Preventing Terrorist Finance in Iraq

1. Preventing Terrorist Finance in Iraq • Robert Looney Professor, National Security Affairs Naval Postgraduate School • Financial Sources of Terrorism and Insurgency in Iraq Washington, DC., April 5, 2005

2. Outline -- Main Issues • Current State of Iraq’s Financial System. • Financial Reforms/Legislation in Iraq. • Iraqi Efforts At Combating Terrorist Finance. • Iraq’s Progress Toward Best Practices. • Difficulties Facing Iraq and the U.S. • Changing Nature of Terrorist Financing. • Iraqi Position Towards Terrorist Finance. • Iraqi Cooperation at the Regional Level.

3. Iraqi Banking System • Many Reforms Initiated by the CPA in Late 2003. • Two Large State-Owned Banks, Al-Rafadain and Rasheed Dominate Banking Sector. • Private Banks Not Permitted Until 1991 – 17 Now Exist. • Private Banks Profitable, but Low Levels of Capitalization Constrain Growth. • Initial Post-War Model of Revitalization Based on Experience of Central and Eastern Europe.

4. Central-Eastern Europe Model Anticipated In Many Ways Similar to Iraqi Banks – • Lacked Management Expertise. • Did Not Have a Sound Financial Base. • Large Amounts of Bad Debt. • Solution: • Western Banks Taking Equity Stakes in Region’s Financial Institutions – Massive Transfer of Expertise. • Bad Loans to State Enterprises Were Written Off. • Injections of Fresh Capital Allowed Banks to Make New Loans.

5. Initial Post-War Situation Somewhat Different Pattern: • Two Main State Owned Banks Had only Limited Loans to State Enterprises – State Enterprises Had Actually Deposited More than They Borrowed. • Banks Basically Funded Government With Government Debt Around Half Their Assets. • Situation Exists Today With Two State Banks Buying up Nearly All of the Government Securities – Little Safe Paper Left for Small Private Banks.

6. Problems Developing the Banking Sector Eastern Europe Model Not Implemented: • With Violence, Little Chance of Either State-Owned Bank Being Privatized -Modernized. • Only Limited Interest in Foreign Banks Purchasing Shares in Iraqi Banks – So Far only Middle Eastern Banks Have Been Active – Delays Modernization, Efficiency. • Most Iraqi Banks Are Frozen Out of the Lucrative Government Bond Market – More Risky Portfolios.

7. Current Situation in Banking As a Result the Banking System Has: • Low Capacity and Capitalization. • Poor Credit Facilities. • Weak System of Money Transfers. • Only Around $2 Billion in Assets. • Lack of Trust and Confidence May be Making the Hawala System An Attractive Alternative for Some Banking Functions.

8. Hawalas While Little Data Exists on Hawals in Iraq, They Are Likely to Be Thriving Due To: • Primitive Commercial Banking System. • Cash Economy. • Lack of Trust in Banks. • Large Criminal/Shadow Economy. • Growing Regulations on Formal System. • Local Generation of Dollars -- Minimizes Formal Bank Accounts.

9. Banking Legislation • Coalition Provisional Authority (CPA) Drafted Transitional Administrative Law (TAL). • Which Sets in Motion Banking Reforms Until Elected Government, Operating Under a Permanent and Legitimate Constitution, Comes into Being Established: • CPA Order No. 93 “Anti-Money Laundering Act of 2004.” • CPA Order No. 94 “Banking Law of 2004.”

10. Anti-Money Laundering Act of 2004 • Criminalizes Money Laundering and Terrorist Financing – Penalties of Imprisonment and/or Fines. • Covers: Spectrum of Financial Intermediaries – Banks to • Foreign Currency Exchanges. • Must Verify Identity of Anyone Conducting Transactions over 5 Million ID, New Accounts of Over 10 Million ID.

11. AML Act of 2004 (contd.) • Records Must Be Kept 5 Years. • STRs Required on Transactions over 4 Million ID from Suspected Criminal or Terrorist Financing Sources. • Tipping Off Prohibited. • Violations May Result in Imprisonment or Fines.

12. Banking Law of 2004 Central Bank of Iraq Given Authority To: • License, Supervise Bank Management. • Established Requirements for Bank Capital, Confidentiality of Records, Audit and Reporting Requirements and Prudential Standards. • AML Act Gives CBI Power to Determine Compliance, Issue Warnings, Monitor Large Deposits. • CBI May Remove Non-Complying Management and Revoke Bank Licenses.

