freeze! financial sanctions and bank responses...)litigation and compliance costs are higher for...
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Freeze! Financial Sanctions and Bank Responses
Matthias Efing* Stefan Goldbach Volker Nitsch
HEC Paris* Deutsche Bundesbank TU Darmstadt
Discussion Papers and presentations represent the authors’ personal opinions anddo not necessarily reflect the views of the Deutsche Bundesbank or its staff.
Matthias Efing (HEC Paris) Financial Sanctions and Bank Responses 1 / 36
Financial sanctions in international diplomacy
Germany imposed financial sanctions on 20 countries between 2002-15204 sanctions have been imposed worldwide between 1914 and 2006(Hufbauer, Schott, Elliott, & Oegg, 2007)
Matthias Efing (HEC Paris) Financial Sanctions and Bank Responses 2 / 36
Financial sanctions in international diplomacy
What do financial sanctions do?
Targeted entities cannot access existing funds.
Targeted entities must not receive new credit or financial services.
Typically part of a larger package of sanctions(export restrictions, arms embargoes, ...).
Designed to minimize harm to civilians while at the same time:
“to bring about a change in policy or activityby the target country, entities, or individuals”
(EU, Common Foreign and Security Policy, 2017)
Matthias Efing (HEC Paris) Financial Sanctions and Bank Responses 3 / 36
Financial sanctions in international diplomacy
What do financial sanctions do?
Targeted entities cannot access existing funds.
Targeted entities must not receive new credit or financial services.
Typically part of a larger package of sanctions(export restrictions, arms embargoes, ...).
Designed to minimize harm to civilians while at the same time:
“to bring about a change in policy or activityby the target country, entities, or individuals”
(EU, Common Foreign and Security Policy, 2017)
Matthias Efing (HEC Paris) Financial Sanctions and Bank Responses 3 / 36
Financial sanctions in international diplomacy
What do financial sanctions do?
Targeted entities cannot access existing funds.
Targeted entities must not receive new credit or financial services.
Typically part of a larger package of sanctions(export restrictions, arms embargoes, ...).
Designed to minimize harm to civilians while at the same time:
“to bring about a change in policy or activityby the target country, entities, or individuals”
(EU, Common Foreign and Security Policy, 2017)
Matthias Efing (HEC Paris) Financial Sanctions and Bank Responses 3 / 36
Financial sanctions in international diplomacy
What do financial sanctions do?
Targeted entities cannot access existing funds.
Targeted entities must not receive new credit or financial services.
Typically part of a larger package of sanctions(export restrictions, arms embargoes, ...).
Designed to minimize harm to civilians while at the same time:
“to bring about a change in policy or activityby the target country, entities, or individuals”
(EU, Common Foreign and Security Policy, 2017)
Matthias Efing (HEC Paris) Financial Sanctions and Bank Responses 3 / 36
Financial sanctions in international diplomacy
What do financial sanctions do?
Targeted entities cannot access existing funds.
Targeted entities must not receive new credit or financial services.
Typically part of a larger package of sanctions(export restrictions, arms embargoes, ...).
Designed to minimize harm to civilians while at the same time:
“to bring about a change in policy or activityby the target country, entities, or individuals”
(EU, Common Foreign and Security Policy, 2017)
Matthias Efing (HEC Paris) Financial Sanctions and Bank Responses 3 / 36
Financial sanctions in international diplomacy
What do financial sanctions do?
Targeted entities cannot access existing funds.
Targeted entities must not receive new credit or financial services.
Typically part of a larger package of sanctions(export restrictions, arms embargoes, ...).
Designed to minimize harm to civilians while at the same time:
“to bring about a change in policy or activityby the target country, entities, or individuals”
(EU, Common Foreign and Security Policy, 2017)
Matthias Efing (HEC Paris) Financial Sanctions and Bank Responses 3 / 36
Financial sanctions and banks
Banks are required to end business with sanctioned entities.
BUT:
European banks were fined over USD 16bnfor money laundering and sanction breaches between 2012 and 2018.
(Moody’s, 2018)
Matthias Efing (HEC Paris) Financial Sanctions and Bank Responses 4 / 36
Financial sanctions and banks
...Deutsche 2015 USD 258m US sanction breachesCommerzbank 2015 USD 1.45bn US sanction breachesBNP Paribas 2015 USD 8.9bn US sanction breachesDeutsche 2017 USD 0.63bn Money laundering (moving Russian money through
accounts in London, Cyprus, Estonia, Latvia)ING Groep 2018 EUR 775m Money laundering & terrorism financing (Uzbekistan)Deutsche ongoing Money laundering by a former affiliate of Deutsche
on the Virgin IslandsDanske ongoing Money laundering by a branch in EstoniaDeutsche ongoing Involvement of Deutsche in Danske scandal...
Matthias Efing (HEC Paris) Financial Sanctions and Bank Responses 5 / 36
Main contribution and findings
1 Focus on legal (non-financial) risk in banking.
2 Multinational banks reroute credit to sanctioned countries.
→ through affiliated banks in offshore locations
→ using internal capital markets, i.e., intra-group credit
3 Why is this possible?
→ ...because of weak supervision and law enforcementin offshore locations.
→ harmonizing just the rules and regulations is not sufficient!
→ also harmonize compliance with a given set of rules!
Matthias Efing (HEC Paris) Financial Sanctions and Bank Responses 6 / 36
Main contribution and findings
1 Focus on legal (non-financial) risk in banking.
2 Multinational banks reroute credit to sanctioned countries.
→ through affiliated banks in offshore locations
→ using internal capital markets, i.e., intra-group credit
3 Why is this possible?
→ ...because of weak supervision and law enforcementin offshore locations.
→ harmonizing just the rules and regulations is not sufficient!
→ also harmonize compliance with a given set of rules!
