Sector Risk Assessment. For Registered Banks, Non-bank Deposit Takers, and Life Insurers. Undertaken by Reserve Bank of New Zealand

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1 Sector Risk Assessment For Registered Banks, Non-bank Deposit Takers, and Life Insurers Undertaken by Reserve Bank of New Zealand As at March 2011

2 Contents Part 1: Executive Summary Executive summary...4 Part 2: Introduction The Anti-Money Laundering and Countering Financing of Terrorism Act Purpose of the SRA.6 AML/CFT Supervisors.7 Structure..8 Other ML/TF assessments...8 Information sources...10 Methodology..11 Limitations Money Laundering and Terrorist Financing...13 Other relevant legislation Part 3: Sector summary 15 Part 4: Sector risks Registered banks - industry overview.17 Structural risks.17 Non-bank deposit takers - industry overview..20 Structural risks..20 Common risks to registered banks and Non-bank deposit takers. 23 Emerging risks 26 Registered banks specific risks.27 Non-bank deposit takers specific risks..29 Life Insurers industry overview. 30 Structural risks P age

3 Specific risks..32 Emerging risks.36 Appendix.37 3 P age

4 Part 1: Executive summary This section provides a brief outline of the SRA and a summary of the risk ratings for the sub-sectors. THE SCOPE OF THE SRA 1. This sector risk assessment (SRA) is the first assessment by the AML/CFT supervisors of the risks of money laundering across the sector they will supervise. The Reserve Bank will supervise registered banks, non-bank deposit takers and life insurers for the purposes of the Anti-Money Laundering and Countering the Financing of Terrorism Act 2009 (the Act). Other AML/CFT supervisors (the Department of Internal Affairs and the Securities Commission) have published similar risk assessments for the sectors they supervise. 2. This SRA will assist the AML/CFT supervisors in understanding the risks of money laundering in the sector. It will also benefit reporting entities as it will assist them to prepare for undertaking risk assessments in their businesses. Reporting entities are required by the Act to undertake a risk assessment prior to establishing an AML/CFT programme. This document may provide guidance to reporting entities on areas of higher risk in their business. LIMITATIONS 3. The assessments of each industry or sub-sector undertaken in this document are based on structural risk indicators. For consistency when comparing sub-sectors we have not taken into account the adequacy or effectiveness of any controls at this stage as the supervisory arrangements provided for in the Act are yet to take effect. 4. There is limited information available on money laundering or terrorist financing risks in New Zealand. A national risk assessment undertaken by the New Zealand Police Financial Intelligence Unit (FIU) has only recently been published. This SRA draws significantly on risk assessments, guidance and reports from other jurisdictions and international organisations such as the Financial Action Taskforce. OVERVIEW OF CURRENT FINDINGS 5. The following assessments are a result of considering the internationally recognised structural risk factors of money laundering in the sub-sectors below. Those structural risk indicators include size and scale of the sector, cash intensity of business, amount of international business, customer base and indicators of potential money laundering activities. 6. The risk assessment model rates structural indicators as high, medium or low based on the available data. Indicators of higher risk are cash intensive products and services along with certain types of customers. 4 P age

5 7. The ratings in this SRA do not take into account risk mitigants that are in place in individual entities or across the sub-sectors. Only a relatively narrow set of AML/CFT requirements is currently in force across the sector. For most reporting entities the AML/CFT supervisors cannot test the effectiveness of existing controls. AML/CFT supervisors powers are limited until the Act comes into force, probably in early For this reason controls have been noted where they exist, but not included in the risk rating process, in order to present consistent ratings that can be compared across sectors. 8. There is little information or evidence to support a rating on terrorist financing in New Zealand at present. Sub-sectortype Registered banks Non-Bank Deposit Takers Finance companies Building Societies Credit Unions Life Insurers Structural risk assessment of ML risk High Medium Medium Medium Low Medium / Low 9. The high rating for banks is consistent with the characteristics of the banking industry in the absence of AML/CFT requirements. This is to be expected given the relative size of the banking sub-sector and the large number and value of transactions compared to other areas. The wide availability and easy accessibility of products and services in banks through millions of transactions have greater risk of money laundering than some other sub-sectors. 10. A risk rating for money laundering is not an indication of financial strength or stability of any financial sector or institution within the sector. 5 P age

