Combating financial crimes during military conflicts
In collaboration with Dina Al Majzoub, CAMS
Introduction
While fears of an all-out military conflict between Israel and Hezbollah are growing, a wider conflict is set to affect market processes and create a complex ecosystem of economic and political relations.
At least 4 major military conflicts occurred every year in the last 30 years affecting global stability, ranging from international terrorism to various security issues, including neighboring country interference (Russia/Ukraine; Syria/Lebanon; Iraq/Iran; Azerbaijan/Armenia), internal ethnic conflicts (Sudan; Nigeria; Mali; Sudan), drug-related violence (Mexico; Colombia), and historical political or ideological disputes (India/Pakistan; Iran/Saudi Arabia). These conflicts directly affect the banking system because they progressively weaken financial integrity and provide organized crime with the chance to thrive.
As there is no specific governmental Anti-Money Laundering (AML) regulation or international standard about such circumstances, banks should analyze new compliance risks independently and map out strategic plans accordingly. The geopolitical risks of military conflicts cause fluctuations in the national financial systems’ stability and exchange rates, which, in turn, have a direct impact on the patterns of customer behavior. Clients create new realities within the financial sector at a pace that regulators can hardly keep up with. From this perspective, the Anti-Financial Crime system of a bank should identify and mitigate the following three types of risk:
I. Flourishment of corruption
The military sector is one of the most capital-intensive sectors and inherently prone to corruption. Military corruption fundamentally differs in its composition and geography from crimes that occur outside the conflict area. It takes place in all the stages of an armed conflict (preparation, engagement, and postwar restoration).
1) Military corruption from deployment plans
The preparation for war includes massive expenditures on armaments and military training, but also commodities imports (fuel; medical supplies). The preparations for armed aggression against Lebanon are highly susceptible to be accompanied by corruption risks associated with speculative overpricing at the level of intermediary firms. Such corruption differs from the classical theft of budget funds in that real (as opposed to shell) companies serve as intermediaries to cover corrupt elements.
By classifying the nature of their payments using the client’s Know-Your-Customer (KYC) profile, banks can have the ability to flag such risks. Banks should identify suspicious patterns, such as frequent large payments to intermediary firms without clear justification and report suspicious activities to relevant authorities accordingly.
2) Military corruption by PEPs
Banks need to acknowledge that Politically Exposed Persons (PEPs) in military corruption pose extremely high risks. Military corruption by PEPs tends to revolve around the securing of expensive contracts or changing their terms. For example, when associates of Israel’s Prime Minister, Benjamin Netanyahu, were involved in a vast bribery scandal for purchasing naval vessels (called “Submarine Affair”), this case revealed large transactions between American and European banks with remarkably high risks from PEPs within military corruption.
To mitigate such risks, KYC compliance staff should proactively update identification data and confirm the legal origin of funds in a suspicious transaction, as recommended by the FATF.
3) Dilution of control functions
State resources focus on combat requirements during the crisis, which dilutes audit and control functions for both the public and private sectors and contributes to domestic corruption.
Although this kind of corruption often translates into more stable foreign currency inflows (case of the UAE), banks should monitor such inflows through an enhanced customer deposit monitoring system and the reinforcement of geographic controls.
4) Corruption from reconstruction deals
Another type of military corruption relates to non-transparent deals in restoring post-war sites. This type takes the form of civil construction projects associated with lower corruption levels. Typically, shell companies set up in relaxed AML standards jurisdictions and consulting agreements facilitate such schemes.
Among the red flags for AML compliance officers are a lack of (or outdated) company information and jurisdictional discrepancies.
II. Vulnerability of refugees
Military confrontations always lead to significant civilian casualties and mass population movements, which act as a spur to crime. Some of the high compliance risks in refugee situations are the smuggling of migrants, ethnic crimes, and tax crimes.
1) Smuggling of migrants
While legally distinct, human trafficking and smuggling have considerable overlap in the financial crime realm. Human trafficking is exploitation-based; smuggling is a crime of illegal border-crossing for profit. Smuggling enterprises primarily deal in cash to pay off bribes and other fees, so banks cannot easily detect money laundering attempts by the beneficiaries.
However, AML officers may focus on SMEs with high cash-generating potential in the service industry which would be most at risk in these smuggling operations.
2) Ethnicity-based crimes
Ethnic crime groups often focus on specific types of crime and operate within particular geographic areas. This specialization helps them exploit local vulnerabilities and evade detection.
To detect AML risks in ethnic crimes, it is necessary to apply KYC protocols based on behavioral patterns in identifying the user. Undocumented immigrants who belong to an ethnic crime often make use of others’ accounts to make payments (mainly small amounts transactions).
3) Tax crimes
Tax crimes may be committed when local enterprises employ refugees who do not have a work permit by paying them in cash to avoid official payroll systems and tax obligations, leading to tax evasion. This pattern leads to a rise in informal financial systems operating outside the regulated financial sector, thus promoting money laundering in the absence of checks.
There are fewer targeted compliance measures for such cases making it easier for businesses to bypass legal requirements.
III. Evasion of sanctions
Recent military conflicts usually occur within a context of economic sanctions imposed by international organizations (such as the United Nations Security Council) or sovereign jurisdictions (such as the U.S.A., the U.K. and the E.U.). The purpose of such sanction regimes is either to prevent the conflict from escalating or to support one party of the conflict (Russia/Ukraine; Israel/Hezbollah; Sudanese Armed Forces/Rapid Support Forces; Iraq/US-led coalition). These regimes force the sanctioned groups to find alternative procurement channels and supply chains, typically by circumventing the established financial system routes.
1) Distortion of market processes
Economic sanctions distort market processes and reconfigure payment geographies. They create artificial barriers and restrictions that alter the natural flow of goods, services, and capital. Sanctioned groups tend to resort to alternative sophisticated financial mechanisms to bypass restrictions on payments, making it difficult for observers to determine what is happening with incoming and outgoing payments. This reconfiguration changes the traditional geography of payments, often diverting them through less transparent channels.
2) Sophisticated financial mechanisms
These transactions can be considered as having significant compliance risks and banks are required to track payment dynamics and structure for every new financial mechanism. This may involve using enhanced due diligence measures to investigate the background and purpose of such transactions and applying continuous monitoring by regularly reviewing transaction patterns to detect suspicious activities. If applicable, advanced analytics technology may help to analyze large volumes of data and identify potential compliance risks.
Conclusion
Corruption in military conflicts is a consistent feature, requiring banks to implement unique compliance controls, even if geographically remote from the conflict area.
Amid escalating concerns of a full-scale conflict between Israel and Hezbollah, Lebanese banks need to realize that the risks of military conflicts are not only physical risks from the war theatres but also enormous compliance risks. These risks emanate from their clients or other banks that have to do with military conflicts. Banks are accordingly required to elevate their compliance controls to mitigate risks of carrying out illegal activities, falling into sanctions, or being burdened with risks at both the reputational and regulatory levels.
