Dirty Money: How Banks Influence Financial Crime

Abstract

On September 21st, 2020, a consortium of international journalists leaked nearly 2,500 suspicious activity reports (SAR) obtained from the U.S. Financial Crimes Enforcement Network, exposing nearly $2 trillion of money laundering activity. The event raises important questions regarding what role banks play in facilitating financial crime and the effectiveness of SAR reporting. In this study, we examine the incentives that banks face to report money laundering activity via SAR reports, and the implications of a bank’s reporting strategy for criminal activity. We first analyze banks' SAR reporting decisions using a stylized model, which predicts that banks facing depressed revenues from their routine business lines and more profit-seeking pressure adopt more lax reporting policies. These reporting policies help to attract criminals, thus increasing the underlying amount of suspicious activities that banks need to examine and report. Empirically, we test the relation between risk-taking incentives and SAR volume at the county level. We find that counties in which banks face higher competition and lower profitability generate higher volumes of SAR activity. To provide further support for the underlying mechanism, we incorporate a maximum likelihood estimation that uncovers a highly elastic demand from criminal customers with respect to banks' reporting stringency. We establish causality using shale gas expansion in unrelated states. Consistent with risk-taking incentives influencing SARs, we find that banks experiencing higher (lower) shale growth generate fewer (more) SAR reports. Overall, our results provide important insights regarding the role of banks in influencing financial crime, and suggest that a bank’s reporting policy has indirect implications for local criminal activity.