The Risks of Corruption that Arise in International Banking

This section will introduce candidates to the challenges of corruption that any corporation is subject to but especially those that operate internationally, where distance from the Centre and different societal cultures add to the problem. The issue is aggravated by the increasing pressure on staff to perform in operational and client-facing roles.

Philp (Corruption Measurement and Definition, 2006) expresses that there is significant consensus in the corruption literature that corruption requires three actors: Actor A that accepts a payment or a material benefit from actor C to the cost of entity B. Actor C would normally not access this benefit without the intervention of actor A. Actor A is usually the holder of a public office and B is the intended beneficiary of that public office such as society in general.

Within this framework there are many variations of corrupt activity. This course focuses on two forms of corruption, namely bribery and money laundering. While bribery is straightforward and defined as dishonestly persuading someone (in a position of power) to act in one's favour by a gift of money or other inducement, money laundering is more complex. It is the process followed by criminals through which they disguise the original ownership and control of the proceeds of illegal operations by making them appear to have derived from legitimate operations. Some of the most common techniques are smurfing, currency exchange and wire transfers.

As said, this section will deal with two quite distinct forms of corruption as are bribery and money laundering. A case of corruption takes place when there is a distortion in the exercise of public office that leads to a gain in a private interest at the expense of the public interest.

Corruption in the form of money laundering tends to involve a greater number of people than bribery and leave a far more detectable footprint. It also takes more of a systemic approach and involves flows of large volumes of money over a period, while bribes tend to be more one-off transactions. Organisations have processes in place to detect cases of money laundering, while such protections are not at all common against bribes. Bribes are more secretive so, while there are orders of magnitude estimates on the volume of money-laundering, these are non-existent or at least even less precise, for bribes. Requirements for secrecy can also lead to further crimes to silence witnesses.

The Financial Times ran a story titled "Silent witnesses" on a high-stakes case of bribes that targeted Eurasian Natural Resource Corporation (ENRC), where there had been at least four suspicious deaths (Burgis & Watkins, 2020). For all these reasons bribes are harder to detect than money laundering. When detected, it is mostly through tip-offs and bribery is investigated through auditing the accounts of those suspected to be involved. If the amounts are large, bribes may be followed by money laundering. When corruption is detected the bank's reputation is shattered and this has a severe impact on the market valuation of the organization. The Danske Bank story broke in 2018 and by 2021 the bank's share price had fallen by 50 percent.

Corruption in the form of bribes needs to be combatted on at least two fronts, the private sector and the public office. On the private sector front, it is established that organisations need to develop an ethical corporate culture that creates the context for performance with integrity. This ethical culture of performance with integrity is created top-down through example and the creation and diffusion within the organization of a clear and well-understood code of ethics. There should be established channels within the organization through which situations of extortion can be aired and dealt with in a corporate fashion rather than through the judgement of individuals on the front line of the organization.

On the public front corruption through bribes needs to be combatted through strengthening transaction governance capacity, that is the simplification of the rules that regulate the public office. It is a common mistake to believe, as is the case particularly in Latin American countries, that highly detailed rules and regulations give objectivity to the processes. The analysis of cases of bribe shows the contrary: detailed rules curtail transparency and empower the holder of public office as an 'expert' on those intricate rules and regulations.

It is not enough that broad and transparent rules and regulations are in place. They must be enforced. The analysis of bribery cases in Latin America reveals that public office rules and regulations are extremely intricate but often poorly enforced. When this happens the voids left in formal institutions are filled by informal institutions such as societal culture. Societal culture determines, through customs and informally accepted ways of doing business, how the relationships between public office and the private sector work. The trouble is that in many countries in Latin America, as revealed by Transparency.org's Corruption Perception Index scores, societal culture accepts increasing levels of corruption as part of the way the world works. Experience shows that once that happens it is extremely difficult to remove, especially because societies frustrated by corruption tend to tackle the problem by replacing people rather than making systemic changes such as revising transaction governance capacity and making rules enforceable.

In the case of money laundering, combatting it is more focalised and needs to be done within the financial institution. Like combatting bribes, it requires developing an ethical corporate culture of performance with integrity in the bank, but in addition involves implementing clearly defined compliance processes and systems, and a compliance organisational unit with sufficient clout to ensure that the operational units abide by those processes and systems.

The study of money laundering cases shows how complicated it is to investigate these cases once they have been detected. By their very nature they involve multiple legal jurisdictions and apply a sophisticated three-stage process of cleansing illicit money by concealing audit trails to the origins of the funds. Although money laundering is a criminal offence that should be detected, chased and controlled by the state, governments have tacitly admitted that they are incapable of doing so and have pushed this responsibility onto banks. Banks get no benefit from chasing money laundering and need to implement costly structures to carry out this duty. It is ironic that they are not compensated for this public duty when they get it right, and yet are severely punished when they fail!

