Country risk rating can work as an effective tool only if there is a broad co-operation among countries across the world. In addition, there is a need to isolate countries that pose a threat and risk for prevention of money laundering

Increasing incidents of money laundering across the world has called for the need to enhance country risk monitoring. The HSBC Bank was fined $1.9 billion for allowing itself to be used to launder a river of drug money flowing out of Mexico, and other banking lapses. One of the key reasons for HSBC failing to notice money laundering in Mexico was its inability to identify risk inherent in Mexico as country. As per a report published by Reuters, “Despite the known risks of doing business in Mexico, the bank put the country in its lowest risk category, which excluded $670 billion in transactions from the monitoring systems, according to the documents”. It is very obvious that Mexico required a different country risk rating that HSBC perceived it to be.

Country risk rating: What does it mean?

So what is country risk rating and why is it so important in the prevention of money laundering activities? As per UK Bribery Act, country risk is defined as follows , “Country risk is evidenced by perceived high levels of corruption, an absence of effectively implemented anti-bribery legislation and a failure of the foreign government, media, local business community and civil society effectively to promote transparent procurement and investment policies”. While this definition does not give a complete insight into what is country risk all about, what it does provide is valuable insight into what needs to be covered as part of identification of country risk broadly. There are many service providers across the world, which provide online tools to measure country risk. One such service provider is www.world-check.com.  BASEL AML Index also gives an insight into country risk rating. While there are tools available to measure country risk, let us look at the parameters which are generally used for measurement of country risk:

Factors to be considered for country risk rating:

1) Corruption Perceptions Index: Corruption is one the key reasons for money laundering all across the world. A lot of black money gets generated because of corruption prevailing at different level of activities, which gets laundered.  While corruption results in generation of black money, it is not easy to identify the source of corruption in each country. In order to identify where a country stands in terms of corruption, Transparency International Corruption Index can act as an effective tool. Published by Transparency International, this index ranks rates each country starting from number 1 on the index having least corruption to the countries having a higher level of corruption. As per 2012 index, Denmark, Finland and New Zealand stood at top of the index indicating least corruption in these countries. While there may not be agreement on the method of calculation of index, the index provides broad insight into corruption in different countries. As per this index in 2012, India stood at 94th rank in the world.

2) Financial Action Task Force (FATF) public statement:  The Financial Action Task Force (FATF) is the global standard setting body for anti-money laundering and combating the financing of terrorism (AML/CFT). In order to protect the international financial system from money laundering and financing of terrorism (ML/FT) risks and to encourage greater compliance with the AML/CFT standards, the FATF publishes the list of jurisdictions that have strategic deficiencies in terms of prevention of money laundering. It works with them to address the deficiencies that pose a risk to the international financial system. FATF classifies countries into different categories. For instance, FATF public statement dated 23rd February, 2013 mentioned following categories of countries:

a) Jurisdictions subject to a FATF call on its members and other jurisdictions to apply counter-measures to protect the international financial system from the on-going and substantial money laundering and terrorist financing (ML/TF) risks emanating from the jurisdictions.

Two countries fall into this category: Iran and North Korea

b) Jurisdictions with strategic AML/CFT deficiencies that have not made sufficient progress in addressing the deficiencies or have not committed to an action plan developed with the FATF to address the deficiencies. The FATF calls on its members to consider the risks arising from the deficiencies associated with each jurisdiction, as described below.

These countries fall into this category: Ecuador, Ethiopia, Indonesia, Kenya, Myanmar, Nigeria, Pakistan, São Tomé and Príncipe, Syria, Tanzania, Turkey, Vietnam and Yemen

FATF classification of countries works as a key resource for identifying the risk that a country has. This is used by many software vendors also for the purpose of gauging the risk that a country may have. The member countries of FATF (currently 34 countries) have lower risks as per the FATF public statement as they have either implemented FATF 40 plus nine recommendations or are in the process of implementing the same.

3) Sanction list as the tool for risk rating of the country: Sanction list is one of the tools used for the purpose of monitoring country risk. Some of the sanction lists used are across different geographies, and these include UN Sanction list, Office of foreign assets and control (OFAC) list, European Union (EU) list and HM Treasury list. Sanction can be for multiple reasons. For example, there can be economic and financial sanctions, military sanction etc. As per European Commission, “In view of the economic significance of the EU, the application of economic and financial sanctions can be a powerful tool. Such sanctions could consist of export and/or import bans (trade sanctions which may apply to specific products such as oil, timber or diamonds), ), bans on the provision of specific services (brokering, financial services, technical assistance), flight bans, investment, payments and capital movements, or the withdrawal of tariff preferences. However, broad economic or financial restrictions may result in unduly high economic and humanitarian costs”.