Matthias Efing (HEC Paris) Financial Sanctions and Bank Responses 6 / 36
Main contribution and findings
1 Focus on legal (non-financial) risk in banking.
2 Multinational banks reroute credit to sanctioned countries.
→ through affiliated banks in offshore locations
→ using internal capital markets, i.e., intra-group credit
3 Why is this possible?
→ ...because of weak supervision and law enforcementin offshore locations.
→ harmonizing just the rules and regulations is not sufficient!
→ also harmonize compliance with a given set of rules!
Matthias Efing (HEC Paris) Financial Sanctions and Bank Responses 6 / 36
Main contribution and findings
1 Focus on legal (non-financial) risk in banking.
2 Multinational banks reroute credit to sanctioned countries.
→ through affiliated banks in offshore locations
→ using internal capital markets, i.e., intra-group credit
3 Why is this possible?
→ ...because of weak supervision and law enforcementin offshore locations.
→ harmonizing just the rules and regulations is not sufficient!
→ also harmonize compliance with a given set of rules!
Matthias Efing (HEC Paris) Financial Sanctions and Bank Responses 6 / 36
Main contribution and findings
1 Focus on legal (non-financial) risk in banking.
2 Multinational banks reroute credit to sanctioned countries.
→ through affiliated banks in offshore locations
→ using internal capital markets, i.e., intra-group credit
3 Why is this possible?
→ ...because of weak supervision and law enforcementin offshore locations.
→ harmonizing just the rules and regulations is not sufficient!
→ also harmonize compliance with a given set of rules!
Matthias Efing (HEC Paris) Financial Sanctions and Bank Responses 6 / 36
Main contribution and findings
1 Focus on legal (non-financial) risk in banking.
2 Multinational banks reroute credit to sanctioned countries.
→ through affiliated banks in offshore locations
→ using internal capital markets, i.e., intra-group credit
3 Why is this possible?
→ ...because of weak supervision and law enforcementin offshore locations.
→ harmonizing just the rules and regulations is not sufficient!
→ also harmonize compliance with a given set of rules!
Matthias Efing (HEC Paris) Financial Sanctions and Bank Responses 6 / 36
Main contribution and findings
1 Focus on legal (non-financial) risk in banking.
2 Multinational banks reroute credit to sanctioned countries.
→ through affiliated banks in offshore locations
→ using internal capital markets, i.e., intra-group credit
3 Why is this possible?
→ ...because of weak supervision and law enforcementin offshore locations.
→ harmonizing just the rules and regulations is not sufficient!
→ also harmonize compliance with a given set of rules!
Matthias Efing (HEC Paris) Financial Sanctions and Bank Responses 6 / 36
Research question and hypothesis
Determinants of banks’ business decisions in sanctioned countries?
Trade-off (Becker, 1968):
+ Preservation of profitable business in sanctioned countries
− ILLEGAL business: (expected) litigation and reputation costs
− LEGAL business: compliance costs
→ Supervisors introduce new regulations to implement sanctions:
more due diligencemore documentation
Matthias Efing (HEC Paris) Financial Sanctions and Bank Responses 7 / 36
Research question and hypothesis
Determinants of banks’ business decisions in sanctioned countries?
Trade-off (Becker, 1968):
+ Preservation of profitable business in sanctioned countries
− ILLEGAL business: (expected) litigation and reputation costs
− LEGAL business: compliance costs
→ Supervisors introduce new regulations to implement sanctions:
more due diligencemore documentation
Matthias Efing (HEC Paris) Financial Sanctions and Bank Responses 7 / 36
Research question and hypothesis
Determinants of banks’ business decisions in sanctioned countries?
Trade-off (Becker, 1968):
+ Preservation of profitable business in sanctioned countries
− ILLEGAL business: (expected) litigation and reputation costs
− LEGAL business: compliance costs
→ Supervisors introduce new regulations to implement sanctions:
more due diligencemore documentation
Matthias Efing (HEC Paris) Financial Sanctions and Bank Responses 7 / 36
Research question and hypothesis
Determinants of banks’ business decisions in sanctioned countries?
Trade-off (Becker, 1968):
+ Preservation of profitable business in sanctioned countries
− ILLEGAL business: (expected) litigation and reputation costs
− LEGAL business: compliance costs
→ Supervisors introduce new regulations to implement sanctions:
more due diligencemore documentation
Matthias Efing (HEC Paris) Financial Sanctions and Bank Responses 7 / 36
Research question and hypothesis
Determinants of banks’ business decisions in sanctioned countries?
Trade-off (Becker, 1968):
+ Preservation of profitable business in sanctioned countries
− ILLEGAL business: (expected) litigation and reputation costs
− LEGAL business: compliance costs
→ Supervisors introduce new regulations to implement sanctions:
more due diligencemore documentation
Matthias Efing (HEC Paris) Financial Sanctions and Bank Responses 7 / 36
How to identify the trade-off?
Identifying assumption:
Sanction-related costs depend on the institutional environment of banks.
⇒ litigation and compliance costs are higher for banks facing
strict supervisioncompliance requirementseffective judicial system
→ i.e., stronger policies against financial crime
Prediction:
Banks in countries with high institutional quality (e.g., Germany) withdrawbusiness from sanctioned countries.
Other banks in countries with weak anti-crime policies (e.g., Panama) dorelatively more business in sanctioned countries.
Matthias Efing (HEC Paris) Financial Sanctions and Bank Responses 8 / 36
How to identify the trade-off?
Identifying assumption:
Sanction-related costs depend on the institutional environment of banks.
⇒ litigation and compliance costs are higher for banks facing
strict supervisioncompliance requirementseffective judicial system
→ i.e., stronger policies against financial crime
Prediction:
Banks in countries with high institutional quality (e.g., Germany) withdrawbusiness from sanctioned countries.
Other banks in countries with weak anti-crime policies (e.g., Panama) dorelatively more business in sanctioned countries.