From the analysis of money laundering cases it can be seen that these phenomena can creep into the organization bottom up as in the HSBC Mexico case where it all started in remote branch offices in Mexico without apparent knowledge by senior management in the initial stages, or it can do so top down with the knowledge of senior management as was the case at Danske Bank. (Recommended watching: Cartel Bank, in season 1 of Dirty Money on Netflix.) It affects multiple stakeholder groups that vary from case to case, but two groups seem to be common to all. These are the tax revenue offices of the countries whose citizens engage in the activity, and the shareholders of the bank whose dividends are reduced by fines that negatively impact their bottom line and whose assets are impacted by sharp drops in market valuation of the bank.

In both HSBC Mexico and Danske Bank Estonia there are clear failures on the part of the Board of Directors. The Boards of both banks did not pay attention to clear early warnings from external sources that laundering could be happening at their bank. Neither did they question abnormally high flows of funds and contributions to profits, despite these signs sounding loud and clear in the financial statements. In both cases they turned a blind eye despite knowing that their banks did not have trustworthy compliance structures and methods in the locations where the money laundering was taking place.

From analysing cases of money laundering, several clear lessons emerge for how Boards of Directors need to operate on governance in the knowledge economy. They need to monitor very carefully that the 'CEO vs Rank & File' relationship promotes an ethical corporate culture, one that not just preserves but increases the intellectual capital of the organization. In particular, it needs to monitor that the bank's structural capital in the form of compliance processes and systems are implemented and abided by, as well as the human capital in the form of training its staff on compliance principles and processes. From the two money laundering cases we discussed, we can observe that a corporate culture that promotes structural capital contributes to building an ethical corporate culture.

Both the HSBC Mexico and Danske Bank Estonia money laundering cases refer to banks that have grown through acquisition, which leads to questioning if this was a factor that increased the opportunities for money laundering. Moreover, a powerful insight from these cases is that in the knowledge economy the business case for implementing corporate systems in newly acquired companies cannot be based purely on tangible benefits. The technology of the bank needs to be treated as a portfolio of ICT investments, with each category in the portfolio applying different qualitative criteria and risk assessments. Least of all can the business case depend exclusively on tangible benefits when the processes and system concerned refer to compliance. Boards need to bear in mind that compliance standards cannot be compromised depending on the size of the acquired subsidiary. If there are doubts in that respect, the decision needs to be escalated one level. The decision cannot be whether or not to implement corporate standards; if there are doubts as to that, the question to be asked is whether the subsidiary should be kept or disposed of. It is also possible to define a two-tier standard of corporate systems consisting of using the corporate systems for the larger subsidiaries and a more agile approach, based on Regtech solutions, for the smaller operations. But what cannot be compromised is the requirement to meet the highest standards in compliance. (By Regtech is meant the application of disruptive new technologies such as machine learning, distributed ledgers, business analytics to assisting banks meet their regulation compliance. Rather than the banks developing or buying these technology solutions, they normally outsource these services to smaller entrepreneurial companies that develop them.)

Another important lesson from both bribe situations and money-laundering cases, is that the Board of Directors in international banks needs to understand the societal culture of the regions where their subsidiaries operate. This understanding of the local societal culture should mediate to define to what degree the bank should operate in a low context or high context approach in that market. (The low context versus high context dilemma comes from the literature in International Business and refers to whether in a globalised operation a multinational company should have a standardised model across all its subsidiaries, with no room for local differences, or whether it should contemplate a need to adapt and thus implement significant local differences across subsidiaries.)

It should also help define the degree of power sharing between the subsidiary and the corporate headquarters, and to what degree they can or need to adapt the corporate strategy to the local market. These are clearly governance decision that need to be discussed at Board level.

Finally, from the analysis of bribe situations emerge two interesting moral dilemmas that are not present in the case of money laundering. The first is whether there is an ethical difference between a private sector operator paying a public officer a bribe to obtain a benefit it would not have won legitimately and paying a public officer a bribe to unblock a benefit it has legitimately won. The other, less sophisticated, dilemma is whether it is valid for a multinational company to avoid bribe situations by selling to the state through independent local distributors, that is avoiding responsibilities by outsourcing their problems to local partners. Independently of the moral dilemmas, the responsibility of the Board is to protect the interests of the shareholders so, from that stance, it needs to assess the risk that any of these situations will have on the reputation of the company.

Topic for Reflection: Read the HSBC and Danske Bank case studies in chapter 5 of the book and reflect, by comparison, on the compliance and AML processes in your bank. Describe the most common money laundering techniques used in your market. Can you detect, in any of your banks markets, vulnerabilities to the risk of money laundering? Does your bank have a corporate culture of performance with integrity? Where do you perceive the emphasis is greater, on performance or on integrity? What do you think is the status of 'transaction governance capacity' in your market?