The pressing issues for banks today are many. Apart from known concerns like capital and figuring out how to comply with the requirements of Basel III, I see that the enforcement of sanctions and embargoes is the nightmare that is really keeping bankers awake at night.
Let’s start with the obvious. Sanctions and embargoes are political trade restrictions put in place against specific countries with the aim of maintaining or restoring international peace and security. Mostly, they are political trade tools imposed by the United Nations, the European Union, and the United States, which are known to place some of the most severe sanctions in the world.
Sanctions are divided into several categories, such as diplomatic sanctions, military sanctions, and athletic sanctions. Furthermore, the UN Security Council implements sanctions on political leaders or economic individuals.
Sanctions are normally imposed for different reasons, often to force cooperation with international law like in Iraq, to contain a threat to peace within a geographical boundary like in Iran, to maintain respect for human rights, democracy, and the rule of law, to prevent weapons from falling into the wrong hands and disrupt terrorist operations, and to change the policies and actions of the targeted country.
It is essential for banks that have international operations to pay attention to, and to stay up-to-date with, the developments of sanctions, because violating sanctions can be very expensive. In countries like the US, violations can result in huge monetary penalties, or even criminal penalties. Hence, it is crucial to highlight that sanctions imposed by the US, primarily those imposed by the US treasury office of foreign assets control (OFAC), have extraterritorial impact on all banks and financial institutions that carry out transactions in US dollars.
Banks should be very careful transacting business with US sanctioned individuals, entities, or countries. The US enforces sanctions more aggressively than other countries by applying heavy penalties on those who violate the sanctions. That is why the OFAC screening and other compliance mechanisms have become important requirements of an effective sanctions programme in most banks and financial institutions. In 2009, the OFAC levied fines and settlements of about $5m. In 2015, that number went up to $6bn. That would suggest that it is a real and growing problem.
Unlike the harsh US sanctions, the EU’s enforcement is a matter of national authorities. Thus, sanction enforcements are less commonplace. There is relatively little published enforcement, with many cases settled far from the public eye.
Having said all that about sanctions, I presume that compliance officers and those bankers who handle international banking operations would find it hard to sleep at night. In banks, the risk is far too high because of the massive numbers of transactions executed every day. Moreover, due to the complexity and cross-border nature of financial transactions and the nature of financial instruments, banks and other financial institutions are exposed to high risk and therefore, are more prone to be the focus of enforcement activity.
I tend to believe that large international and regional banks with branches or subsidiaries in sanctioned countries are more exposed to sanctions than other industries. Sanctions can also apply to smaller banks that deal with high-risk markets that have large numbers of sanctioned parties. Nonetheless, it is wrong to assume that only banks and other financial institutions are affected by the rules of a sanction. Any sector, which involves cross-border transactions with individuals and entities in countries affected by sanctioned regimes, can be at risk of breach.
It is inevitable that automated sanction filters must be used as an integral element of a robust sanctions screening programme. At any point in time there are about 40,000 names on sanctions lists. One might think, well it is easy, and it may be for countries like Cuba, South Korea, Syria, Iraq, and Iran. However, there are second order names that appear on those lists because it does not only include countries that necessarily trade directly. There can be companies that can be listed as second and third order.
The problem with the sanctions lists is they include 40,000 names at any point in time. However, if we start to look at different names, different languages, and different alphabets such as Chinese, Japanese, and Arabic, it gets very complicated. There are also all sorts of fuzzy combinations that might be there. At any point in time, there could be up to 4 billion search criteria out there, according to sanction experts.
Irrespective of the legal jurisdiction, some common process elements need to be in place. The onus is on the financial institutions to prove that they have a process in place. This process includes a series of formal, repeated checks, consistency, accuracy, and a degree of auditability with escalation in place, so that if someone is flagged the appropriate actions are conducted.
Finally, here are simple straightforward compliance tips. Ensure that “know your customer” checks are undertaken, especially when trading with sanctioned countries. Check what financial restrictions are in place on receiving money from sanctioned countries and persons. Know which countries, entities, and individuals are sanctioned.