If a country’s name appears in any of these lists as the banned country, then any financial transactions with the country needs to be completely avoided.

4) Offshore financial centre, tax havens and country risk rating: International Monetary Fund (IMF) describes offshore finance as follows, “Offshore finance is, at its simplest, the provision of financial services by banks and other agents to non-residents. These services include the borrowing of money from non-residents and lending to non-residents. This can take the form of lending to corporates and other financial institutions, funded by liabilities to offices of the lending bank elsewhere, or to market participants. It can also take the form of the taking of deposits from individuals, and investing the proceeds in financial markets elsewhere”.

Offshore financial centres are defined by IMF as the places where the bulk of financial sector activity is offshore on both sides of the balance sheet, (that is the counterparties of the majority of financial institutions liabilities and assets are non-residents), where the transactions are initiated elsewhere, and where the majority of the institutions involved are controlled by non-residents. Most of these offshore financial centres are tax havens also. Since there are limited or no taxes on these centres, investors prefer to keep their money in these centres. As per the recent report released by Boston Consultancy Group, “The wealth held abroad in offshore financial jurisdictions has grown by 6.1 percent in the last year despite efforts by governments to curb tax evasion. The figures have soared to a total of $8.5 trillion. Switzerland is crowning the list of jurisdictions where the funds are being kept.”

The Boston study on offshore financial centre further goes on to add , “Investors appear to prefer the risks related to keeping funds in tax havens against the guaranteed tithe on their fortunes by the tax authorities at home”. However, in many cases the money moves not just because of tax benefit but also other reasons. According to the BCG study, the major inflow of money to the offshore centres over the next five years is likely to come from the rich in emerging economies. These investors choose banks in Switzerland or Liechtenstein for stability and security reasons, rather than for tax evasion.

Offshore financial centres are perceived as risk and threat to prevention of money laundering activities. This risk emanates from the fact that it is difficult to identify the origination of money unless proper checks and controls have been put in place. Basically offshore financial centre are perceived as threat to financial stability. IMF publishes the list of offshore financial centres from time to time. Offshore financial centres need special handling for prevention of money laundering.

5) International Narcotics Control Strategy Report: This is another important source to fathom the risk that a country poses in terms of spreading of money laundering. Drug trafficking is a key source of money laundering in many countries. The International Narcotics Control Strategy Report (INCSR) is an annual report by the Department of State to Congress prepared in accordance with the Foreign Assistance Act. It describes the efforts of key countries to attack all aspects of the international drug trade. For example, the report of 2011 on Pakistan says, “Pakistan continues to suffer from financial crimes related to narcotics trafficking, terrorism, smuggling, tax evasion, corruption, counterfeit goods and fraud. Pakistani criminal networks play a central role in the transshipment of narcotics and smuggled goods from Afghanistan to international markets. The abuse of the charitable sector, trade-based money laundering, money exchange companies, hawala/hundi, and bulk cash smuggling are common methods used to launder money in Pakistan and the region.”

Similarly, this report rates all countries in the world which have a potential threat in context of international drug trade. The report can be used to rate a country for potential threat that a country poses for money laundering.

6) Terrorism and country risk rating: Post 9/11 and other terrorism related events which have happened across the world, have drawn attention to the relationship between money laundering and terrorism. FATF also introduced 9 recommendations for purpose of combating terrorism and prevention of money laundering for promotion of terrorism. Out of 9 recommendations, three key recommendations are as follows:

a. Each country should take immediate steps to ratify and to implement fully the 1999 United Nations International Convention for the Suppression of the Financing of Terrorism.

b. Each country should criminalize the financing of terrorism, terrorist acts and terrorist organizations as predicate offences.

c. Each country should implement measures to freeze without delay funds or other assets of terrorists, those who finance terrorism and terrorist organizations in accordance with the United Nations.

As part of country risk rating, it needs to be seen if the country concerned is sponsoring terrorism directly or indirectly or not. Such countries need to be on watch list.

7) Other Factors:  Apart from the above mentioned factors, other factors that are considered for country risk rating are as follows:

• OFAC specially designated nationals
• World Bank worldwide governance indicator report
• Judgments based on perceived risks by a country or business entities operating in that country

While there are enough indicators available to judge the risks that a country poses. However, the most important factor is international co-operation in this regard. Even today only 34 countries are members of FATF. There is a need to increase membership of FATF so that countries could agree on common grounds to prevent risks emanating from high risk countries. Also, there is a need to isolate countries which pose threat and risk for prevention of money laundering. Threat to international terrorism has increased substantially of late. Country risk rating can work as an effective tool only if there is a broad co-operation among countries across world.

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