators are aggregated by deriving the geometric mean for all indicators within a nested hierarchy.
- Aggregation proceeds upward to sub-factor, factor, module, and overall likelihood using the n-th root equation, n√A, where n is the number of indicators, factors, or risk events, and A is their product.
- Reasons for using the geometric mean:
  - maintains appropriate relationships between modules and factors;
  - smoothes outlying indicator scores, desirable given many indicators are still being tested;
  - results always fall on the seven-point scale.
- Aggregation example for overall likelihood uses the structure: [(A,B1),(C,D,E),(F,G)],H [(B2,((I,J,K,L,M),N)),(B3,(O,P,Q1)),R1,R2], [(R3,R4),(R5,Q2,B3)].
- For modules broken down by institution types, there is an intermediate step to aggregate scores in proportion to the scale of activity within each type.
- The latest available data is used; multi-year databases use the same base year where possible. Financial data is inflation adjusted to a consistent base year using CPI data from IMF's International Financial Statistics (IFS) database. Values are converted to US dollars (US$) using period average annual exchange rates (for the appropriate base year) from the IFS. Ratios (e.g., expenditures to GDP) do not require conversion to US$ if both variables share units.

### Combining likelihood and consequences; risk presentation
- Proxy indicators for consequence are derived largely from perceptions of informed officials via a structured approach, using pre-determined decision-making criteria and measurement scales.
- Officials are informed of likelihood analysis results and given information about potential impact, then asked to judge the level of ML or TF consequences for objectives of interest.
- Overall national ML or TF risk is derived by combining the jurisdiction's ML likelihood and consequences proxy scores; two combination methods:
  - i. Geometric mean of the two proxy scores yields a one-dimensional score comparable against the pre-determined scale in Table 1.
    - Table 1. Risk level scores
      -  6-7 — Extremely higher risk — Urgent priority
      -  5-6 — Much higher risk — Much higher priority
      -  4-5 — Higher risk — Higher priority
      -  3-4 — Higher medium risk — Higher medium priority
      -  2-3 — Lower medium risk — Lower medium priority
      -  1-2 — Lower risk — Lower priority
      -  0-1 — Much lower risk — Much lower priority
  - ii. Combine via the pre-determined matrix in Table 2 (effectively multiplied) to identify relative contributions of likelihood and consequences.
    - Table 2 (Level of ML or TF Risk Matrix) positions Consequence Level (Negligible to Huge or severe) against Likelihood level to produce qualitative categories: Much Lower Risk, Lower Risk, Lower Medium Risk, Higher Medium Risk, Higher Risk, Much Higher Risk, Extremely Higher Risk.
- The framework allows presenting risk as matrices or graphs plotting likelihood against consequences or vice versa, and measuring some consequences against absolute scales and against GDP.

### Implementation and benefits
- Implementing the framework involves collecting objective and subjective data and scoring within analysis modules on a seven-point ordinal scale using pre-determined decision-making criteria.
- In the technical assistance context, disaggregated ML/TF process analysis provides granularity to identify where risk mitigation is most needed.
- Conducting an NRA assists authorities to understand ML and TF risks, provides a framework for response, and fosters inter-agency cooperation and dialogue among stakeholders.

### Conclusion (summary)
- The Fund staff's framework for national ML/TF risk assessments:
  - defines ML and TF risk through contextual definitions of threats, vulnerabilities, and consequences;
  - deconstructs ML/TF processes to focus on key risk events;
  - analyzes drivers and enablers via indicators across risk analysis modules to produce a proxy for likelihood of substantial ML/TF occurring successfully;
  - combines the likelihood proxy with a consequences proxy to produce national ML/TF risk levels;
  - uses objective and subjective data, pre-determined decision-making criteria, and a seven-point ordinal scoring scale.

*Source: _051111pdf - 9.       In ML, a ―threat‖ is largely related to the nature and scale of the potential*

### 24.      The framework will continue to evolve through its application in the context of

### _051111pdf - 24.      The framework will continue to evolve through its application in the context of

### Evolution and application of the framework
- The framework will continue to evolve through its application in the context of technical assistance, assessments, and surveillance.
- To date, the framework has been tested mainly in assisting members to conduct national risk assessments and has been informed by FATF discussions concerning risk-based approaches to AML/CFT controls.
- Staff interest going forward:
  - Validating and refining indicators and decision-making criteria.
  - Defining interrelationships among indicators.
- Expected outcome over time:
  - Help member countries focus scarce AML/CFT resources on risk-mitigation initiatives where there is the most to gain.

### ML Risk Analysis Framework — Risk events and analysis modules (Table 3)
- Risk events are framed as stages in the ML process with contributing risk events (threats (t) or vulnerabilities (v)) and modules of risk factors to analyze.