6 Part 2: Introduction THE ANTI-MONEY LAUNDERING AND COUNTERING FINANCING OF TERRORISM ACT The Anti-Money Laundering and Countering the Financing of Terrorism Act 2009 (the Act) was passed in October The purposes of the Act are: To detect and deter money laundering and the financing of terrorism (ML/TF); and To maintain and enhance New Zealand s international reputation by adopting, where appropriate in the New Zealand context, recommendations issued by the Financial Action Task Force (FATF); and To contribute to public confidence in the financial system. 2. Under Section 131 of the Act, one of the functions of each AML/CFT (anti-money laundering and countering the financing of terrorism) supervisor is to assess the level of risk of ML/TF across all of the reporting entities that it supervises. This has been undertaken in the form of the Sector Risk Assessment (SRA). Three SRAs have been produced one for each of the three AML/CFT supervisors sectors (see AML/CFT supervisors below). PURPOSE OF THE SRA 3. This SRA is the first assessment undertaken by the AML/CFT supervisor of the money laundering risks in the sector. 4. The SRA is intended to: Assist the supervisors in their understanding of particular ML/TF risks within their designated sector; and Provide guidance to reporting entities on the specific risks relevant to their sector or subsector; and Contribute to the New Zealand Police Financial Intelligence Unit (FIU) assessment of ML/TF risks in New Zealand financial institutions. AML/CFT SUPERVISORS 5. The relevant supervisors for the types of reporting entities are detailed in Section 130 of the Act. 6 P age

7 That section allows for AML/CFT supervisors to agree on the appropriate supervisor for a reporting entity where the products or services offered by that reporting entity may be covered by more than one AML/CFT supervisor. There is also provision for supervision of a group of reporting entities as a Designated Business Group by one or more than one AML/CFT supervisor. 6. A reporting entity can only have one supervisor. The national AML/CFT co-ordination committee can appoint an AML/CFT supervisor for a reporting entity in the absence of any agreement by the supervisors. The Act designates three AML/CFT supervisors and gives them and the FIU powers to carry out their AML/CFT functions. 7. The Reserve Bank is the relevant AML/CFT supervisor for: Registered banks Non-bank deposit takers (NBDTs) Life insurers 8. The Securities Commission is the AML/CFT supervisor for: Issuers of securities Trustee companies Futures dealers Collective investment schemes Brokers Financial advisers 9. The Department of Internal Affairs is the AML/CFT supervisor for all reporting entities not covered by the Reserve Bank and Securities Commission. At present this includes: Casinos Money service businesses (including currency exchange and money remittance/transfer) Payroll remittance Lending and other services (including non-bank non deposit taking lenders, debt collection and factoring) Financial leasing Cash transporters Safe deposit/cash storage Issuing and managing means of payment (including non-bank credit card and stored value card providers) 7 Page

8 STRUCTURE 10. There are 4 parts to this document. 11. Part 1: Executive Summary provides a brief outline of the risk ratings for the sub-sectors. 12. Part 2: Introduction - introduces the relevant legislation and gives an overview of the risk assessment process, the methodology used in the assessment of the ML/TF risks in the sector and limitations with the current SRA. 13. Part 3: Sector summary - provides a summary of each sub-sector and the key risk areas. 14. Part 4: Sector risks addresses each sub-sector in depth by highlighting the factors considered in the risk assessment of each sub-sector. In turn this is arranged into different sections: Overview - this provides some general comments on the sub-sector as a whole Structural risks - this section considers the areas of risk identified internationally that are relevant to an assessment of risk relating to the nature and scale of the sub-sector and its operations. Specific risks drawing on international guidance, this section details the major areas of risk of ML/TF in a sub-sector relevant to the business activities undertaken by reporting entities in that sub-sector. OTHER ML/TF ASSESSMENTS Mutual evaluation report of New Zealand 15. The FATF and the Asia-Pacific Group on Money Laundering (APG) completed a Mutual Evaluation Report on New Zealand in October 2009 which described some deficiencies with AML/CFT requirements in New Zealand at that time. These included gaps in law and regulation, limited Customer Due Diligence, insufficient beneficial ownership information availability and vulnerabilities with the New Zealand Companies registration process. 16. The Act, along with Regulations and Codes of Practice yet to be introduced, aim to address vulnerabilities identified by the FATF. 8 P age

9 The risk-based regime three levels of risk assessment 17. The regime introduced under the AML/CFT Act enables AML/CFT activities to be based on risk. The purpose of this is to minimise compliance costs and ensure that resources are targeted towards high-risk, high-priority areas. The Act provides for risk assessment at three levels: National Risk Assessment 18. The FIU has undertaken a National Risk Assessment (NRA) pursuant to section 142(k) of the Act. The NRA s primary audience is relevant government agencies including the AML/CFT supervisors. It gives an overview of AML/CFT issues affecting New Zealand from a law enforcement perspective. Information from government organisations, both domestic and international, contributed to this assessment. Further information will be available from the AML/CFT supervisors and reporting entities for future national risk assessments. 19. The NRA acknowledges the information gaps in the data available to assess ML/TF. The FIU intends to develop and maintain valid and reliable indicators of ML/TF and publish Quarterly Typology Reports. The reports, along with other available intelligence, will inform the AML/CFT supervisors and sectors of trends. Future SRAs will benefit from this information. Sector Risk Assessment 20. AML/CFT supervisors have each produced a risk assessment for their own sector. Future SRAs will draw on a variety of sources, including risk assessments carried out by the FIU and reporting entities. Ongoing SRA work will be conducted by the AML/CFT supervisors in order to fully understand the ML/FT risks within their sectors and to inform reporting entities on risk indicators, trends and emerging issues. SRAs may be revised regularly or on an ad-hoc basis, depending on the rate of change in ML/TF risk affecting a sector. Reporting Entity Risk Assessments 21. Section 58 of the Act requires all reporting entities to undertake an assessment of the risk of ML/FT in their business. The risk assessment must consider the nature, size and complexity of its business, products and services including delivery methods, its customers and any countries it has dealings with as a part of its business. One of the factors that reporting entities must have regard to in developing their risk assessments is guidance material on risk assessment produced by an AML/CFT Supervisor or the Commissioner of Police. This SRA forms part of the guidance material issued by an 9 P age