Matthias Efing (HEC Paris) Financial Sanctions and Bank Responses 8 / 36
How to identify the trade-off?
Identifying assumption:
Sanction-related costs depend on the institutional environment of banks.
⇒ litigation and compliance costs are higher for banks facing
strict supervision
compliance requirementseffective judicial system
→ i.e., stronger policies against financial crime
Prediction:
Banks in countries with high institutional quality (e.g., Germany) withdrawbusiness from sanctioned countries.
Other banks in countries with weak anti-crime policies (e.g., Panama) dorelatively more business in sanctioned countries.
Matthias Efing (HEC Paris) Financial Sanctions and Bank Responses 8 / 36
How to identify the trade-off?
Identifying assumption:
Sanction-related costs depend on the institutional environment of banks.
⇒ litigation and compliance costs are higher for banks facing
strict supervisioncompliance requirements
effective judicial system→ i.e., stronger policies against financial crime
Prediction:
Banks in countries with high institutional quality (e.g., Germany) withdrawbusiness from sanctioned countries.
Other banks in countries with weak anti-crime policies (e.g., Panama) dorelatively more business in sanctioned countries.
Matthias Efing (HEC Paris) Financial Sanctions and Bank Responses 8 / 36
How to identify the trade-off?
Identifying assumption:
Sanction-related costs depend on the institutional environment of banks.
⇒ litigation and compliance costs are higher for banks facing
strict supervisioncompliance requirementseffective judicial system
→ i.e., stronger policies against financial crime
Prediction:
Banks in countries with high institutional quality (e.g., Germany) withdrawbusiness from sanctioned countries.
Other banks in countries with weak anti-crime policies (e.g., Panama) dorelatively more business in sanctioned countries.
Matthias Efing (HEC Paris) Financial Sanctions and Bank Responses 8 / 36
How to identify the trade-off?
Identifying assumption:
Sanction-related costs depend on the institutional environment of banks.
⇒ litigation and compliance costs are higher for banks facing
strict supervisioncompliance requirementseffective judicial system
→ i.e., stronger policies against financial crime
Prediction:
Banks in countries with high institutional quality (e.g., Germany) withdrawbusiness from sanctioned countries.
Other banks in countries with weak anti-crime policies (e.g., Panama) dorelatively more business in sanctioned countries.
Matthias Efing (HEC Paris) Financial Sanctions and Bank Responses 8 / 36
How to identify the trade-off?
Identifying assumption:
Sanction-related costs depend on the institutional environment of banks.
⇒ litigation and compliance costs are higher for banks facing
strict supervisioncompliance requirementseffective judicial system
→ i.e., stronger policies against financial crime
Prediction:
Banks in countries with high institutional quality (e.g., Germany) withdrawbusiness from sanctioned countries.
Other banks in countries with weak anti-crime policies (e.g., Panama) dorelatively more business in sanctioned countries.
Matthias Efing (HEC Paris) Financial Sanctions and Bank Responses 8 / 36
How to identify the trade-off?
Identifying assumption:
Sanction-related costs depend on the institutional environment of banks.
⇒ litigation and compliance costs are higher for banks facing
strict supervisioncompliance requirementseffective judicial system
→ i.e., stronger policies against financial crime
Prediction:
Banks in countries with high institutional quality (e.g., Germany) withdrawbusiness from sanctioned countries.
Other banks in countries with weak anti-crime policies (e.g., Panama) dorelatively more business in sanctioned countries.
Matthias Efing (HEC Paris) Financial Sanctions and Bank Responses 8 / 36
How to identify the trade-off?
Identifying assumption:
Sanction-related costs depend on the institutional environment of banks.
⇒ litigation and compliance costs are higher for banks facing
strict supervisioncompliance requirementseffective judicial system
→ i.e., stronger policies against financial crime
Prediction:
Banks in countries with high institutional quality (e.g., Germany) withdrawbusiness from sanctioned countries.
Other banks in countries with weak anti-crime policies (e.g., Panama) dorelatively more business in sanctioned countries.
Matthias Efing (HEC Paris) Financial Sanctions and Bank Responses 8 / 36
Data
External Position Report for German Banks (Dt. Bundesbank):
Assets / liabilities vis-a-vis all foreign entities, 2003-2015 (monthly)
All German banks (incl. subsidiaries and branches) at home & abroad
Aggregated by type, maturity, (major) currency, and counterparty type
No identities of individual counterparties
→“short-term $-loans to non-financials in Qatar of bank ABC’s subsidiary in UK”
Service Center Financial Sanctions (Dt. Bundesbank):
All EU and UN sanctions
Matthias Efing (HEC Paris) Financial Sanctions and Bank Responses 9 / 36
Data
External Position Report for German Banks (Dt. Bundesbank):
Assets / liabilities vis-a-vis all foreign entities, 2003-2015 (monthly)
All German banks (incl. subsidiaries and branches) at home & abroad
Aggregated by type, maturity, (major) currency, and counterparty type
No identities of individual counterparties
→“short-term $-loans to non-financials in Qatar of bank ABC’s subsidiary in UK”
Service Center Financial Sanctions (Dt. Bundesbank):
All EU and UN sanctions
Matthias Efing (HEC Paris) Financial Sanctions and Bank Responses 9 / 36
Data
External Position Report for German Banks (Dt. Bundesbank):
