Óbuda University. PhD thesis. The interrelations between banking and insurance systems in the prevention of international financial abuse - PDF

Óbuda University PhD thesis The interrelations between banking and insurance systems in the prevention of international financial abuse by Dr. Miroslav Radojicic Supervisor: Nagy Imre Zoltán Doctoral School

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Óbuda University PhD thesis The interrelations between banking and insurance systems in the prevention of international financial abuse by Dr. Miroslav Radojicic Supervisor: Nagy Imre Zoltán Doctoral School on Safety and Security Sciences Budapest, Content 1. Introduction The subject matter and objective of the thesis Scientific hypotheses Research methods Legal frameworks Introductory review Conventions FATF Recommendations Directives National legislation CS: Republic of Serbia Institutional framework for combating financial abuse CS Republic of Serbia International financial abuse Introduction Money laundering Washing machine method Smurfing technique Import and Export Misinvoicing Trade-based money laundering techniques Bartering Cash couriers Tax evasion Tax havens Non-financial frauds Financial frauds in the banking sector Introduction Role of the banking sector in financial frauds Indicators for recognising suspicious transactions for banks Typology of financial frauds in the banking sector Financial frauds in the insurance sector Introduction Role of the insurance sector in financial fraud Indicators for suspicious transactions in the insurance sector Financial frauds typology in the insurance sector International cooperation in prevention of financial abuse Introductory notes Institutional framework FATF International aspects Other forms of cooperation MONEYVAL system Egmont Group International Association for Insurance Supervisors (IAIS) Basel Committee on Banking Supervision The Wolfsberg group International cooperation in prevention of financial abuse Experience of the Republic of Serbia Model of the system for preventive action in cases of financial abuse Main system assumptions The main components of the Model Processes within the Model Conclusion Concluding observations Scientific and professional contributions of the thesis Future research and recommendations References ABSTRACT: The subject matter of this thesis is financial abuse. As this type of abuse goes beyond the state boundaries, i.e. the international aspect of financial frauds, this research predominantly addresses the phenomenon of money laundering, as a dominant type of international financial abuse, and particularly due to its high correlation with terrorism financing, which is one of the major challenges of modern civilisation. In the thesis we describe the institutions which are in charge of prevention, organization and fight against all types of financial abuse, particularly money laundering whose action rests precisely upon the discussed legal frameworks. We present the main money laundering typology and point to the expected trends in the financial sector (banking and insurance sector). Afterwards, we highlight the importance of the international cooperation aimed at preventing and sanctioning the frauds in the two sectors: the banking and insurance sectors. The thesis reiterates the international aspect of organised crime and underlines that financial abuse, particularly money laundering, is a problem of international character, suggesting that possible activities carried out in isolation i.e. at an individual country level, could have rather limited effects. In the thesis we highlight the social significance and the consequences of the financial crime for the country and society, the international aspect of frauds and we also provide the analysis of some specific examples from the practice. The final chapter defines the model of the system for preventive actions in cases of financial abuse. The initial assumption is that a uniform, systemic solution, based on clear, methodological principles may act efficiently to prevent the occurrence of financial frauds. The thesis presents the four main components of the Model and also describes all thirteen processes that connect the Model components. The thesis stresses the international aspect as one of the two processes that connect all four components of the system (along with organisation and coordination). The proposed model is the main scientific and professional contribution of the thesis. 3 KEY WORDS: financial abuse, financial frauds, international financial abuse, money laundering, model. 1. Introduction 1.1. The subject matter and objective of the thesis The subject matter of this thesis is financial abuse. As this type of abuse goes beyond the state boundaries, i.e. the international aspect of financial frauds, this research will predominantly address the phenomenon of money laundering, as a dominant type of international financial abuse, and particularly due to its high correlation with terrorism financing, which is one of the major challenges of modern civilisation. Virtually entire international legislation, recommendations and laws related to the area of financial abuse are directly linked to these areas. The modern financial systems, typical of the current human development stage, consist of a combination of a number of institutions and participants (central bank, commercial banks, savings banks, savings-credit associations, pension funds, investment funds, insurance companies, intermediary organisations), financial markets (foreign currency market, money market, capital market etc.) and financial instruments (debt instruments, equity instruments, derivatives derivative instruments). Within such financial systems, banking and insurance are two particularly important segments, but also the two sectors with the highest exposure to the risks of abuse and fraud. Their roles in the economic system are irreplaceable. All the vital financial functions flow through the channels made available by the banking and insurance sectors the function of payment, money creation, liquidity, crediting, savings, risk prevention, macroeconomy, transfer of resources through space and time, international payment transactions, foreign currency transactions, information providing and the like. Each one of these points carries a risk of errors, weaknesses, harmful actions, abuse, fraud or theft. 