ABSTRACT

This study examines the relationship between countries’ compliance with AML/CFT (Anti-Money Laundering and Countering the Financing of Terrorism) regulations and foreign direct investment. This study, to the best of the author’s knowledge, is the first to establish a link between AML/CFT compliance and FDI, with FDI being the dependent variable and AML/CFT compliance, the independent. The research uses a sample size of 74 FATF member states and extracts data on their FDI net inflows and AML/CFT compliance ratings from the year 2004 to 2016. Furthermore, it employs a multiple regression analysis with five control variables.

The results of the analysis indicate that a country’s compliance with AML/CFT regulations is a driver of the influx of foreign direct investment into its economy. This discovery is important because the costs of compliance – what seems to be the largest barrier – is not as challenging as it used to appear. Bearing this in mind, countries would be encouraged to put more effort into their compliance activities, instead of aiming for the minimum acceptable level, which seems to be the case at the moment. In addition, it is discovered that the market size, quality of infrastructure, quality of human capital and inflation rate are very instrumental in the attraction of FDI.

Keywords: Anti-money laundering, Money laundering, Terrorist financing, Foreign Direct Investment

        Research Background

CHAPTER ONE INTRODUCTION

Money laundering is a phenomenon that undoubtedly has many repercussions at various levels. As far as banks and other financial institutions are concerned, money laundering increases their risk of failure (Burbidge, 2004; Mitchell, Sikka, Arnold, Cooper, & Willmott, 2000). Local merchants are more susceptible to heavy losses due to the unfair competition that shell companies create for them (Burbidge, 2004). At the national level, there are issues such as the destabilization of the financial system (Burbidge, 2004; Mekpor, Aboagye, & Welbeck, 2018), political instability (Aluko & Bagheri, 2012; BOG/FIC, 2011) and the facilitation and strengthening of criminals (Levi, 2002; UNODC, 2014). Nketsiah (2013) also identifies, in his paper, the compromise of national security.

The above-identified repercussions, among others, necessitated the establishment of bodies in order to eliminate, or at least manage, the menace of money laundering as well as terrorist financing and the proliferation of weapons of mass destruction – both closely related crimes. In 1989, the G7 (formerly G8) created the Financial Action Task Force (FATF) initially in response to the growing concern of the global drug problem (FATF, 2014a). However, eventually, its mission grew to incorporate the development of international consensus on measures to detect and seize the proceeds from drug crime and other crimes. The FATF is currently the body responsible for the fight against money laundering and terrorist financing at the global level.

One way the FATF carries out its duties of combatting money laundering and other associated crimes is through the creation of the FATF Recommendations (FATF, 2014a). These

recommendations set out the legal and regulatory measures that countries should take in order to mitigate, if not eliminate, instances of money laundering to the barest minimum within their economies. Therefore, it is very obvious that compliance to these Recommendations are very critical to the fight. However, both literature and empirical data cast a pessimistic overview of how much work countries are actually doing with respect to compliance. According to scholars, there is generally a level of compliance among FATF member states. However, it is quite low and leaves much room for improvement (Mekpor et al., 2018; Naheem, 2018; Yeoh, 2014b; Yepes, 2011). The speculation is that the primary motive for compliance by countries is to prevent themselves from getting in trouble. In the words of Mekpor et al. (2018), “it seems as though countries are doing just enough to avoid being blacklisted by FATF giving the reputational repercussions of blacklisting.” Unger (2007) also wonders: “Countries seem to be eager to disappear from the black list. Is this compliance or only declared compliance, compliance in the books?” One suspected reason for this attitude is the high cost associated with AML/CFT compliance (Mekpor et al., 2018). Demetis & Angell (2006) also speak of the phenomenon of fear-driven compliance. Employees of banks and other financial institutions have been seen to lack faith in the legal system’s ability to convict launderers even after their suspicious transactions are flagged. This is because there is hardly ever any hard evidence to back the suspicions. However, in order to be able to be accountable to their superiors and avoid losing their jobs in instances of identified money laundering, bank employees merely go through routine procedures as expected of them. Employees now report everything unusual without using discretion. Unger & den Hertog (2012) partly confirm this assertion. As a result, many countries have increased reports of money laundering cases, however with a corresponding decline in the quality of information produced (Naheem, 2015; Takáts, 2011). Takáts (2011) refers to this as the theory of Crying Wolf.