Assets / liabilities vis-a-vis all foreign entities, 2003-2015 (monthly)
All German banks (incl. subsidiaries and branches) at home & abroad
Aggregated by type, maturity, (major) currency, and counterparty type
No identities of individual counterparties
→“short-term $-loans to non-financials in Qatar of bank ABC’s subsidiary in UK”
Service Center Financial Sanctions (Dt. Bundesbank):
All EU and UN sanctions
Matthias Efing (HEC Paris) Financial Sanctions and Bank Responses 9 / 36
Data
External Position Report for German Banks (Dt. Bundesbank):
Assets / liabilities vis-a-vis all foreign entities, 2003-2015 (monthly)
All German banks (incl. subsidiaries and branches) at home & abroad
Aggregated by type, maturity, (major) currency, and counterparty type
No identities of individual counterparties
→“short-term $-loans to non-financials in Qatar of bank ABC’s subsidiary in UK”
Service Center Financial Sanctions (Dt. Bundesbank):
All EU and UN sanctions
Matthias Efing (HEC Paris) Financial Sanctions and Bank Responses 9 / 36
Data
External Position Report for German Banks (Dt. Bundesbank):
Assets / liabilities vis-a-vis all foreign entities, 2003-2015 (monthly)
All German banks (incl. subsidiaries and branches) at home & abroad
Aggregated by type, maturity, (major) currency, and counterparty type
No identities of individual counterparties
→“short-term $-loans to non-financials in Qatar of bank ABC’s subsidiary in UK”
Service Center Financial Sanctions (Dt. Bundesbank):
All EU and UN sanctions
Matthias Efing (HEC Paris) Financial Sanctions and Bank Responses 9 / 36
Data
External Position Report for German Banks (Dt. Bundesbank):
Assets / liabilities vis-a-vis all foreign entities, 2003-2015 (monthly)
All German banks (incl. subsidiaries and branches) at home & abroad
Aggregated by type, maturity, (major) currency, and counterparty type
No identities of individual counterparties
→“short-term $-loans to non-financials in Qatar of bank ABC’s subsidiary in UK”
Service Center Financial Sanctions (Dt. Bundesbank):
All EU and UN sanctions
Matthias Efing (HEC Paris) Financial Sanctions and Bank Responses 9 / 36
Data
External Position Report for German Banks (Dt. Bundesbank):
Assets / liabilities vis-a-vis all foreign entities, 2003-2015 (monthly)
All German banks (incl. subsidiaries and branches) at home & abroad
Aggregated by type, maturity, (major) currency, and counterparty type
No identities of individual counterparties
→“short-term $-loans to non-financials in Qatar of bank ABC’s subsidiary in UK”
Service Center Financial Sanctions (Dt. Bundesbank):
All EU and UN sanctions
Matthias Efing (HEC Paris) Financial Sanctions and Bank Responses 9 / 36
Data
One observation is a triplet (bank, country of counterparty, month)...
Never sanctioned Sanctioned at least once
Obs. Mean S.D. Obs Mean S.D.
bank abroad 2,230,944 0.49 0.50 159,107 0.43 0.49bank outside EU 2,230,944 0.35 0.48 159,107 0.29 0.45b. in ctry of counter. 2,230,944 0.02 0.15 159,107 0.01 0.07
total assets 2,230,944 245,300 2,597,298 159,107 37,118 268,687loans 2,230,944 180,265 2,203,512 159,107 33,729 218,300counterparty = bank 2,230,944 101,970 1,353,109 159,107 14,480 148,379
(positions in e1,000 ; positions with counterparties in Germany excluded)
Matthias Efing (HEC Paris) Financial Sanctions and Bank Responses 10 / 36
Data
One observation is a triplet (bank, country of counterparty, month)...
Never sanctioned Sanctioned at least once
Obs. Mean S.D. Obs Mean S.D.
bank abroad 2,230,944 0.49 0.50 159,107 0.43 0.49bank outside EU 2,230,944 0.35 0.48 159,107 0.29 0.45b. in ctry of counter. 2,230,944 0.02 0.15 159,107 0.01 0.07
total assets 2,230,944 245,300 2,597,298 159,107 37,118 268,687loans 2,230,944 180,265 2,203,512 159,107 33,729 218,300counterparty = bank 2,230,944 101,970 1,353,109 159,107 14,480 148,379
(positions in e1,000 ; positions with counterparties in Germany excluded)
Matthias Efing (HEC Paris) Financial Sanctions and Bank Responses 10 / 36
Data
2040
6080
Num
ber
2002 20062004 2008 2010 2012 2014 2016
Bank groups with presence abroadBank groups with presence outside EUBank groups with presence outside FATF
Foreign Presence of German Banks
Matthias Efing (HEC Paris) Financial Sanctions and Bank Responses 11 / 36
Data
2030
4050
60
Num
ber
2002 2004 2006 2008 2010 2012 2014 2016
Foreign host countriesHost countries outside EUHost countries outside FATF
Foreign Countries Hosting German Banks
Matthias Efing (HEC Paris) Financial Sanctions and Bank Responses 12 / 36
How do German banks implement sanctions?
How about...
German banks located inside Germany ,
their branches and subsidiaries abroad ?
Matthias Efing (HEC Paris) Financial Sanctions and Bank Responses 13 / 36
How do German banks implement sanctions?
How about...
German banks located inside Germany ,
their branches and subsidiaries abroad ?
Matthias Efing (HEC Paris) Financial Sanctions and Bank Responses 13 / 36
How do German banks implement sanctions?
How about...
German banks located inside Germany ,
their branches and subsidiaries abroad ?
Matthias Efing (HEC Paris) Financial Sanctions and Bank Responses 13 / 36
Identifying a compositional shift in credit supply
No sanction
DEU CYP
bank locations
RUS SWE
counterparty locations
Sanction on RUS
DEU CYP
bank locations
RUS SWE
counterparty locations
Matthias Efing (HEC Paris) Financial Sanctions and Bank Responses 14 / 36
Identifying a compositional shift in credit supply
Log Assetsb,c,t = β1 Sanctionc,t Dum: c sanctioned in t
+ β2 Abroadb × Sanctionc,t Diff-in-Diff
+ κb,c bank-country F.E.
+ ηb,t bank-time F.E.