10 AML/CFT Supervisor. AML/CFT supervisors are preparing further guidance on the process of carrying out a reporting entity risk assessment. 22. The following diagram outlines the inter-relationship of the risk assessment process: National Risk Assessment (NRA) The NRA will inform: Sector Risk Assessment (SRA) The SRA will inform: Reporting Entity Risk Assessments INFORMATION SOURCES 23. The SRA has drawn together information from a number of sources. Currently there is little comprehensive or precise data available to fully assess the ML/TF risks across all products, services or areas in each sector. As a result, the SRAs drew heavily on overseas based experience and findings from similar jurisdictions with AML/CFT requirements, such as the Australian Transaction Reports and Analysis Centre (AUSTRAC). This is combined with observations from multi-national organisations that New Zealand is a member of including the FATF and APG, as well as the Wolfsberg Group, Interpol, and the International Monetary Fund where applicable. 24. This information is supplemented by local information, particularly data received from entities that responded to various surveys and/or interviews by AML/CFT supervisors. Consideration has been given to other data sources available to the AML/CFT supervisors including summary Suspicious Transaction Report (STR) data and information provided by the FIU, as well as industry expertise, knowledge and experience from internal and external resources relevant to the sector. 25. A number of reporting entities responded to the Reserve Bank survey on AML/CFT in December The survey requested rudimentary information on the business, including types of products and services offered and how they are offered to new customers along with the makeup of the customer base. 10 P age

11 26. Because of the wide range of products and services in the sectors the Reserve Bank will supervise and the crossover of those products and services with other sectors, this SRA has also considered the findings of the other supervisors about risks when they are reasonably similar. METHODOLOGY 27. The AML/CFT supervisors have drawn upon international guidance in preparation of the SRAs. This assessment follows an international model for AML/CFT risk assessments developed by the World Bank and the APG. 28. The model assesses a series of structural risk indicators to indicate the nature and scale of possible ML/TF in New Zealand. These include: Size of the sub-sector or industry, including value of transactions; Turnover volume; High cash intensive products and services; Frequency of international transactions; Higher risk customer types; and Indicators of potential ML activities including the number of Suspicious Transaction Reports currently recorded from each sub-sector under the Financial Transaction Reporting Act 1996 requirements, any prosecutions or convictions that indicate ML. 29. Each risk indicator is assessed as LOW, MEDIUM or HIGH based on current information and understanding of the ML/TF risk in the sector. 30. Following the assessment of the structural risks, the assessment model then considers a basic overview of any high level AML/CFT regulatory requirements and the current supervision environment. Potential high level considerations include: AML/CFT Regulations/Guidelines/enforcement mechanisms; AML/CFT on-site inspections and off-site monitoring; Resources committed to AML/CFT supervisory authorities; Market entry/control (including fit and proper requirements); and Monitoring of transactions and adequacy of STR reporting. 11 P age

12 31. Because the Act is not fully in force, the policies, procedures and controls that may manage or mitigate the risks in the sectors reporting entities have not been assessed. Because we are not considering the effectiveness of reporting entities controls in the risk rating process, we have made no judgements whether the risks in the sector are adequately managed or mitigated. Individual entities may have systems and controls in their business that adequately address some or all of the risks discussed in the risk assessment. This SRA assesses the risk across the sector and not at the individual reporting entity level. Entities that have already developed expertise and knowledge in ML/TF will find that knowledge beneficial when interpreting the ML/TF risks to their business. 32. Specific areas of risk within the sector are also identified and assessed in the SRA. Products and services offered by businesses in a sector that are susceptible to ML/TF are evaluated as well as determining whether any delivery channels or customer types were likely to be more at risk of money laundering. This SRA does not necessarily identify or comment on all financial activities undertaken by entities within the sector. 33. Given the limitations of available information and the early stage of the implementation of the AML/CFT requirements of the Act, it is likely that this first SRA will differ in scope from subsequent assessments. It is intended that this assessment will be the foundation of more detailed and informative assessments in years to come. The AML/CFT supervisors anticipate that SRAs will be revised as further information and data becomes available from reporting entities, the FIU and overseas. 34. It is anticipated that reporting entities may determine how ML/TF risks will be assessed in their business using a different approach to the SRA methodology. LIMITATIONS 35. This SRA has been produced prior to full implementation of the Act with inevitable limitations on the risk assessment process. The following limitations to the SRA process were identified: information on money laundering in New Zealand is limited, with some reliance on international typologies and guidance to identify risks; reporting entities have various degrees of understanding of AML/CFT legislation, procedures or the ML/TF risks in their business, therefore the perception of risks may not be fully developed in some responses to surveys; 12 P age

