Possible impacts if FATF-ICRG includes Nepal in 'Grey-List'

Feb14,

  

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The Mutual Evaluation Report (MER) for Nepal was released in September 2023 following a long evaluation process in 2022–2023 by the Asia Pacific Group on Money Laundering (APG) Assessment team, which was based on the 40 Recommendations and 11 Immediate Outcomes of the Financial Action Task Force (FATF). Nepal has been automatically entered in the FATF International Co-operation Review Group (ICRG) procedure since October 2023, based on its MER results. Nepal is now under the ICRG observation period. Based on the country's progress, the FATF will decide on next steps during its annual plenary meeting in February 2025.

According to the MER published in September 2023, Nepal's AML/CFT system was thoroughly reviewed to determine whether it met international standards and how well it addressed the risks of money laundering, terrorist financing and proliferation financing (ML/TF/PF). The conclusions and recommendations presented in the MER represents Nepal's strengths and weaknesses in regard to fight against ML/TF/PF and other financial crimes. They also provide foundation for improving Nepal's AML/CFT regime, mechanisms and procedures and fixing any shortcomings that were found.

Ratings of Nepal in Mutual Evaluation Report, 2023

Based on FATF Methodology, country's ratings are segregated in two broader categories: technical compliance and effectiveness compliance. Technical compliance assessment evaluates specific requirements of each of the 40 FATF recommendations, the pertinent institutional and legislative framework of the jurisdiction, and the authority and procedures of competent authorities. The foundation of an AML/CFT system is made up of these 40 FATF recommendations.

Mutual evaluations primarily consist of an effectiveness compliance assessment. Based on the ML/TF/PF risk profile of that jurisdiction, it evaluates the degree to which a country meets a specified set of outcomes that are essential to an efficient and well-functioning AML/CFT system. The efficiency of the country is evaluated based on how well they meet predetermined goals that are essential to an efficient AML/CFT system, taking into account the jurisdiction's ML/TF/PF risk profile. It involves assessing how things are actually done in accordance with context and risk. It is measured using the Immediate Outcomes (IOs) mentioned in the FATF Methodology and focuses on the outcomes attained.

 

Rating Scales and ratings for Nepal in Technical Compliance and Effectiveness Assessment in MER, 2023 is summarized in tables, below: - 

 

Technical Compliance Ratings

SN

Ratings of Recommendations

Count

1

Compliant

5

2

Largely Compliant

16

3

Partially Compliant

16

4

Non-Compliant

3

5

Not Applicable

0

Total Recommendations

40

 Effectiveness Assessment Ratings

SN

Ratings of Immediate Outcomes (IOs)

Count

1

High level of effectiveness

0

2

Substantial level of effectiveness

0

3

Moderate Level of effectiveness

4

4

Low level of effectiveness

7

Total Immediate Outcomes

11

Is there possibility of Nepal to be listed under 'grey list'?

When a Mutual Evaluation Report (MER) identifies weaknesses in a country’s implementation of the standards, it is referred to the FATF’s International Cooperation Review Group (ICRG) for review, in cases such as the following:

1. It has 20 or more non-Compliant (NC) or Partially Compliance (PC) ratings for technical compliance; or

2.  It is rated NC/PC on 3 or more of the following Recommendations: 3, 5, 6, 10, 11, and 20; or

3. It has a low or moderate level of effectiveness for 9 or more of the 11 Immediate Outcomes, with a minimum of two lows; or

4. It has a low level of effectiveness for 6 or more of the 11 Immediate Outcomes.

5. In addition, a country may be referred if it does not participate in a FATF-style regional body (FSRB) or does not allow mutual evaluation results to be published in a timely manner; or if it is nominated by a FATF member or an FSRB. The nomination is based on specific money laundering, terrorist financing, or proliferation financing risks or threats coming to the attention of delegations.

Since Nepal qualifies the criteria number 3 and 4 of above list, it has automatically entered in the FATF ICRG process since October 2023. Currently it is under FATF ICRG's observation period till October 2024 and based upon the progress shown by Nepal, further process shall be decided by FATF on its annual plenary to be organized on February, 2025. This means Nepal has opportunity to not enter in 'grey list' by implementing recommended actions of MER. But if Nepal fails to present significant level of progress in this regard, it may go through grey listing procedure.

A jurisdiction that enters the ICRG review process as a result of its mutual evaluation results has a one-year Observation Period to work with the FATF or its FATF-style regional body (FSRB), such as APG, to address deficiencies before possible public identification and formal review by the FATF.

