27/09/2018

Assessing Bahrain’s performance combating money laundering & terrorism financing

The Financial Action Task Force (FATF) recently published a 230-page report investigating measures taken by Bahrain to address money laundering and terrorism financing. While the report noted that measures to address these issues needed to be further strengthened, FATF concluded that “domestic coordination, cooperation and information exchange at the operational level is strong and proactive”.

Following the money: This is my Middle East-focused blog series focusing on my areas of specialisation: Money laundering, financial crime, sanctions evasion and funding for terrorist and militant groups. Barry Marston, Senior Consultant, Aperio Intelligence

 

Key findings from the FATA report

  • Domestic coordination and information exchange at the operational level is “strong and proactive”. However, action by the authorities needs to be strengthened and more closely aligned with ML/TF risks.
  • Bahrain has a “moderate” and “still evolving” level of understanding about the risks it faces from money laundering and terrorist financing (ML/TF).
  • International cooperation is “collaborative and provided upon request and spontaneously”, with priority given to action against terrorism and terrorism financing.
  • Application of proportionate mitigating measures by major financial institutions is “robust”. However, implementation of preventive measures within the non-financial sector needs improvement.
  • A ML/TF national risk assessment process was being conducted by the Bahrain authorities at the time of the FATF report was being compiled.
  • The Central Bank of Bahrain (CBB) has “strong elements of a risk-based approach to supervision”. The CBB has imposed a range of sanctions and made referrals for prosecution.
  • Bahrain has “strong controls” to prevent criminals from beneficially holding a management function in financial institutions.

 

Background to Bahrain’s financial sector

The report noted Bahrain’s importance as a regional Middle Eastern financial centre and trading hub, with a “well-developed financial sector” and liberal business environment: Bahrain “enjoys a strong, diverse, and competitive economy which promotes business growth”.

Oil comprises 75.6% of Bahrain’s budget revenues and 20% of GDP. However, the financial services sector accounted for 16.5% of GDP in 2016 and constitutes the largest non-oil component of Bahrain’s GDP, while being the Kingdom’s largest employer. Bahrain’s financial sector includes 29 retail banks and 76 wholesale banks. Fourteen of these retail banks are locally incorporated while fifteen are branches of foreign banks.

The presence of 26 Islamic banks (retail and wholesale) affords Bahrain the largest concentration of Islamic finance institutions in the Middle East. Islamic banking sector assets rose from $1.9bn in 2000 to $25.7bn by 2016, with total banking sector assets amounting to $192.7bn.

Historically, the Lebanese civil war from 1975 afforded Bahrain the opportunity to overtake Beirut as the region’s leading financial centre. Many leading regional banks establishing themselves in Manama and remained there, catering to rapidly-growing GCC markets fuelled by the 1970s oil boom. By the early 1990s Bahrain had become a global centre for Islamic banking. The most recent growth priority in Bahrain’s financial sector has been in the field of technology and innovation, with Bahrain recently unveiling FinTech Bay, largely catering to financial technology start-ups.

Principal money laundering risks

Bahrain is currently working on its own “National Money Laundering and Terrorist Financing Risk Assessment”. According to the Bahraini authorities’ ongoing assessment of ML risks, the key threats are investment fraud (highest threat); cash courier/cross-border violations including smuggling (high); prostitution (high); human trafficking (medium); drug trafficking (medium); corruption (medium); and illegal trade in work permits (medium). The banking sector is viewed as the most targeted sector for ML, with money-changers and real estate being medium-risk targets.

Local authorities report that the most common financial criminal convictions have been for matters such as domestic fraud and criminal breach of trust. Recent designations of certain zones where non-Bahrainis are permitted to purchase real estate has led to a significant influx of new buyers, including expatriates and non-residents. Dealers in precious metals and stones were also assessed to pose a potential laundering risk.

Oversight of investments, individuals or commercial entities from high-risk regions of the world was also judged to be a key challenge; with Bahraini financial institutions sometimes struggling to accurately assess risk levels for engaging with potential customers and counterparties from these states. It was noted that Bahrain had severed relations with a neighbouring state judged to be the highest threat for challenges of financial crime and terrorism funding – namely, Iran.

Money Laundering investigations

Bahrain’s Financial Intelligence Directorate (FID) was assessed to be “well integrated” through electronic systems and direct communication channels with other agencies. There is “strong and effective” cooperation between the FID and other law enforcement authorities.

Bahrain has a “sound legal framework” for the investigation of money laundering (ML) and Bahrain’s financial and judicial authorities have recently pursued a number of complex ML investigations. A wide range of sanctions have been imposed for ML offences. Of the 34 individuals convicted of ML between 2012 and 2017, the average sanction applied was four years imprisonment, with the highest fine exceeding $500,000.

Financial institutions were found to have a good understanding of ML risks, although sometimes understanding was weaker on terrorism financing issues. However, understanding of these issues in non-financial sectors “needs improvements,” with due diligence of customers in these sectors found to be “less robust.” The verification of beneficial ownership was assessed as needing improvement in both financial and non-financial sectors.

Customer due diligence (CDD)

Bahrain was rated “partially compliant” for the manner in which institutions conducted due diligence on customers. Improvements in due diligence procedures were specifically required for the licensees in the capital markets and licensed insurance companies. The CBB Rulebook requires financial institutions to implement the CDD measures when:

  1. establishing business relations with a new or existing customer
  2. carrying-out transactions above BHD 6,000, or where multiple transactions exceed this threshold
  3. carrying out wire transfers, irrespective of amount
  4. there is a suspicion of money laundering or terrorist financing
  5. having doubts about the veracity or adequacy of existing CDD information

 

For the purposes of identifying and verifying beneficial ownership, standard CDD practice by Bahraini financial institutions tended to include taking bank references; visiting or contacting the company by telephone; undertaking a company search or other commercial enquiries; accessing public and private databases; making enquiries through a business information service or credit bureau; or confirming a company’s status with an appropriate legal or accounting firm.