- Risk event (1): ML or TF activity will be attempted
  - (1a) Domestic proceeds being generated or available.
    - (t) Presence of domestic proceeds.
    - (A) Amount of domestic proceeds generated or available.
    - (a) Crime type; Cash, financial, and physical assets; Organized and other crime.
    - (v) Inadequate suppression of domestic predicate crime.
    - (B1) LEA (general efforts to suppress crime) — Powers, Resources, Effectiveness.
  - (1b) Foreign proceeds entering the jurisdiction.
    - (t) Presence of foreign proceeds.
    - (C) Amount of foreign proceeds entering the jurisdiction.
    - (a) Jurisdiction of origin, and same factors as for domestic POC.
    - (v) Existence of cross-border products, services, assets, and circumstances that can be abused to meet ML‘s importing and exporting needs.
    - (D) Cross-border products, services, assets, circumstances.
    - (v) Cross-border scrutiny does not suppress cross-border ML activity.
    - (E) Border security measures and scrutiny. — Currency, Financial transactions, Physical assets, People.
  - (1c) Abuse of jurisdiction’s products, services, assets, or other circumstances for ML activity
    - (v) Jurisdiction and its institutions providing goods, services, assets, and other circumstances that can be abused to meet the ML‘s needs.
    - (F) General jurisdiction environment — Economy, Legal system & rule of law, Business environment & Regulatory quality, Political environment, Culture & integrity, AML/CFT commitment.
    - (G) Products, services, assets, and circumstances offered — Sectors, Institution types, Scale, Customer base, Delivery channels, General mitigants.
  - (1d) Corruption to facilitate ML occurring
    - (v) Corruption in LEA, cross-border scrutiny, institutions.
    - (H1) Corruption.

- Risk event (2): If attempted, perpetrators will not be caught
  - (2a) ML activity not being detected by the authorities
    - (v) LEAs do not detect ML activity directly; LEAs only investigate predicate crime; LEAs not told of foreign enquiries or don’t treat as ML leads.
    - (I)[O] STR Reporting system — Requirements, Volumes, Quality; Sectors, Institution type.
    - (J) Transaction & Account Monitoring — Requirements, Effectiveness.
    - (K) Customer Identification, profiling, ongoing and enhanced due diligence — Requirements, Effectiveness.
    - (L) Capacity and competence of institutions — Systems & controls, Resources, Guidance received.
    - (M) Supervision — Effectiveness when deficiencies identified.
    - (N) FIU — Effectiveness of analysis, dissemination.
  - (2b) If detected, ML activity not being investigated adequately
    - (B3) LEA (specific efforts to suppress ML) — Effectiveness of investigations.
    - (O) Record-keeping — Requirements, effectiveness, secrecy.
    - (P) Transparency of ownership — Entity and asset types, Register requirements, powers to obtain information.
    - (Q1) Cross-border cooperation — Effectiveness of administrative cooperation, MLA, and extradition to obtain evidence and people.
  - (2c) If investigated, perpetrators not being prosecuted
    - (R1) CJS (Prosecution & Judiciary) — Prosecution and convictions, ML & predicate crimes; CJS priorities, constitution, law, & jurisprudence.
    - (v) Perpetrators outside jurisdiction; inability to extradite; prosecutor not pursuing ML charge; prosecutor not pursuing any charge; inefficient or ineffective CJS or court system.
  - (2d) If prosecuted, perpetrators not being convicted
    - (R2) CJS (Laws) — Adequacy of laws.
    - (v) Ineffective prosecution; incompetent judiciary; inadequate wording of criminal laws.
  - (2e) Corruption to facilitate ML occurring
    - (H2) Corruption — Corruption in LEAs, FIU, CJS, institutions and authorities supervising or monitoring institutions.

- Risk event (3): Once caught, perpetrators are not sanctioned adequately
  - (3a) Convicted perpetrators not punished adequately
    - (v) Inadequate fines being collected; ineffective systems for collecting fines.
    - (R3) CJS (Sanctioning) — Amount and average of fines collected.
    - (R4) CJS (Laws, Policy, Jurisprudence, Prosecution & Judiciary) — Powers, Sanctions imposed.
    - (v) Inadequate prison terms being served or imposed; ineffective prison system.
    - (R3) CJS (Sanctioning) — Length and average of prison terms served.
  - (3b) Convicted perpetrators not being deprived of their assets
    - (R5) CJS (Asset confiscation) — Powers, Policy, Sanctions imposed, Effectiveness focus on assets confiscated.
    - (v) Inadequate recovery of assets; inadequate resources devoted to asset recovery; inability to recover assets from foreign jurisdictions.
    - (Q2) Cross-border cooperation — Effectiveness of administrative cooperation, and MLA to recover assets.
    - (B3) LEA — specific aspects of ML — Assets seized or frozen.
  - (3c) Corruption to facilitate ML occurring
    - (H3) Corruption — Corruption within the authorities.