        Research Problem

It is quite apparent – and troubling, to say the least – that the highest motivation for any individual, institution or country to comply with AML/CFT directives is to avoid trouble. It also explains to an extent why compliance is not as effective as it should be. The issue is particularly worrying because the distress that financial crimes such as money laundering and terrorist financing cause cannot be overstated. According to a study by the United Nations Office on Drugs and Crime (UNODC), in 2009, of the 3.6 % of global gross domestic product that was as received as a result of criminal proceeds, 2.7% of it was laundered – an equivalence of USD 1.6 million (FATF, 2019). The 1998 statistics of the International Monetary Fund also estimated the size of money laundering to be between USD 590 billion and 1.5 trillion, which constituted between 2% and 5% of the world’s GDP (FATF, 2019). However, these figures are far from precise, as the clandestine nature of the crime makes it impossible for anyone to have accurate statistics on the magnitude of financial losses. It is very apparent that any country that subjects itself to those crimes causes much damage to itself. Perhaps, it is also an indication that there is still a lot of work to do with respect to knowledge of the repercussions of money laundering and terrorist financing as well as the essence of AML/CFT procedures and compliance.

Gradually, the world is beginning to appreciate the gravity of damage by financial crimes especially money laundering and terrorist financing. At least, it appears to be the case in research and academic circles. Evidently, the attention that scholars across the globe have given to issues pertaining to these phenomena has been observed to have increased over the years. Previous research on money laundering have covered areas such as typologies and emerging trends and threats in money laundering (Simser, 2012); the role of banks in Ghana in the fight against money

laundering (Nketsiah, 2013); conditions, environments and mechanisms that facilitate or impede money laundering (Dostov & Shust, 2014; Irwin, Slay, Choo, & Liu, 2014); the link between anti- money laundering and Enterprise Risk Management (Welbeck, 2015); factors hampering the implementation of international AML laws (Keesoony, 2016); the effectiveness of existent AML/CFT measures (Kemal, 2014; Teichmann, 2017) and the determinants of AML compliance in FATF member states (Mekpor et al., 2018). However, to the best of the researcher’s knowledge, little or no research has been done that links compliance to anti-money laundering/countering the financing of terrorism regulations and the inflows of foreign direct investment into a country.

It has been stated a number of times that money laundering and terrorist financing have a lot of ramifications at various levels. However, avoidance of the stated effects does not appear to be enough motivation for institutions and countries. It has also been conjectured that one major factor that has been identified as an impediment to AML/CFT compliance is the cost that is incurred. Perhaps, the perception is that the losses do not match up to the costs that are incurred in managing the menace. However, this is not the case, as the statistics indicate. Nonetheless, this research identifies the need to find a better motivation, from a financial viewpoint, for all entities to be compliant – one that would, to an extent, reduce, if not completely nullify the costs that accompany AML/CFT compliance. Foreign Direct Investment (FDI) has been seen to be very instrumental in a country. A positive relationship has generally been established between FDI and growth (Borensztein, Gregorio, & Lee, 1998; Li & Liu, 2005). Other benefits that the host country is known to receive are the transfer of knowledge and skill to domestic firms (Haddad & Harrison, 1993); provision of technology and innovation (Perez, 1997) and the maintenance of a healthy balance of payment (Kumari & Sharma, 2017). If various countries are aware that their actions pertaining to AML/CFT has an influence on the FDI they attract, they would be encouraged to be

more enthusiastic in their efforts. The purpose of this paper, therefore, is to examine the impact that AML/CFT compliance has on Foreign Direct Investment inflows.

        Research Objective

The objective of this paper is to investigate the impact that compliance with AML/CFT regulations has on Foreign Direct Investment influx in FATF member states.