Terrorism financing is a global problem requiring effective and coordinated solutions at the national, regional and multilateral levels. Fighting it, however, is costly; and measuring success is challenging.
Indeed, in our extremely inter-connected world, where trillions of dollars are transacted through formal and informal markets daily, tracking suspicious transactions is a herculean task. Counter-terrorism experts must keep pace with terrorists and terrorist organizations as they adapt to newly-introduced regulatory frameworks and countermeasures and find new ways to move funds, within and across jurisdictions. Additionally, financial regulators face the dilemma of imposing rules and regulations to track suspicious activity that may prove difficult to monitor and enforce, and could seriously impede the free flow of financial resources.
To be sure, to the extent that financial resources are the lifeblood of terrorist operations, Combating the Financing of Terrorism (CFT) is an important counter terrorism tool that may prevent future attacks from taking place; disrupt operational capabilities of terrorist organizations; prevent alliance formation, training and recruitment of future terrorists; and prevent the acquisition or development of deadly weapons.
We need to continue our efforts to combat the financing of terrorism because, far more important than the amounts intercepted themselves, following the money trail enables the gathering and sharing of information by law enforcement across jurisdictions that can then serve to identify and destroy terrorist cells and networks. To that end, closer international cooperation, better monitoring, and greater enforcement of rules and regulations are needed; as well, more research into incentive structures that induce good behavior and cooperation between countries must be envisaged.
To understand this, one should understand the main actors involved in the fight against terrorism financing, recognize some of the challenges they face, and examine the implications of combating the financing of terrorism within the financial system.
Since 9/11, considerable resources have been devoted by states and international organizations to combat the financing of terrorism. The U.S. adopted the Patriot Act, which among other things, strengthened measures ‘to prevent, detect and prosecute international money laundering and financing of terrorism.’ In October 2001, the Financial Action Task Force (FATF), an intergovernmental body created in 1989 to deal with money laundering, extended its mandate to combating the financing of terrorism. The UN Security Council adopted Resolution 1373 shortly after the 9/11 attacks. The Council also created a Counter Terrorism Committee to monitor state compliance with the resolution and provide expert assessments and counter-terrorism technical assistance to member countries.
There are now more than 100 national financial intelligence units (FIUs) around the world that process and share information about suspicious transactions related to money laundering and terrorism financing.
Several countries have reformed their anti-money laundering (AML) and counter-terrorism financing or Combating the Financing of Terrorism (CFT) regulations to conform with the standards set by the Financial Action Task Force (FATF). The latter has issued several recommendations on AML/CFT and collaborates with other international organizations such as the UN, the World Bank, and the IMF. For example, the IMF has facilitated information sharing, encouraged good practices, and provided technical assistance to countries such that they may comply with AML/CFT standards established by the FATF.
The FATF has also encouraged the creation of FIUs (which now meet informally as the Egmont Group to share information and expertise) and regional-type FATF bodies.
Canada’s financial information unit is the Financial Transactions and Reports Analysis Centre of Canada (FINTRAC) that was created in July 2000 under the Proceeds of Crime (Money Laundering) Act. The Act was amended in 2001 to become the Proceeds of Crime (Money Laundering) and Terrorist Financing Act. In 2008-2009, FINTRAC received some 68,000 suspicious transaction reports and made 556 case disclosures (more than double the amount in the previous financial year) to various law enforcement agencies, about 10% of which were related to terrorism financing, and more than 80% related to money laundering.
Money Laundering and Terrorism Financing
The FATF framework addresses both money laundering and combating the financing of terrorism (AML and CFT) and links these two phenomena. However, motivations and objectives behind money laundering and terrorism financing are different, and they thus require different investigative techniques.
Money laundering is carried out for profit, and the illicit proceeds of crime are hidden or transformed so that they can be used legally or re-invested in criminal organizations. Most money laundering activities such as drug trafficking, embezzlement and corruption are not related to terrorist activities though terrorists may engage in money laundering.
The complexity of transactions carried out by money launderers makes them hard to detect; techniques range from movement to offshore accounts where anonymous banking is allowed, or breaking large deposits into small amounts that are below the thresholds considered suspicious by authorities.
In the case of terrorism financing, funds can originate from both legitimate and criminal proceeds in the placement stage. For instance, we have seen countless examples where money collected by community-based organizations and charities are diverted to terrorists. An interesting example in the Canadian context is the World Tamil Movement, a community-based organization which has been under investigation by the Royal Canadian Mounted Police and Government of Canada since 2006 and listed as a terrorist organization in 2008. This led to Canada’s first conviction in 2010 for financing a banned terrorist organization, the Liberation Tigers of Tamil Eelam (LTTE). Traditional AML techniques that focus on the placement stage are not helpful when the source of funding is legitimate. Instead, CFT should focus on the integration stage and move up the system to identify contributors. In fact, one of the fallouts of the 9/11 attacks was a recognition that existing money laundering controls at the time, due to their focus on illicit flows, could not detect the hijackers’ transactions.
However, when the source of funding is illegal, AML techniques are equally applicable. In other words, as one builds capacity (by investing financial resources, providing training and so on) to combat money laundering and terrorism financing, it is important to recognize the variety of methods of detection and prevention that may be required.
