Unintended Consequences of Anti-Money Laundering and Combating the Financing of Terrorism (AML/CFT)

Abstract

Money laundering is illegal world-wide and constitutes a significant economic inefficiency. One must wonder why current anti-money laundering and combating the financing (AML/CFT) efforts are primarily driven by the threat of terrorism and drug-trafficking when the overwhelming majority of illicit money flows is due to other causes, primarily fraud. The significant costs imposed on financial institutions, together with ever increasing levels of regulation mandated by AML/CFT efforts and the minuscule in comparison illicit money flows intercepted by these efforts has thereby resulted in both moral hazard and conflicts of interest for financial institutions. Furthermore, AML/CFT efforts take on a new meaning when one realizes that illicit money, flows not only through traditional banks but also shadow banks and other non-bank financial intermediaries. The costs of compliance are enormous in comparison to the benefits with the “war on terrorism” superseding the more relaxed “war on drugs”, although even the latter was onerous in comparison to the even more relaxed efforts against the more widespread “white-collar” crime of fraud. In this paper, we trace the evolution of the present AML/CFT regime while at the same time assessing the costs and benefits of this government initiative on the efficiency of the financial system both in modern advanced economies and as well as the less developed economies of the world.