I am happy to be taking part in this important conference marking 15 years since the establishment of the Israel Money Laundering and Terror Financing Prohibition Authority. Since the Authority was established, there has been a big and very important change in the Anti-Money Laundering (AML) area in Israel, which has had a major impact on the economy and society.
In my remarks, I would like to present the Banking Supervision Department’s perspective on the AML regime in Israel, and particularly on the increased stringency of compliance risk management. I will describe what changed in those years, the ramifications for customers, and what, in our opinion, is required going forward.
The banking system in Israel offers a very wide range of products and services, which are intended to allow the provision of quality and advanced banking services to business and private customers, the large majority of whom are law-abiding.
However, in recent years, a significant tightening in compliance risk management at banks has been necessary, and was carried out, against the background of marked changes in legislation worldwide and in Israel, and against the background of US authorities’ investigations at banks worldwide with regard to compliance. Some of the investigations at Israeli banks in areas of tax evasion by US customers have not yet been concluded, and in part of them some failures were found. Nonetheless, it is important to say that the US investigations are of events of the past, which reflected the “world back then”. Since then, lessons have been learned and there has been a marked increase in the stringency of Banking Supervision Department requirements and a marked tightening in the manner of managing compliance risks at banks.
I would like to discuss the following questions today:
First, have we not moved from one extreme to the opposite extreme, when it comes to compliance requirements of the banks and customers? From the one extreme where we were 20 years ago—of lack of awareness and handling of the issue, a world in which companies and private individuals managed bank accounts while the banks were not required to check whether the source of the funds was illegal activity—we have moved to the other extreme, in which we find ourselves today, where the expectations of regulatory and compliance entities are that the banks will be their long arm with regard to preventing money laundering, terrorism financing, and tax evasion, including enforcement of foreign countries’ tax laws. All this, while taking into account that in Israel there are still nonbank entities to whom an AML regime does not apply, that do not have an Order in effect nor effective regulation or compliance, though they are interested in opening accounts in the banking system, which they view as critical to their activity.
The second question is, what is the price paid by customers for the extremely tight handling and strict enforcement on banks with regard to compliance—customers that are innovative companies, new immigrants, charitable organizations working for the public good, nonresidents, and others? I won’t leave you in suspense—the answer is that the price is very high.
The third question is should we move the pendulum back to a more balanced location, and if so, what do we need to do for that?
I will begin with a short description of how things developed, from the banking perspective:
In 2000, with the enactment of the Prohibition on Money Laundering Law in Israel, the change was reflected in banks’ increasingly being required to serve as the long arm of the various authorities, in order to identify and prevent the transfer of funds that ostensibly serve illegal activity, and particularly after the establishment of the Authority in 2002, they even had to submit reports on such. That is, the banks and other financial institutions were drafted to serve in the war on serious crime and later, on terror as well.
The banks set up large compliance systems, invested huge amounts of resources—among other things in computer systems and human resources—and essentially changed their whole work processes vis-à-vis their customers.
Throughout the years, the Banking Supervision Department implemented the change and enforced it, the banks increased the stringency of their approach to examining funds and customers and alerted authorities when there were suspicious signs, and the authorities even succeeded in stopping, via the banks’ alerts, numerous illegal activities. Thus the authorities reported and continue to report to us though today.
At the end of the previous decade, the US began to lead a stricter line of major investigations against banks worldwide with regard to compliance aspects, while expanding the areas of compliance to tax issues as well. In effect, the US “changed the rules of the game” in its conduct toward countries, primarily Switzerland, which was known for its banking confidentiality, and as a result banks worldwide were fined huge amounts of money—hundreds of millions, and even billions, of dollars—for noncompliance with various laws.
Within this framework, an investigation began as well into three Israeli banks that had activities in Switzerland. In the investigation, it turned out that US customers of the banks did not pay taxes to US authorities, and that products offered by the banks to customers—products that were accepted worldwide—made it easier for those customers to evade taxes. I note that at that time, the law in Israel did not define tax crime as a source offense in the Prohibition on Money Laundering Law. The law was only changed in this regard in 2016.
The Banking Supervision Department learned lessons over the course of the years from the US investigations issue, and sent an unequivocal message to Israeli banks—the Banking Supervision Department has no tolerance for compliance risks, including in cross-border activity. That is, if there is any doubt in terms of compliance, then there is not a doubt—do not open the account and do not permit the funds transfer. The reason is the large responsibility, in the personal area and the criminal area, which is liable to be imposed on a banker if and when the risk in the customer’s account materializes. As a result, the banks made their controls over all customers’ accounts much stricter, and this is reflected in their requesting more and more documentation from customers, asking many questions, stopping funds for which it is not fully clear what their source is, and the friction with customers increased markedly.
The result is that today, at the Banking Supervision Department, we receive repeated complaints from many entities about the difficulties that these stringencies create for customers. In particular, we receive complaints about banks’ strict policy regarding nonresidents, new immigrants, fintech companies, companies that arrange loans between people (PTP), payment institutions, entities and people that deal with virtual currencies, as well as free loan societies, currency service providers, charitable organizations, and lawyers handling trusts—these are all entities in which it is more difficult to identify the source of their funds. A large portion of them are legitimate entities, but their operations are complex, and in some cases unsupervised.
There are those who claim that the reason banks refuse to open accounts for such customers is that they are concerned about competition, but the analysis we carried out at the Banking Supervision Department regarding these situations shows that this is not the case. Banks manage accounts for, and extend large volumes of credit to, companies that compete with them directly. The reason for the difficulties experienced by some of the companies in opening and managing banks accounts are, as I noted, the compliance risks.
Against the background of the situation we have reached, in which regulation and enforcement in the area of compliance risks lead to bankers’ fear and to an adverse impact for some groups in the economy, I call on regulators and enforcement entities to sit down together and think of what can be done to somewhat balance the pendulum. Following are some of the directions in which we at the Bank of Israel thing there should be progress:
1. First, the activities of fintech companies, PTP, free loan societies, currency service providers, and charitable organizations must be regulated in law—a Prohibition on Money Laundering Order must be set and these entities must be supervised as well, so that it will be their responsibility to serve as a “first line of defense” in managing compliance risks, when they open an account at a bank. This is in order to allow them to operate with great ease and to reduce frictions with banks. There are currently still many entities that conduct activities in the economy without appropriate regulation and supervision.
2. Likewise, it is important that the State Attorney publishes enforcement policy, which will establish that with the realization of compliance risk (and some risks will be realized), calculations should be of overall compliance at the bank, similar to the framework defined by the Israel Securities Authority with regard to administrative enforcement, and the regulator should be consulted regarding this. Such policy should emphasize that activity in line with the regulator’s directives shall be defined as activity in which the bank took on honestly.
Supervisory authorities in Israel and worldwide are speaking about the proportionality required in managing compliance risks. We certainly join in this call, but it is important that the proportionality is also in enforcement, when the risk is realized, per the framework noted above.
3. Additionally, to encourage innovation and competition in the financial sector, a “regulatory sandbox” should be defined, which will enable fintech companies to enter it and easily open a bank account, with an easing of the banks’ compliance requirements regarding such companies.
We at the Bank of Israel believe that a collaborative effort by regulators and enforcement entities is needed, and that to the extent that we take such steps we will succeed in reducing the fear at banks about the area of compliance, and to balance the pendulum for the benefit of companies and individuals, a great majority of which make a positive contribution to the economy.