13 insufficient availability of detailed data and information to inform some risk areas; variable quality of data across some of the sectors with more qualitative sources used; the limited scope of current legislative requirements; and STR data reporting currently only allows for quantitative analysis. 36. The majority of these limitations will be addressed by development of the AML/CFT regime and more engagement with reporting entities. The SRA will evolve as the quality of information improves. AML/CFT supervisors expect that when the statutory obligations come into force and reporting entities are supervised for compliance with these obligations, more and better information on the AML/CFT risks facing the sectors will emerge. Future risk assessments should contain a better balance of quantitative and qualitative information. MONEY LAUNDERING AND TERRORIST FINANCING 37. This assessment focuses on the risk of money laundering in the sector as there is limited information on terrorist financing in New Zealand for the AML/CFT supervisors to comment on. 38. Money laundering is concerned with concealing the origins of funds or assets. Funds are generated through illegal operations, such as drug manufacture and supply, and launderers attempt to hide its origin through a number of often complex transactions. There are generally 3 stages to money laundering: Placement involving the introduction of illicit funds into the financial system Layering - the numerous transactions designed to confuse any tracing of funds to its original source Integration legitimising the funds through ordinary financial activity 39. With money laundering, the criminal activity has already taken place. With terrorist financing, the focus is on preventing the criminal activity from occurring. The characteristics of terrorist financing can make it difficult to identify. These include the low value of transactions and that funding can come from legitimate as well as illicit sources. Where illicit funds are being used, the methods employed to monitor money laundering may also be applicable for terrorist financing as the movement of those funds often relies on similar methods to money laundering. 13 P age

14 40. There have been no convictions for terrorist related offences in New Zealand since the introduction of the Terrorism Suppression Act in The FIU and the 2009 Mutual Evaluation Report indicate that there is little evidence to suggest terrorist financing is occurring in New Zealand and consider the risk of terrorist financing to be low. The FIU is better placed to provide information on terrorist financing indicators and activities at present. OTHER RELEVANT LEGISLATION Financial Transactions Reporting Act 1996 (FTRA) 41. The FTRA contains the AML/CFT requirements that will be in place for financial institutions and casinos until the Act fully commences. The FTRA currently applies to entities that are the subject of this risk assessment. 42. The purpose of the FTRA is to facilitate the prevention, detection, and investigation of money laundering in New Zealand. This is assisted by requiring financial institutions to meet certain obligations in relation to financial transactions. This includes the verification of identity, STRs and record keeping. The Financial Service Providers (Registration and Dispute Resolution) Act The objectives of the Financial Service Providers (Registration and Dispute Resolution) Act 2008 are to identify financial service providers, to allow for more effective monitoring and evaluation of financial service providers, to assist supervision of reporting entities with AML/CFT obligations and to improve consumer redress in the financial sector. 44. Financial service providers were required to be registered by December P age

15 Part 3: Sector Summary Registered Banks Overall structural risk rating - HIGH 1. There are 19 registered banks in New Zealand with 10 of those operating as branches of overseas incorporated banks. Registered banks are likely to have developed an understanding of AML/CFT requirements by virtue of operating to various international requirements in other jurisdictions. 2. Banks may be used at all stages of money laundering. Because of the relatively wide availability and easy accessibility of products and services of banks, the banking sub-sector is considered a primary avenue for money laundering. The higher risk based on structural indicators can be attributed to millions of dollars and transactions that flow through the banking sub-sector to a variety of countries, including to possibly high risk countries. 3. The higher rating for registered banks is consistent with international experience and expectations of the characteristics of the banking sub-sector in an environment with no AML/CFT requirements in place. Institutions may have policies, procedures or controls in place to manage some or all the risks outlined in this risk assessment which may lower the overall risk rating that they have for their own business. When supervisory powers are in force and testing of controls can be completed, the high risk rating for registered banks may be reviewed. Non-Bank Deposit Takers Overall structural risk rating MEDIUM Deposit taking finance companies - MEDIUM Building Societies and cooperatives - MEDIUM Credit Unions LOW 4. The NBDT sector is made up of a number of sub-sectors including deposit taking finance companies, building societies and cooperatives, and credit unions. Recent changes in the sub-sector include new prudential requirements and a reduction in the number of entities operating as non-bank deposit takers. 5. The rating for deposit taking finance companies considers that they do not have the cash intensive products and services that other sub-sectors may have but they do have a reasonable level of transactions by value and volume. 6. Building societies and cooperatives operate in a similar way to registered banks, although international transactions are rated lower, as are indicators of money laundering use in the subsector. 7. Credit unions are rated as having a lower risk of money laundering as collectively they are domestic focussed with a lower risk customer base and few indicators of money laundering activity. 15 P age

