Global Financial Integrity

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China’s Underground Bank


Reforms Will Need to Be Further-Reaching and Institutionally Minded if China Hopes to Truly Curb Corruption and Illicit Financial Flows

The coverage of China’s financial sector has been quite the roller coaster of late: from President Xi Jinping’s anti-corruption campaign to bad loan collateral to CCTV’s exposure of the Bank of China’s “money laundering” schemes, it’s hard to discern the emerging country’s financial status.

However, one thing remains eminently clear: China has a deeply systemic illicit financial flow problem. It comprises both the individuals singled out in Xi’s purge (and a myriad of those who are not) as well as the corporations that facilitate this illegal behavior. According to our research, China remains the largest exporter of illicit money, with over a trillion dollars flowing illegally out of the country from 2002-2011:

That rich Chinese have been investing in international property and foreign assets is no secret. With such huge amounts of money leaving the country–over $50B in 20 years–it was not surprising to find large banks were facilitating illegal outflows. CCTV’s allegation was that Bank of China and China Citic Bank were helping rich Chinese individuals stash money abroad by manipulating currency controls and providing “underground” banking services to wealthy clients. China’s strict currency control laws, most notably that which states no more than $50,000 per year may be sent across the border by an individual, was undoubtedly a hindrance to wealthy Chinese looking to make large investments overseas.

It is worth noting that calling the Bank of China allegations “money laundering”–as most news outlets have done–may be a bit of a misnomer. By breaking currency control laws, the banks were not technically committing or assisting in money laundering, since that would require the source of funds be illicit. Granted, some of the funds may have been illegally acquired, and it seems that Bank of China was eager to streamline those funds abroad like any other.  However, it is likely that a lot of this exported wealth was licitly gained; as such, the focus of the BOC probe should be on currency control laws, especially when such policies are so stringent.

The allegations should also open the door to larger, formal investigations into China’s banking system, especially as it pertains to shuffling wealth abroad. The concurrence of a growing Chinese credit bubble, shadow banking, and now a cross-border money transferring scandal alludes to a dangerous trend: aggressive and unsustainable hot money flows out of China.

Xi’s anti-graft campaign has purported to tackle this issue. While Xi is focusing on a relevant facet of illicit financial flows from China–the corruption of individual elites–questions have arisen about the selective nature of these attacks. Furthermore, his purge of “tigers” (wealthy and corrupt party apparatchiks) has been accompanied with a flurry of questionable government actions, such as appropriating fancy cars as military property, drawing the focus away from hot money flight from China and towards more superficial compliance. Some, such as Professor Steve Tsang, Director of China Policy Institute from the University of Nottingham, suspect that Xi’s campaign may not even be corruption-centered:

But the entire anti-corruption’s [sic] campaign is not designed to end corruption. It is designed to enhance the capacity of the Party as an instrument of control and governance, and also to improve its credibility for the same purposes.

His reforms will need to be further-reaching and institutionally minded if he hopes to dent China’s corruption problem. Corrupt individuals will always find means of accomplishing their goals provided they have the institutions to do so. Resources for transferring money illegally need to be dismantled completely and the individuals that facilitate these services–not just those who utilize them–must be punished.

Though a bit of a rough comparison, Xi’s anti-graft campaign shows that solely targeting individuals is an unconvincing means of rooting out corruption, just as the cases of BNP Paribas and other major banks caught laundering money or evading taxes for wealthy clients show that only punishing an institution isn’t enough. Both avenues of eliminating bad behavior–the corporate and the individual–need to be approached in tandem to effectively curtail corruption, especially in a country like China whose political and corporate agendas are undeniably intertwined.

Equally distressing is the complicity of the international community in these operations. A large part of this scheme involved the Australian Significant Investor Visa (SIV) program, in which foreign nationals could acquire permanent resident status by investing $5 million or more in Australian property or companies. Australia’s failure to effectively question the legality of the transactions suggests a greater need for KYC and AML monitoring across borders–especially in high-reward investment schemes like SIV.

Similarly, real estate transactions, especially in the US, need increased KYC regulations in order to ensure the money used to purchase property has been legitimately transferred to the US. Just as Xi’s prosecution of corrupt individuals and institutions cannot be selective, nor should the world’s decision to arbitrarily pursue or ignore certain financial crime.

Xi’s commitment to stopping illicit financial flows will be tested with his response to the recent allegations of currency control violations and money laundering. His crackdown on “naked” officials: those who have family overseas and who are transferring funds overseas, shows that there is, at least at a basic level, an interest in reining in illicit financial flows. However, taking away fancy cars and ousting individual—albeit high-ranking—officials of the Communist Party won’t do much in the long run if the institutions they can use to export their wealth remain intact. Should the government ignore the Bank of China probe and fail to take systemic action, it may substantiate claims that Xi is only hoping to consolidate political power rather than do what is economically optimal.

The CCTV probe into Bank of China, Xi’s anti-graft campaign, and the reining in of tigers are all part of a complicated narrative with both political and economic undertones, and must be viewed as such. Hopefully these attacks are not just the result of spats between Communist Party factions (as some commentators have suggested) because the issues they reveal are formidable and must be addressed seriously.

Image Source: Flickr / Some Rights Reserved By  Riccardo Cuppini