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Courtesy of Asim Iftikhar Nagi/Wikimedia

Security Through Financial Integrity: Mending Pakistan’s Leaky Sieve

Tom Keatinge and Anton Moiseienko
Occasional Papers, 23 May 2019
Centre for Financial Crime and Security Studies, Pakistan, AML/CTF
This Occasional Paper focuses on the role of Pakistan’s financial institutions in detecting and preventing the transfer of corruption proceeds.

Corruption and Financial Integrity

Corruption in developing countries is a major challenge for development and stability. Illicit cross-border outflows of corruption proceeds are particularly damaging, as they drain the country of finances with little chance of them ever being recovered. Pakistan is among the states that face this challenge. The current government of Pakistan has claimed its commitment to reducing corruption in the country on many occasions. In addition to repatriating stolen assets, the effective prevention of corruption-related illicit outflows is key to delivering on that commitment.

Alongside trade, Pakistan’s financial system is a key conduit for moving value in and out of the country. It is therefore the first line of defence against the exfiltration of corruption proceeds from Pakistan. This relates to both the formal financial system, including banks and licensed exchange companies, and the informal value-transfer systems, better known as hawala or hundi. Although prohibited by law, hawala and hundi remain widespread in Pakistan. To ensure the resilience of Pakistan’s financial system against abuse by corrupt actors, it is essential to drive up financial crime compliance standards in regulated businesses and take enforcement action against hawaladars operating illegally.

Challenges Facing Pakistan’s Financial System

There are several challenges in relation to the capacity of banks, exchange control companies and other financial institutions to prevent, detect and report suspicious activities that may be related to corruption.

Tax Avoidance and Shadow Economy

The first of these challenges is the extent of tax evasion in Pakistan. Much of the country’s economy operates under the radar of the tax authorities and is therefore cash-based and undocumented. For a financial institution that seeks to ascertain the legitimacy of its client’s business, this poses practical challenges. In law, regulated businesses are theoretically expected to report suspicious activities related to a range of crimes including tax evasion in the amount equivalent to approximately £55,000. In practice, this poses challenges given the number of businesses that would have to be reported and investigated in a country where only approximately 1.5 million people out of 200 million file tax returns, as required by law. Once a financial institution deals with an individual or business that cannot adequately account for the source of their money, the capacity to identify where the money comes from – that is, initially legitimate but untaxed business or criminal activity – is limited. Tackling this challenge will require several changes to current approaches in both the public and private sectors. The regulators of Pakistan’s financial sector, the State Bank of Pakistan (SBP) and Securities and Exchange Commission of Pakistan (SECP), should clarify their expectations in relation to the reporting of tax evasion. These clarifications should reinforce the need to comply with reporting obligations while ensuring that financial institutions’ resources are not disproportionately directed towards addressing tax offences at the expense of other predicate offences (offences that give rise to criminal proceeds).

Challenges in the Banking Sector

In relation to other predicate offences, including those that are seen as particularly serious – such as corruption – financial institutions should share best practices in relation to identifying higher-risk customers – for instance, customers operating in industries known to be particularly susceptible to criminal infiltration – and establishing the source of their funds and wealth. As two RUSI workshops held in Karachi suggest, this conversation is still in its infancy, with most of the banks’ compliance efforts to date being directed at establishing automated  transaction-monitoring processes. The SBP’s supervision style should also be adjusted to pay greater attention to banks’ understanding and mitigation of risks. The current focus of the SBP’s enforcement effort has been the implementation of decision-making processes in relation to the reporting of suspicious transactions, as well as automated transaction-monitoring systems.

Challenges in the Exchange Companies Sector

Outside the banking sector, the activities of exchange companies appear to pose  money-laundering risks. Like banks, they can move funds in and out of Pakistan. But unlike banks, the ownership of exchange companies is opaque and potential links to politically exposed persons, who pose higher corruption risks, are impossible for an outside observer to ascertain. Very little is known about compliance practices in the sector and there is evidence that at least some Pakistani banks are wary of doing business with exchange companies due to money-laundering risks. These are exacerbated by the historical ties of exchange companies with hawala/hundi businesses, which are known for moving money surreptitiously. More visible SBP supervision of exchange companies is essential, as are enforcement efforts by the Federal Investigation Agency against unlicensed hawala/hundi operators.

Challenges in Other Parts of the Financial Sector

Businesses regulated by the SECP are only beginning to come to terms with  anti-money-laundering requirements after the SECP promulgated a new set of regulations in 2018. Some of these businesses question either the need for such regulation altogether or their practical ability to follow it. Outreach and enforcement efforts by the SECP, including the publication of case studies that show how regulated businesses can be abused for money-laundering purposes, can both demonstrate the rationale behind the regulations and alert the sector to the possibility of enforcement.

International Aspects

Private Sector Role

It is not only Pakistani institutions or individuals that are involved in transferring corruption proceeds out of Pakistan. The role played by overseas banks in their interactions with Pakistani financial institutions cannot be ignored. Non-Pakistani correspondent banks enable Pakistani banks to make transfers to a wider range of banks all over the world than would otherwise be possible. With correspondent banks, including those in London that were interviewed for this research, being aware of money-laundering challenges that Pakistan faces, they seek to ensure that their Pakistani respondent banks have appropriate anti-money-laundering controls. However, this outside pressure has its limits and does not negate the need for changes discussed above.

Inter-Government Engagement

International engagement on financial crime issues at the government-to-government level is also ongoing. To date, however, this conversation has largely been at cross-purposes. The ‘grey-listing’ of Pakistan by the Financial Action Task Force (FATF) in June 2018 has been perceived as political and therefore unfair in Pakistan. The focus of the FATF on counterterrorist financing in Pakistan is seen as a foreign preoccupation that unjustly obscures the issue of greatest relevance to Pakistan itself, namely the proceeds of corruption siphoned off outside the country. It is possible that this perception could be mitigated if issues related to financial crime were discussed in concert and covered both terrorist financing and money laundering, including the questions of exfiltration of corruption proceeds from Pakistan that its government is concerned about.

A similar mismatch in Pakistani and international illicit finance-related priorities is evident in the UK–Pakistani relationship, with the UK seen in Pakistan as a prolific enabler of corruption in the country. In contrast, although the UK government has been active in supporting Pakistan’s criminal justice development, the predominant focus of UK law enforcement efforts in connection with Pakistan has been drug trafficking. Combining the UK perspective on Pakistan as a destination country for the proceeds from drug trafficking and from other organised crime activities, and Pakistan’s view of the UK as a magnet for corruption proceeds, is vital to promoting a productive dialogue and cooperation.

BANNER IMAGE: Former building of the State Bank of Pakistan, now known as the State Bank Museum. Courtesy of Asim Iftikhar Nagi/Wikimedia

Tom Keatinge
Director, Centre for Financial Crime and Security Studies, RUSI

Tom Keatinge is the Director of the Centre for Financial Crime and Security Studies at RUSI, where his research focuses on matters at... read more

Anton Moiseienko
Research Fellow, Centre for Financial Crime and Security Studies

Anton is a Research Fellow at RUSI’s Centre for Financial Crime and Security Studies. His current and recent research covers a range of... read more

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