Banking: Crime and Compliance

Spearhead Analysis – 30.08.2016

By Farrukh Karamat
Senior Research Coordinator, Spearhead Research


The financial crisis triggered in 2007, unleashed a series of far-reaching consequences including, stringent changes to the regulatory regime and the imposition of heavy penalties on Banks. Some Economists viewed this crisis as being one of the worst since the Great Depression of the 1930s. Billions of dollars have been paid out in fines since 2007 not just for the misdeeds pertaining to risky toxic assets, such as the mortgage-backed securities, but for the ongoing misdemeanors by the financial sector. These fines have covered violations such as market manipulation, sanctions, money laundering, tax evasion, lending and consumer practices, mortgage-backed securities, foreclosures, mergers and acquisitions, and mortgage repurchases.

Table-1: Global Penalties by US Regulators

Global Penalties by US Regulators

With investigations initiated by the different US Regulatory bodies, penalties and settlements totaling some US$161 Billion have been paid out by financial institutions during the period 2007-2015. During the period penalties for market manipulation, sanctions, money laundering, tax evasion, lending and consumer practices totaled US$45.25 Billion and accounted for 28.1% of the total payout by the banks. A hefty 71.9% of the penalties revolved around mortgage-related activities. For the total penalties and settlements of US$161 Billion, US banks accounted for 77.5% and non-US Banks 22.5%. Bank of America has been one of the largest offenders, having paid out in excess of US$55 Billion during the period. It is estimated that in total the scale of the payout was roughly equivalent to the annual economy of Greece or Portugal (Reuters).

Table-2: Year-wise Penalties on Banks


As can be seen in Table-2 the scale of global financial penalties has been rising for both the US and non-US based banks. Thus, while regulatory enforcement is being tightened there is an incidence of rising violations as well.

The fines have impacted many banks’ capacity to rebuild capital, reduced dividends for investors, and cut the amount available for lending. It is expected that the misconduct bill will continue to rise. While changes have been implemented a lot more needs to be done. We still continue to hear of millions being paid out as penalties by financial institutions. HSBC and Standard Chartered, two banks well known in the region have recently been fined for global sanctions and money laundering violations by US regulators. So while the regulators continue to try and tighten the noose, a culture shift is required within the financial institutions to bring about a paradigm shift.

Perhaps, Mark Taylor, the Dean of Business School at University of Warwick and a former FX trader has put this in the proper perspective,

“The problem is the incentives for cheating markets are massive. If you can shift a rate fractionally you can make millions and millions of dollars for your bank and then for bonuses. Once senior executives feel they are personally at risk if the culture doesn’t change, and individual traders feel they are at risk of being put in prison, then you will get a culture change,”

Internationally, Banks have invested a lot of money in their Compliance programmes, in terms of systems, personnel and training. Efforts are being made to bring about a culture shift to be in Compliance and to avoid violations. With enhanced scrutiny and given time it is expected that violations such as the one that perpetuated the 2007 financial crisis would be avoidable.

With the risk of operating overseas branches and the potential impact of penalties for violations within a strict regulatory regime, how does this bode for the Pakistan based banks? There are estimated to be over a hundred overseas branches and offices of Pakistani banks. They have to operate as per the laws of the local countries. Given the debacle over the closure of the once mighty BCCI, Pakistan banks need to be extra cautious to avoid raising any red-flags with the regulators.

There have been instances when the Pakistan banks have run afoul of the international regulators:

  • At one point prior to its privatization Habib Bank Limited was almost closed down in the United Kingdom by the Financial Services Authority (FSA) and was later re-structured as Habib-Allied Bank.

  • In 2008 a Paris court fined the National Bank of Pakistan 200,000 Euros and gave two-year suspended jail sentences to two of its bosses for their role in a money laundering scheme. Two other bank executives were acquitted after the trial that examined charges against four banks and 151 people accused of involvement in a scam that sent cheques back and forth between France and Israel between 1996 and 2001.

  • In 2015 there was news that since 2011 the US Federal Reserve barred Habib Bank Limited from conducting any dollar-clearing transactions or accepting any new accounts for US dollar clearing because the bank was not in compliance with US anti-money laundering laws. As per Fed’s assessment HBL’s risk management had broken down, as well as its compliance with laws such as the Bank Secrecy Act and regulations issued by the US Treasury Department. Additional remedial and risk management requirements were placed on the Bank.

  • In 2015 OFAC fined the New York Branch of National Bank of Pakistan US$28,800 for 7 wire transfers made to an entity on OFAC’s list of Specially Designated Nationals, totaling $55,952.14. The bank’s sanctions compliance software failed to generate an alert warning and it processed all 7 transactions in violation of US sanctions. The total base penalty amount for the violations was $64,000, but the bank’s conduct was mitigated by, the fact that the violations were the result of a software error and so no one at the bank was aware of the violations.

  • In August 2016 there was news that the only US branch of Habib Bank Limited was been slapped a strict enforcement order by United States Federal Reserve after significant breakdowns were identified in the Branch’s anti-money-laundering program which was found to be not in compliance with US federal laws. As per the Wall Street Journal, following the enforcement order Habib Bank had been stopped from opening new dollar-clearing accounts, which are one of the US services to send and receive dollars from abroad, or even correspondent accounts with foreign banks.

The State Bank of Pakistan and the Banking sector operate under a policy that allows the relatively free movement of foreign currency in and out of the country, which could have ramifications, given the emphasis by international regulators, who are trying to curb activities under AMLTF and Sanctions laws.

The Protection of Economic Reforms Act, 1992 in Pakistan categorically states:

“The provisions of this Act shall have effect notwithstanding anything contained in the Foreign Exchange Regulation Act, 1947 (VII of 1947), the Customs Act, 1969 (IV of 1969), the Income Tax Ordinance, 1979 (XXXI of 1979), or any other law for the time being in force.”

“All citizens of Pakistan resident in Pakistan or outside Pakistan and all other persons shall be entitled and free to bring, hold, sell, transfer and take out foreign exchange within or out of Pakistan in any form and shall not be required to make foreign currency declaration at any stage nor shall anyone be questioned in regard to the same.”

“All citizens of Pakistan resident in Pakistan or outside Pakistan who hold foreign currency accounts in Pakistan and all other persons who hold such accounts, shall continue to enjoy immunity against any enquiry from the Income Tax Department or any other taxation authority as to the source of financing of the foreign currency accounts.

  • The balances in the foreign currency accounts and income there from shall continue to remain exempted from the levy of wealth-tax and income tax and compulsory deduction of zakat at source.

  • Te banks shall maintain complete secrecy in respect of transactions in the foreign currency accounts.

  • The State Bank of Pakistan or other banks shall not impose any restrictions on deposits in and withdrawals from the foreign currency accounts and restrictions if any shall stand withdrawn forthwith.”

Given the Act, Pakistan Banks need to establish stringent independent Compliance programmes to ensure that all Money Laundering and Terrorist Financing Laws as well as Sanctions regulations are being met. A culture of compliance needs to be instilled among the Banks and in order to monitor the overseas banking sector it is no longer sufficient to send an audit or compliance team from Pakistan for 2-3 weeks to review the overseas branches. Such teams are often ill-equipped to understand and interpret the international regulations. The State bank of Pakistan needs to ensure that the overseas branches have independent systems and qualified personnel in place to ensure compliance with the relevant laws. Compliance training, resources, and processes need to be implemented as any lapse in this regard, as the potential scale of penalties that have been imposed on the banking sector globally could inflict potentially irreparable damage on the financial system of the country.