- Notes (selected exact excerpts)
  - (a) "The approach advocated is to identify all proceeds generating offenses even if laundering those proceeds is not a domestic criminal offense. It is unlikely that a figure for proceeds entering the jurisdiction can be estimated accurately."
  - (b) Emphasis on and success for proceeds generating crimes (i.e., powers, resources, and reported crime clearance rates).
  - (c) All modules that look at AML/CFT agencies look at each agency‘s powers, resources, and effectiveness (output and performance).
  - (d) Cross border products and services may also be of potential use to domestic launderers who wish to export some or all of their proceeds.
  - (e) This module analyzes and scores factors that differentiate cross-border ML activity from domestic ML activity.
  - (f) "The first prototype of this module mainly identifies the existence of higher risk products and services and their use."
  - (g) "Corruption influences all of the ML process, giving launderers the potential to override all controls."
  - (j) "Mutual Legal Assistance"
  - (k) "For ML and predicate crimes. Sanctions may be less critical than the chance of being caught, and incarcerating members of criminal groups without confiscating assets may lead to higher levels of organized crime and corruption (See Eide, 2000, and Buscaglia, 2008)."

### Indicator scoring examples and scales (Tables 4–7)
- Table 4 — Examples of scoring for indicators linked to intrinsic properties or products, services, jurisdiction, etc.
  - Likelihood descriptor → Measurement scale for economic activity → Likelihood of an event or activity occurring annually — descriptor → Likelihood as potential probability? → Likelihood as indicative frequency → Indicator score
  - Examples (exact rows preserved):
    - Extremely higher likelihood | 1t+ Extremely sophisticated range and volume | Almost certain | More than 95% chance | At least once per year | 7
    - Much higher likelihood | 100b-1t Extensive range and volume | Very likely | More than 75% chance | Occurs at least once every two years | 6
    - Higher likelihood | 10b-100b Attractive range and volume | Likely | More than 50% chance | Occurs at least 3 every 4 years | 5
    - Higher medium likelihood | 1b-10b Normal range and volume | Possible | More than 30% chance | Occurs around once every 3 years | 4
    - Lower medium likelihood | 100m-1b Not particularly attractive range or volume | Unlikely | Less than 30% chance | Might occur once every 5 years or so | 3
    - Much lower likelihood | 10m-100m Very limited range or volume | Rare | Less than 10% chance | Might occur once every ten years | 2
    - Very much lower | 0-10m Almost none | Almost incredible | Less than 5% chance | Might occur less than once every twenty years | 1

- Table 5 — Examples of scoring for indicators linked to general controls or mitigants
  - Likelihood descriptor → Mitigant implemented across: Ability of non-residents to do something; Police officers per 100,000 of population; Indicator score
  - Examples (exact rows preserved):
    - Very much higher likelihood | < 10% of business activity or no requirements | Unlimited plus – may have special privileges | < 30 | 7
    - Much higher likelihood | ≥ 10- 25% of business activity | Unlimited – at least same ability as residents | ≥ 30 | 6
    - Higher likelihood | ≥ 25-50% of business activity | Almost unlimited – but with some additional administrative requirements | ≥ 62.5 | 5
    - Higher medium likelihood | ≥ 50-70% of business activity | Limited – with some minor limitations and conditions | ≥ 125 | 4
    - Lower medium likelihood | ≥ 70-85% of business activity | Very limited –usually requiring official approval or authorization | ≥ 250 | 3
    - Much lower likelihood | ≥ 85-95% of business activity | Extremely limited – some prohibitions, or always requiring official approval or authorization | ≥ 500 | 2
    - Very much lower | ≥ 95% of business activity | Impossible. Effectively prohibited. | ≥ 1,000 | 1

- Table 6 — Examples of scoring for vulnerabilities linked to weaknesses in AML/CFT controls
  - Likelihood Descriptor → Reporting entities per AML/CFT supervisory staff member FTE; For perceptions of performance quality and controls; Annual ML prosecutions per $B of POC (if known) OR GDP; Compliance with FATF Recommendations; Indicator Score
  - Examples (exact rows preserved):
    - Extremely higher | No supervision | Abysmal | None | NC or not scheduled for 2004 methodology assessment | 7
    - Much higher | ≥ 100 | Very poor | < 0.06 | PC + ineffective | 6
    - Higher | ≥ 52 | Poor | ≥ 0.06 | PC + effective or scheduled for its first ever assessment. | 5
    - Higher medium | ≥ 26 | Adequate | ≥ 0.12 | Scheduled for its first 2004 methodology assessment, and has been assessed previously. | 4
    - Lower medium | ≥ 13 | Good | ≥ 0.24 | LC + ineffective | 3
    - Lower | ≥ 6 | Excellent | ≥ 0.48 | LC + effective | 2
    - Much lower | 6 or less | World Best Practice | ≥ 0.96 | C | 1

