Cracking down on financial crimes

Finance Minister Clyde Caruana said recently that “there is an element” of Malta being a nation of tax dodgers.

Financial crime is a huge business for criminal organisations. According to the United Nations Office on Drugs and Crime (UNODC), it is estimated that up to $2 trillion of illicit funds are laundered through global financial networks every year   ̶   equivalent to 3.6% of global GDP   ̶   and it is increasing each year.  Worldwide, 90% of money laundering crimes go undetected due to the highly complex nature of financial services.

Financial crimes lead to substantial losses in government tax revenues, impacting public finances.  In particular, tax evasion is a major factor in this loss. The Tax Justice Network estimates the annual global loss of tax revenue due to tax evasion at US$312 billion a year, roughly equivalent to the GDP of Finland. This loss hampers governments’ ability to finance essential services such as healthcare, education, and infrastructure development.

Moreover, financial crimes such as fraud and money laundering also have marked economic consequences for businesses. An Association of Certified Fraud Examiners (ACFE) report puts the loss due to fraud to organisations at around 5% of their annual revenue, translating to about $3.6 billion annually.

An interim report published by the High-Level Panel on International Financial Accountability, Transparency, and Integrity (FACT) stated that resources that could help the world’s poor are being drained by tax abuse, corruption, and financial crime. Its estimates include $500 billion losses to governments each year from profit-shifting enterprises and $7 trillion in private wealth hidden in haven countries, with 10% of world GDP held offshore.

A report by the global audit and consultancy firm Deloitte and the Institute of International Finance under the title The global framework for fighting financial crimepointed out that, in the European Union alone, less than 1% of illicit financial flows are intercepted, and this does not take into account the fact that illicit proceeds do not always make their way into the financial system. This cross-border criminal finance supports some of the worst problems confronting society today, including terrorism, sexual exploitation, modern slavery, wildlife poaching, and drug smuggling.

The situation in Malta

It is no different in Malta.  Finance Minister Clyde Caruana said recently that “there is an element” of Malta being a nation of tax dodgers, and substantiated this claim by revealing that, in 2019, when the economy was doing well just before Covid hit and the country’s growth rate was 6% in real terms, just 35 to 40% of businesses were declaring they were making a profit. The rest were declaring a breakeven or even a loss.

Again, on another recent occasion the Minister revealed that more than half of businesses in Malta are not VAT compliant.  The Inland Revenue Department estimated that the government is losing out on between €120 and €150 million through VAT evasion every year.  The introduction of AI-powered software last year seems to be having an effect already, alerting the authorities when a person or business’s declared income does not tally with their accumulated wealth.   The €3 million spent on the software will have been well worth it, probably being repaid in well under a year through higher revenue.

Ignoring the threat from financial crimes can do untold damage.  Thus, the website Sanctions Scanner says that “Malta’s flourishing economic landscape draws financial misconduct like a magnet.  Money laundering and corruption cause great damage to Malta’s financial landscape. The public trust has been shaken due to the allegations of high-level politicians and officials being involved in organised crime activities.“

The website mentions the notorious Pilatus Bank scandal, which revealed alleged money laundering schemes involving offshore entities and influential individuals, while Malta’s reputation as a tax haven has attracted individuals seeking to evade taxes through intricate schemes.  The interconnectedness of corruption and financial crime with politics and government, with a potential to facilitate political bribery and undue influence by private interests, have also raised concerns.

With the onset of the digital age, Malta has witnessed a surge in financial scams, with a proliferation of online scams and Ponzi schemes. The aftermath of the tragic murder of journalist Daphne Caruana Galizia uncovered the inner workings of financial crimes. This included fraudulent financial activities that preyed on unsuspecting victims, which undermined both individual financial security and overall trust in the financial sector.

A globalised, digitalised world

Global finance controls haven’t kept pace with a globalised, digitalised world. The International Consortium of Investigative Journalists, in its 2020 FinCen Files, revealed how some of the biggest banks have allowed criminals to move around $2tn of dirty money around the world.

Financial crimes can also affect financial markets stability and undermine investor confidence, not to mention the impact on investment and business growth. Investors are less inclined to invest in countries or businesses with a high risk of financial crime.  This means that countries with weak anti-money laundering regulations and enforcement will probably face reduced investment, economic growth, and competitiveness.

Financial crimes also result in the diversion of resources from productive sectors to illegal activities. This is because such crimes create distorted incentives and undermine the rule of law, impeding economic development.

Another negative side-effect is that financial crimes have implications for income distribution and poverty reduction.  For example, the benefits of economic growth are not distributed equitably in countries with high financial crimes. In these circumstances, it becomes more difficult to achieve the UN’s Sustainable Development Goals (SDGs), as poverty reduction programmes and economic growth are undercut while the fight against corruption suffers a setback.