The CBB Rulebook requires institutions to conduct ongoing due diligence on transactions and sources of funds with ongoing customers, to ensure that the transactions being conducted are consistent with the institution’s knowledge of the customer and their risk profile. Insurance licensees are also required to implement CDD, with enhanced due diligence applied on customers identified as having a higher risk profile. There was found to be no uniform understanding by lawyers concerning the need to verify the identity of their clients and retain client identification for the requisite periods of time.

Higher-risk countries & politically exposed people

Bahrain was rated by the FATF report to be partially compliant in mitigating money laundering risks from high-risk countries. It was assessed that countermeasures had not been clearly established in existing regulations.

The CBB Rulebook requires banks and financial institutions to apply enhanced due diligence measures to business relationships and transactions originating from high-risk countries highlighted by the FATF. The type of enhanced due diligence applied must be “effective and proportionate to the risks”. The CBB is empowered to issue binding directives to ensure that financial institutions apply countermeasures where there are weaknesses in countries in relation to which the FATF has called for enhanced due diligence.

Financial institutions were generally found to be aware of the enhanced measures required for politically exposed people (PEPs), and “do not usually distinguish between domestic and foreign” individuals. They have put systems in place to identify PEPs, family members and close associates. Institutions tend to use open sources and commercial databases for the screening process and conduct their own research.

Commercial & financial transparency

Bahrain’s Sijilat system for the registration of commercial entities was commended as “robust” and “helpful”. The registry includes information on authorised signatories, boards of directors and shareholders who own more than 5% of the company’s shares, along with beneficiaries. However, some concerns were noted about the accuracy of beneficial ownership information.

Bahrain is ranked at seventeenth position on the 2018 Financial Secrecy Index (FSI). The two other leading regional banking centres of Dubai and Lebanon were rated at 11th and 9th places respectively. Bahrain was given a relatively high financial secrecy score of almost 78 out of 100. Bahrain can be expected to significantly improve its banking secrecy rating in coming years, having signed up to the OECD common reporting standard on tax affairs in 2017.

This OECD reporting standard obliges financial institutions in Bahrain to automatically abide by international standards in sharing financial data, particularly in relation to tax affairs. It remains to be seen how far Bahrain’s implementation of these measures will go in addressing the FSI’s criticisms of banking secrecy related to disclosure of data, anti-money laundering and tax regulation.

Corruption and financial mismanagement

In recent years, annual reports assessing instances of reported corruption and inefficient use of public funds have been gaining increased public attention, with the full audit report or summarised conclusions being published through the media. Officials accused of criminality have been referred to the judiciary, with aspects of these reports reviewed and acted on by Parliament. In 2013, the Crown Prince established a committee of investigation to oversee the cases highlighted by these annual reports by the National Audit Bureau (now the National Audit Office).

The sharp reduction in oil revenues between 2014 and 2017 led to substantive budget cuts of most ministries, with attention closely focused on wasteful spending. For example; guidelines were introduced limiting numbers of those who could travel on official delegations, with subsequent annual audit reports drawing public attention to cases where various departments had failed to spend prudently. The National Institute for Human Rights was one of the institutions which faced criticism for expenditure on overseas travel.

Terrorism financing

Bahrain has faced a domestic challenge from terrorism, with a succession of bombing attacks against the security forces among other targets, leading to the deaths of around 23 policemen. After 2014, ISIS threatened to target Shia mosques in Bahrain as part of a campaign of attacks against GCC states.

A number of shipments of smuggled weapons have been impounded which were linked back to Iran. Seizures of munitions imported from abroad between 2015 and 2017 included firearms, C4 explosives and even the equipment required for manufacturing sophisticated EFPs (explosively formed penetrators), of the kind used to attack US troops in Iraq. However, overall volumes of foreign financing for domestic radical groups is understood to be relatively small. In the past, action was taken against Sunni groups raising money for Syria, when there was a suspicion that these funds risked being channelled towards extremist groups.

Future Bank was set up in Bahrain in 2004 as part of a joint venture involving two prominent Iranian banks, Bank Melli and Bank Saderat. The bank was later blacklisted by US and British officials, before being shut down definitively by the Bahraini authorities in 2015, accusing it of being a “trojan horse” for terrorism funding. The bank was found to have concealed at least $7 billion of transactions between 2004 and 2015.

The FATF report found that Bahraini officials were aware of the need to address terrorist financing. However, within financial institutions, employees tended to be relatively more confident about addressing money laundering challenges; compared to “less robust” action against terrorism funding risks. The ability to address such risks in non-financial sectors tended to be weaker still.

 

About Barry Marston

At Aperio, Barry specialises in Iran, Saudi Arabia, the wider Gulf region; capitalising on 20 years of experience in working across the Middle East. His portfolio includes corporate intelligence, money laundering, financial crime, sanctions evasion and funding for militant and terrorist groups.

Barry spent six years working as the British Government’s Arabic and Persian Spokesman. He also held responsibility for the UK Foreign Office’s communications policy for the Middle East and Islamic world, specialising in counter-extremism, sanctions, international law and trade issues.

Between 2011 and 2018, Barry was based in the GCC region, working for Weber Shandwick and Fortune Promoseven as a media consultant and project director. His portfolios included work for some of the largest privately-held and state-owned organisations in the Middle East region. Barry also conducted political and economic forecasting and analysis for commercial clients. He is a fluent Arabic and Persian speaker and has operational capability in Hebrew, Russian and French.