Implications to Nepal if listed in 'grey list'

A jurisdiction having a low ME compliance grade will either be included as one of two categories: "Jurisdictions under Increased Monitoring" (also known as the "grey list") or "High-Risk Jurisdictions subject to a Call for Action" (also known as the "black list").  According to FATF, as of February 2024, the Democratic People's Republic of Korea (DPRK), Iran, and Myanmar are on such "black list," while 21 other nations are on the "grey list." When the FATF places a jurisdiction under increased monitoring, it means the country has committed to resolve swiftly the identified strategic deficiencies within agreed timeframes and is subject to increased monitoring. This statement identifies countries that are actively working with the FATF to address strategic deficiencies in their regimes to counter money laundering, terrorist financing, and proliferation financing. (FATF, 2024)

'Grey listing' by FATF ICRG is a very strong signal to all stakeholders across the globe. Being classified as a Jurisdictions under Increased Monitoring does not usually imply isolation from the outside world. But countries are hesitant to conduct business under the same terms and conditions with countries that pose a risk. As a result, doing business internationally may get much more expensive. High-risk nations may experience social and political difficulties in addition to financial difficulties.

Directly or indirectly, any nation under 'grey list' may experience one or more of the negative consequences in different dimensions as below: -            

i.    Consequences to Economy

·     Impact on Financial Sector: Grey listing can undermine confidence in a country's financial system. Banks and financial institutions may face increased scrutiny and due diligence requirements when dealing with transactions involving the grey-listed jurisdiction. This can lead to higher compliance costs and reduced access to international financial services.

 

·     Reduced Foreign Investment: Grey listing can deter foreign investors who may perceive increased regulatory risks and uncertainties associated with doing business in a jurisdiction under increased monitoring. This can lead to a decline in foreign direct investment (FDI) and capital inflows, also likely lead to a decline in local investment and exports which can negatively impact economic growth and development.

 

·  Negative consequences in the GDP size and economic growth: Direct and indirect negative consequences in the GDP size and economic growth. For example: In a paper titled “Bearing the Cost of Global Politics – the Impact of FATF Grey-Listing on Pakistan’s Economy,” Dr. Naafey Sardar estimated that Pakistan lost $38 billion in GDP and $3.6 billion in foreign direct investment from 2008 to 2019. If we assume 4% loss ratio due to grey listing in context of Nepal, then Nepal could loss in GDP around Rs. 9 billion within 4 years only because of grey listing reason. Unwanted Expansion of Informal Sector which may jeopardize and limit the areas and influence of Fiscal and Monetary Policy.

 

·   Restrictions on International Transactions: Grey listing may result in restrictions or enhanced scrutiny on cross-border transactions involving the grey-listed jurisdiction. This can hinder international trade and remittances, disrupt supply chains, and increase transaction costs for businesses operating in or dealing with the affected jurisdiction. For high import-based countries, like Nepal, high inflation due to high cost imposed by other countries as a result of being high-risk country.

ii.    Consequences to Banking Sector

·     Increased Compliance Costs: Banks operating in a grey-listed jurisdiction may face heightened regulatory requirements and increased compliance costs. They may need to invest in additional AML/CFT measures, such as enhanced customer due diligence, transaction monitoring systems, and staff training, to meet international standards and regulatory expectations.

 

· Restricted Correspondent Banking Relationships: Grey listing can lead to correspondent banks, particularly those in other jurisdictions, imposing stricter due diligence requirements or terminating correspondent banking relationships altogether with banks in the grey-listed jurisdiction. This can limit access to international payment networks, increase the cost of processing cross-border transactions, and hinder the ability of banks to conduct global business operations.

 

·  Limited Access to Financial Services: Banks in grey-listed jurisdictions may find it more challenging to access certain financial services and products offered by international financial institutions. This could include difficulties in obtaining trade finance, syndicated loans, or participation in global financial markets, ultimately restricting their ability to support economic activities within the jurisdiction. Along with decreasing foreign capital inflows, the listing is likely to negatively impact bank access for people. According to a review done by FATF, banks become more risk averse and narrow access to banking services in response to receiving grey list status. 

 

·  Impact on Profitability and Stability: The increased compliance costs, restricted access to correspondent banking services, and reputational risks associated with grey listing can negatively impact the profitability and stability of banks in the affected jurisdiction. This may lead to reduced profitability margins, increased loan pricing, and heightened vulnerability to financial shocks, potentially affecting the overall health of the banking sector and broader economy.

iii.     Consequences to Private / Business Sector

·     Restricted Access to Financial Services: Grey listing can result in limited access to international financial services for businesses operating in the affected country. Banks may face challenges in establishing or maintaining correspondent banking relationships, which can impede cross-border transactions and trade finance operations.