- Table 7 — Examples of pre-determined scales for scoring consequences
  - Consequence descriptor → Amount of ML or TF activity (estimated ML activity / as % of GDP / estimated TF activity) → Geographic Reach → Effect on a “system” or an “objective” → Indicator score
  - Examples (exact rows preserved):
    - Huge or Severe | Huge value > $100b | > 20% | > $10m | More than one continent OR Global | Very serious, long-term impairment of system functions (destroys or almost destroys system's functionality) OR achievement of the objective | 7
    - Very Major | High value > 50b - $100b | 10 – 19.99% | > 5m - $10m | Regional countries OR within a continent | Serious medium-term effects that begin to impair system functionality (or which destroy or almost destroy an isolated part of the system OR that begin to impair achievement of the objective) | 6
    - Major | Major value > $10b - $50b | 5 – 9.99% | > $1m - $5m | Bordering countries only | Major, medium-term effects with potential to threaten system functions OR achievement of the objective | 5
    - Moderate | Moderate value > $1b - $10b | 2.5 – 4.99% | > $100k - $1m | National | Moderate, short-term effects not affecting system functions OR on achievement of the objective | 4
    - Minor | Medium value > $100m - $1b | 1.25 - 2.49% | > $10k - $100k | Regional (within a country or some provinces or states) | Minor short-term effects on whole system OR on achievement of the objective | 3
    - Very Minor | Low value ≥ $10m - $100m | 0.625 - 1.249% | ≥ $1,000 - $10,000 | Local (within a city) | Minor short-term effects on isolated part of system OR on achievement of part of the objective | 2
    - Negligible | Negligible value < $10m | < 0.625% | < $1,000 | Negligible OR Within suburb, precinct, or small town | No noticeable harm - business as usual. | 1

### Annex 4: Integrating AML/CFT into modular stability assessments and Article IV surveillance (Introduction)
- Purpose:
  - Reviews literature and case studies underpinning policy proposals in Section III.
  - Supports the argument that ML/TF and associated predicate crimes can impact financial sector stability and external stability.
- Key premise:
  - "Money laundering and the financing of terrorism are financial crimes with economic effects."
  - "Money laundering requires, as a sine qua non, an underlying, primary, profit-making crime, along with the intent to conceal the proceeds of the crime or to further the criminal enterprise."
- Economic effect noted:
  - These activities generate financial flows that involve the diversion of resources away from economically- and socially-productive uses—and these diversions can have negative impacts on the financial sector and external stability of member states.

*Content derived from the supplied IMF chapter excerpt.*

### 2.      Relatedly, strong AML/CFT controls and institutions should have a positive impact

### 2.      Relatedly, strong AML/CFT controls and institutions should have a positive impact on economic performance

### Role and rationale of AML/CFT controls
- AML/CFT controls are designed to help ensure that competent authorities can detect, prevent, and suppress profit-motivated crime and terrorism.
- Effective AML/CFT contributes to protecting the integrity of markets and systems, including the financial system, by promoting the rule of law, good governance and the fight against corruption.
- International standards on AML/CFT are intended to ensure universal, collective action, harmonized legislation and regulations, and effective international cooperation.
- Money laundering (ML) and the financing of terrorism (TF) constitute a type of “financial abuse,” and effective AML/CFT implementation can mitigate facilitators of financial abuse such as poor regulatory and supervisory frameworks and weak tax systems.

### Transmission channels from ML/TF to macroeconomic and financial outcomes
- Money laundering could have macroeconomic impacts due to:
  - Policy mistakes due to measurement errors in macroeconomic statistics arising from money laundering;
  - Changes in the demand for money that seem unrelated to measured changes in fundamentals;
  - Volatility in exchange rates and interest rates due to unanticipated cross-border transfers of funds;
  - Other country-specific distributional effects or asset price bubbles due to disposition of “black money;”
  - Development of an unstable liability base and unsound asset structures of individual financial institutions or groups of such institutions, creating risks of systemic crises and, hence, monetary instability;
  - Effects on tax collection and public expenditure allocation due to misreporting and underreporting of income;
  - Misallocation of resources due to distortions in relative asset and commodity prices arising from money laundering activities; and
  - Contamination effects on legal transactions due to the perceived possibility of being associated with crime.
- Financial system abuse can impose welfare losses, compromise bank soundness with potentially large fiscal liabilities, lessen the ability to attract foreign investment, and increase the volatility of international capital flows and exchange rates.

