Streamline bank rules for spotting sanctions violators

As it inherits a sanction regime of vital interest to U.S. national security, the Biden administration should revamp banks’ sanctions requirements to make them more targeted and otherwise more effective.

For decades, the U.S. sanctions regime (applied against nations, groups or individuals) has used banks as a fighting force. And thus far, they have been very poorly led.

The chain of command for administering sanctions is confused. Ultimate responsibility rests with the president and the Treasury Department through its Office of Foreign Assets Control, but battlefield command has been assumed by bank examiners. As a result, banks receive tactical orders that are at odds with the overall mission or strategy.

As background, it is important to highlight a general misunderstanding about how banks implement economic sanctions. Most believe that OFAC publishes a list of sanctioned individuals or companies, and that banks screen transactions against that list, and block transfers to anyone on the list.

But it’s far more complicated than that, and less effective. In practice, the list of sanctioned individuals or companies is useless to banks in enforcing sanctions.

Sanctioned individuals are clever enough to avoid transacting in their own names once designated. So, while Iran’s unelected Supreme Leader Ayatollah Ali Khamenei is currently on the sanctions list, the unfortunate fact is that there are likely thousands of other Ali Khameneis with bank accounts who are neither on the list nor guilty in any way.

Thus, a Bank Policy Institute study shows that for international automated clearinghouse transactions, sanctions screening produces true matches at a rate of 0.0005%. For domestic transactions that use real-time payment or Zelle payment networks, the number is 0.0000%.

Because sanctioned individuals most often transact through shell companies or nominees, any effective enforcement regime therefore would require banks to spend resources using advanced analytics to identify those companies or nominees; and working closely with U.S. government agencies whose mission is to know where the bad guys are hiding.

In other words, focus on detecting evasion. Thus, the Treasury Department and OFAC have consistently instructed banks to operate a risk-based program that focuses their resources on productive uses.

But OFAC does not examine banks for compliance. Rather, it uses dialogue and the threat of enforcement to promote compliance. Of course, this is how laws in this country are generally enforced. But large banks also have on-site examiners from the federal banking agencies who have stepped in to assume command. Their orders are clear.

First, the (unproductive) screening against the published OFAC list is deemed essential. And not just the listed names, but also multiple variants. Meaning, not just all the wrong “Khameneis,” but also all the “Kameneis,” “Khomeneis” and “Khamenis” name variants.

Second, banks are expected to establish policies that require screening of nearly every transaction — both foreign and domestic, large and small — regardless of the likelihood of it being a sanctioned one. So if someone sends a $20 Venmo payment to cover last night’s pizza, it’s highly unlikely to be a payment to an overseas Russian oligarch, but it is screened by Venmo just the same.

Third, a transaction that is routed through different banks must be screened by every one of those banks, despite that the originating bank almost certainly knows the customer best.

Finally, any model designed to identify evasive behavior must run the gauntlet of the federal banking agencies’ 2011 model risk management guidance, adopted primarily for financial functions like asset valuation and capital measurement, where precision is vital and rapid change relatively unimportant. Applied to sanctions, it is an innovation killer.

What makes this situation all the remarkable is that Congress never envisioned the banking agencies playing any role here.

In contrast to the Bank Secrecy Act and anti-money-laundering framework, where Congress granted examination authority to the Treasury Department and that authority was delegated to the banking agencies, Congress did not grant them any regulatory, examination interpretive or enforcement authority over economic sanctions.

By law, they have no greater authority to enforce sanctions laws than securities, tax or environmental protections laws. And yet, they issue the orders.

There is precedent for reform, however. An extraordinary bipartisan consensus was reached at the end of 2020 with respect to the need for AML reforms, yielding historic legislation and significant regulatory changeas well.

With sanctions, legislation is not necessary. The OFAC simply needs to issue a regulation that dictates bank sanction-related programs be risk-based and innovative, and then insist that the regulation be followed — by banks, and by their regulators.

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