 

·    Increased Compliance Costs: Businesses may incur higher compliance costs as a result of enhanced due diligence requirements imposed by financial institutions in response to grey listing. This can include additional Know Your Customer (KYC) procedures, transaction monitoring, and reporting obligations, leading to increased administrative burdens and operational expenses.

 

·   Difficulty in Obtaining Financing: Grey listing can make it more challenging for businesses to access financing from international lenders and investors. Foreign banks and investors may be reluctant to extend credit or invest in projects located in grey-listed jurisdictions due to perceived risks associated with financial crime and regulatory compliance.

 

·    Impact on Trade and Investment: Grey listing can disrupt international trade and investment flows, particularly for businesses engaged in cross-border transactions. It may lead to delays in payment processing, higher transaction costs, and increased uncertainty, deterring foreign investors and impacting supply chains.

 

·  Perception of Risk: Grey listing can create negative perceptions about the safety and security of a country among potential tourists. Travelers may perceive a grey-listed country as having higher risks related to financial crime, terrorism financing, or overall stability, which could deter them from visiting.

 

iv.     Consequences to foreign Aid/grants

·     Reduced Access to International Financial Institutions: Grey listing may limit a country's access to financial aid and grants provided by international financial institutions such as the World Bank, International Monetary Fund (IMF), and regional development banks. These institutions often have strict eligibility criteria and may be reluctant to provide funding to countries with perceived higher risks of financial crime or inadequate AML/CFT measures.

 

·   Conditionality on Aid and Grants: International donors and development partners may impose conditions related to AML/CFT compliance as a prerequisite for receiving financial assistance or grants. Countries on the grey list may be required to demonstrate progress in addressing deficiencies and implementing reforms to strengthen their AML/CFT regimes before accessing funds.

 

·    Higher Cost of Borrowing: Grey listing can lead to higher borrowing costs for governments seeking to finance development projects through sovereign bonds or loans in international capital markets. Credit rating agencies may downgrade the country's credit rating, resulting in increased interest rates and financing expenses, making it more expensive to borrow funds for development purposes.

 

·     Impact on Bilateral Assistance: Grey listing may also affect bilateral assistance provided by donor countries. Donor governments may reassess their aid commitments and disbursements to grey-listed countries, especially if they perceive heightened risks associated with financial crime or terrorism financing. This could result in reduced allocations of bilateral aid and grants for development projects and programs.

 

·    Constraints on Economic Development: The reduction in financial aid and grants resulting from grey listing can constrain a country's ability to finance essential infrastructure projects, social programs, and poverty alleviation initiatives. This may impede economic development efforts and exacerbate socio-economic challenges, particularly in low-income and developing countries that rely heavily on external assistance for sustainable growth.

 

·  Reputational Damage: Grey listing can damage a country's reputation and credibility among international donors, investors, and development partners. Negative perceptions of weak AML/CFT controls and financial crime risks associated with the grey-listed status may undermine trust and confidence in the country's governance structures, hindering efforts to attract investment and secure financial assistance. Nation’s governance, legal, institutional and AML/CFT regime is considered weak, reputation and image of country's financial sector will be at stake and hence overall image of country is considered weak.

 Conclusion

Despite these drawbacks, the grey/black list acts as a potent motivator for nations to reform their legal framework, implement key recommendations of MER and strengthen AML/CFT regime to stop and combat money laundering, terrorist financing and proliferation financing. The FATF/APG collaborate closely with member nations on the grey/black list to create action plans that address the structural issues.

Money laundering related 20 acts along with Asset (Money) Laundering Prevention Act (ALPA, 2008) has been recently amended by parliament of Nepal and is in final stage of approval by hon. President. Along with such legal reform, there are several efforts made by concerned government agencies and private sector to improve the deficiency in AML/CFT regime. Based on the recommended actions of MER, AML/CFT related national strategy and action plans for 2024-28 is being formulated and soon to be issued by Government of Nepal. Hopefully Nepal will be able to present significant progress during observation period and implement the key recommended actions prescribed by MER. If Nepal becomes successful in doing this, it does not have to go through painful grey listing procedure. In any cases, Nepal should implement, as soon as possible, the priority actions and recommended actions mentioned in Mutual Evaluation Report, 2023.

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Disclaimer: The opinions expressed in this article are those of the author. They do not  reflect the opinions or views of the FIU-Nepal or NRB.

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References:


(नेपाल राष्ट्र बैंक कर्मचारी संघद्धारा प्रकाशित 'अरुणोदय' (अंक-२८, २०८१) बाट साभार) 

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