16 8. This assessment is for the particular industry and do not relate to individual reporting entities. Life Insurers Overall structural risk rating MEDIUM/LOW 9. AML/CFT requirements in the Act only apply to life insurance at present. Consideration may be given to extending the scope of obligations to general insurance in the future. Certain aspects of some life insurance products may also be excluded in part from the scope of the Act or for customer due diligence purposes. Life insurers should consider the impact of AML/CFT Regulations when they are promulgated. 10. As with registered banks, many insurers also operate in other jurisdictions and are subject to AML/CFT requirements in those countries. Application of AML/CFT supervision and requirements can vary. 11. The life insurance sub-sector can be perceived as lower risk relative to other financial institutions. For this reason it may attract money launderers unless adequate controls are in place. Large single payments and payouts are particularly attractive, as is the ability to nominate and change the beneficiary of policies. The AML/CFT supervisors will consider the effectiveness of any controls in the future. 16 P age

17 Part 4: Sector Risks 1. The fourth part of this SRA highlights the indicators considered in the risk assessment of each subsector. This section covers: an overview of the sub-sector, a discussion of pertinent structural risks that are relevant to the assessment of risk, any specific risks relevant to the business activities undertaken by reporting entities in that sub-sector and finally any emerging risks identified internationally that may be potential issues for the sector in New Zealand. Registered Banks and Non-Bank Deposit Takers 2. There are a number of products and services that are common to registered banks and NBDTs. A discussion of the structural elements relevant to banks and NBDTs are presented separately followed by risks common to both sub-sectors. Any specific risks to the sub-sector follow separately. Registered Banks Industry Overview 12. There are 19 registered banks in New Zealand. The use of the term bank in a name or title is restricted to those financial institutions that are registered and supervised as banks by the Reserve Bank. Many registered banks have been required to comply with AML/CFT requirements in other countries and are therefore one of the most developed entity types in considering the impact of the New Zealand AML/CFT requirements. AML/CFT procedures are also a requirement for registration as a bank in New Zealand. 13. The latest FATF/APG Mutual Evaluation of New Zealand in 2009 noted that, as in other countries, laundering of proceeds of crime has extended beyond the traditional banking services. However, the banking sector is still a primary avenue for money laundering. Of concern is the level of due diligence undertaken on customers; particularly deficiencies in relation to beneficial owners, politically exposed persons (PEPs) and correspondent banking relationships. Overall the level of risk of money laundering being conducted in or through registered banks is high. Structural indicators Size 14. The large part banks play in the financial sector in New Zealand is a major factor in the high risk rating. Banks account for 80% of the total assets of the New Zealand financial sector with assets of 17 P age

18 around $377 billion as at 30 June The large scale of operations is also reflected in staff numbers with over 25,000 people employed across the country in the banking sector. 15. More than 6.5 million transactions take place daily through the banking system with funds movement in excess of $65 billion. However, of the 19 registered banks, one third of the banks are responsible for over 80% of the turnover volume and balance sheet asset size. Transactions through the banking sector range in size from small to very high value. Cash intensive products and services 16. Banks in New Zealand offer a wide range of products and services. In providing general banking facilities, banks offer a number of cash intensive products which have a high risk of being used to launder money. Proceeds from criminal activity have traditionally taken the form of physical currency at the placement stage of money laundering. Placement of dirty money in the financial system also occurs when criminal proceeds can be mingled with legitimate business takings before depositing into accounts. Cash intensive products include over-the-counter services such as depositing or withdrawal of cash, sales and purchases of foreign exchange, issuing or cashing travellers cheques, and purchase of reloadable cash card products. International transactions 17. A significant proportion of transactions by value through the banks on a daily basis are international. Analysis of these transactions to determine which countries are parties to all transactions is currently unavailable. It is expected that most international transactions will be a source of higher risk. It is anticipated that transactions with parent companies will be a lower risk. 18. One factor that will increase the risk is transactions with higher risk countries. Available information may not necessarily highlight the involvement of higher risk countries where, for example, transactions may be conducted indirectly with such countries. There may be legitimate reasons for transactions in or through certain countries but there are risks with international transactions or foreign counter parties. Geographic risk comes from dealing with persons, entities or countries in jurisdictions with lax or no protection or deterrents to money laundering or terrorist financing. Customers 19. A complete breakdown of the customer base of the banks is also not available at present. With over eight million accounts held by individuals, families, social groups and businesses at banks in New Zealand, it may be challenging for banks to know all their customers well and be aware of all the risks associated with them at present. Access to banking facilities by non-residents is a factor that can increase the risk of money laundering if there are not genuine reasons for operating an account in New Zealand. The use of banking facilities by foreign Politically Exposed Persons (PEPs) also 18 P age