The relatively low cost of conducting terrorist operations, when compared to amounts of money laundered, makes the former harder to detect by law enforcement. The 9/11 attacks, which required extensive planning, are estimated to have cost less than half a million dollars, whereas the U.S. Embassy bombing in East Africa, and the Madrid train bombing are estimated to have cost US$50,000 and US$10,000 respectively. Furthermore, as formal financial sector regulations become tighter, terrorism financing activities are increasingly moving to informal value transfer systems (IVTS), also known as Hawalas; trade-based money laundering; and cash couriers.
IVTS have become more popular in recent years as a result of increased international labour mobility and improvements in information and communications technologies. Given the importance of ‘trust’ in these systems, record-keeping is often lacking or minimal. They are also cheaper and faster than formal transfers. For the most part, IVTS are used for legitimate transfers, such as when migrant workers send remittances to relatives in their home country, however, it is a real challenge for law enforcement to distinguish legitimate from illegitimate transfers.
In the case of trade-based money laundering, this can take the form of false invoicing or the exchange of easily-transportable high-value commodities like gold or diamonds. Customs and border agencies often lack resources to track suspicious transactions. With increased trade liberalization and the complexity of such transactions and financing mechanisms, the trading system has become increasingly vulnerable to exploitation by both organized crime and terrorists.
Illicit cash couriers have also been linked with money laundering and terrorism financing, again as a response to increased regulations in the formal financial sector. Couriers leave no paper trail and are difficult to detect. For instance, cash couriers purportedly played an important role in the 2002 Bali bombings.
Besides knowing the methods used to transfer money, it is equally important to understand who is behind these transfers. Although some countries have been identified as state sponsors of terrorism, private funding seems to have grown in importance in recent years, partly because countries resent the international isolation that results from being labeled as ‘state-sponsors’ of terrorism. Private sources include ‘legal’ ones such as personal donations, charitable organizations and business profits that are deliberately used to fund terrorism. These sources are sometimes hijacked by terrorists, so that donors may not always know that they are supporting terrorist activities.
In recent years, reports have surfaced that trade in a variety of goods are also connected to terrorism. Certain sectors of the economy (for example, construction) are also more vulnerable to terrorist activities. Such trends follow the practice of criminal organizations to launder money, and use businesses to fundraise and provide sensitive material. On the other hand, it is rather difficult to see any clear trend that tends to be favoured for fundraising by terrorists. Most use a combination of different methods as a direct response to the range of institutional and regulatory frameworks that they face. As we have pointed out, distinguishing ‘legal’ from ‘illegal’ sources of financing can be helpful in determining the choice of detection technique and approach.
Implications for the Financial System
A well-functioning financial system is vital to the process of economic development. When left unchecked, money laundering and terrorism financing can severely damage the integrity and stability of this system.
Even when financial institutions work together reasonably well by pooling risks, the inevitable presence of asymmetric information, where one party to a transaction has more information than the other party, gives rise to the well-known problems of moral hazard (borrowers behaving differently once they are given loans) and adverse selection (borrowers being mostly of the risky-type). As a result, financial institutions tend not to be able or willing to exercise due diligence in differentiating illegal transactions from legal ones, and imposed government regulations become necessary to force them to do so.
Regulators are equally affected by information asymmetries. They cannot perfectly monitor whether financial institutions are responding to their requests, and regulations ultimately need to factor in the incentive structure faced by these institutions. Clearly, when regulations are lacking, as in the case of offshore financial centres (OFCs), there is a higher likelihood that these will be exploited for criminal and terrorist activities. For countries that derive much of their revenue from the financial sector, and where the benefits are high compared to the costs of organized crime or terrorism (which tend to take place in other places and do not affect them directly), unless international regulations and standards are strictly enforced or alternatives presented, they have no incentive to behave differently.
Similarly, in the case of IVTS, these can be the result of formal market restrictions such as limits on foreign exchange transactions or artificial interest rate ceilings. They serve a legitimate clientele whose needs cannot be met elsewhere, and policies that try to regulate them should consider reasonable alternatives such as making the formal financial system more attractive. Options for accomplishing this could include reducing transaction costs, providing attractive financial services and products, or through educational programs that can foster trust in the formal financial systems. Also, regulations should not disrupt the flow of services completely (especially the ones that are for legitimate reasons). For example, an extremely costly and burdensome regulatory framework may well force some of these IVTS’ underground, making them harder to detect. More importantly, collaboration between law enforcement and financial institutions in terms of sharing timely intelligence about best practices (both detection and reporting) is essential in fighting terrorism financing.
The Way Forward
Notwithstanding the difficulties and challenges in tracking terrorism financing, it remains an important tool in the arsenal of counter-terrorism. The collection and sharing of financial and technical information needs to be continually improved at the national and regional levels, and international cooperation must be improved. Despite considerable efforts in fighting terrorism financing, we have yet to see the emergence of an international body that can coordinate global efforts to fight this global problem. This is necessary because criminal and terrorist organizations are rational actors that have been able to adapt quickly to changing environments.
Law enforcement, the intelligence communities and financial institutions must stay ahead of the game; existing regulations need to be enforced and monitored, and any regulatory structure should factor the incentives of actors to respond to it, by, for example, proposing alternative systems, or compensating good behavior as well as sanctions for those who do not comply.
Yiagadeesen Samy is an associate professor at the Norman Paterson School of international affairs at Carleton University (www.carleton.ca/~ysamy).
© FrontLine Security 2010