( + γc,t country-time F.E. )
+ εb,c,t
size of lending relationship (b, c)credit supply of bank b in month t
credit demand of country c in month t
(Khwaja and Mian, 2008)
Matthias Efing (HEC Paris) Financial Sanctions and Bank Responses 15 / 36
Credit supply in DEU (abroad) decreases (doesn’t change).
Log Total Assetsb,c,t (1) (2) (3) (4)
Sanctionc,t -0.470*** -0.275* -0.470***(0.151) (0.164) (0.086)
Abroadb × Sanctionc,t 0.532*** 0.511***(0.110) (0.169)
Sum of coeff. 0.062p-value 0.753
bank-country (b, c) Yes Yes Yes Yesbank-time (b, t) Yes Yes Yes Yescountry-time (c, t) No No No Yes
Bank sample DEU All All AllObs. 1,217,711 2,377,900 2,377,900 2,377,900R2 0.858 0.840 0.840 0.844
Matthias Efing (HEC Paris) Financial Sanctions and Bank Responses 16 / 36
Credit supply in DEU (abroad) decreases (doesn’t change).
Log Total Assetsb,c,t (1) (2) (3) (4)
Sanctionc,t -0.470*** -0.275* -0.470***(0.151) (0.164) (0.086)
Abroadb × Sanctionc,t 0.532*** 0.511***(0.110) (0.169)
Sum of coeff. 0.062p-value 0.753
bank-country (b, c) Yes Yes Yes Yesbank-time (b, t) Yes Yes Yes Yescountry-time (c, t) No No No Yes
Bank sample DEU All All AllObs. 1,217,711 2,377,900 2,377,900 2,377,900R2 0.858 0.840 0.840 0.844
-38%
Matthias Efing (HEC Paris) Financial Sanctions and Bank Responses 16 / 36
Credit supply in DEU (abroad) decreases (doesn’t change).
Log Total Assetsb,c,t (1) (2) (3) (4)
Sanctionc,t -0.470*** -0.275* -0.470***(0.151) (0.164) (0.086)
Abroadb × Sanctionc,t 0.532*** 0.511***(0.110) (0.169)
Sum of coeff. 0.062p-value 0.753
bank-country (b, c) Yes Yes Yes Yesbank-time (b, t) Yes Yes Yes Yescountry-time (c, t) No No No Yes
Bank sample DEU All All AllObs. 1,217,711 2,377,900 2,377,900 2,377,900R2 0.858 0.840 0.840 0.844
-24%
Matthias Efing (HEC Paris) Financial Sanctions and Bank Responses 16 / 36
Credit supply in DEU (abroad) decreases (doesn’t change).
Log Total Assetsb,c,t (1) (2) (3) (4)
Sanctionc,t -0.470*** -0.275* -0.470***(0.151) (0.164) (0.086)
Abroadb × Sanctionc,t 0.532*** 0.511***(0.110) (0.169)
Sum of coeff. 0.062p-value 0.753
bank-country (b, c) Yes Yes Yes Yesbank-time (b, t) Yes Yes Yes Yescountry-time (c, t) No No No Yes
Bank sample DEU All All AllObs. 1,217,711 2,377,900 2,377,900 2,377,900R2 0.858 0.840 0.840 0.844
Matthias Efing (HEC Paris) Financial Sanctions and Bank Responses 16 / 36
Specification (3) graphically...
-.2-.1
0.1
.2
-12 -8 -4 0 4 8 12 16
Time to sanction (months)
bank is in Germany bank is abroad
Log Assets Abroad of German Banks
Matthias Efing (HEC Paris) Financial Sanctions and Bank Responses 17 / 36
Do we care about the inertia of German banks abroad?
050
01,
000
1,50
02,
000
2,50
0
Eur
o (b
n)
2004 2008 2012 2016
In Never Sanctioned Countries
010
2030
40
Eur
o (b
n)
2004 2008 2012 2016
In Sanctioned Countries
External Positions of German Banks
banks inside DEU banks abroadbanks outside EU banks outside FATF
Matthias Efing (HEC Paris) Financial Sanctions and Bank Responses 18 / 36
Prediction 1:
Banks do relatively more business in sanctioned countries if they are located injurisdictions that are less committed to fighting financial crime.
(low expected litigation costs and low compliance costs related to due diligence)
⇒ Theoretical literature on int’l regulatory arbitrage
Acharya (2003), Dell’Ariccia & Marquez (2006):
competitive advantages of banks in weaker jurisdictions.
Matthias Efing (HEC Paris) Financial Sanctions and Bank Responses 19 / 36
Prediction 1:
Banks do relatively more business in sanctioned countries if they are located injurisdictions that are less committed to fighting financial crime.
(low expected litigation costs and low compliance costs related to due diligence)
⇒ Theoretical literature on int’l regulatory arbitrage
Acharya (2003), Dell’Ariccia & Marquez (2006):
competitive advantages of banks in weaker jurisdictions.
Matthias Efing (HEC Paris) Financial Sanctions and Bank Responses 19 / 36
Financial Action Task Force (FATF)
Intergovernmental organization founded in 1989 on the initiative of the G7
Housed at the OECD headquarters in Paris
Developing policies to combat money laundering and terrorism financing
Non-FATF: Isle of Man, Malta, Panama, etc.
Matthias Efing (HEC Paris) Financial Sanctions and Bank Responses 20 / 36
Financial Action Task Force (FATF)
Explicitly addressing sanctions:
“to freeze without delay the funds or other assets of, and to ensure that no fundsor other assets are made available, directly or indirectly, to or for the benefit of,any person or entity either (i) designated by, or under the authority of, the UnitedNations Security Council under Chapter VII of the Charter of the United Nations(...)”
Precise preventive measures regulating customer due diligence, record keeping,transparency of counterparty information, international cooperation, business inhigh-risk countries, etc. For example:
“financial institutions should be prohibited from keeping anonymous accounts oraccounts in obviously fictitious names.”