19 heightens this risk. Likewise, high net worth customers pose a higher risk due to the larger amounts they have available to deposit or invest and the ease of fund movement private banking type facilities may afford them. Banks in New Zealand offer services to all these types of customers. Also of concern is the ability of non-customers using the banking system, for example by depositing into accounts held by other persons or one-off transactions such as currency exchange or wire transfers. Data indicating money laundering activities in the subsector 20. Most suspicious transaction reports (STRs) filed with the NZ Police FIU, originate from the banking sector with nearly 3000 recorded in The next highest entity type filed approximately onethird of the number of STRs the banks file. This is to be expected given the relative size of the banking sector and the large number and value of transactions compared to other sectors. Data available over the last few years suggests that numbers of STRs from banks decreased between 2004 and 2008 but rose slightly in Analysis by the FIU indicates that the quality and usefulness of information supplied is improving. Controls 21. An assessment of the control measures applicable to the sector has not been undertaken prior to implementation by reporting entities of the measures required to achieve compliance with the Act, including risk assessments and AML/CFT compliance programs. Banks are currently operating under the reporting requirements of the Terrorism Suppression Act 2002 (TSA) and the Financial Transaction Reporting Act 1996 (FTRA). Some foreign owned banks operate to some extent with systems and controls necessary to comply with AML requirements from home jurisdictions of the parent bank. There are currently no supervisory inspections or monitoring to ensure compliance with ML/TF requirements in New Zealand such as the FTRA. There is some scope for prudential supervision requirements to implement certain aspects such as the fit and proper test for senior managers and directors, and to outline expectations on the establishment of internal AML/CFT procedures in banks. 19 P age

20 Non-Bank Deposit Takers Industry overview 22. Non-bank deposit takers (NBDTs) are defined in the Reserve Bank of New Zealand Act NBDTs are entities that issue debt securities to the public in New Zealand (as further defined by section 3 of the Securities Act 1978) and who carry on the business of borrowing and lending money or providing financial services, or both 1. Many operate in a similar nature to registered banks by providing a range of financial services including accepting deposits and lending funds. The NBDT sector is made up of sub-sectors, namely deposit taking finance companies, building societies and cooperatives, and credit unions. Non-deposit taking finance companies that provide lending services only are covered in the SRA produced by the Department of Internal Affairs. 23. Regulation of the NBDT sub-sector is undergoing some change with new legislation placing additional prudential requirements on entities in the sector. Further, new requirements are expected that will include licensing, fit and proper person requirements for directors and senior management of NBDTs and the ability to place restrictions on changes of ownership. 24. There have also been changes in the makeup of the sector over the last few years with the departure of a number of entities through amalgamation with other entities or liquidation. AML/CFT requirements under the Act are not generally intended to apply to financial institutions in liquidation, receivership or operating under a moratorium agreement where entities are restricted from issuing further debt securities and lending. 25. This SRA considers the risks overall in the NBDT subsector. The individual components of the NBDT subsector are often quite distinct in character; therefore consideration has been given to the risks for particular entity types such as the deposit taking finance companies, building societies and cooperatives, and credit unions. Overall the level of risk of money laundering being conducted in or through NBDTs is assessed as medium. The level of risk in deposit taking finance companies is assessed as medium. The level of risk in Building Societies and cooperatives is assessed as medium. The level of risk in Credit Unions is assessed as low. Structural indicators Size 26. At the time of writing, there are more than 60 known entities in the NBDT sector. One third of those are deposit taking finance companies numbering around 20 entities with $5billion in assets. A few 1 All building societies and credit unions are included in this definition even if they do not issue debt securities. 20 P age