### Evidence, data constraints, and research developments
- Research since the mid-1990s has expanded; the field is less data-poor than before, but significant gaps remain, especially in quantitative analysis due to poor quality and heterogeneity of country data on criminal behaviors and proceeds.
- Staff will continue developing stronger empirical evidence and analytical frameworks recognizing that these relationships remain difficult to map.

### Impact of AML/CFT sanctions, blacklisting, and loss of market access
- AML/CFT-related sanctions and blacklists (e.g., FATF NCCT process, national PATRIOT ACT sanctions) can affect financial sector efficiency and a jurisdiction’s attractiveness to investment.
- When countries or financial institutions are blacklisted or under AML/CFT scrutiny, heightened due diligence requirements impose costs on transactions that can be transmitted across the financial sector and the economy via disinvestment or slowed/reversed investment growth in real and financial sectors.
- Evidence (case studies and empirical work) indicates potential harm from such actions, especially for relatively small financial centers:
  - Liechtenstein: Net income of banks fell from Sw F 549 million to Sw F 251 million between 2000 and 2002; assets under management fell from Sw F 112 billion to Sw F 96 billion; revenues to the government declined from Sw F 64 million to Sw F 27 million.
  - St. Kitts and Nevis: Number of IBCs and trusts declined “from 17, 500 and 3,000 in 1999 to 13,500 and 950, respectively, in 2003,” with negative impacts on government revenues from the offshore financial sector.
  - Vanuatu: NCCT listing led to declines in offshore incorporations and offshore banks, with a decline in government revenues from that sector of 26 percent.
  - Cook Islands: Loss in revenue exceeded 70 percent following NCCT listing.
  - BIS locational banking variables study for 46 jurisdictions produced mixed results; only 14 percent of regressions were statistically significant, but indicated impacts on small island OFCs and on Egypt, Israel, Lebanon, and Russia.
  - Fund-commissioned studies identified nonbank external deposits as the variable most sensitive to listing/delisting events, though results for 196 jurisdictions lack robustness due to data limitations.
- Anecdotal evidence:
  - Senior international bank official in the Caribbean (2011) indicated St. Kitts and Nevis, St. Vincent, and Dominica “are still reeling from the effects” of past blacklisting.
  - Liechtenstein officials described the FATF sanction period as “a real disaster.”
  - Political reactions in jurisdictions under threat of sanctions (Cayman Islands, Isle of Man, Mauritius, Austria) suggest policymakers perceived potential costs of noncompliance as sufficiently high to implement required reforms.
- Conclusion drawn: Sanctions and blacklists are consequential; remaining compliant with international standards is conducive to financial and external stability.

### Capital flows, capital flight, and destabilizing effects
- Volatility of international capital flows is recognized as potentially destabilizing for financial sectors; portfolio investment is usually more volatile than foreign direct investment, and portfolio investment by nonresidents is a source of particular instability.
- Vito Tanzi emphasizes that volatility originating from money laundering is problematic because such flows are driven not by jurisdictional fundamentals but by “differences in controls and regulations which make money laundering a safer activity in some countries than in others,” and criminal flows can significantly influence exchange rates, interest rates, and asset prices (e.g., real estate).
- OECD-sponsored analysis of the Korean economy identified creation of a Financial Intelligence Unit (FIU) as a measure to help prevent “rising short-term capital inflows from posing a threat to the Korean economy.”
- Linkages between capital flight and money laundering documented in an Asian Development Bank study with Russian, Nigerian, Zambian, and Pakistani examples.
  - Russia (1990s): Money laundering techniques (under-invoicing of export earnings, fake advance import payments, bank transfers bypassing controls) were channels of flood of flight capital; UN study found “In the Russian Federation, money laundering is always linked to the problem of capital flight and a subsequent lack of investments.”