Matthias Efing (HEC Paris) Financial Sanctions and Bank Responses 21 / 36
Credit supply outside FATF countries increases.
Model 1 Model 2
Log Total Assetsb,c,t (1) (2) (3)
Sanctionc,t -0.320**(0.159)
Not in FATF country b 0.826** Sum: 0.506** 0.718**× Sanctionc,t (0.363) p-value: 0.035 (0.311)
In country of counterparty b,c 1.436*** Sum: 1.116*** 1.621***× Sanctionc,t (0.259) p-value: 0.000 (0.507)
bank-country (b, c) Yes Yesbank-time (b, t) Yes Yescountry-time (c, t) No Yes
Obs. 2,377,900 2,377,900R2 0.840 0.844
Matthias Efing (HEC Paris) Financial Sanctions and Bank Responses 22 / 36
Credit supply outside FATF countries increases.
Model 1 Model 2
Log Total Assetsb,c,t (1) (2) (3)
Sanctionc,t -0.320**(0.159)
Not in FATF country b 0.826** Sum: 0.506** 0.718**× Sanctionc,t (0.363) p-value: 0.035 (0.311)
In country of counterparty b,c 1.436*** Sum: 1.116*** 1.621***× Sanctionc,t (0.259) p-value: 0.000 (0.507)
bank-country (b, c) Yes Yesbank-time (b, t) Yes Yescountry-time (c, t) No Yes
Obs. 2,377,900 2,377,900R2 0.840 0.844
-27%
Matthias Efing (HEC Paris) Financial Sanctions and Bank Responses 22 / 36
Credit supply outside FATF countries increases.
Model 1 Model 2
Log Total Assetsb,c,t (1) (2) (3)
Sanctionc,t -0.320**(0.159)
Not in FATF country b 0.826** Sum: 0.506** 0.718**× Sanctionc,t (0.363) p-value: 0.035 (0.311)
In country of counterparty b,c 1.436*** Sum: 1.116*** 1.621***× Sanctionc,t (0.259) p-value: 0.000 (0.507)
bank-country (b, c) Yes Yesbank-time (b, t) Yes Yescountry-time (c, t) No Yes
Obs. 2,377,900 2,377,900R2 0.840 0.844
+66%
Matthias Efing (HEC Paris) Financial Sanctions and Bank Responses 22 / 36
Credit supply outside FATF countries increases.
Model 1 Model 2
Log Total Assetsb,c,t (1) (2) (3)
Sanctionc,t -0.320**(0.159)
Not in FATF country b 0.826** Sum: 0.506** 0.718**× Sanctionc,t (0.363) p-value: 0.035 (0.311)
In country of counterparty b,c 1.436*** Sum: 1.116*** 1.621***× Sanctionc,t (0.259) p-value: 0.000 (0.507)
bank-country (b, c) Yes Yesbank-time (b, t) Yes Yescountry-time (c, t) No Yes
Obs. 2,377,900 2,377,900R2 0.840 0.844
+205%
Matthias Efing (HEC Paris) Financial Sanctions and Bank Responses 22 / 36
Limitations
Measurement error:
Some countries outside the FATF are members of regionalorganizations with similar objectives as the FATF.
→ Focus on FATF-non cooperative countries:
Countries that the FATF has officially declared as non-cooperative.
German bank affiliates in Malta, Jersey, Mauritius, Guernsey, Russia,Cyprus, Iran, Pakistan, Philippines (as of February 2018)
Matthias Efing (HEC Paris) Financial Sanctions and Bank Responses 23 / 36
Limitations
Measurement error:
Some countries outside the FATF are members of regionalorganizations with similar objectives as the FATF.
→ Focus on FATF-non cooperative countries:
Countries that the FATF has officially declared as non-cooperative.
German bank affiliates in Malta, Jersey, Mauritius, Guernsey, Russia,Cyprus, Iran, Pakistan, Philippines (as of February 2018)
Matthias Efing (HEC Paris) Financial Sanctions and Bank Responses 23 / 36
Credit supply from high-risk jurisdictions
Model 1 Model 2
Log Total Assetsb,c,t (1) (2) (3)
Sanctionc,t -0.287*(0.161)
Non-cooperative country b 1.104** Sum: 0.817* 1.111**× Sanctionc,t (0.461) p-value: 0.052 (0.440)
bank-country (b, c) Yes Yesbank-time (b, t) Yes Yescountry-time (c, t) No Yes
Obs. 2,377,900 2,377,900R2 0.833 0.836
Matthias Efing (HEC Paris) Financial Sanctions and Bank Responses 24 / 36
Credit supply from high-risk jurisdictions
Model 1 Model 2
Log Total Assetsb,c,t (1) (2) (3)
Sanctionc,t -0.287*(0.161)
Non-cooperative country b 1.104** Sum: 0.817* 1.111**× Sanctionc,t (0.461) p-value: 0.052 (0.440)
bank-country (b, c) Yes Yesbank-time (b, t) Yes Yescountry-time (c, t) No Yes
Obs. 2,377,900 2,377,900R2 0.833 0.836
+126%
Matthias Efing (HEC Paris) Financial Sanctions and Bank Responses 24 / 36
Prediction 2:
Bank groups allocate business to their affiliated branches and subsidiaries abroadin a way that minimizes legal risk and compliance costs.
→ Internal capital markets in multinational bank groups?
Matthias Efing (HEC Paris) Financial Sanctions and Bank Responses 25 / 36
Prediction 2:
Bank groups allocate business to their affiliated branches and subsidiaries abroadin a way that minimizes legal risk and compliance costs.
→ Internal capital markets in multinational bank groups?
Matthias Efing (HEC Paris) Financial Sanctions and Bank Responses 25 / 36
Rerouting credit
Example: German bank laundering Russian money moving itto accounts on Cyprus.
