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Előd Takáts International Monetary Fund. A Theory of “Crying Wolf”. The Economics of Money Laundering Enforcement. The views expressed herein are those of the author and should not be attributed to the IMF, its Executive Board, or its management. Roadmap. Money laundering Related literature

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A theory of crying wolf l.jpg

Előd Takáts

International Monetary Fund

A Theory of “Crying Wolf”

The Economics ofMoney Laundering Enforcement

The views expressed herein are those of the author and should not be attributed to the IMF, its Executive Board, or its management.


Roadmap l.jpg
Roadmap

  • Money laundering

  • Related literature

  • Model and Analysis

    • Information Laffer curve

  • Empirical evidence

  • Policy implications

  • General crying wolf problem


Money laundering l.jpg
Money Laundering

  • Definition: illicit transfer

    • Traditional

    • Terrorism financing

  • Predicate crimes

    • Drug dealing, tax evasion, terrorism

  • Importance

    • Funds moved: $0.6-1.5 trillion half through US

    • Harm: even larger

    • Revenues: 5-15%

    • Public interest


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Bank Reporting

  • Reports

    • Rule based reports (standard)

    • Discretionary reports (new problem): SAR

  • SAR (Suspicious Activity Report)

    • Bank expertise and judgment

    • “Constructive ambiguity”

  • Bank’s incentive to report: fines

    • Fines for false negatives


Problem outline l.jpg

fines

report

investigation

monitor

signal

Problem: Outline

Government

Bank

Transaction


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Economics

  • Building blocks:

    • Coarse communication

    • Coarse incentives (fines for false negatives)

    • Uncertainty

    • Dual task: monitor and report

    • No ex-post state verification

  • Policy implications

    • Optimal fines (1-3) to avoid crying wolf

    • Reporting fees (4)

    • Increased harm, lower fines (2)


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Information Laffer curve

# Prosecution

# Reporting

Fines

F’

F*

F**


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Information Laffer curve

# Prosecution

# Reporting

Fines


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Some Evidence

  • Empirical predictions:

    • Fines: increase

    • SAR: increase

    • Prosecution: Humped shaped curve

  • Data consistent



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Further Evidence

  • FinCEN (April 2005) on ‘defensive filing’:

  • We estimate that if current filing trends continue, the total number of Suspicious Activity Reports filed this year will far surpass those filed in the previous years.

  • …it fuels our concern that financial institutions are becoming increasingly convinced that the key to avoiding regulatory and criminal scrutiny under the Banking Secrecy Act is to file more reports, regardless of whether the conduct or transaction identified is suspicious. …

  • If this trend continues, consumers of the data - law enforcement, regulatory agencies, and intelligence agencies - will suffer.


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Policy Implications

  • Decrease fines to stop crying wolf (Prop 2)

    • Lower nominal fines (OCC internal memo, 2005)

    • Centralize prosecution (Attorneys’ Manual, 2005)

    • ‘Safe harbor’ for sound processes

  • Introduce reporting fees (Lemma 4)

    • Price externality of information dilution

    • Or longer reports: higher cost, less coarseness

  • New angle on Patriot Act (Lemma 8, 9)

    • Fine increase: intuitive, but wrong reaction



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Conclusion

  • Contribution

    • First step: money laundering enforcement

    • Implementable policy recommendations

    • General crying wolf problem

  • Application: auditing

    • Crying wolf and material transactions

  • General lesson

    • Information= data + filtering

    • Crying wolf: filtering

    • Information age: abundant data, needed filtering


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