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The E.U. tried to blacklist countries at high risk for money laundering, but it backfired. Here’s why.

Politically, the list was doomed.

- March 13, 2019

Last Friday, European Union member states unanimously rejected a blacklist of countries identified as posing a high risk of money laundering or terrorist financing. The proposal by the European Commission, the E.U.’s executive administrative body, would have added four U.S. territories, Saudi Arabia and Panama to a list with the likes of Iran, North Korea and Yemen. Unsurprisingly, the United States and Saudi Arabia vociferously objected. The commission has promised to deliver a new list by the summer, this time in close consultation with member states.

Compiling and maintaining such lists isn’t just about the public shaming of recalcitrant countries. Lists are at the heart of a broader system that requires banks to carry out extra scrutiny of transactions with blacklisted countries. Individuals, banks and companies in listed countries can experience delays and higher costs in sending money abroad.

International organizations such as the E.U. also use blacklists to drive policy change. A blacklist simplifies complex information, making it easy for both states and market actors to punish bad behavior. But to work, these lists require broad international support, which the commission’s blacklist did not have.

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A brief history of money-laundering blacklists

Since 1989, countries have worked together to stop money laundering, a process by which criminals disguise illicit money by transferring it through banks and businesses. After 9/11, when it was revealed that the hijackers had received thousands of dollars through bank transfers, policymakers expanded the anti-money-laundering effort to include terrorist financing.

Countries work on these issues through the Financial Action Task Force (FATF). The FATF is a small, 38-member intergovernmental body. What it lacks in size it makes up for in economic clout. Members include not only the United States and its European allies but also core emerging economies such as China, Brazil, Russia and India. International organizations such as the FATF issue standards rather than law. But their decisions can have major effects on domestic policy. Arguably the FATF’s biggest impact has been through its blacklist.

Why do blacklists work?

Blacklists, and other types of indexes and rankings, are increasingly common ways to get governments to change their behavior. As my research and others’ have shown, rating and evaluating countries can lead to new laws and regulations. This strategy has been shown to have consequences across business, education, human trafficking, illicit financing and development.

Blacklists may affect behavior in different ways. The FATF blacklist is powerful because of its impact on banks. Under domestic law in most countries, banks are required to consider whether a customer could be engaged in money laundering or terrorist financing, which means that banks pay extra attention when someone from a high-risk country such as Iran tries to send money through the financial system. Extra time means extra money, and banks pass these costs along to individuals and companies in listed countries.

This gives countries incentives to act quickly to change laws and get themselves off the list. In my research, I show that the FATF blacklist is correlated with significant policy changes. Of the more than 60 countries listed since 2010, more than 75 percent have substantially tightened their laws and regulations on combating money laundering and terrorist financing.

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Doomed to failure

So why did E.U. countries reject the commission’s plan? The European Commission’s blacklist was controversial for several reasons. Saudi Arabia, Panama and the four U.S. territories may indeed pose a risk of money laundering, but so do many other countries that were notably left off the list. By including some countries, but not others like Russia and the Cayman Islands, the commission made it easier for affected countries to claim that the list was unfair.

But the bigger issue was diplomatic. Ever since the commission announced a draft list in January, Saudi Arabia has been lobbying E.U. members and threatening to cancel lucrative contracts with some European countries. Lobbying and diplomatic pressure matter — the U.K. and Spain expressed vocal opposition before the commission even released its final list. And that was before the United States entered the fray.

Because blacklisting is effective, adding a country to the list can have immediate financial consequences. This is why, within hours of the commission’s February announcement, the U.S. Treasury Department had advised American banks to ignore the list. Once the United States joined Saudi Arabia and Panama in lobbying E.U. members, the blacklist’s demise was all but assured.

Blacklists on money laundering and terrorist financing rely on countries to implement them domestically. Governments have to buy in to the process to encourage their banking sectors to punish offenders. This is why the FATF, a body with both technical expertise and the support of powerful economies, has had such substantial consequences. Opposition from two of the world’s largest financial sectors meant that the European Commission’s list was bound to fail.

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Will there be another blacklist?

The commission’s February list is done. But the political forces that supported it are still mobilized. European Parliament members have issued a letter opposing “political interference” in the listing process. The European Commission could find other suitable candidates. In a few months, there could be a new listing controversy. Without political support, however, a blacklist is likely to meet an untimely end.

Julia C. Morse is assistant professor of political science at the University of California at Santa Barbara.