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The consequences of a poor anti-money laundering program: the HSBC case study

On 17 July 2012, the United States Senate Permanent Subcommittee on Investigations (the Committee) released a lengthy report detailing significant deficiencies in the anti-money laundering (AML) and counter-terrorism financing systems of one of the largest banks in the world.  The report is the result of a year-long inquiry by the Committee involving over 75 interviews and the examination of more than 1.4 million documents.  It reveals a long history of weak anti-money laundering controls resulting in the misuse of HSBC’s key US affiliate to launder the proceeds of drug trafficking, circumvent the prohibitions designed to prevent funds from being directed to rogue jurisdictions and to provide US dollars to banks linked to terrorist financing.

The Committee chose to focus on HSBC as a case study to examine the current money laundering and terrorist financing threats associated with correspondent banking.  Correspondent banking involves the provision of financial services, such as moving funds, exchanging currency or cashing monetary instruments, by one financial institution to another, where the two institutions are based in different countries.  The Committee focused on a range of ongoing risks associated with correspondent banking, as well as the regulatory failures that it states allowed AML problems within HSBC to ‘fester for years’ (p. 4).  Some of the risks illustrated in the report are summarised below.

High risk affiliates

Since 2002, US AML laws have required all US banks to conduct due diligence reviews before opening a correspondent account for any foreign financial institution.  Despite this, HSBC’s key US affiliate, HBSC Bank USA N.A. (HBUS) continued to open and operate correspondent accounts for other HSBC affiliates without conducting any AML due diligence and with insufficient monitoring.
One of the many HSBC affiliates for which HBUS opened a correspondent account was HBSC Mexico, or HBMX.  HBMX operated in a high risk country, had high risk clients and offered high risk products such as US dollar accounts in the Cayman Islands.  It also had a history of severe AML deficiencies.  Yet it was treated by HBUS as low risk.
In addition, HBUS failed to conduct any AML monitoring of bulk cash transactions from HSBC affiliates for a three year period, during which time it accepted over US$15 billion in cash from them.  From 2007 to 2008, HBMX was the single largest exporter of US dollars to HBUS, shipping US$7 billion in cash to HBUS in that time, more than any of the four larger Mexican banks.  Both Mexican and US authorities have expressed concerns that bulk cash shipments could only have reached that volume if they included the proceeds of drug trafficking.
Circumventing prohibitions put in place by the Office of Foreign Assets Control (OFAC)
OFACmaintains a list of prohibited persons and countries that US banks use to create a filter to identify and halt potentially prohibited transactions (such as those that could lead to funds being directed to terrorists, persons involved with weapons of mass destruction and rogue jurisdictions).  The list serves a similar purpose to the Consolidated List maintained by Australia’s Department of Foreign Affairs and Trade, and lists countries and individuals subject to United Nations sanctions as well as those subject to US sanctions.
The Committee received documents indicating that HSBC affiliates took actions to circumvent the OFAC filter when sending certain transactions through their US dollar correspondent accounts at HBUS.  An independent auditor hired by HBUS has identified over 28 000 undisclosed OFAC sensitive transactions sent through HBUS between 2001 to 2007, worth US$19.7 billion.  The review has identified 2600 of those transactions, 79 of which involved Iran, as ‘Transactions of Interest’ requiring further analysis.  While internal documents showed that senior HBUS officials were informed of the problem as early as 2001, there was no effective action taken to halt the practice. Potentially prohibited transactions continued to be sent to Burma, Cuba, North Korea and Sudan, among others, until at least 2007.
Disregarding links to terrorism
HSBC has been one of the most active global banks in the Middle East, Asia and Africa.  It has conducted substantial banking activities in Saudi Arabia, both through affiliates and business with the Al Rajhi Bank.  Following the 11 September 2001 terrorist attacks, evidence emerged that Al Rajhi Bank and some of its owners had links to financing organisations associated with terrorism (including that the bank’s key founder was an early financial benefactor of al Qaeda).  On the basis of such information, HBUS closed the correspondent banking and banknotes accounts it had provided to the bank.  However, when Al Rajhi Bank threatened to end all business with HSBC unless it was given access to HBUS’s US banknotes program, it agreed to resume supplying shipments of US dollars.  HBUS provided almost US$1 billion to Al Rajhi Bank between 2006 and 2010, when HSBC decided to withdraw from the banknotes business.  It also supplied US dollars to two other banks despite similar evidence of links to terrorist financing.
Regulatory failures
When reading the Committee’s report, an obvious question springs to mind: what were the regulators doing as these problems unfolded?
The Office of the Comptroller of the Currency (OCC) is responsible for chartering, regulating and supervising all US banks that hold a national charter, and became HBUS’s primary regulator in 2004.  The OCC oversaw HBUS’s AML program and conducted regular compliance examinations.  Yet the Committee found:
Year after year, those AML examinations exposed AML deficiencies. Each time problems were identified, HBUS promised to correct them and sometimes did. But those corrective actions were narrowly targeted and, instead of improving, the bank’s overall AML program deteriorated, resulting in the dramatic failures described in the September 2010 Supervisory Letter (p. 285).
In addition to the seven recommendations the Committee directed to HBSC, it made three to the OCC on how to improve its AML oversight functions and intervene more strongly when it discovers problems.
Next steps
The report recognises that HSBC has recently announced a range of measures to improve its AML program in the US and globally.  However, it points out that HBUS announced similarly promising reforms in 2003 when facing enforcement action.  David Bagley, the Head of Group Compliance for HSBC since 2002, resignedat a Committee hearing on the day the report was released.
The US Department of Justice is now conducting an investigation that could lead to criminal charges against HBUS.  Significant penalties are available under US law.  Penalties of US$160 millionwere imposed on Wachovia Bank for money laundering lapses in 2010.  More recently, ING agreed to pay a record US$619 million penalty for OFAC violations involving the movement of more than US$2 billion through the US banking system for Cuban and Iranian clients.  HBUS reportedlyearmarked US$1 billion for enforcement action earlier this year.
For its part, the OCC has stated in its testimony that it agrees with the concerns reflected in the Committee’s recommendations and that it will take actions in response.