Tracking monetary transactions: transparency or suspicion?

Charles Goldfinger

Presentation at 5^th International Meeting on Ethics, Finance and Responsibility,

Observatoire de la Finance, September 29, 2006 Geneve

This is not going to be an even-handed Science-Po like expose, balancing between arguments for transparency and those for suspicion, before coming to a evenhanded conclusion that a right balance has to be struck between the two. As far I am concerned suspicion trumps transparency in most if not all aspects of monetary transactions, particularly in their monitoring and tracking. Suspicion is widespread and multiform. Corporate and household users who order the transactions are distrustful of bankers, whom they suspect of gouging them, and of public authorities, who want to know more than senders and receivers are prepared to disclose. And public authorities are wary of systems and networks they cannot fully control. Central banks want to make sure that they have means to fulfill their official mandate of managing inflation and, in some cases, broader economic performance. Fiscal agencies closely monitor monetary transactions, looking for evidence of fraud and money laundering. And while fraudulent transactions represent only a small fraction of the total, the only way to detect them is to monitor and to analyse all the transactions. Thus, the demand for transparency from monetary authorities is clearly driven by the suspicion of motives of transaction users. This is the rationale behind the sustained efforts of the authorities to limit the use of cash and to impose stringent reporting requirements on financial institutions accepting cash deposits and cash disbursements.

The problem with transparency is the ambiguity of its definition. Different actors of monetary transactions view the transparency in an asymmetrical fashion: transparency for them, opacity for their counterparts. Authorities want to be able to track the monetary transactions without fully disclosing their knowledge and their intentions. Users seek a full disclosure of costs of their transactions and the extent of regulatory monitoring while preserving the privacy and discretion of their activities. Financial institutions, which are in the position to provide all the technical means of transactions transparency, prefer to limit themselves to the strict minimum.

Moreover, this multilateral distrust is growing and suspicion is spreading. This is a result of interactions between economic, political and technological factors, which determine the dynamics of monetary transactions.

Economic factors drive the rapid growth and diversification of monetary transactions. This growth accompanies overall economic expansion. Diversification reflects the globalization and integration of the world economy. In particular, globalization entails huge migratory flows between zones of high employment and sources of labor. The monetary counterparts of migratory flows are the workers’ remittances. In the recent years, international financial institutions such as the World Bank and the International Monetary Fund began to pay closer attention to the mechanics of workers’ remittances and attempted to measure their importance. Their research highlighted the economic and financial importance of remittances, whose flows appear to be larger than that of Foreign Direct Investment (FDI). It also showed the sophistication of informal transaction networks, of which hawalas, used initially by Mecca pilgrims and then extended to remittances of workers from Islamic countries. Those networks operate outside both the formal banking system and the official monetary regulatory structures. It is unlikely that they will become part of the former. Big retail banks are ill-equipped to handle retail international transaction, which represent a very small percentage of their transaction volume. Global cards networks, Visa, MasterCard or Amex, only focus on selected customer groups and certain type of transaction. Given the specificity of the remittance business, only one global financial institution is dedicated to this space, Western Union.

In 1994, Western Union was acquired by the leading US payment processing firm, First Data. However, First Data decided recently to spin-off Western Union to its shareholders.

So, international monetary transfer business is shared between Western Union and ill-defined galaxy of informal transfer arrangements. Whether such a structure will persist is not clear, as the technological evolution may attract new entrances and transform the operating mode of the exiting ones.

The political factors are driven by the growing concern of authorities, which view international funds flow not only as vehicles for fraud and criminal money laundering but also as the privileged channel of financing cross-border terrorism. It is not that the money transactions are increasingly used for illegitimate purposes but for the police and counterterrorist agencies, “follow the money” constitutes a cost-effective and required approach to crime solving and even more important, to crime prevention.

OECD countries have set up a Financial Action Task Force to coordinate their efforts to combat money laundering and international terrorism in 1989. Their efforts took on new urgency in the aftermath of September 11, 2001 and July 7, 2005 attacks in New York and London respectively.

US authorities in particular sought to harness the potential of technology to monitor in detail both domestic and international transactions. Their efforts were disclosed in recent months, when traditional media reported large-scale monitoring programs, carried out domestically by the National Security Agency (NSA) and internationally by the CIA. Domestic programs primarily involved the telecommunication companies but the international program used the well-known international fund transfer network, SWIFT. The disclosure of SWIFT’s participation created quite a controversy in Europe, as SWIFT is incorporated in Europe (as a Belgium co-operative company) and its involvement was not disclosed to national financial authorities. Yet, the media reports about what they called the SWIFT affair left me with a sense of incredulity. It seems inconceivable that the SWIFT management would act without approval of its Board of Directors and its banking shareholders. It is also difficult to believe that the Bank of International Settlements (BIS), which hosts Financial Stability Forum, whose goal is strengthen international coordination and surveillance capability of central banks, was not aware of the program. Last but not the least, monitoring SWIFT records only would provide a partial information on transactions and their beneficiaries as SWIFT does deal with final beneficiaries. Thus, either SWIFT program was complemented by other programs, apparently not disclosed, monitoring domestic retail payment networks or SWIFT gathers more information than it officially acknowledges. It is difficult to make a definite assessment as interested parties are not talking. US government went even as far as to claim that the mere disclosure of the existence of the program is harmful to national security. Not only is the transparency out of the question but disinformation and misdirection are widespread. This is in accordance with the “Enigma” precedent, when during the World War II, the UK government sought by all means to prevent any leaks about the fact that it cracked the German “Enigma” used for confidential military communications.

And, yet the same Information Technology, which makes it feasible for authorities to deploy vast and, presumably, accurate tracking and monitoring tools, threatens their ultimate efficiency. Internet makes the network architecture standard and easy implement. It puts at disposal of an average user sophisticated routing and encryption. Creating a new, secure and safe, network is no longer a monopoly of large formal institutions. Establishing a full-fledged general purpose payment network is of course a task of much higher order as its use depends critically on the reputation of its operator and of its users. Nevertheless, a group of people, who want to set a transaction network to facilitate transactions among themselves, can do it quickly and securely.

Mobile technology further increases the freedom of action of users. Mobile handset can become a payment terminal, allowing users to send orders and to monitor their progress. One can envisage the handset and the mobile network becoming the preferred infrastructure of informal remittance transfer systems.

This evolution did not escape the attention of mobile telephone operators and handset suppliers, for whom payment system and financial transactions create new business opportunities. Many experts expect them to become significant players in those segments. This has not happened so far. This is due to in large part to strategic uncertainty of telecom players, who hesitate between go-it-alone or consortium approach. They are also concerned about competitive response of financial institutions, at the time when they have to continuously redefine their business models. However, one major and quite simple reason was that current generation of mobile networks is simply not geared to handle data traffic: transmission speed is too low and is functionality limited. This is about the change with the on-going deployment of 3G (CDMA) networks, which will allow high-speed data transmission. After becoming broadband, Internet is going mobile.

Its advent is likely to speed up the decision-making process of telecom players and accelerate their entry into payment services.

Authorities are well-aware of this evolution and are seeking to define new rules for electronic money in the cyberspace. Such definition is bound to quite complex, given the continuously evolving configuration of players and speed of economic and technological changes. In any case, it is likely that it will be guided by a principle of limited transparency and maximum suspicion. Pioneers of e-commerce thought that e-payments system have to be built on the infrastructure of trust. They were mistaken, what is required is a robust infrastructure of distrust.