21 large multi-million dollar businesses that significantly contribute to the estimated $50 million plus value of transactions on a daily basis through NBDTs. 27. There are 11 registered building societies with eight taking deposits in New Zealand. There is one known cooperative. Building societies and the co-operative account for around $3billion of the $9 billion NBDT industry. 28. Credit unions represent more than 50 percent of the NBDTs by number but hold less than $1 billion in assets. Roughly two-thirds of all transactions in NBDTs occur through credit unions. Cash intensive products and services 29. Deposit taking finance companies receive a low rating for the cash intensive products and services indicator. A number of the deposit taking finance companies are specialist lenders in areas such as rural finance, asset based lending or property finance. Funds loaned or received through products such as debentures, are likely to be through electronic means or cheque rather than physical cash. 30. Building societies, cooperatives and credit unions offer a similar range of high cash intensive products and services to the core activities of retail banks. Products identified in the banking sector for over-the-counter services included depositing of cash, foreign exchange business including issuing or cashing travellers cheques, and the purchase of reloadable cash product cards. The potential misuse of general deposit type accounts for the purposes of money laundering are similarly an issue in the NBDT sector. Term deposit accounts are lower risk products where the term arrangements cannot be broken. This is due to the amount of time the funds are unavailable. Money launderers prefer readily available funds and the ability to quickly move those funds to avoid them being detained if any irregularities are identified. International transactions 31. International transactions make up a very small proportion of transactions in the NBDT subsector. The number of transactions with overseas institutions through deposit taking finance companies is higher than in building societies and credit unions. This is mainly from payments being made to other countries rather than receipt of funds into NZ. 32. Available data indicates that building societies have very few transactions with overseas persons but those transactions are of a greater dollar value than international transactions by credit unions. 33. Current information suggests that international transactions through credit unions represent less than one percent of their total transactions. 34. International transactions are susceptible to ML/TF as such transactions may be difficult to trace, particularly in offshore centres or business secrecy jurisdictions. Transactions involving countries with limited or no ML/TF controls will be a higher risk. It is not known at the present time how many transactions in the NBDT subsector involve higher risk jurisdictions. 21 P age

22 Customers 35. The customer base varies across the sub-sectors of the NBDTs. Of the responses received from the RBNZ survey in December 2009, no entity indicated that they had any foreign politically exposed persons as customers. Several NBDTs, across all sub-sectors, indicated they did business with trusts, charities and non-new Zealand residents. 36. Building societies, cooperatives and credit unions require membership of the entity for customers to access services. Credit unions include small community organisations and generally focus on the supply of financial services to members associated with a particular community, geographical location, or employer. 37. NBDTs should still be wary of illicit funds being mingled with legitimate proceeds of business or personal wealth sources by any customer type. Data indicating money laundering activities in the subsector 38. Data indicating ML/TF occurring in New Zealand is limited at present. The STR data that is available is not necessarily an indication of ML/TF but indicates circumstances where customer activity has raised suspicion. 39. There has been a steady level of STR reporting from the NBDT subsector. In 2009, STRs processed by the FIU increased for those reported by finance companies although this number was still less than the number processed from either the building societies or credit unions in previous years. In 2009, building societies, cooperatives and credit unions reported around half the number of STRs recorded from those entities in The FIU has indicated that generally the quality of reporting under the FTRA regime has improved recently. They are not yet in a position to comment on quality at the sector or sub-sector level. The FIU intends to issue further guidance and feedback on STR reporting in due course. Controls 41. Like banks, NBDTs have relatively limited obligations with respect to ML/TF requirements under the TSA and the FTRA until the AML/CFT Act comes into effect. Supervisors are yet to commence supervisory oversight of compliance with the AML/CFT Act. New legislation covering licensing requirements for NBDTs is expected to be introduced in Some deposit taking entities with exemptions from NBDT prudential requirements will still be required to implement AML/CFT programmes and conduct risk assessments. 22 P age

23 ML/TF risks in the registered banks and non-bank deposit taking subsectors Deposit taking and related cash management account services 42. Deposit taking and related cash management account services have an increased risk of being used for ML/TF and can be used at all 3 stages of ML. 43. They are used during the placement stage of ML which involves the physical depositing of cash into an account or payment of cash for a service. Despite advances in technology that encourage cashless transactions, a significant number of transactions continue to be made with physical currency and pass through banks each day. Physical cash can be introduced into the financial system either purely as proceeds of crime or intermingled with legitimate personal or business funds. The amount of cash deposited may be indicative of illegal funds if it appears that the transaction amount or group of transactions has been structured to fall below a reporting or identification threshold or the amounts appear inconsistent with the customer profile. Automatic teller machines (ATMs), fast deposit services and bank teller services allow for physical deposits to be made into accounts. Deposits may also be made by third parties into another person s account. 44. Layering is the second stage of money laundering where deposit taking accounts are used to launder funds. Prompt or early withdrawal or transfer of funds between accounts is characteristic of layering techniques. Receipt or withdrawal by cheque, money order or bank draft provides the means to move funds including to or from other countries. The funds may be consolidated with other recently transferred monies prior to being moved again or withdrawn to make purchases with the cleaned funds. International reports often highlight the quick turnaround from the various deposits of funds to large withdrawals by cheque, bank draft or wire transfer in ML case studies. Deposits and withdrawals may be structured under reporting or identification thresholds in an attempt to avoid suspicion. Cheque, money transfer and debit card usage appear in numerous case studies overseas in relation to proven ML/TF activities. Money launderers may often disregard any penalties for early withdrawal of investment deposit accounts. 45. Deposit accounts are also used in the integration stage of ML whereby money is reintroduced to the financial system as clean funds once the origin has been obscured. 46. Investment accounts such as term deposits may attract less attention than current transaction accounts from persons attempting to launder funds where term deposit arrangements limit access to and movement of those funds. Electronic banking facilities 47. Electronic banking can favour anonymity and therefore increase the likelihood of its potential use in money laundering. Australian typology reporting in has also acknowledged electronic banking as one of the most common ways used to launder funds P age