Corruption is rife in many countries where governance and transparency in the public administration is lacking.  Suffice to say that, according to Transparency International, Malta ranks poorly in a world corruption index, placing only in 54th place with a score of 51 and is almost at the bottom of the EU rankings  ̶  our score is the lowest in a decade.

Impacts

There are several well-known instances of these consequences.  One of the best known was the collapse of Lehman Brothers in 2008.  The bank’s overreliance on complex and risky financial instruments such as mortgage-backed securities, collateralised debt obligations (CDOs), and credit default swaps (CDSs) and its aggressive accounting   ̶   triggered by fraud, deception and mismanagement   ̶   led to the worst economic downturn since the Great Depression.

Another noteworthy impact is the erosion of public trust in institutions. Financial crimes are known to undermine the legitimacy of financial systems, governments, and other institutions, corroding public confidence in them. The Edelman Trust Barometer 2023 reports that only 39% of respondents worldwide trusted their governments to do what was right.  A recent Eurobarometer survey showed that only 36% of Maltese tend to trust their government (the figure represents a significant decline from 63% in January and 43% in June).

Financial crimes have also been blamed for income disparities and social unrest. In a landmark 1998 study titled Does Corruption Affect Income Inequality and Poverty?, empirical evidence gathered by the International Monetary Fund (IMF) showed that income inequality increased significantly in countries with high levels of corruption.  The concentration of wealth and power in the hands of a tiny minority can exacerbate social tensions, leading to protests and even violent conflict. Both the Gini coefficient and the S80/20 ratio have worsened in Malta since 2013, indicating greater income disparities.

Inequality can also create barriers to economic growth and development, as resources are not distributed equitably, and the poor cannot access opportunities. This, in turn, can perpetuate cycles of poverty and undermine social mobility.

Perhaps the most significant danger of financial crimes is their link to other illicit activities, such as organised crime and terrorism. Money laundering, fraud, and bribery can provide the funds needed to finance these activities, which can have devastating consequences for global security. These funds can finance the drug trade, human trafficking, and terrorist activities. The UNODC states that $1.1-$2.1 billion are earned by drug traffickers annually.

A moving target

Crime is a moving target. Bad actors are also embracing new technologies on top of their traditional techniques. Secret US government documents reveal that JPMorgan Chase, HSBC, and other big banks have defied money laundering crackdowns by moving staggering sums of illicit cash for shadowy characters and criminal networks that have spread chaos and undermined democracy around the world. The banks concerned kept profiting from powerful and dangerous players even after US authorities fined these financial institutions for earlier failures to stem flows of dirty money.

Strengthening safeguards

The international community has made significant progress toward strengthening safeguards against money laundering and terrorist financing, with help from the IMF and other organisations. The Financial Action Task Force, which is the international standard-setter in this area, has been very active in these efforts.  We all know how hard it came down on Malta when it put us on the Grey List.

Malta has pulled up its straps, after several years when it kept ignoring warnings from various international institutions.  Thank God, we exited the Grey List quite quickly but this does not mean that we can flag in implementing a strong strategy on anti-money laundering and combatting the financing of terrorism.  Addressing critical financial integrity issues remains a challenge.  Often, there remains a major gap between progress on technical compliance, such as enacting new laws, and the effectiveness of these efforts.

For example, very little laundered ill-gotten proceeds are ever confiscated. Suffice to say that an Asset Recovery Bureau that was set up in 2015 had only recovered a risible €2,760 in criminal assets by 2018.  The Bureau somewhat awoke out of its slumber lately and in 2023 managed to collect €5m. That is still a drop in the ocean. 

The multifaceted impact of money laundering reverberates across the local landscape, as it does elsewhere, infiltrating businesses and the economy.  Only a robust and comprehensive anti-money laundering (AML) compliance programme can counteract the severe and extensive effects of this illicit practice.  AML is a safeguard, not only against financial institutions unwittingly drawn into the web of money laundering but also against the erosion of trust within the economy.  This is especially important in Malta, where the financial sector is a critical pillar of economic growth.

One of the areas that remains a concern is the enforcement of penalties and sanctions for financial crimes.  Though we have severe penalties, ranging from hefty fines to imprisonment and asset forfeiture, their enforcement remains a problem. We have had several instances of MFSA and FIAU fines being challenged and overturned in the courts.  What is holding the government back from introducing legislation that addresses this problem is beyond me.

Lastly, action is also required to mount a strong and regular education campaign to mitigate the risks associated with financial crimes by raising awareness, implement robust prevention and detection strategies, and enforce compliance with regulatory frameworks.  The Government, businesses, and individuals all have a role to play in combating financial crimes. 

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