No sanction:
DEU CYP
bank locations
RUS SWE
counterparty locations
Sanction on RUS
DEU CYP
bank locations
RUS SWE
counterparty locations
Matthias Efing (HEC Paris) Financial Sanctions and Bank Responses 26 / 36
Rerouting credit
Dep. variable: Credit that parent b in Germany sends to its affiliates in location c.Regressor: Credit that affiliates of b in location c provide to sanctioned countries.Sample: 2010-2015
Log Growth Intra-Group Creditb,c,t
(1) (2) (3) (4)
Log Growth Affiliates’ Sanctioned Creditb,c,t 0.039** 0.040** 0.039** 0.034**(0.016) (0.016) (0.016) (0.017)
Log Growth Affiliates’ Total Creditb,c,t 0.399***(0.091)
Month F.E. (t) Yes No No NoBank-country F.E. (b, c) No Yes Yes YesBank-month F.E. (b, t) No Yes Yes YesCountry-month F.E. (c, t) No No Yes YesObs. 471,318 471,318 471,318 471,318
Matthias Efing (HEC Paris) Financial Sanctions and Bank Responses 27 / 36
Rerouting credit
Log Growth Intra-Group Creditb,c,t (1) (2) (3)
Dum(Affiliates’ Sanctioned Credit Growthb,c,t > 0) 0.044* 0.014 0.167***(0.025) (0.030) (0.054)
Dum(Affilates’ Sanct. Cr. Gr.b,c,t > 0) × Outside FATF c 0.146**(0.061)
Log Growth Affiliates’ Total Creditb,c,t 0.400*** 0.400*** 0.166*(0.096) (0.096) (0.090)
Month F.E. (t) No No NoBank-country F.E. (b, c) Yes Yes YesBank-month F.E. (b, t) Yes Yes YesCountry-month F.E. (c, t) Yes Yes YesSample of affiliate countries all all non-FATFObs. 471,318 471,318 237,704
Col. 1: ∼5% more intra-group credit when affiliate increases credit in sanctioned countries.Col. 2-3: ∼16% more intra-group credit in the case of affiliates located outside the FATF.
Matthias Efing (HEC Paris) Financial Sanctions and Bank Responses 28 / 36
Mechanisms to prevent arbitrage:
1 Increase supervisory intensity and law enforcement in non-FATF countries(‘EU only’ sanctions vs. UN-wide sanctions)
2 Align legal compliance requirements of bank parents and their affiliatesabroad (subsidiaries vs. branches)
Matthias Efing (HEC Paris) Financial Sanctions and Bank Responses 29 / 36
Effects on credit supply for “EU only” sanctions.Model 1 Model 2
Log Total Assetsb,c,t (1) (2) (3)
EU Sanctionc,t -0.219UN Sanctionc,t -0.408*
Not EU country b × EU Sanc.c,t 0.138 Sum: -0.081 0.188Not EU country b × UN Sanc.c,t -0.422* Sum: -0.830* -0.535*
Not FATF country b × EU Sanc.c,t 0.689*** Sum: 0.470*** 0.596***Not FATF country b × UN Sanc.c,t 1.177 Sum: 0.755 1.073
bank-country (b, c) Yes Yesbank-time (b, t) Yes Yescountry-time (c, t) No Yes
Obs. 2,377,900 2,377,900R2 0.840 0.844
(s.e. not reported)
Matthias Efing (HEC Paris) Financial Sanctions and Bank Responses 30 / 36
Mechanisms to prevent arbitrage
Alternatively:
“Import” German compliance requirements to offshore locations?
⇒ Choose legal status of German bank establishments abroad s.t. theymust comply with German (EU) rules and regulations?
⇒ Compare branches to subsidiaries!
Unlike subsidiaries (subject to local law), German branches must complywith EU regulations regardless of their location!
⇒ Formally identical compliance requirements for branches and parents!
Matthias Efing (HEC Paris) Financial Sanctions and Bank Responses 31 / 36
Mechanisms to prevent arbitrage
Alternatively:
“Import” German compliance requirements to offshore locations?
⇒ Choose legal status of German bank establishments abroad s.t. theymust comply with German (EU) rules and regulations?
⇒ Compare branches to subsidiaries!
Unlike subsidiaries (subject to local law), German branches must complywith EU regulations regardless of their location!
⇒ Formally identical compliance requirements for branches and parents!
Matthias Efing (HEC Paris) Financial Sanctions and Bank Responses 31 / 36
Mechanisms to prevent arbitrage
Alternatively:
“Import” German compliance requirements to offshore locations?
⇒ Choose legal status of German bank establishments abroad s.t. theymust comply with German (EU) rules and regulations?
⇒ Compare branches to subsidiaries!
Unlike subsidiaries (subject to local law), German branches must complywith EU regulations regardless of their location!
⇒ Formally identical compliance requirements for branches and parents!
Matthias Efing (HEC Paris) Financial Sanctions and Bank Responses 31 / 36
Mechanisms to prevent arbitrage
Alternatively:
“Import” German compliance requirements to offshore locations?
⇒ Choose legal status of German bank establishments abroad s.t. theymust comply with German (EU) rules and regulations?
⇒ Compare branches to subsidiaries!
Unlike subsidiaries (subject to local law), German branches must complywith EU regulations regardless of their location!
⇒ Formally identical compliance requirements for branches and parents!
