Financial Transparency Coalition

Photo: Ian Britton, FreeFoto.com

I read an article from The Wall Street Journal (WSJ) today detailing the settlement of charges by United States and New York prosecutors against UK-based Barclays PLC for accepting money from sanctioned countries.  The bank was accused of concealing the origins of and then accepting money from Cuba, Libya, Iran and other sanctioned countries whose money may not legally enter the United States.

According to U.S. prosecutors, Barclays followed instructions from foreign banks to omit their names from payment messages.  Barclays also routed certain payments through an internal account so they would appear to be coming from Barclays rather than a bank in Iran or Cuba…In one email referenced by prosecutors, an employee wrote about how to avoid detection: “A good example is Cuba which the US says we shouldn’t do business with but we do.”

It sounds like good news, but is it?  Unfortunately, this case is not likely to change the behavior of banks – maybe not even Barclays.  The agreed upon fine, $298 million, is the same amount that Barclays claims to have processed in payments from these countries between 1995 and 2006. (The Justice Department says that an internal review came up with $500 million as the value of the illicit transactions.)  According to the WSJ, Barclays earned $4.6 billion in profits for the first six months of 2010, which is already far in excess of the value of the fine.  Furthermore, from 1995-2006, Barclays reported pre-tax profits of roughly £40.5 billion, which, if you will permit me the liberty of using current exchanges rates, is approximately US$63.31 billion.  A fine of $298 million then is only about 0.5% of the profit Barclays earned during the12-year period of the illicit activity!

At the same time, it is safe to assume that Barclays has been investing for profit the money it earned from fees for processing these payments from the sanctioned countries.   On the downside for Barclays, its reputation may be tarnished by the charges.  The value of any lost business as a result would be hard to quantify, but I think it’s fair to assume that it is/will probably not be greater than the value derived from the illicit transactions it processed (otherwise the bank, a profit-maximizing entity, would not have accepted the risk of the activities in question).  This leads me to conclude that if Barclays and other banks were to run a cost-benefit analysis of accepting money from sanctioned countries, they may still find it profitable and continue to take the money, because the risks and costs associated with accepting or processing illicit money may not outweigh the financial benefits derived from these monies.  Also remember that $298 million is only what we know about…

The United States government needs to change its disincentive/penalty structure, and increase the potential costs to banks.  It could attempt to do so by significantly increasing the fine a company would face if caught, but the nature of settlements and the fact that each bank’s balance sheets are different poses challenges to the effectiveness of this strategy.

The most effective measure would be to deny access to the United States for banks caught flouting its laws.  This “stick” was used to great effect post 9/11 with the Patriot Act to virtually shut down shell banks around the globe. Fortunately, at least someone at the US Treasury Department seems to be on the same wave-length.  Yesterday Treasury sent out a fact sheet on new Iranian Financial Sanctions Regulations:

Under these regulations, Treasury will close down or severely restrict the access of foreign financial institutions to the United States if they engage in any of a range of activities involving designated Iranian proliferation or terrorist entities.

Treasury Official Stuart Levy is out discussing the new regulations with foreign banks.  The WSJ had a very apt quote from him: “This is new in the sense that it puts at risk something that’s very important to every financial institution, namely their access to the United States.”  Cue the flashing light bulb on the thinking cap!

Kudos to the US Treasury Department for taking this step, but they shouldn’t stop with Iran.  Banks should face the same consequence for receiving money from all sanctioned countries, people, and activities (drugs, trafficking, etc.).  Fines are a joke; access to US financial markets is serious.  The United States government has to be serious if it wants banks to take the laws seriously.