### Fraud, financial sector abuse, and country-level crises
- Fraud undermines trust, a foundational element of functioning financial markets; reputational damage weakens financial systems and investor confidence.
- Financial sector fraud can cause large-scale bank insolvencies, large capital outflows, or loss of access to international financial markets.
- Recent large-scale fraud examples with international implications (reported magnitudes):
  - Madoff: $13 to $21 billion
  - ENRON: $30 billion
  - Parmalat: $20 billion
  - WorldCom: $11 billion
  - Stanford: $8 billion
  - Bank of New York: $7.5 billion
- Country cases:
  - Afghanistan (Kabulbank, 2010): If bank failure is found to be caused by fraud or insider dealing, relative to the size of the economy and formal financial sector it could be among the largest criminal bank insolvencies in history; consequences may include hindering development of the formal financial system, reduced donor confidence, potentially large fiscal cost, and complicated asset recovery given governance problems and capacity constraints.
  - Dominican Republic (2003): Bank insiders concealed related-party lending and embezzlement using double accounting. Total direct cost of the bank bailout to three failed commercial banks in 2003 amounted to 21 percent of GDP. Consequences included:
    - Rapid depreciation of the peso by approximately 65 percent (due to loss of confidence) leading to very high inflation (54 percent in 2004) and serious erosion of real incomes.
    - Approximately 1.5 million Dominicans (about 16 percent of the population) fell below the poverty line in the aftermath of the banking crisis, of which 670,000 fell into extreme poverty.
    - Although GDP growth rebounded since 2004, the government and central bank continue to struggle to service the resulting higher debt stock.

*IMF background annex discussing channels linking money laundering, terrorist financing, financial crime, and macro/financial stability outcomes.*

### 15.      Tanzi believed, as did the Fund 2001 Staff paper, that global capital markets

### _051111pdf - 15.      Tanzi believed, as did the Fund 2001 Staff paper, that global capital markets

### Trust, confidence, and regulatory capture
- Tanzi and the Fund 2001 Staff paper: global capital markets depend on trust and confidence; contamination by money controlled by criminal elements would inevitably affect confidence.
- Bankers may attempt to influence regulators and supervisors with offers of jobs or other emoluments and may buy influence with politicians who can affect regulators and supervisors.
- Corruption can hamper the effectiveness of “circuit breakers” and regulatory capture can prevent prompt and effective corrective action following a negative shock.
- Supervisory reluctance to tackle large banks can be driven by political power of some bank owners/managers and organized crime behaviors, including outright physical fear.

### Latvian banking crisis (1995)
- Crisis scope and macro effect:
  - Involved banks represented 40 percent of banking sector assets and 53 percent of household deposits.
  - The crisis led to a 1.6 percent fall in GDP.
- Causes and features:
  - Abuse by insiders in a context of inadequate enforcement of existing prudential regulations.
  - Owners and managers treated banks as ready-made sources of financing for their own business interests, often trade activities with parties in Russia (often illicit).
  - Majority of insolvent banks had exceeded limits on lending to owners; connected lending was crucial in the collapse of Baltija Bank.
- Supervisory capacity:
  - Latvian central bank was urged, including by the Fund, to increase the number and skills of supervisors.
  - Failure to adopt advice was partly due to an environment corrupted by launderers (strong political power of some bank owners/managers and support of some parliamentarians and officials for failed large banks).
- Note: Similar supervisory capture and avoidance of large institutions were noted during the 2008–2009 financial crisis.

### Terrorism, terrorist financing, and financial impacts
- General observations:
  - Countries that have experienced terrorist attacks or prolonged conflict tend to focus on human and political costs rather than financial sector impacts, though direct and indirect financial costs exist and are proportional to the size of the attack/insurgency.
- September 11, 2001 example:
  - OECD working paper quantified direct costs to New York’s financial district at $28.4 billion, with significant near-term, albeit temporary, loss in consumer confidence in the US and elsewhere in the developed world.
  - Shocks to financial markets were noticeable but transient: heightened risk premia, “flights-to-quality,” increased corporate/benchmark spreads, and implied volatility.
- Macro study using ITERATE and Penn World Table (177 countries over 33 years):
  - Finding: “...on average, the incidence of terrorism may have an economically significant negative effect on growth, albeit one that is considerably smaller and less persistent than that associated with either external wars or internal conflict. As well, terrorism is associated with a redirection of economic activity away from investment spending and towards government spending.”
- Advanced vs developing economies:
  - Developed nations are more frequent targets of terrorist acts than developing countries, but economic impacts of less frequent events in developing countries appear significantly greater.
- Broader vulnerabilities:
  - Terrorist financing can undermine financial system stability; banks seen as conduits for terrorist financing may face international sanctions or difficulty finding counterparts, undermining their stability.
  - Event-driven effects vary across activities, sectors, countries and time and depend on the nature of attacks, multiplier effects, and policy responses.