4 The most relevant features of modern financial systems are as follows: dynamics, openness and complexity. Dynamics comes as a result of the fact that the economic and financial systems are constantly experiencing changes and new events, thus exposing the system to temporary states of balance and imbalance. Financial system is not a static one and set for good. Modern financial systems are continuous, and operate 24 hours a day, 7 days a week, 365 days a year. The openness comes as a result of the necessity of operations in the global market, i.e. the companies' natural need to embark on various forms of cooperation with business partners, outside the boundaries of their national economies. Banking and insurance, as well as the financial system as a whole, achieved a global character long ago. The international flows of financial assets and capital are at such scale that it is almost impossible to live and operate isolately from the international community. Complexity of the financial systems comes as a result of the circumstances in which they comprise a large number of sub-systems and a series of participants, and are regulated by complex legislation, both at the national and international level, and they share the same fate and the consequences of the events at the global level. Under the impact of the events at the international level, the emergence of the economic crisis and novel trends in the corporate world, there has been a rapid surge of financial frauds in the previous decade, which has forced the companies, international institutions and organisations to establish the new mechanisms, instruments, strategy and institutions to tackle the issues. In the first line, these were directed towards domestic entities, aimed at increasing the efficiency of internal oversight, achieving the credibility of financial reporting, establishing the efficient external control, with a view to closing the channels for the leakage of funds, preventing the money laundering and disabling the direct 5 financial crime, but the one craftily implementing the state-of-the-art technology as well. The abuse in this area has directly undermined the economic stability of the countries, slowed down the economic growth, increased the unemployment, encouraged political conflicts and intensified the social tensions. The accurate data is not available, yet it is estimated that thousands of billions of dollars have been withdrawn from the legitimate flows in these ten years, and transferred into the narcotics market and arms trade, trafficking in human beings and terrorism. The second objective of actions against the financial frauds was directed towards the development of international cooperation, creation of new regional and universal institutions, upgrading the specific financial regulations and forming the global defence mechanism for the prevention of financial abuse. After the 9/11 events when the twin towers were destroyed in New York, the world realised that the terrorist actions, global crime and numerous conflicts around the globe were backed by the enormous financial resuorces, moved from the legal financial flows through the illegal channels, abuse, corruption and frauds in order to form their own interests, ambitions, armies, even territories. In this respect, the prevention, supression and hindering the financial abuse at the international scale has become a critical issue for the entire international security, and thereby for the protection of stability, integrity and independence of each international community member state. The leading international organisations, and primarily, the United Nations, the European Union, other regional organisations and institutions, specialised professional, expert and security associations have undertaken a series of activities to this end, but the financial abuse with the both global and individual effect has not been supressed yet. With the fast development of information technology, and the liberalisation of all kinds of communication and transport, with the development of new products in the banking and insurance industry, the additional room emerges wherein the individuals, groups and organisations with bad intentions seek to obtain illegal profit and commit frauds of all kinds. The entities and institutions involved in money laundering and 6 terrorism financing attempt to abuse the free movement of capital and provision of financial services, which is a threat to the stability of every country's financial system. This is the reason why the institutional and legal frameworks are constantly upgrading, at both the national and international levels, where it is becoming more and more evident that only through a closer cooperation, a more solid organisation and uncompromising relationship towards the perpetrators of abuse can this threat be defeated. The frauds in banking are predominantly in the sphere of identity theft and breaching the electronic security of bank accounts, while the insurance is increasingly dominated by a variety of false claims and fraudulent actions related to risk claims. As a part of further activities against the financial frauds, the states should first establish the cooperation with the neighbouring countries, regardless from their political differences and enmity, and afterwards at the regional level, so that they could use this standpoint to form a common ground for global security aimed at combating the financial abuse. The countries must not forget that the criminals and criminal organisations are only limited by their own imagination, and not by international boundaries. Therefore, if the countries remain oriented towards their own laws and state borders, they will fail to undertake measures against the financial abuse of the international nature. The countries must direct their joint efforts towards a comprehensive, theoretical and practical research of the methodology and techniques of financial abuse, reviewing and expanding the indicators related to wrongful acts, development and innovation of typology of frauds, identification of all forms of financial crime in banking and insurance, finalising the legislation, supplementing the criminal legislation, advancing the police and investigative methods, harmonising the penalty and judicial policy in this respect, and a series of other measures possessing both the legal and economic dimension, as the financial frauds undermine every country's legal system as much as they undermine the country's economic being. The countries must network their institutions for combating the financial abuse, and particularly the ones in the area of banking and insurance. 