Matthias Efing (HEC Paris) Financial Sanctions and Bank Responses 31 / 36
Branches vs. subsidiaries
Subsidiaries Branches
Log Total Assetsb,c,t (1) (2) (3) (4)
Sanctionc,t -0.396*** -0.363**(0.098) (0.149)
Not in FATF country b 1.133** Sum: 0.737* 0.487* Sum: 0.124× Sanctionc,t (0.483) p-value: 0.067 (0.278) p-val: 0.656
In country of counterp.b,c 1.352*** Sum: 0.956*** 2.548*** Sum: 2.185***× Sanctionc,t (0.134) p-value: 0.000 (0.279) p-val: 0.000
bank-country (b, c) Yes Yesbank-time (b, t) Yes Yescountry-time (c, t) No YesObs. 1,780,575 1,815,036
Matthias Efing (HEC Paris) Financial Sanctions and Bank Responses 32 / 36
Mechanisms to prevent arbitrage
Branches behave more like subsidiaries than like their parents!
⇒ Formally harmonizing rules and regulations (branches = parents) isnecessary but not sufficient.
⇒ Also harmonize supervision and enforcement of these rules!
(→ model by Acharya, 2003)
Matthias Efing (HEC Paris) Financial Sanctions and Bank Responses 33 / 36
Mechanisms to prevent arbitrage
Branches behave more like subsidiaries than like their parents!
⇒ Formally harmonizing rules and regulations (branches = parents) isnecessary but not sufficient.
⇒ Also harmonize supervision and enforcement of these rules!
(→ model by Acharya, 2003)
Matthias Efing (HEC Paris) Financial Sanctions and Bank Responses 33 / 36
Extensions and robustness
1 Loans versus other bank assets – qualitatively similar effects
2 Non-bank versus bank counterparties – effects concentrated inpositions with non-bank counterparties
3 Euro-denominated external positions – qualitatively similar effects
Matthias Efing (HEC Paris) Financial Sanctions and Bank Responses 34 / 36
Extensions and robustness
1 Loans versus other bank assets – qualitatively similar effects
2 Non-bank versus bank counterparties – effects concentrated inpositions with non-bank counterparties
3 Euro-denominated external positions – qualitatively similar effects
Matthias Efing (HEC Paris) Financial Sanctions and Bank Responses 34 / 36
Extensions and robustness
1 Loans versus other bank assets – qualitatively similar effects
2 Non-bank versus bank counterparties – effects concentrated inpositions with non-bank counterparties
3 Euro-denominated external positions – qualitatively similar effects
Matthias Efing (HEC Paris) Financial Sanctions and Bank Responses 34 / 36
Conclusion
1 Multinational banks reroute credit to sanctioned countries.
2 ...via internal capital markets.
3 ...managing legal (non-financial) risks.
4 ...arbitraging supervision and law enforcement!
→ Not enough to harmonize only regulations!
5 Only a part of total German credit is rerouted.
⇒ The average German bank (irrespective of its location) still reducespositions by -24% (compared to -38% by banks located in DEU).
Matthias Efing (HEC Paris) Financial Sanctions and Bank Responses 35 / 36
Conclusion
1 Multinational banks reroute credit to sanctioned countries.
2 ...via internal capital markets.
3 ...managing legal (non-financial) risks.
4 ...arbitraging supervision and law enforcement!
→ Not enough to harmonize only regulations!
5 Only a part of total German credit is rerouted.
⇒ The average German bank (irrespective of its location) still reducespositions by -24% (compared to -38% by banks located in DEU).
Matthias Efing (HEC Paris) Financial Sanctions and Bank Responses 35 / 36
Conclusion
1 Multinational banks reroute credit to sanctioned countries.
2 ...via internal capital markets.
3 ...managing legal (non-financial) risks.
4 ...arbitraging supervision and law enforcement!
→ Not enough to harmonize only regulations!
5 Only a part of total German credit is rerouted.
⇒ The average German bank (irrespective of its location) still reducespositions by -24% (compared to -38% by banks located in DEU).
Matthias Efing (HEC Paris) Financial Sanctions and Bank Responses 35 / 36
Conclusion
1 Multinational banks reroute credit to sanctioned countries.
2 ...via internal capital markets.
3 ...managing legal (non-financial) risks.
4 ...arbitraging supervision and law enforcement!
→ Not enough to harmonize only regulations!
5 Only a part of total German credit is rerouted.
⇒ The average German bank (irrespective of its location) still reducespositions by -24% (compared to -38% by banks located in DEU).
Matthias Efing (HEC Paris) Financial Sanctions and Bank Responses 35 / 36
Conclusion
1 Multinational banks reroute credit to sanctioned countries.
2 ...via internal capital markets.
3 ...managing legal (non-financial) risks.
4 ...arbitraging supervision and law enforcement!
→ Not enough to harmonize only regulations!
5 Only a part of total German credit is rerouted.
⇒ The average German bank (irrespective of its location) still reducespositions by -24% (compared to -38% by banks located in DEU).
Matthias Efing (HEC Paris) Financial Sanctions and Bank Responses 35 / 36
Conclusion
1 Multinational banks reroute credit to sanctioned countries.
2 ...via internal capital markets.
3 ...managing legal (non-financial) risks.
4 ...arbitraging supervision and law enforcement!
→ Not enough to harmonize only regulations!
5 Only a part of total German credit is rerouted.
⇒ The average German bank (irrespective of its location) still reducespositions by -24% (compared to -38% by banks located in DEU).
Matthias Efing (HEC Paris) Financial Sanctions and Bank Responses 35 / 36
Conclusion
1 Multinational banks reroute credit to sanctioned countries.
2 ...via internal capital markets.
3 ...managing legal (non-financial) risks.
4 ...arbitraging supervision and law enforcement!
→ Not enough to harmonize only regulations!
5 Only a part of total German credit is rerouted.
⇒ The average German bank (irrespective of its location) still reducespositions by -24% (compared to -38% by banks located in DEU).
Matthias Efing (HEC Paris) Financial Sanctions and Bank Responses 35 / 36
Appendix
Parent bank
Affiliatedsubsidiary
NFIOtherbanks
25
50
25 25
25
25
Foreigncountry
Germany
Matthias Efing (HEC Paris) Financial Sanctions and Bank Responses 36 / 36