13. Other Aspects: Iraqi AML Act • Calls for Establishment Money Laundering Reporting Office in CBI. • MLRO Separately Funded, Operate Independently to Collect Information on Transactions -- Block Funds or Assets Belonging to Former Regime. • Recommends Government of Iraq Ensure Any New Legislation that Either Replaces or Enhances the AML Act or the Banking Law Meets Current International Standards. • New Government Should Implement Laws As Rapidly As Possible and Seek to Become a Full Member of a FATF Style Regional Body as Opportunity Presents Itself.

14. Iraq’s Efforts at Combating Terrorism Finance -- Overview Areas of Implementation: • Establishment of a Legal Framework – Some Progress. • Creation or Strengthening of an Administrative Infrastructure – Little Progress. • Introduction and Use of a Variety of Different Regulatory Measures – Little Progress. • Evidence of Enforcement -- Little Progress.

15. Terrorist Financing--Best Practice Goals For Iraq: Legal Framework • Criminalizing of Terrorist Financing –The Raising or Provision of Funds for Terrorist Acts – (Iraq: Yes). • Capacity to Freeze – Authority to Freeze Funds Without Prior Authority (Iraq: Yes). • Terrorist Financing Convention – Signed the International Convention for the Suppression of the Financing of Terrorism (Iraq: No).

16. Terrorist Financing--Best Practice Goals For Iraq: Administrative Framework • Have in Place a Financial Intelligence Unit (FIU) – (Iraq, No). • Commitment of Additional Resources for Building Institutional Capacity to Deal With Local Aspects of Terrorist Financing – (Iraq, No). • Request/Receive Assistance Related to Financial Law and Practice, Training for Financial Institutions etc (Iraq, No).

17. Terrorist Financing--Best Practice Goals For Iraq: Regulatory Measures • Listing – Shows Evidence of Implementing Lists that Go Beyond that Developed by the UN or the U.S. Treasury’s OFAC List (Iraq, No). • IVTS Policy --Established Some System for Regulating or Registration of Hawalas. (Iraq: No) • Charities – Regulate and Monitor the Operations of Charities Within (and Beyond) Borders (Iraq: Yes). • Bank/FI Compliance – In Various Areas: (Iraq: Some). • Banks Notified of the Names of Individuals or Groups. • Reporting Requirements Have Been Placed on Banks. • Reporting Requirements Extended to Other Financial Institutions Beyond Banks • Provide Assistance to Banks.

18. Terrorist Financing--Best Practice Goals For Iraq: Enforcement • Freezing of Funds (None for Iraq). • Arrests Since 9/11 (None for Iraq). • Other Evidence – Additional Enforcement, Bilateral Cooperation Agreements etc. (None for Iraq).

19. Iraq: Relative Progress inCombating Terrorist Finance

20. Iraq: Relative Progress in Compliance and Implementation

21. Problems for the Future: General Considerations • Difficulties in Extending the Existing Global Anti-Money Laundering Systems to Include Efforts to Combat Terrorist Finances. • Inability to Deal Adequately With Islamic Charities. • Extraordinary Capacity of Terrorist Networks to adapt Through Appropriation of Organized Crime Methods. • The Fact that Attacks are Cheap.

22. Global Financial Challenges • Financial Action Task Force (FATF) Extended Mandate to Cover Terrorist Financing – Initial Problems Faced Similar to Money Laundering—Weak Links to be Exploited. To Achieve Global Effort Often Means More Diluted Action Likely to Be – UN Freeze of al-Qaeda Bank Accounts, but Not Other Assets. • Money Laundering and Terrorist Finances Global in Scope and Transnational in Operation. • Criminals and Terrorists Engage in Jurisdictional Arbitrage, Exploit Jurisdictional Voids, Create Jurisdictional Confusion. • To Overcome these Problems Need Sustained and Systematic Cooperation. Efforts of this Nature are Very Difficult: Many Countries Simply Lack the Will or Means to Conduct This Effort.

23. Difficulties in Obtaining State Cooperation • Sympathetic to Cause of Terrorist Groups – Reluctant to Implement Measures. • With Other Problems, Combating Terrorism Has a Low Priority. • Do not Want to become Target of Terrorists. • Do not have the Resources to Implement Anti-Terrorist Financing Measures. • As of Late 2003 108 States Had not Complied with UN Requests for Reports on their Efforts to Implement Sanctions Against Terrorist Groups, Although 25 Known to Have al-Qaeda (or associate group) Presence. • Many other Countries Reporting to the UN Have Failed to Seriously Implement their Commitments. • Result: Continued Existence of Safe Havens.