7 The main research objectives are: Exploring, detecting, defining preventive operations concerning financial sector and insurance companies. The goal is to determine protective systems by getting to know concrete misuse cases, which prevent further realization. This way we strengthen the security of the financial sector and reduce the danger to minimum. Additional research objectives are: Overview and systematisation of the normative and institutional frameworks required for combating financial abuse Studying through the main typologies and indicators for the financial frauds in the banking and insurance sectors Highlighting the importance of international cooperation in combating the financial crime Studying through the examples from the practice Highlighting the importance of certain activities not sufficiently emphasised in combating the financial crime, such as: staff training and improvement, communication and propaganda, organisation and coordination 1.2 Scientific hypotheses The main assumptions which are the basis for the thesis research It is possible to develop a uniform, systemic solution to the efficient fight against financial abuse. This solution must be based on clearly defined, science-based, methodological principles. Prevention is the most efficient form of protection of the financial sector (primarily the banks and insurance companies) from frauds and abuse. The main methodological principle the system is based on for the purpose of preventive actions in cases of financial abuse is that it must be based on riskassessment. The system model, apart from the assessment of the risk of 8 exposure to financial abuse, also implies the risk classification, within the existing fraud typology, as well as its materialisation in the form of suspicious transactions International cooperation is a necessary condition for the efficient prevention of financial abuse Additional hypotheses: The use of ICT facilitates combating the financial crime All the employees tasked with the prevention and fight against the financial frauds need to undergo continuous training The awareness of the general public needs to be raised in terms of the importance and consequences of financial abuse, so as to ensure the preventive actions 1.3 Research methods For developing this thesis, the following scientific methods were applied: The first part of the thesis makes use of the collection method and the analysis of the existing scientific results and achievements, The analysis of the secondary sources (the analysis of documentation) has been applied to a large extent. For developing the Model of the system for preventive actions in cases of financial abuse (hereinafter the Model), the following were used - the case study method, the best practices techniques, process approach, process analysis, business intelligence techniques, and risk analyses. The methods for model development, collection and data analysis methods were used. For the implementation of the Model, the statistical research methodology was used, along with the appropriate methods and techniques: data collection, data processing and analysis method, concluding method. 9 The research results are presented in a narrative, descriptively, and through a number of tables, figures and graphs with the comparative results. The research is interdisciplinary, as it involves the methodology, criminology, information science and other areas of science. Based on the analysis of the thesis, it may be concluded that the applied scientific methods and techniques are suitable, in terms of their relevance and structure, for the topic and the research performed. 2. Legal frameworks 2.1. Introductory review Fight against crime is among the fundamental principles upon which the European Union rests. In his paper, Europe in 12 lessons, Pascal Fontaine states that European citizens are entitled to live in freedom, without fear of persecution or violence, anywhere in the European Union [24] yet his paper emphasises that international crime and terrorism are among the greatest concerns of European citizens. It is stated that organised crime is becoming more sophisticated and that it regularly uses European or international networks for its activities. Terrorism has clearly showed it knows no boundaries. In order to respond to the highly intertwined organised crime and terrorism, authorities in charge of combating and fighting crime established the Schengen information system (SIS), which was set up at the EU level. SIS comprises a large number of mutually connected databases which allow the police and judicial authorities to exchange information on persons or objects missing, e.g. data pertaining to stolen automobiles, works of art, persons wanted for arrest or extradition purposes. New generation database (SIS II) will have a greater capacity and will provide for the storage of new types of data, in accordance with the new concepts in informatics (Big Data, Data Mining etc.). 10 The paper also argues that one of the best ways of catching criminals is to track the movement of the proceeds they generated from crime. To this end and with a view to hindering the financing of criminal and terrorist organisations, the EU implements the laws on the prevention of money laundering. The most important step taken in this field in recent times, concerning cooperation among bodies in charge of internal affairs (police), was the creation of the European Police Office (Europol), which is headquartered in The Hague and which employs police and customs officers. Europol handles a whole number of international crime forms: drug trafficking, trade in stolen vehicles, trafficking in human beings, sexual exploitation of women and children, child pornography, counterfeiting, trade in nuclear and radioactive substances, terrorism, money laundering and euro counterfeiting. [45] The EU has taken a clear standpoint on the manner in which the organised crime must be combated, by adopting the strategy entitled The Prevention and Control of Organised Crime: a European Union Strategy for the Beginning of the New Millennium, published in the Official Journal of the European Union on 3 May [132] Building on the largely accepted opinion that the primary motive of much organised crime is financial gain , the strategy concludes that effective prevention and control of organised crime, therefore, would focus on tracing, freezing, seizing and confiscating the proceeds of crime . [87] This chapter of the thesis provides an insight into legal frameworks governing financial institutions in the context of prevention of international financial abuse, by discussing international regulations safeguarding the field of fight against money laundering and terrorism financing, as well as related conventions, recommendations and directives. The end of the chapter will provide an illustration of the legal framework of the Republic of Serbia. 11 2.2. Conventions Acts of financial abuse at an international level usually relate to money laundering and terrorism financing. A large number of initiatives have been launched under various international organisations so as to set up universally accepted standards in this field. Such standards are set forth by: 1. Conventions 2. Recommendat
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