24 48. Electronic banking transfers facilitate the movement of funds for a variety of transactions. Electronic fund transfers are a popular method of moving illicit funds because of the instantaneous nature of the transactions. Funds can be moved and mingled with other legitimate or illicit funds before being transferred again. This helps to obscure the origin of the funds. Electronic transactions may also be structured below reporting or identification thresholds to avoid detection. 49. Where the transactions occur without any face to face contact with the institution, criminal organisations can use accounts set up by other persons, nominees or shell companies as a front for their activities and the anonymity can benefit them. Electronic banking facilities often can be set up in circumstances where it is difficult to verify the persons operating the account as distinguished from the account opener. Leasing / lending activities 50. Personal and business lending, including property or asset finance lending, are not often perceived as risky areas for ML/TF in the industry but can be higher risk activities. The susceptibility of loans to obtain funds by fraud is readily understood. The proceeds may be laundered or loan advances may be sent off-shore as clean funds. However, the use of assets as security for loans where those assets have been obtained with proceeds of crime is not well understood. There is a risk that the assets purchased with illicit funds may be used as security to obtain clean funds from entities in the sector. Alternatively illicit funds or criminal proceeds may be used for early repayment of a loan funding a legitimate asset purchase. The opportunity for ML/TF in this area occurs where loan repayments are able to be made in cash and the source of funds for large cash payments is unclear. The FIU has indicated in the National Risk Assessment that the purchase of valuable assets is an area of increasing concern for ML/TF. 51. Deposit taking finance companies are involved in a significant proportion of lending activities, including property finance and leasing of high value machinery or other assets. Personal and mortgage lending are common in retail banks, building societies, cooperatives and credit unions. 52. The Department of Internal Affairs has also considered lending activity in the SRA produced for their sector. Wire transfers 53. Wire transfers, especially international wire transfers, have a relatively high risk of use in ML/TF activities. The rapid movement of funds around the globe creates many opportunities for its misuse. This is particularly true where the origin or path of the funds is not fully disclosed. The use of wire transfers to move funds cross-border relatively quickly has been noted overseas as one of the most common methods to launder funds. 54. Wire transfers between jurisdictions can obscure the source of funds, particularly where information on the originator of the transaction is incomplete or absent. Transactions through banks located in New Zealand may be one of many stops in a transaction path in an effort to 24 P age

25 disguise the country of origin and give the appearance of clean funds from a lower risk jurisdiction. For higher risk transactions, sufficient information needs to be obtained and maintained to understand the nature and purpose of the transaction. Risks may include opportunities for deletion or substitution of information in the corresponding message to circumvent money laundering controls. The risks may relate to the jurisdictions the wire transfer comes from or passes through as well as the parties to the transaction and the accompanying information message. Whilst international wire transfers are more likely to attract suspicion, domestic transfers are not free of risk. 55. Although wire transfers in the NBDT subsector are generally completed through New Zealand banks or money remittance services, the receipt and payment of funds by wire transfer through NBDTs is still a risk for the subsector. Wire transfer transactions on behalf of non-customers also increase the risk of use in ML/TF where due diligence has not been undertaken or a profile of expected transactions has not been established. The Department of Internal Affairs address similar risks in the SRA issued by that agency for money remittance services. Customer risk 56. The ML/TF risks associated with customers are many and varied. False names may be used to open and operate accounts. Persons operating accounts can be acting on behalf of customers as nominees with multiple persons having access to cards on an account. Customers with obscure ownership structures or where beneficiaries are not identifiable heighten the risk. Such customers include trusts, off shore companies and shell entities. Newly established entities or businesses that are shell companies or have obscure ownership structures may be a front for ML/TF activities. 57. Case studies overseas reveal ML/TF activity involving transfers from accounts and bank drafts payable to trusts or companies where the nature or ownership of the organisation is not readily understood. Likewise, facilities provided to higher net worth customers, particularly those with dedicated customer representative relationships, can be misused for ML if transactions are rarely questioned because of the higher value of the business to the reporting entity. Banks in New Zealand have many of these types of customers. 58. Financial services at specific institutions in the NBDT sector are generally only available to members of that institution. Credit unions typically provide services to persons connected in some way in terms of geographical location or present or former employment, although some have common bonds that allow members from a number of different sectors of society. Established customers with transactions that adhere to low value transaction profiles may reduce the risk of their accounts being used for ML/TF. That same assumption may attract money launderers to deposit funds or transact with those institutions because of the perceived reduced monitoring of customers. Foreign currency exchange 59. Easy access to services to convert currency is attractive to money launderers. Exchanging funds for 25 P age