24. Problems Controlling Islamic Charities • UNMG Has Noted General Reluctance to Act Against Charities – Higher Standard of Proof is Demanded. • Terrorist Financial Support Structures are Not Static. • Adapt in a Variety of Ways Even When Included on the UN List. • Close Branches, Open New Offices, Change Names. • Support terrorists Less Through Direct Contributions Than Through Logistic Support. • Still Some Success in the area – Terrorist Financing More Problematic and Funds Neither As Plentiful or as Easily Moved as in the Past.

25. Alternative Sources of Finance • With Traditional Sources of Financing More Problematic Terrorist Groups Adapting to New Sources of Funding. • Moving More into Areas of Organized Crime. • Kidnapping, Extortion, Drug Trafficking, Smuggling, Robbery, Fraud. Advantages: • Do Not Require Steep Learning Curve. • Significant Investments Not Necessary. • Low Costs and High Gains – Weaken Opposition. • Have Shifted from Normal Banking Channels to Informal Transfer Systems – Hawala. • “Green Money” From Islamic Enterprises, Financial Institutions. • Transformed Funds into Easily Transportable Commodities – Diamonds.

26. Low Cost of Terrorist Operations • Other Problem With Trying To Control Finances of Terrorists is that Terrorist Attacks Can be Carried Out With Small Sums of Money. Estimates: • Kenya, Tanzania Embassies -- $50,000 • USS Cole -- $10,000. • Bali Bombings -- <$50,000. • Istanbul -- $40,000 • Madrid -- $10,000. • Problem – Low Cost and Terrorist Adaptations have Made it More Difficult to Follow Money Trail and Use it as a Critical Warning Indicator – Terrorist Groups More Financially Self-Sufficient.

27. Evolution of Terrorist Financing

28. Economics of Iraqi Insurgency To Compensate for Difficulty of Tapping Traditional Sources of Terrorist Financing, Insurgents Have Begun Generating More of their Own Income Thorough Exploiting Various Weaknesses in Post-War Iraq: • Administered Markets – Black Market Arbitrage. • Unstable Markets – Oil Futures • Security Vacuum—Kidnappings, Robbery. • Enforcement Capabilities – Drug Trade • Financial Underdevelopment – Money Laundering. • No Doubt Many of These Activities Involve Utilizing Hawalas For Money Transfers.

29. Arbitrage Opportunities • CBI Uses Stability of New Iraqi Dinar (NID) Against U.S. Dollar as a Major Policy Objective -- Anti-Inflationary Tool. • Subsidies Through Administered Price System Makes Smuggling-Black-Market Arbitrage Profitable. • Overvalued Exchange Rate (US$1:NID1,460) Adds to Profitability of Arbitrage.

30. Main Areas of Black-Market Arbitrage • Gasoline – Liter of Subsidized Gasoline cause about US$0.1 with the black market price is between $0.26 and $0.36. • Profits: Tanker of Gasoline Sold At Controlled Price $340 – At Black Market Price -- $4,800. Potentially more if smuggled out of the country. • Leads to Corruption – Gas Station Owners, Government Officials. • Subsidized Food A Less Lucrative Commodity for Arbitrage, But Still Profitable. • Not Clear Why Iraqi Dinars are Being Smuggled Out of Country.

31. Futures Markets While No Hard Data Exist it is Logical that Insurgents/Terrorists Have a Financial Advantage in Manipulating Futures Markets. • Futures Markets For Oil Gas Well Developed. • Easy for Participants to Remain Anonymous. • Ultimate Inside Information – Know When Event Will Occur and Likely Impact of Prices. • Take Out Forward Contract to Buy Oil At Agreed Price. • Blow up Pipeline – Price Goes Up, But Have a Contract to Purchase the Oil at the Lower Stipulated Price For Resale at the Elevated Price. • Same true to a lesser extent for natural gas.

32. Insurgency Economy

33. Implications for Iraq With Terrorist Methods of Financing in Iraq Shifting to Informal Transfer Networks and Self-Financing Through Criminal Activity: • To What Extent Will Terrorist Financing and Money Laundering Through the Financial System Be Seen As an Important Issue in Iraq? Not likely to have a High Priority Given Alternative Sources of Funding, Anti-US Sentiment. • To What Extent Will the U.S./IMF Exert Leverage over Iraqi Policy? Regional Countries in the MENAFATF? The Pressure Will Be There, Legislation/Regulations Will be Enacted, But Enforcement Will Lag. • Speed and Extent to Which The Banking System Can Established on Sound Footing. Will Take Years Before the Formal Banking System Would Be An Attractive Vehicle for Money Laundering or Terrorist Finance. Regulation of Hawalas as in UAE Might Be Helpful in Combating Terrorist Finance.

