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Tuesday, 12 March 2013 08:40

Africa: Warning On Russian Illicit Financial Flows

MoneyLaunderingLIBERIA, Monrovia, March 12, 2013, (The New Republic) - Governments in West Africa should be wary of the influx of Russian businessmen to the region following media reports that the Governor of the Central Bank of Russia recently stated that roughly $50 billion was illegally siphoned out of the country in 2012, echoing research published recently by Global Financial Integrity (GFI), a Washington, DC-based research and advocacy organization, which estimated that an annual average of $62 billion was illicitly smuggled out of Russia in recent years.

Observers familiar with these activities have warned that some of these illicit funds are making their way to West Africa where businessmen claiming to be operating in these countries launder these funds.

"Most of these companies are shelf companies registered in the British Virgin Islands," one source told The New Republic. "They have no assets or liabilities. But they turn up with $5 million in cash to invest in mining, for example. And they don't even have any mining equipment. How is this possible? According to Bloomberg News, Russian Central Bank Governor Sergei Ignatyev said that the majority of these illicit flows "seem to be controlled by one well-organized group of people."

The Director of the GFI, Raymond Baker said: "Russia has a severe problem with illegal flows of money. It's gratifying to see that the Governor of the Central Bank acknowledging it. That's the first step to curtailing these outflows.

"Claims by the Kremlin later in the day that Ignatyev's estimates may have been 'exaggerated,' were followed by radio-silence from the Central Bank Chief on the topic after he made his initial remarks--despite being asked follow-up questions by reporters," added Baker.

"Russia is the most opaque economy we've analyzed at GFI, and the Russian people really deserve to have an open and honest discussion about the illicit money flowing into and out of the country. As our research shows, hundreds of billions of dollars have been lost since the fall of the Soviet Union that could have been used to invest in Russian healthcare, education, and infrastructure. At the same time, more than a half trillion dollars has illegally flowed into the Russian underground economy, fueling crime and corruption."

The GFI report published earlier said that the Russian economy hemorrhaged US$211.5 billion in illicit financial outflows from 1994 - the earliest year for which data is available following the dissolution of the Soviet Union - through 2011.

The study, titled "Russia: Illicit Financial Flows and the Role of the Underground Economy," also measures massive illicit inflows to the Russian economy of US$552.9 billion over the 18-year time-span, raising serious questions about the economic and political stability of the nation currently chairing the G20.

"Russia has a severe problem with illegal flows of money," said Baker. "Hundreds of billions of dollars have been lost that could have been used to invest in Russian healthcare, education, and infrastructure."

GFI Lead Economist Dev Kar and GFI Economist Sarah Freitas, the authors of the study, estimate the size of Russia's underground economy at a massive 46 per cent of GDP per year over the time period. Moreover, illicit outflows and inflows were found to drive the domestic underground economy, which includes - among other things - drug smuggling, arms trafficking and human trafficking.

Thus, illegal capital flight was determined to contribute to a fall in governance. Growth in the underground economy likewise was shown to drive illicit flows, creating "a snowballing effect, whereby both the underground economy and illicit flows continue to grow at an increasing rate unless policy measures and institutions intervene," according to Dr. Kar, the principle author of the report, who worked as a senior economist at the International Monetary Fund before joining GFI.

A one per cent increase in the size of the underground economy was found to increase the cross-border flow of illicit money by seven per cent. The report reveals that, according to World Bank staff, Russia's underground economy is 3.5 times larger than corresponding G7 economies like the US, France, and Canada, and Russia lags far behind every G7 country in all six dimensions of governance measured by the World Bank.

Further, illicit flows and the underground economy both grew significantly over the 18-year period studied, driven in large part by an overall deterioration in governance and widespread tax evasion. The study highlights that in three out of the six key governance factors measured by the World Bank - voice and accountability, control of corruption, and regulatory quality - Russia's standings have deteriorated since the fall of the Soviet Union, while remaining poor in the other categories - rule of law, government effectiveness, and political stability.

"So long as the Russian authorities fail to shrink the underground economy, Russia will continue to hemorrhage scare capital, both illicit and licit, to the detriment of economic and political stability and undermining the nation-state," write Dr. Kar and Ms. Freitas in the 68-page report.

Unrecorded wire transfers detected by GFI's Hot Money Narrow (HMN) model were the primary method for moving money illicitly out of Russia. HMN, which accounted for US$135 billion or 63.8 per cent of illicit outflows over the period studied, is one of two models used by GFI to estimate illicit financial flows--the other being the Gross Excluding Reversals (GER) model, which tracks trade-based money laundering through the fraudulent mis-invoicing of customs declarations. Still, trade mis-invoicing accounted for the remaining 36.2 per cent, or US$76.5 billion, of illicit outflows, and it is growing in significance.

The prevalence of unrecorded money transfers through banks is not surprising when considering the state of the Russian banking system. Citing research by the Financial Action Task Force, Dr. Kar and Ms. Freitas note serious weaknesses in Russian banks including that:

Some banks are still believed to be owned and controlled by criminals and their front men; There is no requirement to investigate the background and purpose of suspicious transactions or to record and maintain such information for follow-up by regulatory agencies; While credit institutions are prohibited from opening anonymous accounts, there is no specific provision that prohibits banks from maintaining existing accounts under fictitious names;

Gaps in monitoring wire transfers remain; Sanctioning powers and the sanctions themselves are in general completely inadequate; A key weakness is the lack of effectiveness of financial sector supervision regarding AML/CFT compliance; and The existing AML/CFT regime and its implementation do not effectively deal with the illegal alternative remittance systems operating in Russia.

"There will continue to be massive illegal outflows of money through unrecorded wire transfers as Russia neglects to address these shortcomings in the banking system," adds Dr. Kar. A notable finding of the report is that higher oil prices were found to drive licit capital flight as well as the broader definition (CED+GER) of capital flight from the country.

"With oil exports accounting for more than half of Russia's total exports in 2011, such a significant link cannot be ignored," said Ms. Freitas, the GFI Economist. "Our study shows that Russia's dependence on oil, combined with its lack of fundamental reform and its endemic corruption, explain massive outflows of both licit and illicit capital."

As European and Russian officials currently weigh the merits of bailing out the Cypriot economy, GFI's study raises serious concerns about the legitimacy of Cyprus' financial sector.

The report notes that Cyprus, a tiny island nation with a GDP of just US$23 billion, is the largest source and destination of Russian foreign direct investment (FDI) from 2009-2011. According to the IMF, Cyprus sent US$128.8 billion in FDI into Russia in 2011, more than five times the size of Cyprus' GDP. "The recorded FDI positions merely reflect the round-tripping of prior illicit deposits from Russia into Cyprus," write Dr. Kar and Ms. Freitas in the report.

"Cyprus is a laundry machine for dirty Russian money," added Dr. Kar. GFI recommended that Russia used its influence in global forms such as the G20, G8, and United Nations to increase the transparency in the international financial system and curtail the illicit flow of money into and out of Russia. (Source: The New Republic in Liberia, Monrovia)



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