### Tax evasion, tax fraud, and fiscal impacts
- Fiscal consequences:
  - Tax evasion leads to higher fiscal deficits, underinvestment in public goods, inadequate social safety nets, and substandard government services; it affects ability to invest in health, education, infrastructure, and institutions.
- Tax fraud as a proceeds-generating crime:
  - Large scale tax fraud is estimated to be the most prevalent and significant of all proceeds-generating crimes.
  - In many jurisdictions AML/CFT frameworks are used to detect, investigate, prosecute tax evasion laundering, and recover proceeds, including when hidden abroad.
- Empirical examples and estimates:
  - Guyana study (1970–2000): absent evasion through informal sectors, Guyana could have collected an additional 7 percent of GDP per year over the 30-year period.
  - VAT gaps in EU countries: up to 34.5 percent of hypothetical revenue (Italy); Spain, Greece, and Belgium in the 19–22 percent range.
  - U.S. individual income tax gap estimated at 13.7 percent of hypothetical revenue, or close to $290 billion (2001 data).
- Greek case study:
  - Fiscal consolidation central to adjustment under the stand-by arrangement; dependent on improvements in addressing wide tax evasion and corruption in tax administration.
  - Selected data: in 2006 the VAT Gap was 30 percent in Greece compared to 12 percent on average in the EU-25.
  - In 2007 the number of verifications to taxpayers was 0.2 percent in Greece compared to 4.1 percent on average for OECD countries.
- Risks from nonresident tax evader deposits:
  - Financial sectors dependent on deposits from nonresident tax evaders risk sanctions and sudden destabilizing withdrawals if enforcement intensifies or tax amnesty programs change depositor incentives.

### Macroeconomic distortions and channels of impact from money laundering and criminal proceeds
- Identified areas of impact:
  - Distortion of consumption: criminal spending patterns and asset purchases to conceal origins can distort specific sectors (example: real estate studies, Colombia in the 1980s).
  - Distortion of investment and savings: laundering-driven investment decisions prioritize concealment over profit-maximization, producing economically sub-optimal choices and resource misallocation.
  - Distortion of trade and exchange rate: trade mispricing for money laundering purposes can distort balance of payments indicators; smuggling and capital inflows/outflows affect interest and exchange rates. Example: Nigeria — exchange rate differential reflected a premium purchasers paid to falsify import documents to evade customs duties or make otherwise restricted or illicit transfers.
  - Distortion of demand for money: Quirk calculated that each 10 percent increase in crime results in a 6 percent reduction in broad money demand and a 10 percent reduction in currency demand “as the related proceeds are laundered in parallel financial markets.”
- Quantified macro impact:
  - Quirk (1996) estimated that every 10 percent increase in money laundering associated with crime resulted in an estimated 0.1 percent reduction in annual GDP growth rates.
- Broader adverse effects:
  - Corruption, especially grand corruption, negatively affects fiscal balances, FDI, and growth.
  - Production and trafficking in illegal narcotics diverts resources from legal and productive investments.
  - Illegal logging and other environmental crimes despoil natural resource wealth, incompatible with sustainable growth and development.
  - Large illegal sectors can be deadweights on formal economies, resulting in sub-optimal growth; in extreme cases, unchecked criminal activity can threaten state functions and the rule of law, with associated adverse economic effects.

### Policy implications and tools noted in the text
- Strengthening supervision:
  - Increase number and skills of supervisors; resist political and criminal influence that leads supervisors to avoid tackling large, systemically important institutions.
- Use of AML/CFT to combat tax evasion:
  - Robust AML/CFT controls can limit the banking system’s use to launder proceeds of tax evasion and serve as an effective instrument in combating tax evasion.
  - Where tax crimes are predicate offenses to money laundering, AML legal and institutional tools can detect and investigate laundering of tax evasion proceeds, prosecute tax offenders, and recover proceeds, including when hidden abroad.
- Fiscal consolidation and tax administration reforms:
  - Fiscal consolidation efforts (example: Greece stand-by arrangement) depend on improvements in addressing tax evasion and corruption in tax administration.
- Consideration of criminal-sector effects in macroeconomic policymaking:
  - Macroeconomic policymakers must take large-scale crime, underground activity, and associated money laundering into account because they can distort official data on employment, consumption, and currency transactions, complicating policy design and implementation.

*IMF PDF chapter/section content unit*

### 27.      There is a large and growing body of evidence proving the negative impact that

### There is a large and growing body of evidence proving the negative impact that corruption has on economic growth.

### Corruption: broad economic effects
- Corruption diverts resources from basic needs and perverts efficient and equitable allocation in the economy.
- Corruption and grand corruption are detrimental to the formulation and implementation of sound economic, and especially fiscal policy.
- The costs of corruption affect many elements of the economic system—from the fiscal balance sheet to the balance of payments to the financial system.