34. Future Developments • How Will Regional Developments – MDNAFATF, Country Efforts at Combating Terrorist Funding Influence Iraqi Decision Makers? – Depends on Whether Other Country Actions are Voluntary or Coerced. If Iraqis see a Consensus Towards Terrorism Developing They Will Likely Cooperate – Otherwise Probably not. • Will Iraq Join Regional Groups in Combating Terrorist Financing/Money Laundering? May Join Groups in Time, But More to Receive Assistance -- Will Be a Passive Observer. • Will Iraq Move to Monitor Charities More Closely? Possibly Not With Rising Influence of Religious Groups – Depends on Resolution of Political Disputes –Problems in Agreeing What is a Bad Terrorist. • Will New Islamic Enterprises and Banks Thrive in Iraq--Become a Source for Terrorist Financing in Iraq? Possibly – With Unstable Situation, Most Foreign Investment in Finance Will Be From Regional Enterprises, Increasing the Likelihood of Islamic Influence.

35. Remaining Questions. • To What Extent Will The United States Be Willing to Provide both Financial and Technical Assistance to Iraq’s Anti-Terrorist Financing Program? • Will Iraq Receive a Priority Over Other MENA Countries? • Or Will the U.S. Perceive the Threat Greater Elsewhere? Currently Iraq Not Listed as a “Country of Concern.” • To What Degree Do Average Iraqis View Terrorist Financing as A Major Threat? • Given Limited Resources What Is the Most Effective Means of Combating Terrorism in Iraq? • Will There be Broad-Based Support for Crackdowns on Terrorist Financing? Or Will it Only Be on a Regional Basis, Leaving Many Areas in Iraq a Safe Haven for Terrorist Financing Activities.

36. Remaining Questions (contd.) • How Will Pervasive Iraqi Corruption Affect the Country’s Approach to Terrorist Financing? What are The Prospects for Reducing Corruption in Iraq? Iraq Currently Rated the Most Corrupt Country in the Middle East. • How Will an Newly Elected Iraqi Government Define Terrorism – Has not been Easy For Many Regional Countries to Distinguish Between “Good” and “Bad” Terrorism – A Major Factor Undermining Regional Cooperation. • How Rapidly Will Alternative Terrorist Financing Systems Evolve? Will it Be Considerably Faster than the Iraqi Authorities Ability to Respond Effectively: • Hawalas and other ITSs. • Black Market Peso Exchange. • Charitable Organizations. • Green Money • Trade Based Money Laundering. • Ultimately Outcome Will Depend In Large Part on the Type of Government that Becomes Established in Iraq.

37. Rentier State Political Systems Possible Political Systems • Factional Democracy–Weak Party Venezuelan Model. • Reformist Autocracy – Technocratic Indonesia 1970s. • Pragmatic Theocracy – Iran/Baathist Meld. Unlikely Outcomes • Traditional Theocracy – Iran Model. • Predatory Autocracy – Ba’thist Model. • Mature Democracy – Norway. • Paternalistic Autocracy – Saudi Arabian Model.

38. Iraqi Politics and Terrorist Financing • Factional Democracy – Short Time Horizon. Corruption May be High. Little Agreement on “Good” vs. “Bad” Terrorism. Terrorist Financing Policies Inconsistent and Incomplete. Little Regional Cooperation on Terrorist Financing. • Reformist Autocracy – Longer Time Horizon. Corruption More Controlled. Chance of a Consistent Policy Toward Terrorist Financing. Greater Efforts in Regional Cooperation. • Pragmatic Theocracy – Corruption Confined to Certain Groups -- U.S. Limited Control Over Terrorist Financing Policy. Only Marginal Efforts in Regional Cooperation Over Terrorist Financing.

39. Appendix: Terrorist Financing—Regional Agreements-- MENAFATF Middle East and North Africa Financial Action Task Force (MENAFATF). • Iraq Not a Member. • Inaugurated November 2004. • Headquarters Bahrain. • Members: Algeria, Bahrain, Egypt, Jordan, Kuwait, Lebanon, Morocco, Oman, Qatar, Saudi Arabia, Syria, Tunisia, UAE and Yemen.

40. Appendix:MENAFATF Objectives • Build Effective Arrangements Throughout Region to Combat Money Laundering and Terrorist Financing Within Particular Cultural Values, Constitutional Framework and Legal Systems of Member Countries. • Adopt and implement 40 Recommendations of FATF Against Money Laundering. • Cooperate Together to Raise Compliance With These Standards. • Work Together to Identify Money Laundering and Terrorist Financing Issues and to Develop Regional Solutions for Dealing With Them.