### Financial-sector-specific impacts (findings from empirical work)
- A 2005 IMF working paper found a strong association between corruption and a shallower and less efficient financial system.
- A study of African financial crises between 1980 and 1999 indicated that “the average length of time an African banking system spent in crisis increased with the level of government corruption.”
- Corruption has been associated with:
  - sub-optimal monetary policies in developing countries (Huang & Wei, 2006),
  - disruptive capital flight during Asian currency crises (Moghadam, Samavati, & Dilts, 2003),
  - difficulties in attracting FDI (Samanta, 2006; Kose, Praasad, Rogoff, and Wei, 2006).
- The negative impact of corruption on public finance was examined in an FAD-edited volume, Governance, Corruption, and Economic Performance, published in 2002.

### Scale of illicit markets relative to formal GDP
- Transactions in illegal markets (usually drug production and trafficking) are large relative to the country’s formal sector (official) GDP.
- Afghanistan example:
  - Potential export value of 2010 opium production: US$1.4 billion, equivalent to roughly 11 percent of the government‘s GDP estimate.
  - Opium export value in 2010 was down from 34 percent and 26 percent in 2008 and 2009, respectively.
  - Corruption recently measured at 20 percent of GDP.
  - The illicit sector drives growth through consumption and agriculture and penetrates the country‘s incipient formal real and financial sector.
- Impacts on policy: Discounting the illicit sector from analysis reduces the complexity of the actual situation and adversely affects monetary and fiscal policy, government forecasts, and trade assessments.

### Illicit coca/cocaine sectors in Andean and other countries
- Peru:
  - Staff estimate: share of production of coca and cocaine represents 0.9 percent of total GDP in 2009.
- Bolivia:
  - Reports that cultivation of coca leaf represents some 1/8–1 1/4 percent of total GDP.
  - UNODC sources suggest illicit coca production formed 21 percent and 14 percent of agricultural output in 2008 and 2009, respectively.
  - Bolivia reports that the cultivation of coca leaf represents between 3.6–8¼ percent of total Agriculture GDP from 1990–2008.
- Colombia:
  - Share of production of coca and cocaine ranged between ¾–3¾ percent of total GDP from 2000 to 2008, declining toward the end of the period due to coca eradication efforts.
- Asia:
  - Myanmar and Laos are similarly impacted (UNODC South-East Asia Opium Survey 2010).
- Transmission channels and sectoral effects:
  - Illicit sectors do not generate activity exclusively in the informal sector, nor do all funds immediately leave the country.
  - Two opposing mechanisms are possible:
    - Crowding out: resources devoted to illicit production drain from other productive opportunities, reducing activity in other sectors and creating social and political unrest.
    - Spillover increases: illicit activity may create spillover effects that increase economic activity in other formal and informal sectors.
  - Fund staff have developed an analysis of the impact of shocks from the cocaine economy on Peruvian GDP, providing econometric support for transmission channels and a methodological basis for evaluating significance across countries.

### Spillover effects, AML/CFT, and cross-border risks
- Spillovers associated with ML/FT and predicate crimes include destabilizing inflows and outflows, and cross-border transmission of criminal proceeds and risks.
- Weaknesses in one country‘s AML/CFT regime can create opportunities for foreign criminals to launder proceeds of domestic crimes.
- Specific risks and channels:
  - Financial products and services with special features may facilitate concealment of beneficial ownership.
  - Lax enforcement of customer due diligence regarding foreign politically-exposed persons can allow proceeds of corruption to be transferred illicitly from a developing country to a developed one.
  - Money raised in one jurisdiction can be used to finance terrorist acts in another.
  - Cross-border tax evasion is a special case where predicate crimes may be defined differently across jurisdictions.
- Cross-border impact examples:
  - Scandals such as Madoff, ENRON, Parmalat, WorldCom, Stanford, and BoNY had cross-border impacts.
  - Criminal proceeds not macro-relevant in a large developed economy can have destabilizing effects when exported to a smaller economy.
  - Antigua and Barbuda: consequences of fraud by the Stanford Financial Group overwhelmed the small island economy, implicated senior Antiguan regulators, and caused a significant economic downturn prompting a request for an IMF program.
  - Russian criminal proceeds were a destabilizing factor in neighboring Latvia in the 1990s.

### Concluding observations (stability and spillovers)
- Money laundering, terrorist financing and related predicate crimes may undermine the stability of the originating country and have adverse spillover effects on the stability of other countries.
- Examples of spillover dynamics:
  - Extensive criminal activities in one country may lead to illicit transfers and large short-term capital flows to another country with potential destabilizing effects on that country’s economy.
  - Availability of money laundering services in one jurisdiction may encourage and facilitate tax evasion in neighboring countries with adverse effects on their fiscal positions.

*Source: Excerpts from IMF chapter/section on corruption, illicit markets, and financial stability.*

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_Source: https://www.imf.org/-/media/websites/imf/imported/external/np/pp/eng/2011/_051111pdf.pdf_